SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K/A
                                 AMENDMENT NO. 210-K
                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark  One)
[X]  Annual  report  pursuant  to section 13 or 15(d) of the Securities Exchange
     Act  of  1934  for  the  fiscal  year  ended  MayDecember  31,  20022003  or
[ ]  Transition  report  pursuant  to  section  13  or  15(d)  of the Securities
     Exchange  Act  of  1934  for  the  transition  period  from _____June 1, 2002 to
     _____December  31,  2002

Commission  file  number  0-6814000-6814

                                U.S. ENERGY CORP.
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             (Exact Name of Registrant as Specified in its Charter)

                 Wyoming                                  83-0205516
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     (State or other jurisdiction of                  (I.R.S.  Employer
     incorporation or organization)                  Identification  No.)

     877  North  8th  West
     Riverton,  WY                                                 82501
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     (Address of principal executive offices)                    (Zip Code)

Registrant's  Telephone  Number,  including  area  code:          (307) 856-9271
                                                                  --------------

          Securities registered pursuant to Section 12(b) of the Act:

                                      NONE
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          Securities registered pursuant to Section 12(g) of the Act:

                          COMMON STOCK, $0.01 PAR VALUE
- --------------------------------------------------------------------------------
                                (Title of Class)

     Indicate  by  check  mark  whether the Registrant (1) has filed all reports
required  to  be  filed by Section 13 or 15(d) of the Securities Exchange Act of
1934  during  the  preceding  12  months  (or  for  such shorter period that the
Registrant  was required to file such reports), and (2) has been subject to such
filing  requirements  for  the  past  90  days.  YES  X[X]  NO  [ ]

     Indicate  by  check mark whether the registrant is an accelerated filer (as
defined  in  Rule  12B-2  of  the  Act).  YES  [ ]  NO  [X]

     The  aggregate  market  value  of  the  shares  of  voting  stock  held  by
non-affiliates  of  the Registrant as of September 11, 2002,June 30, 2003, computed by reference to
the  average  of  the  bid  and asked prices of the Registrant's common stock as
reported  by the National Market System of NASDAQon  Nasdaq  Small  Cap  on  that  date,  was  approximately
$39,855,194.92$61,728,467.

     Class                                   Outstanding  at  September 11, 2002March  24,  2004
- -------------------------------------     -----------------------------------------------------------------------------     ------------------------------------
     Common Stock, $0.01 par value                  12,075,49313,992,750  shares

Documents  incorporated  by  reference:  Portions  of the documents listed below
- ---------------------------------------
have  been  incorporated by reference into the indicated parts of this report as
specified  in  the  responses  to  the  referenced  sections  of  this  filing.

     Proxy  Statement  for  the Annual Meeting of Shareholders to be held December 2002,in June 2004,
into  Part  III  of  the  filing.

     Indicate by check mark if disclosure of delinquent filers, pursuant to Item
405  of Regulation S-K is not contained herein and will not be contained, to the
best  of  the  Registrant's  knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in  Part  III  of this Form 10-K or any
amendment  to  this  Form  10-K.10-K  [  ]].


                                      -1-



DISCLOSURE  REGARDING  FORWARD LOOKINGFORWARD-LOOKING  STATEMENTS

     This  Annual  Report  on  Form  10-K  includes "forward-looking statements"
within  the  meaning  of  Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). All statements other than statements of historical
fact  included in this Report, are forward-looking statements, including without
limitation  the  statements  under  Management's  Discussion  and  Analysis  of
Financial  Condition  and  Results of Operations and the disclosures about Rocky
Mountain  Gas,  Inc.  and  plans  for developing its coalbed methane acreage. In
addition,  whenever  words like "expect," "anticipate" or "believe" are used, we
are  making  forward-looking  statements.

     Although  we believe that our forward-looking statements are reasonable, we
don't  know  if  our  expectations  will  prove  to be correct. Important future
factors  that  could cause actual results to differ materially from expectations
include:  Domestic  consumption  rates  for natural gas; domesticand  market  prices for natural gas, uranium, gold, and molybdenum;gas; the
amounts  of  gas we will be able to produce from our coalbed methane properties;
the  availability of permits to drill and operate coalbed methane wells; whether
and  when  gas  transmission  lines will be built toin reasonable proximity to ourthe
coalbed  methane properties; and whether and on what terms the capital necessary
to develop ourthe properties can be obtained. The forward-looking statements should
be  carefully considered in the context of all the information set forth in this
Annual  Report.

                                     PART I

ITEM  1  AND  ITEM  2.  BUSINESS  AND  PROPERTIES.

(A)  GENERAL.

     U.S. Energy Corp. is a Wyoming corporation (formed in 1966) in the business
of  acquiring,  exploring,  developing  and/or  selling  or  leasing  mineral
properties. In this Annual Report, "we", "company""we," "Company" or "USE" refersrefer to U.S. Energy
Corp.  including  subsidiaries  unless  otherwise specifically noted. Our fiscal
year  ends  December 31; this is the first full year of our new fiscal year (the
prior  year ended May 31.31, and the last Annual Report was a transition report for
the  seven  months  ended  December  31,  2002  (filed  April  1,  2003)).

     In  fiscal 2002,2003,  most of our business activity was devoted to the coalbed methane
i.e., acquiring acreage, drilling exploratory wells, testing the wells,
and negotiating the purchase of a coalbed methane ("CBM")  producing field. The
coalbed methane gas activities arebusiness,  which is conducted through Rocky Mountain Gas, Inc ("RMG") a
subsidiary  of  the  Company.

     In  2003,  RMG transferred certain of its CBM assets including a producing,
and  several  non-producing,  CBM  properties  to  Pinnacle  Gas Resources, Inc.
("Pinnacle"),  a  newly-organized  Delaware  corporation.  Other parties to this
transaction  included  CCBM, Inc. and its parent company Carrizo Oil & Gas, Inc.
("CRZO")  of  Houston  Texas; and seven affiliates of Credit Suisse First Boston
Private  Equity.  As a result of the transaction, RMG became a 37.5% shareholder
of  Pinnacle  and  RMG  accounts  for  its  investment on the equity method. RMG
recorded  revenues  from  gas sales from mid-2002 until the transfer to Pinnacle
was  completed  in mid-2003. See "Transaction with Pinnacle Gas Resources, Inc."

     On  January  30,  2004,  RMG  acquired  producing  and  non-producing  CBM
properties  located  near  Gillette,  Wyoming,  corporation owned 51.2% by USE and 40.5% by Crested Corp. at
May 31, 2002, Crested isfrom  Hi-Pro  Production,  LLC
("Hi-Pro").  These  properties  contain  proven  gas  reserves. A portion of the
purchase  price  was  paid  with  a  70.5% majority-owned subsidiaryloan from institutional lenders under a $25
million mezzanine lending facility, which was established in connection with the
Hi-Pro  purchase;  additional  loans  will  be  available  to  acquire  more CBM
properties,  subject  to  lenders'  approval.  In the first quarter of USE, see below.
Properties of2004, RMG
raised  $1.8  million in working capital from institutional investors. See "Coal
Bed  Methane  -  RMG  Equity  Financing."


                                      -2-



     RMG's properties are heldlocated in Wyoming and southeastern Montana. As of the
filing  date  of  this  Annual  Report,  RMG  holds  approximately 280,486264,300 gross
(128,200  net)  mineral acres of coalbed methaneCBM properties. We also hold commercial properties, mostA limited amount of which are located in Utah that
were acquired as part of a uranium property and mill acquisition. In fiscal
2002, only the commercial properties produced revenues. For financial statement
presentation purposes, the Company has two segments of business; minerals and
commercial operations (motel, real estate and airport), see note I to the
financial statements. However, presently the Company's business priority is
focused mainly on CBM.

     We have conducted exploratory
drilling  and  testing  was conducted on certainsome of the coalbed methanenon-producing properties in
2003,  but  in  general,  significant  additional  work  (gathering
production datais needed before we can
determine  if  those properties contain gas reserves. No prediction is made when
such  determinations  can  be  made.

     In  2003,  the Company sold an indirect subsidiary (Canyon Resources) which
owns  commercial  properties  in Ticaboo, Utah. Canyon Resources was acquired in
the  1990s  from a producing property, and on other properties, the
dewateringutility as part of completed wells, and drilling and dewatering more wells) will have
to occur to establish if we have any proved reserves. Specifically, we expect to
make a determination whether there are proved reserves on our producing property
(Bobcat property) by February 14, 2003, and on another property (Clearmont,
which is not now in production) by April 30, 2003. We did not receive any
revenues from coalbed methane

                                        2





gas sales through the endan acquisition of the most recent fiscal year (May 31, 2002),
although after that date, we have been selling coalbed methane gas from the
producing Bobcat property (bought in June 2002).

     For detailed information about our coalbed methaneuranium properties and business
strategy, please see "Mineralsa
uranium  mill  near  Ticaboo, Utah. See "Oil And Gas, and Other Properties." The
uranium  properties  and  mill,  presently  inactive,  have  not  been sold. See
"Inactive  Mining  Properties  -  Coalbed Methane" below.

     We don't know if anything of value will result from our activities in the
coalbed methane area: Only a limited number of exploratory wells have been
drilled, and there is not yet enough information from these wells to determine
if they contain proved reserves;Uranium."

     Historically, gas prices are lowfor production in the Powder River Basin (our area
of  activity),  have  been  lower  than  national  prices due to limited pipeline
"takeaway capacity." This limitation was somewhat eased in late 2002 and continued2003 by
new pipeline construction and enlargement of existing lines, and will be further
improved  with  more  capacity  in  2005.  For  example, a new large pipeline is
planned  to  be  in  service  in  January 2005, running from the Cheyenne hub in
Cheyenne,  Wyoming,  to  Kansas.  See  "Gas  Markets."

     However,  on  both  historical  and  seasonal  bases,  gas prices have been
volatile. A return to low gas prices, will affectparticularly if aggravated by the negative
price  differential experienced by Powder River Basin producers, could adversely
impact  not  only  the economics of the producing Bobcat property,current production but also the economics of the
exploration  projects  as  they  move  into  production  in  the  future. In addition,
delays in obtaining permits needed for continued exploration could delay our
coalbed gas plans, and more funding may be needed but may not be available.

     USE  and  Crested  originally  were  independent companies, with two common
affiliates  (John  L. Larsen and Max T. Evans; Mr. Evans died in calendarFebruary 2002).
In  1980,  USE  and  Crested  formed  a  joint  venture ("USECC") to do business
together  (unless one or the other elected not to pursue an individual project).
As  a  result  of USE funding certain of Crested's obligations from time to time
(due  to Crested's lack of cash on hand), and Crested subsequently paying these
debtspaid a portion of
this  debt  by  issuing  common  stock  to  USE, Crested became a majority-owned
subsidiary  of  USE  in  fiscal  1993.  In  fiscal  2001, Crested issued another
6,666,666  shares  of  its  common stock to reduce Crested's debt owed to USE by
$3.0  million,  which  increased  USE's  ownership  of Crested to 70.5%71.5%. All the
operations  of  USE'sUSE  (and  Crested's)
operationsCrested)  are  in  the  United  States.

     In  the first quarter 2004, USE obtained $350,000 of equity funding from an
accredited  investor  (100,000  restricted  shares  of  common stock, three year
warrants to purchase 50,000 shares at $3.00 per share; and five year warrants to
purchase  200,000  shares  at $3.00 per share). Proceeds will be used as working
capital.

     Principal  executive  offices  of  USE  are  located  in the Glen L. Larsen
building  at  877  North  8th  Street  West,  Riverton, Wyoming 82501, telephone
307.856.9271.307-856-9271.  RMG  has  a  field  office  in  Gillette,  Wyoming.

     Most  of  the  Company's (USE's) operations are conducted through subsidiaries, the
USECC  Joint  Venture  with  Crested,  and jointly-owned subsidiaries of USE and
Crested.


                                      -3-
The  Company's  subsidiaries  are:

                                  
Percent Primary Subsidiary Owned by USE* Business Conducted ---------- ------------- ------------------ Plateau Resources, Ltd. 100.0% Uranium (Utah) - Inactive - shut down; Motel/real estate - Active Energx, Ltd. 90.0% Gas - Inactive - shut down Four Nines Gold, Inc. 50.9% Contract Drilling/Construction - Inactive (since 2001) Sutter Gold Mining Company 66.3% Gold (California) - Inactive - shut down Crested Corp. 70.5% Uranium, gold and molybdenum properties (all inactive and shut down), and exploration activities on coalbed methane properties Yellowstone Fuels Corp. 35.9% Uranium (Wyoming) - Inactive - shut down Rocky Mountain Gas, Inc. 91.7% Coalbed methane exploration Northwest Gold, Inc. 96.0% Gold (Montana) - InactivePercent Primary Subsidiary Owned by USE* Business Conducted ---------- ------------- ------------------ Plateau Resources Ltd. 100.0% Uranium (Utah) - inactive mill - shut down Motel/real estate - sold Rocky Mountain Gas, Inc. 88.5% Coalbed methane - active Energx, Ltd. 90.0% Gas - inactive - shut down Crested Corp. 71.5% Uranium, gold and molybdenum Properties (all inactive and shut down), and exploration activities on coalbed methane properties Sutter Gold Mining Company 78.5% Gold (California) - inactive - Being reactivated Four Nines Gold, Inc. 50.9% Contract Drilling/Construction - inactive USECC Joint Venture 50.0% Uranium (Wyoming, Utah), gold and molybdenum,** all inactive and shut down; real estate management and coalbed methane exploration
3 *IncludesYellowstone Fuels Corp. 35.9% Uranium (Wyoming) - inactive - Shut down Pinnacle Gas Resources, Inc. 37.5% CBM exploration and production - active * Includes ownership of Crested Corp. in RMG and Sutter. **There are no plans to put the molybdenum property into production in the foreseeable future. See "Inactive Mining Properties - Molybdenum.Molybdenum and Item 3, "Legal Proceedings". Until September 11, 2000, USE, USECC and Kennecott Uranium Company ("Kennecott") owned the Green Mountain Mining Venture ("GMMV"), which held a large uranium deposit and uranium mill in Wyoming. On September 11, 2000, USE and Crested settled litigation with Kennecott involving the GMMV by selling their interest in the GMMV and its properties back to Kennecott for $3,250,000, and receiving a royalty interest in the uranium properties.properties and miscellaneous equipment. The GMMV properties are shut down. Kennecott also assumed all reclamation obligations on the GMMV properties; reclamation obligations for an ion exchange facility located on properties outside the GMMV were not assumed by Kennecott, see "Sheep Mountain Partners - Properties" below. Other uranium properties and a uranium mill in southeast Utah are held by Plateau Resources Ltd., a wholly-owned subsidiary of USE. The Utah uranium properties are shut down. TheActivities on the mineral properties held by Sutter Gold Mining Company ("SGMC"), a majority-owned subsidiary of USE, are were shut down because the currenthistorical market price of gold doesdid not permit raising the necessary capital necessary to build a mill and put the properties into production. However, improved gold prices over the last 12 months have revived the capital markets, particularly in Canada. See "Sutter Gold Mining Company, below." In coalbed methane, we compete against many companies, some of which are much larger and better financed than the Company. The principal area of competition is encountered in the financial ability to acquire good acreage positions and drill wells to explore coalbed methane potential, then, if warranted, drill production wells and install production equipment (gathering systems, compressors, etc.). We own a royalty interest in a molybdenum property in Colorado; the property is owned by Phelps Dodge Corporation, a worldwide integrated minerals company with inventories of exploration, development stage, and producing properties, involving numerous metals and other minerals.Corporation. We believe, at the present time, that Phelps Dodge does not have a plan to place the molybdenum property into production. -4- In the motel, real estate and airport operations area (significant in termsas a percentage of fiscal 2002 revenues for 2003, but not our primary business focus), we own and manage an office building (where ourthe Company's headquarters are located), and small parcels of land, all in Riverton, Wyoming, and a small amount of additional acreage elsewhereother land in Wyoming and Colorado. We also ownAn indirect subsidiary (Canyon Resources), owned a townsite, a motel, and convenience store and other commercial facilities in Utah. There is no significant competitionUtah, which was sold in August 2003, thus greatly reducing activities in this area; although parcels are sold from time to time, we are not in the land development business.commercial segment. (B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS. During 2003, the threeseven months ended December 31, 2002, and the (former) fiscal yearsyear ended May 31, 2002, for technical financial presentation purposes, we operated in threetwo business segments: (i) coalbed methane gas exploration (and holding shut down mines and mineral properties),; and (ii) motel,commercial (motel, real estate, and airport operations, and (iii) contract drilling/ construction (principally in fiscal 2000 and the first quarter of fiscal 2001)operations). Contract drilling/construction operations were shut down as an operating segment in fiscal 2001. The principal products of the operating units within each of the reportable industry segments for the three fiscal years ended May 31, 2002 are set forth in the table below. For more information, see note I to the financial statements. While we technically had threetwo segments in this three year31 month period, most of ourby December 31, 2003, all activities in minerals motel/(except coalbed methane) and commercial (motel/real estate/airport, and contract drilling/construction haveairport), had ceased or havewere severely curtailed, and the motel/commercial properties in Utah had been severely curtailed. Thesold. As of the date of this Annual Report, the only current activities of a material and recurring nature are in coalbed methane,methane. The principal products of operating units within each of the reportable industry segments for the full year 2003, the seven months ended December 31, 2002 and motel operations and management services. 4 the (former) fiscal year ended May 31, 2002 are shown below. For more information, see note I to the financial statements. INDUSTRY SEGMENTS PRINCIPAL PRODUCTS Coalbed Methane Gas ExplorationMinerals: CBM Acquisition of coalbed methane (and holdingproperties, Exploration and Production production of mining properties properties, and exploration and which are shut down) development of such properties for coalbed methane gas.methane. (and shut down mineral This activity is material and recurring, and properties) is our principal business focus. Sales and leases of mineral- bearingmineral-bearing properties and, from time to time, the production and/or marketing of uranium, gold and receipt of advance royalties on molybdenum. Activities in uranium, gold and molybdenum are shut down as recurring activities. Motel, Real Estate andGold properties are being reactivated at the date of this Report. Commercial: Operation of a motel and rental of Airport Operations real Motel/Real Estate/ estate, operation of an aircraft fixed base Airport FBO operation (fuel sales, flight instruction and aircraft maintenance),maintenance, which was shut down in the (former) fiscal year 2002; and variousmotel and real estate activities (sold in 2003)). Various contract services, including managerial services for subsidiary companies. Only the motel and real estate, and management services activities remain active now. Though significant in terms of contributions to revenues on a historical basis, these operations are auxiliary to the principal business focus of the company (coalbed methane). Contract Drilling/Construction Contract drilling of coalbed methane gas wells, construction of drill sites, gas pipe lines, reservoirs and reclamation of locations. This activity has been shut down. (C)companies, continue. -5- C) NARRATIVE DESCRIPTION OF BUSINESS (INCLUDING ITEM 2 - PROPERTIES). COALBED METHANE (AND INACTIVE MINING PROPERTIES) COALBED METHANE GENERAL. Rocky Mountain Gas, Inc. ("RMG") was incorporated in Wyoming on November 1, 1999 for business in the coalbed methane industry in Wyoming and Montana. RMG is a subsidiary of the Company (owned 51.2%50.3% by the Company and 40.5%39.8% by Crested as of MayDecember 31, 2002)2003 (as of the date of this Annual Report, 49.4% by the Company and 39.1% by Crested). In 2003, RMG transferred all of its interest in certain coalbed methane properties, including a producing property, to Pinnacle. At September 25, 2002the same time, Carrizo Oil & Gas, Inc.'s wholly owned subsidiary CCBM, Inc. ("CCBM") (with which RMG has an agreement to jointly acquire and explore properties) transferred to Pinnacle all of its interests in the same properties, and affiliates of Credit Suisse First Boston contributed equity financing to Pinnacle. See "Transaction with Pinnacle Gas Resources, Inc." On January 30, 2004, RMG (through its wholly-owned, newly organized subsidiary RMG I LLC, "RMGI") acquired coalbed methane properties in the Powder River Basin of Wyoming. See "Acquisition of Producing and Non-Producing Properties from Hi-Pro Production, LLC." Part of the purchase price was financed under a $25 million mezzanine credit facility. RMG I plans to drill five development wells on the Hi-Pro properties in 2004 and upgrade existing infrastructure to improve gas production, and, subject to raising equity funding, drill up to 120 exploratory wells on undeveloped Hi-Pro acreage in 2004 and 2005. In addition, RMG plans to drill exploratory wells on the Castle Rock and Oyster Ridge properties, and seek to acquire other producing coalbed methane properties, primarily in Wyoming. Financing may be available under the mezzanine credit facility for more acquisitions, if approved by the lenders. As of the filing date of this Annual Report, RMG does not have any agreements to acquire other producing properties. RMG raised $1.8 million of equity financing in the first quarter of 2004. As of the filing date of this Annual Report, RMG holds leases and options on approximately 277,586264,300 gross mineral acres of federal, state and private (fee) land in the Powder River Basin ("PRB") of Wyoming and Montana. MostMontana and adjacent to the Green River Basin of Wyoming, not including acreage held by Pinnacle. As of the filing date of this acreage was acquired in the fiscal year ended May 31, 2001. As of September 25, 2002Annual Report, there are no108 producing CBM wells on any of the acreage. Not included in this acreage total is the 1,940 gross acres in the Bobcat Property, a producing CBM property acquiredproperties bought by RMG from Hi-Pro Production, LLC. RMG owns an average 58% working interest (46.4% average net revenue interest, before deduction of overriding royalty interests held by lenders) in June 2002. Through May 2002, 58 CBMthese properties. From RMG's inception, through December 31, 2003, 72 exploratory wells have been drilled, almost all with funds provided by industry partnerspartner CCBM Inc. and former industry partner SENGAI (see below). 43 of the wells were on properties transferred to Pinnacle in mid-2003. The balance of 29 wells (15 of which have been plugged and abandoned) are on properties held by RMG. Reserves have not been established for any of the properties on which these wells have beenwere drilled. Independent reserve evaluations will be conducted and reported by February 14, 2003 for the Bobcat property (bought as a producingThe Castle Rock property in June 2002)southeast Montana , and by April 30, 2003 for the Clearmont prospect (undrilled acreage acquired in fiscal 2001, drilling started in fiscal 2002). InOyster Ridge property adjacent to the case of the Bobcat property, reliable daily production data is being obtained (well gas pressure, water production, etc.) to provide the necessary data base for a reserve evaluation. For the Clearmont property, the current dewatering process 5 should be completed and initial gas sales commence in early 2003,Green River Basin (southwest Wyoming), are large properties which will provide the necessary data base for a reserve evaluation of that property. In summary, the valuation process for the investments in Bobcat will be completed by February 14, 2003, and for Clearmont by April 30, 2003. See "Acquisition and Exploration Capital Expenditures" below. The valuation will be made when there is enough information to do so. If production has not reached levels that are economic at the gas prices on evaluation date, there would be no proved reserves on the subject property. We have not established that our investments in coalbed methane properties and exploration activities will yield anything of value. We will not be able to make that assessment until the presence, or absence, of reserves on the properties is established. The first properties to be evaluated will be Bobcat and Clearmont. Other properties (especially Castle Rock and Kirby) are very large and will require the drilling of numerous exploratory wells and extended dewatering periods for each group or "pod" of wells (from 6 to 18(possibly as much as 24 months after drilling and completion) before an assessment of reserves can be made. In some areas where no other coalbed methane wells on adjacent properties are dewatering the coal seam, the dewatering process could take as long as 24 months.-6- Among the uncertainties we face in the process of determining if our coalbed methane investments will yield value are the following: Prices for gas sold in the Powder River Basin are typically lower than national prices, and therefore, the lowest in the United Stateseconomics of Powder River Basin properties can be adversely affected more readily by lower gas prices. The Hi-Pro properties, and may not improve enough, over a sustained time period,all revenues therefrom, are pledged to make many properties economic;service $3,635,000 of debt. To continue exploration efforts, additional capital (in addition to RMG's one-half of remaining balance under the $2,245,000CCBM $5.0 million drilling commitment, which one half of remaining balance was $305,100 at MayDecember 31, 2002 remaining from CCBM, Inc.'s drilling fund) to continue exploration efforts2003) will be needed. Permitting issues for new wells on undeveloped acreage may be needed but not available; and permitting issues may delay further work.delayed. An unfavorable confluence of these uncertainties if realized, could result in a write-down of the carrying value of those properties which don't produce enough gas at low prices to be economic; thein a write-down of the carrying value of other properties which need more wells drilled and dewatered to establish or improve the economics of production (but the capital isn't available);production; and/or the delay (whether from lack of capital or permitting problems) in establishing reserves for the larger prospects where many wells will have to be drilled to assess their value. Certain technical terms used in the oil and gas industry appear in this Annual Report. The following are general definitions of those terms: Working interests percentages of a mineral lease total 100%; the working interest owners together (an aggregate of 100%) pay all of the costs to hold undeveloped leases, drill and complete wells on leases, and produce minerals from the leased property (including pump costs, gathering and transmission costs and marketing costs). Net revenue interests are the percentages of production which the working interest owners own, after deduction for payment of royalties to the owners of the minerals under lease (private parties, the Bureau of Land Management, or the State, as applicable). Owners of royalty interests pay none of the costs to drill, complete, or operate wells on a lease. An overriding royalty interest is carved out of the total net revenue interest; overriding royalty interest holders pay none of the costs to hold, drill, or produce the minerals. All owners pay their share of ad valorem and severance taxes. TRANSACTION WITH PINNACLE GAS RESOURCES, INC. On June 23, 2003, RMG, CCBM and its parent company Carrizo Oil & Gas, Inc.; and seven affiliates of Credit Suisse First Boston Private Equity (the "CSFB Parties") signed and closed agreements for a transaction with Pinnacle. The transaction included: (1) the contribution to Pinnacle by RMG and CCBM of all of their ownership of a portion of the CBM properties owned by RMG and CCBM, in exchange for common stock and options to buy common stock in Pinnacle; and (2) $17,640,000 cash to Pinnacle by the CSFB Parties for common stock and series A preferred stock of Pinnacle, and warrants to purchase series A preferred stock of Pinnacle. Pinnacle is a private corporation. Only such information about Pinnacle, as its board of directors elects to release, is available to the public. All other information about Pinnacle is subject to confidentiality agreements between Pinnacle, RMG, and the other parties to the June 2003 transaction. At December 31, 2003, RMG's ownership in Pinnacle's common stock was 37.5%. RMG's ownership of Pinnacle on a fully-diluted basis will change if the CSFB Parties fund subsequent capital requests from Pinnacle and/or exercise their warrants to buy equity in Pinnacle, and/or if RMG and/or CCBM exercise their options to buy equity in Pinnacle, or other events occur. See the discussion under Pinnacle Equity Transaction below. Immediately following, and in connection with, the transaction, Pinnacle acquired additional producing and non-producing CBM properties located in the Powder River Basin of Wyoming from Gastar Exploration, Ltd. ("Gastar," listed on the Toronto Stock Exchange), referred to below as the "Gastar acquisition." The transaction and the follow-on Gastar acquisition provide (1) Pinnacle the funded opportunity to explore and develop the contributed and acquired assets, and to acquire and explore, and if warranted, -7- develop, additional CBM properties in Wyoming and Montana; and (2) RMG (through its ownership interest in Pinnacle) the opportunity to benefit (on a passive basis) from the continued development of the contributed assets and other properties which Pinnacle may acquire in the future. Since June 2003, Pinnacle has acquired additional acreage, and drilled numerous exploratory and development wells. RMG now has interests in approximately 264,300 gross (128,200 net) mineral acres:(A) 173,400 gross (66,900 net) acres in the Castle Rock, Oyster Ridge, and Baggs properties, which were not contributed to Pinnacle (these properties are operated by RMG and held with its industry partner CCBM, Inc.); and (B) 52,700 gross (47,000 net) mineral acres acquired from Hi-Pro Production, LLC. The acreage total does not reflect properties held by Pinnacle. The acreage total for Oyster Ridge includes the proposed acquisition from Kerr McGee (38,184 gross, 11,455 fully diluted net). See "Oyster Ridge". CCBM is a wholly-owned subsidiary of Carrizo Oil & Gas, Inc. ("Carrizo," a Nasdaq listed company). Carrizo, CCBM and RMG entered into an agreement in July 2001 for CCBM to buy a 50% interest in, and fund exploration and development of, RMG's CBM properties then owned. Prior to and in connection with the Pinnacle transaction, CCBM paid RMG approximately $1.8 million cash to complete its purchase of 50% of RMG's contributed CBM properties, thus enabling CCBM to contribute its interests in the CBM properties to Pinnacle as having been fully paid for. See "Continuing Operations of RMG, Continuing Agreement with CCBM, and the AMI Agreement, After the Pinnacle Transaction" below. - PINNACLE EQUITY TRANSACTION Pinnacle is authorized to issue common stock (100 million shares, $0.01 par value) and preferred stock (100 million shares, $0.01 par value). Pinnacle has established series A preferred stock with the following provisions: Liquidation preference of $100.00 per share; 10.5% compounded cumulative annual dividend (12.5% after July 1, 2010); redeemable at Pinnacle's option after July 1, 2004 at a premium declining to par after July 1, 2009 (mandatory redemption if there is a change in control of RMG or CCBM); and with voting rights (a) pari passu with the common stock on regular matters, and (b) as a separate class, to authorize changes in the series A preferred stock, to authorize issuance of stock senior to or in parity with the series A preferred stock, to approve any reorganization or merger of Pinnacle, to approve Pinnacle's sale of substantially all its assets, and similar matters. Pinnacle's board of directors has eight directors (two each from RMG and CCBM, and four from the CSFB Parties). The chart below summarizes (a) the contributions made by the parties to the transaction at the closing, and (b) as of the closing, the subsequent contributions which would be made by the CSFB Parties in response to future capital requests from Pinnacle. As of the filing date of this Annual Report, as a result of a capital request funded after the closing by the CSFB parties, RMG owns 37.5% of the common stock of Pinnacle. -8-
Equity in Pinnacle -------------------- Series A Equity Rights in Pinnacle Parties Contribution Common Stock Preferred Stock Warrants(1) Options Common Stock(2) ------- --------------- -------------- --------------- ----------- ----------------------- RMG All CBM 75,000 shares -0- -0- 30,000 shares properties (except Castle Rock, Baggs and Oyster Ridge) CCBM All CBM 75,000 shares -0- -0- 30,000 shares properties (except Castle Rock, Baggs and Oyster Ridge) CSFB $ 17,640,000 50,000 shares 130,000 shares 130,000 -0- Parties CSFB $ 11,760,000(3) 120,000 shares 120,000 -0- Parties
- ---------------------------------------- (1) At $100 per share of common stock. (2) Options to buy common stock at $100.00 per share, as increased by 10% per annum compounded quarterly for the first 15,000 shares, and 20% per annum for the second 15,000 shares. (3) Commitment to fund subsequent capital requests from Pinnacle, not more than $11,760,000, if made prior to July 1, 2004, for development work on CBM wells, or (if approved by CSFB Parties) a property acquisition. The commitment price is $980,000 for each 10,000 shares of series A stock (coupled with warrants to purchase 10,000 shares of common stock, exercisable at $100 per share). As a result, RMG has recorded its 37.5% equity investment in pinnacle at the carrying value of its coalbed methane properties of approximately $922,600. Sanders Morris Harris Inc. ("SMH") of Houston, Texas acted as financial advisor to RMG on the Pinnacle transaction. For its services in connection with the transaction and the Gastar acquisition, SMH was paid $650,000 by Pinnacle. As additional compensation for SMH's services, USE issued to SMH 50,000 restricted shares of common stock and warrants to purchase (until June 30, 2006) another 50,000 restricted shares of common stock (at $5.00 per share). SMH did not receive any equity or equity rights in Pinnacle in connection with the transaction or the Gastar acquisition. - GASTAR ACQUISITION With proceeds from the CSFB financing, Pinnacle paid Gastar $6.2 million for approximately 50% of Gastar's working interest in existing producing and non-producing CBM properties which included 95 producing wells in the early stages of dewatering and approximately 36,529 gross developed and undeveloped acres. The majority of the leases are either part of or located adjacent to the producing Bobcat property, which RMG and CCBM contributed to Pinnacle. Pinnacle also agreed to fund up to $14.5 million of future drilling and development costs on behalf of Gastar and Pinnacle prior to December 31, 2005, on the properties purchased from Gastar. -9- - CONTINUING OPERATIONS OF RMG, CONTINUING AGREEMENT WITH CCBM, AND THE AMI AGREEMENT AFTER THE PINNACLE TRANSACTION RMG retained ownership, with CCBM, of the Castle Rock, Oyster Ridge, and Baggs projects, totaling about 189,000 gross acres (currently about 173,400 gross acres net of 15,200 gross acres returned to Anadarko after the transaction date and expiration of one lease). RMG and CCBM plan to continue exploration and development activities on these properties as well as acquiring other properties in Wyoming and Montana, under their July 2001 agreement (see "Carrizo - Purchase and Sale Agreement"). Presently there are no agreements for RMG and CCBM to acquire producing properties. CCBM paid RMG approximately $1.8 million for CCBM's outstanding purchase obligation (under the July 2001 agreement) on CCBM's interests in those properties it contributed to Pinnacle. The balance on the note at December 31, 2003 was $836,200. The balance of CCBM's original purchase obligation is payable in monthly installments of approximately $52,800 through November 2004 with a balloon payment of $282,400 due on December 31, 2004. In connection with the transaction with Pinnacle, RMG and Pinnacle signed a transition services agreement, for Pinnacle to pay RMG to assist in setting up operational accounting systems for Pinnacle through December 2003. The agreement was terminated by RMG effective January 1, 2004. Also in connection with the transaction, RMG, CCBM, Carrizo, USE and the CSFB Parties signed an area of mutual interest ("AMI") agreement: Until June 23, 2008, Pinnacle has the right to acquire from the other parties up to 100% of any interest in oil and gas leases, or interests therein or mineral interests or rights to acquire same, which the other parties acquire, at the same price paid or payable by the other parties, within the Powder River Basin in Montana and Wyoming (excluding most of Powder River County, Montana). The original AMI agreement between CCBM and RMG from July 2001 is superseded by the new AMI agreement, except for areas outside the new AMI agreement territory, wherein the original agreement is still in effect. With respect to the properties acquired from Hi-Pro (see below), CCBM and Pinnacle waived their rights to buy any of the producing or undeveloped acreage. ACQUISITION OF PRODUCING AND NON-PRODUCING PROPERTIES FROM HI-PRO PRODUCTION, LLC On January 30, 2004, RMG I, LLC ("RMG I"), a wholly-owned subsidiary of RMG, purchased coalbed methane properties from Hi-Pro for $6,800,000. This transaction was closed after December 31, 2003. See the subsequent event footnote to the financial statements in this Annual Report. The purchased properties (all located in the Powder River Basin of Wyoming) include 247 completed wells and 40,120 undeveloped fee acres. As of the filing date for this Annual Report, 108 wells now are producing approximately 5.9 million cubic feet (Mmcf) of gas per day (approximately 3.1 Mmcf per day net to RMG I). Net daily Mmcf sales are less than gross production, due to produced gas being consumed to run compressors, and from adjustments by purchasers for thermal content (gas is sold based on BTU heat content). RMG I owns an average 58% working (average 46.4% net revenue) interest in the producing wells and proved developed acreage, and a 100% working (average 80% net revenue) interest in all of the undeveloped acreage. The net revenue interest percentage after deduction of the overriding royal interests held by lenders (see "Mezzanine Credit Facility") are 44.66% for the producing and five future wells to the Wyodak coal, and 78.0% for production from deeper coals and all of the undeveloped acreage. The transaction was structured as an asset purchase, with RMG I as the purchaser, in connection with the establishment of a mezzanine credit facility for up to $25,000,000 of secured loans to acquire and develop more proven coalbed methane reserves. RMG may utilize RMG I for future acquisitions (none are presently -10- under contract or agreement in principle). See "Mezzanine Credit Facility." A substantial portion of the cash consideration paid to Hi-Pro was funded with the initial advance on the credit facility. RMG I replaced Hi-Pro as the contract operator for 89% of the wells that were acquired. RMG negotiated the purchase based on the $7,113,000 present value, discounted 10%, of gas reserves recoverable (and the estimated future net revenues to be derived) from proved reserves in the Hi-Pro properties, as estimated as of November 1, 2003 by Netherland Sewell and Associates, Inc. See "Reserve Date" below for the estimate as of December 31, 2003. The $6,800,000 purchase price reflects a deduction, negotiated by the parties in January 2004, to account for the decrease in gas production from October 2003 due to the impact on production from deferred maintenance on the properties, and the expected cost of such maintenance work after closing. - TERMS OF THE PURCHASE. The purchase price of $6,800,000 was paid: X $ 776,700 cash by RMG. X $ 588,300 net revenues from November 1, 2003 to December 31, 2003, which were retained by Hi-Pro.(1) X $ 500,000 by USE's 30 day promissory note (secured by 166,667 restricted shares of USE common stock, valued at $3.00 per share). X $ 600,000 by 200,000 restricted shares of USE common stock (valued at $3.00 per share).(2) X $ 700,000 by 233,333 restricted shares of RMG common stock (valued at $3.00 per share).(3) X $3,635,000 cash, loaned to RMG I under the credit facility ---------- agreement. (4) $6,800,000 (1) RMG paid all January operating costs at closing. Net revenues from the purchased properties for January 2003 were credited to RMG I's obligations under the credit facility agreement. These net revenues were considered by the parties to be a reduction in the purchase price which RMG otherwise would have paid at the January 30, 2004 closing. (2) USE has agreed to file a resale registration statement with the SEC to cover public resale of these 200,000 shares. (3) From November 1, 2004 to November 1, 2006, the RMG shares shall be convertible at Hi-Pro's sole election into restricted shares of common stock of USE. The number of USE shares to be issued to Hi-Pro shall equal (A) the number of RMG shares to be converted, multiplied by $3.00 per share, divided by (B) the average closing sale price of the shares of USE for the 10 trading days prior to notice of conversion. The conversion right is exercisable cumulatively, as to at least 16,666 RMG shares per conversion. (4) See "Mezzanine Credit Facility." - PROPERTIES PURCHASED. RESERVE DATA Netherland Sewell and Associates, Inc. ("NSAI," Houston, Texas), independent petroleum engineers, have prepared a report on the proved reserves, as of December 31, 2003, estimating recoverable reserves from the Hi-Pro properties, and the present value (discounted 10%) of future cash flow therefrom. NSAI's report takes into account fixed pricing for some production in 2004 and 2005, reflects the reduction in RMG's net revenue interests due to the overriding royalty interests held by lenders, and (except for fixed pricing in 2004 and 2005) is based on the Henry Hub Spot market price of $5.965 per mmbtu, adjusted by lease for energy content, transportation fees and regional price differentials on December 31, 2003, without price escalation. -11- NET PRESENT RESERVES VALUE (Mmcf) (discounted at 10%) ------ --------------------- Proved Developed Producing 2,206.490 $4,589,600 Proved Developed Non-Producing 464.423 $1,084,800 Proved Undeveloped 733.780 $1,382,000 ---------- ---------- Total 3,404.693 $7,056,400 ========= ========== The present value, discounted 10% value ("PV10 value") was prepared after ad valorem and production taxes on a pre-income tax basis, and is not intended to represent the current market value of the properties.estimated gas reserves purchased from Hi-Pro. The PV10 discount factor is not the same as the standardized measure of present value calculations which are determined on an after-income tax basis. Reserves as of November 1, 2003 were calculated by NSAI based on actual production up to June 30, 2003, with production decline curves to November 1, 2003 estimated based on that production, resulting in total net proven reserves of 4,034.5 Mmcf. For estimates as of December 31, 2003, NSAI was supplied with actual production data through that date. Because actual production was below the production predicted for the same period by the November 1, 2003 decline curves, the decline curves for the later report had a lower starting point on January 1, 2004 and a steeper rate of decline. These new decline curves thus predict lower future production (3,404.693 Mmcf net to RMG) as of December 31, 2003. We expect production in 2004 from producing wells, and hence proven reserves (after adjustments for actual gas produced), will increase as maintenance work now in progress (which had been deferred by Hi-Pro in the last two quarters of 2003) is completed in the second quarter 2004. The reduction in the present value, discounted 10%, of proven reserves at November 1, 2003 ($7,113,000) as compared to December 31, 2003 ($7,056,400) was less than 1%, notwithstanding the decreased volume of reserves, due to the higher price at the later date compared with prices used in the November 1, 2003 estimate ($4.50 per mcf in 2003, $4.29 in 2004, and $4.25 in 2005). There are numerous uncertainties inherent in estimating gas reserves and their estimated values. Reservoir engineering is a subjective process of estimating underground accumulations of gas that cannot be measured exactly. Estimates of economically recoverable gas, and the future net cash flows which may be realized from the reserves, necessarily depend on a number of variable factors and assumptions, such as historical production from the area compared with production from other areas, the assumed effects of regulations by government agencies, assumptions about future gas prices and operating costs, severance and excise taxes, development costs, and work-over and remedial costs. The outcomes in fact may vary considerably from the assumptions. The PV10 value takes into account RMG I's contracts to sell 2,000 Mmbtu per day in 2004 at a fixed price of $4.76 per Mmbtu, and 1,000 Mmbtu per day in 2005 at a fixed price of $4.14 per Mmbtu. From time to time, RMG I may sign fixed price contracts for more production. In addition, gas market prices will vary, possibly by significant amounts, throughout each year, and on an average basis from year to year. For these reasons, the cash flow realized from production likely will vary from the estimates of cash flow used to determine the PV10 value. Estimates of the economically recoverable quantities of gas attributable to any particular property, the classification of reserves as to proved developed and proved undeveloped based on risk of recovery, and estimates of the future net cash flows expected from the properties, as prepared by different engineers or by the same engineers but at different times, may vary substantially, and the estimates may be revised up or down as assumptions change. In addition, it is likely that actual production volumes will vary from the estimates. -12- The PV10 discount factor, which is required by the SEC for use in calculating discounted future net cash flows for reporting purposes, is not necessarily the most appropriate discount factor, based on interest rates in effect in the financial markets, and risks associated with the gas business. The business of exploring for, developing, or acquiring reserves is capital intensive. To the extent operating cash flow is reduced and external capital becomes unavailable or limited, RMG's ability to make the necessary capital investment to maintain or expand the gas reserves asset base would be impaired. There is no assurance future exploration, development, and acquisition activities will result in additional proved reserves. Even if revenues increase because of higher gas prices, increased exploration and development costs could neutralize cash flows from the increased revenues. - FUTURE PLANS FOR THE HI-PRO PRODUCTION PROPERTIES In the second quarter of 2004, RMG I plans to drill five proven undeveloped locations to the Wyodak coal, continue a remedial workover program on a number of existing wells, and upgrade the gas gathering and pipeline facilities included in the purchase. The workover program is estimated to cost $250,000 and will be funded by the working interest partners. The drilling and gathering upgrade is estimated to cost approximately $640,000, and is being funded with a loan from the mezzanine credit facility. The programs are designed to enhance production from current levels. After the 5 new wells to the Wyodak are drilled, there will be no more undrilled locations on the currently producing properties available for the Wyodak coal. The first coals of interest under the undeveloped acreage are the Anderson and Canyon coals (for example under the Reno property); the Wyodak coal is not present under the undeveloped acreage. In addition to the 5 new wells, RMG-I plans to hook up 2 additional wells that were previously drilled by Hi-Pro and are in close proximity to the 5 new wells. The Wyodak coal formation is 200 to 600 feet from surface. Existing infrastructure for the Wyodak wells (gathering lines, compressors, and water disposal) should significantly reduce drilling and completion costs for new wells to the deeper Dannar and Moyer coals (1,100 to 1,800 feet). Subject to raising capital, up to 120 wells could be drilled and completed to these deeper coals in 2004 and 2005, all on locations now producing from the Wyodak. This development activity is contingent upon obtaining future financing. We do not expect that funding for this activity will be available through the mezzanine credit facility. No reserves have been established for the Dannar and Moyer coals. Because no other operators are producing gas from or dewatering these coals in the vicinity of the Hi-Pro properties, we expect several pods of wells will have to be drilled and completed to these coals, with an extended dewatering period (which could be up to 24 months), before significant gas production begins. RMG is also developing plans to put five coalbed methane wells from the Reno property on production during 2004. The Reno property was part of the Hi-Pro acquisition. The target coals on the Reno property are the Anderson coal, which is about 600-650 feet in depth and approximately 40 feet in thickness and the Canyon coal which is about 700-850 feet in depth and 35 feet in thickness. Four wells were previously drilled by Hi-Pro, at the Reno Property which were completed in both the Anderson and Canyon coals, with slotted screening in each. In addition, in March 2004, RMG I drilled a fifth well, which has been completed in the Canyon coal. The shallower Anderson coal may be completed at a later date. Four additional well locations exist at the Reno property based upon 80-acre spacing. The Reno property consists of 760 gross and net acres, all on fee acreage. It is located in Campbell County, Wyoming, approximately 50 miles south of Gillette. RMG owns a 100% working interest in this property. -13- - MEZZANINE CREDIT FACILITY. RMG I has signed a credit agreement with Petrobridge Investment Management, LLC (Houston , Texas) as lead arranger, and institutional lenders, for up to $25,000,000 of loans to RMG I. The loan commitment is through June 30, 2006. All loans will have a three year term from funding date. Funding to acquire and/or improve any project is subject to the lenders' approval of the transaction and RMG I's development plan. The first loan ($4,340,000 on January 29, 2004) under the credit facility has been applied to the Hi-Pro asset purchase ($3,700,000) including transaction costs and professional fees; and for a Phase I development program ($640,000). Terms for all loans under the credit facility include the following: X Principal is not amortized, but interest must be paid monthly. All revenues from the properties owned by RMG I (including all current and new wells) is paid to a lock box account controlled by the lenders, from which is paid by the lenders, the lease operating costs, revenue distributions, RMG I operating fees and RMG pumping fees (all approved by the lenders). With the exception of operating and pumping fees, no revenues will be available for RMG operations until all loans are paid off. X The loans are secured by all of RMG I's properties and by RMG's equity interest in RMG I. X The lenders, in the aggregate, receive an overriding royalty interest of 3% of production from the wells producing when the acquisition was closed, and 2% of production from new wells on an 8/8ths working interest basis, proportionately reduced where less than 100% of the working interest is owned by RMG I. For the Hi-Pro properties, the 3% rate applies to all wells (producing and to be drilled) to the Wyodak formation (an aggregate override of 1.74%), and 2% to all wells to deeper formations (aggregate override to be determined based on working interest ownership by well). Override payments to the lenders are not applied to the loan balances. The percentage of overrides on future properties may vary. X Negative covenants: RMG I will not permit the ratio of (a) total debt to EBITDA to exceed 2.00 to 1.00; (b) EBITDA to interest expense and rents (lease expense) to be less than 3.00 to 1.00; c) current assets to current liabilities to be less than 1.00 to 1.00; or (d) PV 10 (proved developed producing reserves) to total debt to be less than 1.00 to 1.00. All these ratios are to be determined quarterly. In addition, RMG I shall not permit net sales volume of gas from its properties to be less than 270 Mmcf, 230 Mmcf, 230 Mmcf and 210 Mmcf for each quarter in 2004, or less than 180 Mmcf per quarter in 2005 and the first two quarters of 2006. At closing of the Hi-Pro acquisition, USE issued to the participating lenders three year warrants to purchase a total of 318,465 shares of common stock of USE (subject to vesting) at $3.30 cash per share. At closing of the Hi-Pro Acquisition, warrants on 63,693 shares vested. The remaining warrants will vest at the rate of the right to buy one USE share for each $157 which RMG I subsequently borrows under the credit facility. Regardless of when vested, all warrants will expire on the earlier of January 30, 2007, or the 180th day after USE notifies the warrant holders that USE' stock price has achieved or exceeded $6.60 per share for a consecutive 15 business day period. USE has agreed to file a registration statement with the SEC to cover public resale of the warrant shares. The preceding is a summary of some of the terms of the credit agreement, and is qualified by the text of the agreement, filed with this Annual Report as an exhibit. -14- - RMG EQUITY TRANSACTION In the first quarter, RMG raised $1,800,000 of equity financing from the sale of shares of Series A Preferred Stock in RMG, and warrants to purchase shares of common stock of USE, to institutional investors. Proceeds are being used for RMG working capital. The terms of the securities sold are: X 600,000 shares of Series A Preferred Stock at $3.00 per share. The Series A Preferred Stock bears a 10% cumulative annual dividend (payable on March 1 of each year, beginning March 1, 2005), payable at RMG's election in cash or shares of common stock of RMG (at $3.00 per share) or shares of common stock of USE (at 90% of USE' volume weighted average price for the five days, referred to as the "set price"). The Series A Preferred Stock is convertible at the holder's election into shares of common stock of RMG, at $3.00 per share, or shares of common stock of USE at the set price, until February 2006, at which time all Series A Preferred Stock shares not previously converted shall automatically be converted into shares of common stock of RMG. The Series A Preferred Stock carries a liquidation preference of $4.05 per share. X Warrants to purchase 150,000 shares of common stock of USE, at the set price. The investors did not pay additional consideration for the warrants issued in connection with the purchase of the Series A Preferred Stock. The warrants are exercisable as to 25% of the underlying shares beginning in May 2004, and an additional 25% of the underlying shares on each of the six months, nine months, and twelve months thereafter, at which time the warrants are exercisable for the full number of underlying shares. USE may call the warrants for exercise if USE's volume weighted average price (VWAP) for its stock exceeds $6.00 for any consecutive 15 trading days; warrants not exercised by the tenth trading day after a call notice is sent will be cancelled. X The number of shares of RMG or USE common stock issuable in payment of dividends on, or conversion of, the Series A Preferred Stock, and the number of shares of common stock of USE issuable on exercise of the warrants, are subject to adjustment in certain events to protect the holders from dilution. The first anti-dilutive provision is 'full ratchet': If RMG or USE issue shares of common stock, or derivative securities exercisable for or convertible into such shares of common stock, at a price less than $3.00 per share for RMG stock or the set price for USE stock, at any time until 30 days after a registration statement (to be filed by USE) has been declared effective by the SEC to permit the resale to the public by the holders of the USE common stock issuable on payment of dividends, in conversion, and on exercise of warrants, then the issue price for the dividends and conversions, and the exercise price of the warrants (for RMG and USE common stock, as applicable) shall be reduced (ratcheted down) to equal the lower issue price, until the 30th day after the registration statement is declared effective. X The second anti-dilutive provision would take effect after that 30th day: The issue price would be adjusted up to a fully weighted adjusted price, and would continue to be adjusted for any other issuance by RMG or USE of stock or derivative securities at a price less than $3.00 or the set price, as applicable, until the Series A Preferred Stock is converted to common stock or RMG or USE, or until the expiration of the warrants, as applicable. As an example of fully weighted anti-dilution protection, if RMG were to sell 3,200,000 shares of common stock at $2.50 per share, the dividend and conversion price on the Series A Preferred Stock would be $2.91. The preceding is a summary of some of the terms of the Series A Preferred stock designation, and the USE warrants, and is qualified by the text of the documents filed with this annual report as exhibits. VOLUMES, PRICES AND GAS OPERATING EXPENSE - BOBCAT PROPERTY (TRANSFERRED TO PINNACLE GAS RESOURCES, INC. IN JUNE 2003) This table shows RMG's 27.6% working (22% net revenue) sales volumes of gas produced, average sales prices received for gas sold, and average production costs for those sales, for the seven months ended -15- December 31, 2002, and for the year ended December, 2003, all from the Bobcat property which was transferred to Pinnacle in June 2003. Year Ended Seven Months Ended December 31, 2003 December 31, 2002 ------------------- ------------------- Sales volumes (mcf) 81,516 64,314 Average sales price per mcf(1) $3.71 $1.86 Average cost (per mcf)(2) $1.91 $1.91 (1) From time to time, we sold some of the production at a set price and the balance at daily market prices. For the six months ended June 30, 2003, we sold 37.0% of our share of production at contract prices and 63.0% at the market. There were no gas sales after June 30, 2003. (2) Includes direct lifting costs (labor, repairs and maintenance, materials and supplies, workover costs, insurance and property, gathering, compression, marketing and severance taxes). ACQUISITION AND EXPLORATION CAPITAL EXPENDITURES - ALL PROPERTIES THROUGH DECEMBER 31, 2003 From inception on November 1, 1999 through MayDecember 31, 2002,2003, RMG incurred totalnet acquisition (purchase price and holding costs) and exploration costs (drilling and completion) on coalbed methaneCBM properties of approximately $6,170,600.$1,353,900, which does not include approximately $2,194,900 funded by CCBM on RMG's behalf for leasehold, drilling and completion costs. Unproved coalbed methane properties on the company's balance sheet have been reduced by $1,125,000at December 31, 2003 reflect the reduction (by $5,143,000) to reflect the reduction of the full cost price as a result of the principal paymentpayments made by CCBM.CCBM under its agreement with RMG and by payments from other industry partners. The foregoing data does not include $922,600 spent by RMG on properties transferred to Pinnacle. The $922,600 was recorded at December 31, 2003 as an investment in Pinnacle. The following table shows certain information regarding the gross costs incurred. Year Ended Mayincurred by RMG. Costs associated with the Hi-Pro acquisition after December 31, ------------------------------- 2002 20012003 are not included.
Year Ended Seven Months Ended Year Ended December 31, December 31, May 31, ------------- ------------------- ----------- 2003 2002 2002 ------------- ------------------- ----------- ----------- Acquisition costs $ 368,700 $ 870,600 Exploration 87,400 283,900 $ 446,100 $ 1,154,500 Acquisition costs $ 107,100 $ 936,200 $ 192,600 Development 158,300 97,200 87,400 ------------- ------------------- ----------- $ 265,400 $ 1,033,400 $ 280,000 ============= =================== ===========
The acquisition costs included amounts paid for properties, , delay rentals, lease option payments, and general and administrative costs directly attributable to the acquisitions. The recorded amounts for acquisition and exploration of $4,995,600$265,400, $1,033,400, and $5,881,700,$280,000 represent 16.3%1.1%, 3.6%, and 19.3%1.0% of total assets at December 31, 2003, December 31, 2002, and May 31, 2002, and 2001. 6 respectively. We use the full-cost method of accounting for gas properties. Under this method, all acquisition and exploration costs are capitalized in a "full-cost pool" as incurred. Depletion of the pool will be recorded using the unit-of-production method. To the extent that such capitalized costs in the full-cost pool (net of depreciation, depletion and amortization and related deferred taxes) exceed the present value (using a 10% discount rate) of -16- estimated future net after-taxpre-tax cash flows from proved gas reserves (which will beas established by the reserve reports, to be obtained by the company), the excess costs will be charged to operations. If it is determined that there are no reserves on the Bobcat or Clearmont properties, allAll acquisition and exploration costs previouslyfor a property are capitalized until such time as reserves can be established, or not, for the property. If no reserves are established, those propertiescapitalized costs will be written-downtransferred to the amortization basis and chargedbe subject to operations. Toan impairment testTo the extent reserves are established for an exploration property to be less than such costs, the costs will be written-down to the amount of present value of the reserves. In this event, assets would decrease and expenses would increase. Once incurred, a write-down of gas properties can't later be reversed. In addition, if at some point in the future the exploration work on our other prospects (in particular the larger prospects) would beis delayed because of lack of capital or permitting delays, or both, with the result that it cannot be established whether or not proved reserves exist on the properties, the exploration costs for those properties would be written-off. When reserve reports are obtained on our properties, any resulting impact on the financial statements will be reported in the next periodic filing with the SEC. OVERVIEW OF RMG.COALBED METHANE PROPERTIES As of the filing of this report,Annual Report, we hold leases and options to develop approximately 280,486264,300 gross mineral acres (including 43,71169,895 acres we haveunder options on)- see "Oyster Ridge" below) under leases from the United States Bureau of Land Management, the states of Wyoming and Montana, and private landowners. Table 1 shows the total gross and net lease acres held in each prospect, and the amount of such acreage held by RMG and by companies with which RMG has agreements (CCBM, Inc. and Quaneco, L.L.C.). These agreements are summarized under "Carrizo - - Purchase and Sale Agreement" and "Quaneco - Agreement." Acreage data assumes CCBM completes its obligations; CCBM will own its 50% working interest in wells drilled under CCBM's drilling fund commitment, but if CCBM does not complete its purchase obligations, CCBM would not be entitled to a reduced working interest in the remaining undrilled acreage. CCBM currently has purchase rights to acquire a 6.25% working interest in the Castle Rock prospect, and owns a 6.25% working interest in eight wells in Castle Rock, which were drilled by Suncor Energy Natural Gas America, Inc. ("SENGAI"). RMG's and CCBM's interests in the Castle Rock prospect, as shown in Table 1, reflect the completion of SENGAI's drilling program in late calendar 2001. SENGAI elected not to exercise its option under an Option and Farmin Agreement on February 8, 2002. See the summary below, and "SENGAI - Option and Farmin Agreement." Prospects are evaluated for coal potential using available public and industry data, taking into account proximity to other positions held by RMG and existing or planned gas transmission lines, and whether drilling and production permits can be obtained and the costs thereof. The final decision to acquire a prospect is made by the presidentexecutive officers of RMG. Well drilling and testing is done by outside contract drilling companies. Drilling results (cores, gas and water flow rates, and other data) are evaluated by RMG staff, using customary technical methods, to determine if any coal zones encountered in the well should be completed for production. Completion requires setting casing pipe down to the coal zone(s), installing pumps, and installing and setting up the necessary surface equipment (for example, water disposal lines and water holding tanks and/or holding ponds for evaluation wells, in Montana, pending production permitting approvalpermitting), and water holding ponds in Wyoming).dewatering the well sufficiently so production can start. The decision whether to complete the well is made by RMG's president. 7 the executive officers of RMG. Table 1 reflects RMG's, Quaneco's and CCBM's acreage position as of the filing of this report.Annual Report. Table 1 does not reflect the reduction in net acreage held by RMG if Anadarko Petroleum, Inc. exercises its optionoptions to back inback-in for a 25% working interest on 43,71131,711 gross acres or Kerr McGee exercises its option to back-in for a 40% working interest on 38,184 gross acres within the Oyster Ridge prospect. Also, 43,71169,895 of the acres shown as held in Oyster Ridge assume we continue to earn acreage under the drill-to-earn-acreage provisions of the option agreementagreements with Anadarko.Anadarko and Kerr McGee. See "Description of Prospects - Oyster Ridge" below. -17- TABLE 1
- -------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Project and Date Gross Lease Net Lease RMG Net Quaneco Net CCBM Net Acquired Acres Acres Acres Acres Acres - ------------------------------------------------------------------------------------------------------- Castle Rock 123,840 111,567 48,811 55,784 6,973 Jan. 2000 Kirby 80,254 74,512 18,628 37,256 18,628 Jan. 2000 Bobcat June 1,940 930 465 0 465 2002 Oyster Ridge 65,247 65,247 25,729 0 25,729 Dec. 1999 Clearmont 6,305 3,745 1,873 0 1,873 Jan. 2000 Sussex 640 640 320 0 320 Jan. 2000 Finley 160 160 80 0 80 Jan. 2000 Baggs North 120 120 60 0 60 Jan. 2000 Gillette North 80 80 40 0 40 Jan. 2000 Arvada 1,900 1,700 850 0 850 Jan. 2000 - ------------------------------------------------------------------------------------------------------- TOTAL 280,486 258,701 96,856 93,040 55,018 - -------------------------------------------------------------------------------------------------------
We own a 25% working interest (20% net revenue interest) on 80,254 gross and 74,512 net acres in the Kirby prospect (southeast Montana) and a 50% working interest (from 30% to 50% net revenue interest) on 72,622 net acres in other prospects (all in Wyoming).Date Gross Lease Net Lease RMG Net Quaneco Net CCBM Net Acquired Acres Acres Acres Acres Acres - -------------------------------------------------------------------------------- Castle Rock 123,840 111,567 48,811 55,784 6,973 Jan. 2000 Oyster Ridge 87,642 87,642 32,380 0 32,380 Dec. 1999 Baggs North 120 120 60 0 60 Jan. 2000 Hi-Pro 52,740 51,938 46,974 0 0 Jan.2003 - -------------------------------------------------------------------------------- TOTAL 264,342 251,267 128,225 55,784 39,413 - -------------------------------------------------------------------------------- We own a 43.75% working interest (35% net revenue interest) in the Castle Rock prospect on 123,840 gross and 111,567 net acres in southeast Montana. CCBM Inc., a subsidiary of Carrizo Oil and Gas, Inc., can purchase a 6.25% working interest in our acreage (6,973 net acres) of the Castle Rock prospect if they meet certain payment obligations. In July 2001, we sold a 50% working interest in all our coalbed methane leases, except at Castle Rock, to CCBM for $7,500,000, plus other considerations.consideration. The acreage data abovein Table 1 reflects this transaction.these transactions. CCBM willagreed to pay up to $5,000,000 for drilling and completing coalbed methaneCBM wells on the properties owned by RMG and CCBM. Drilling started on the Clearmont prospect in Wyoming in August 2001. This drilling program should be sufficient to drill a total of approximately 60 coalbed methane wells to completion or abandonment stage. We have a carried working interest in all of the wells drilled on properties owned in these programs. 8 AsJuly 2001 (after the Pinnacle transaction, those properties consist of August 15, 2002, we had set casing on 31 wells (80 acre spacing units) at the Clearmont prospectCastle Rock, Baggs, and are nowthe Oyster Ridge property (not including the Kerr-McKee earn-in acreage)). To date, CCBM has not indicated whether they will participate in the processKerr McGee acreage under the AMI agreement as it is still under review by CCBM under the AMI review timeline. CCBM has the right to participate as to 50% of drilling additional wells. No reservesthe working interest we acquire in properties RMG or RMG I acquires in the future; if CCBM elects to participate, RMG or RMG I would not have been established to date. Drilling permits for 58 additionala carried interest in wells have been issued for the Clearmont prospect.on future properties. A total of 5872 wells have been drilled on RMG acreage to through MayDecember 31, 2002: five2003: 5 in (former) fiscal 2001year 2001; 53 in (former) fiscal 2002.year 2002; 12 in the seven months ended December 31, 2002; and 2 in 2003. 43 of the wells were drilled on properties transferred to Pinnacle in mid-2003. Nineteen of the wells were drilled by SENGAI in Castle Rock under the terms of the Suncor Optiona option and Farmin Agreement (see below).farmin agreement. Eleven of those 19 wells were stratigraphic wells and will be reclaimedhave been plugged by Suncor;SENGAI; 8 of those 19 wells were completed and are owned by RMG (93.7%(93.75% working interest) and CCBM (6.25% working interest), as Quaneco opted out of maintaining a working interest in the 8 wells. Other than the Castle Rock wells, RMG and CCBM both have a 50% working interest in all of these wells (see Table 2 below). For information on the 19 wells drilled by SENGAI in Castle Rock, see "SENGAI - Option and Farmin Agreement" below. As of MayDecember 31, 2002,2003, CCBM and RMG have spent approximately $2,775,000$2,194,900 of the $5,000,000$2,500,000 drilling fund.fund CCBM is committed to spend on RMG's behalf. This reflects a reduction of $391,000 for RMG's participation in two of Carrizo's Gulf Coast wells. We are relying on the $2,245,000$305,100 balance to pay for 100% of thecontinued drilling and completion costs on up to 33 more wells currently permitted, for which work is scheduled to start September 2002: 16 wells on the Clearmont prospect (estimated costs $1,255,000); 9 wells on the Bobcat prospect (estimated costs $800,000); 6 wells on the Arvada prospect (estimated costs $550,000);Castle Rock and 2 wells on the Oyster Ridge prospect (estimated cost $150,000). Like previous wells drilled with the CCBM drilling fund,properties, as to which RMG will have a 50% carried working interest with no financial obligation toof RMG for drilling and completion costs until afterthe drilling fund is exhausted. For other properties we acquire in which CCBM has spent $5,000,000. Workelects to participate, CCBM would be delayed if CCBM were not able to fund these costs. Presently, we do not have the capital resources to fund thesebear 50% of drilling and completion costs and would have to obtain the necessary capital from other industry partners or from sale of equity in the Company.for their 50% working interest. Future annual financial obligations for our coalbed methane properties consist of approximately $286,300 for fiscal 2003$173,100 gross in acreage rental fees to the lessors which will be paid 50% by RMG and 50% by CCBM on all acreage except Castle Rock, and 21,536 acres within Oyster Ridge which are not covered by the option with Anadarko. Costs and fees for Castle Rock will be paid 43.75% by RMG, 6.25% by CCBM, and 50% by Quaneco, except for the eight wells owned by RMG and CCBM, which will be paid 93.75% by RMG and 6.25% by CCBM. Table 2 shows the wells drilled on RMG's prospects from June 1, 2000 through May 31, 2002. Under the agreement with Carrizo, RMG has a carried working interest in all these wells (with the exception of a $156,634 payment that was made by RMG2004 ($81,800 net to cover 50% of a non-consent cost for 12 wells; CCBM also paid $156,634 to cover 50% of their cost in acquiring a non-consent working interest in those 12 wells), as CCBM has paid for all drilling and completion costs on the wells other than the 19 Castle Rock wells. RMG has a carried working interest in the 8 Castle Rock wells which were completed (out of the 19 drilled in that prospect), as SENGAI paid for all drilling and completion costs on the 8 Castle Rock wells under a drilling program completed in December 2001. RMG owns a 93.75% working interest and CCBM owns a 6.25% working interest in the 8 Castle Rock wells (CCBM paid for its interest in these wells, see "SENGAI - Option and Farmin Agreement")RMG). With the exceptions noted above, all the wells on the Oyster Ridge, Clearmont and Arvada prospects have been drilled at CCBM's sole expense since its participation began on June 30, 2001. Table 2 lists the number of wells drilled, the total exploration costs and the remaining number of wells currently permitted for drilling as of MayDecember 31, 2002. 92003. Wells permitted for drilling on the Hi-Pro properties are shown; exploration costs and numbers of wells drilled by Hi-Pro Production are not shown. -18- TABLE 2 ROCKY MOUNTAIN GAS, INC.
- ----------------------------------------------------------------------------------------------------------------- PROSPECT FY 2001 FY 2002 New Year 2002 FY 2003 Prospect 6/1/00-5/31/01 6/1/01-5/31/02 6/1/02-12/31/02 1/1/03-12/31/03 TOTAL Remaining (6/1/00 - 5/31/01) (6/1/01 - 5/31/02) Permits Wells $ Wells $ Wells $ Wells $ Wells $ Permits - -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- Castle Rock 33* $283,900 19** $2,500,000 $ 283,894 19* $ 2,500,0004,300 0 0 22 $ 2,783,894 15 Kirby 0 $ -- 0 $ -- 0 $ -- 6$2,788,200 5 - --------------------------------------------------------------------------------------------------------------------------- Oyster Ridge 2 $ 150,503150,500 5 $ 464,177*464,200 3,400 0 0 7*** 7 $ 614,680618,100 4 - --------------------------------------------------------------------------------------------------------------------------- Hi-Pro n/a n/a n/a n/a n/a n/a n/a 0 Clearmont 0 $ -- 28 $ 1,470,351 28 $ 1,470,351 59 Arvada 0 $ -- 1 $ 64,790 1 $ 64,790 3n/a n/a 9 - -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- TOTAL 5 $ 434,397 53 $ 4,499,318 58 $ 4,933,715 83 - -----------------------------------------------------------------------------------------------------------------434,400 24 2,964,200 7,700 0 0 29 3,406,300 18
* Drilledone well has been plugged and abandoned ** drilled by SENGAI, ** These costs include an additional $169,314 spent on the two wells drilled during fiscal 2001. BOBCAT PROPERTY. On April 12, 2002, the Company and RMG signed an agreement to purchase working interests in approximately 1,940 gross acres of coalbed methane properties in the Powder River Basin of Wyoming. The contract closed on June 4, 2002. The Company paid the seller $500,000 cash and another $150,000 by issuing 37,500 shares of its restricted common stock to the seller; CCBM paid $500,000 cash to the seller and Carrizo Oil & Gas, Inc. issued its restricted shares of common stock valued at $150,000. The properties are located approximately 25 miles north of Gillette, Wyoming, in Campbell County. To date, 18 coalbed methane wells11 have been drilled; 13plugged and abandoned *** includes 3 wells are currently hooked up and produced in June 2002 at a combined gross rate of approximately 878,000 cubic feet of gas per day (878 mcf) (288 Mcf net rate to our working interest) from the two primary coals on the property: the Cook coal (11 wells) at 650 feet, and the Canyon coal (2 wells) at 450 feet. Production began in late December 2001 (before RMG acquired the property). This net rate reflects the average 32.8% working interest (26.2% net revenue interest) in the 13 wells now producing. Our working interest in all the Bobcat acreage is an average of 27.6% (net revenue interest 22%). There are no proved reserves established for this property. For August, 2002, RMG received an average price of $1.33 per Mcf (1,000 cubic feet) for the 30,404 Mcf of gas sold from the Bobcat field, with prices ranging from $0.83 to $1.79 per Mcf. See "Gathering and Transmission of CBM Gas" below. The property is currently producing at uneconomic rates of production at these prices. RMG is replacing and upgrading some equipment and adding a compressor, with the expectation of improving production volumes through the remainder of 2002 and thereafter. An independent evaluation of CBM reserves will be undertaken and completed in February 2003, regardless of whether production increases from the August 2002 levels, and regardless of gas prices when the reserve evaluation is made. Reserve information will be disclosed when available. No independent reserve evaluation has been started to date, as RMG needed to take over operations of the field and obtain data after the property was purchased in June, 2002. Permitsthat have been issued for drilling 30 more wells on 80 acre spacing. CCBM has exercised its right to participate in purchase of the Bobcat property, for 50% of the interests in the property subject to the agreement. For information on agreements with CCBM, please see "Carrizo - Purchaseplugged and Sale Agreement" below. RMG operates the properties. 10 The seller keeps as an overriding royalty interest all net revenue interest in the properties in excess of 80%. RMG and CBM each hold an average of 31% working interest and an average of 25% net revenue interest, in the drilled wells.abandoned CARRIZO - PURCHASE AND SALE AGREEMENT. On July 10, 2001, RMG closed a Purchase and Sale Agreement with CCBM, Inc., a Delaware corporation which is wholly-owned by Carrizo Oil & Gas, Inc., Houston, Texas (NMS "CRZO"). The agreement between CCBM and RMG is intended to finance the further exploration of the acreage prospective for coalbed methane currently owned by RMGproperties held in Montana and Wyoming, and to acquire and develop more acreage in Wyoming and the Powder River Basin of Montana.properties. RMG has assigned CCBM an undivided 50% interest in all of RMG's existingthen current coalbed methane properties (with the exception of Castle Rock of which only a 6.25% working interest was assigned) for a purchase price of $7,500,000 by a promissory note payable in principal amounts of $125,000 per month plus interest at an annual rate of 8%, over 41 months (starting July 31, 2001) with a balloon payment due on the forty-second month. TheseThis note was reduced in connection with CCBM's contribution of properties consistedto Pinnacle (see "Transaction with Pinnacle Gas Resources, Inc. - Continuing Operations of RMG, Continuing Agreement with CCBM, and the Kirby, Oyster Ridge, Clearmont, Sussex, Finley, Baggs North,AMI Agreement, after the Pinnacle Transaction"), and Gillette North properties. Thethe balance on the note is secured with a 50% undivided interest is pledged back to RMG to securein the purchase price,remaining properties (Oyster Ridge and will be released 25% when 33.3% of the principal amount ($2,500,000) of the purchase price is paid, another 25% when total principal payments reach 66.6% of the principal amount ($5,000,000) of the purchase price, and the balance of the total 50% undivided interest when all of the principal amount ($7,500,000) of the purchase price, has been paid.Baggs North (but not Hi-Pro). CCBM has the right to participate in other properties RMG may acquire (like the Bobcat property) under thean area of mutual interest ("AMI"), see Agreement for Purchase of agreement. This agreement has been modified by the Bobcat Property" above, andAMI agreement signed in connection with the Pinnacle transaction; CCBM waived its right to participate in the Hi-Pro acquisition. For information on the original AMI below. To start exploration, and as part of the consideration for the acquisition, CCBM agreed to pay $5,000,000 to drill and complete from 30 to 60 wells on the coalbed properties. RMG will be "carried" for its 50% interest in these wells, and will not be required to pay any of such costs. After the initial $5,000,000 has been spent, RMG and CCBM each will pay for their 50% share of costs in subsequent wells, and also will pay for their 50% share of operating costs for the wells drilled and completed in this drilling program. Without CCBM's consent, none of the drilling funds can be used for operations associated with water disposal wells, gas compression beyond 100 PSIG, or for facilities downstream of compression beyond 100 PSIG. CCBM will earn a 50% working interest in each well location (80 acres) and gas production therefrom, regardless of the status of payments on the promissory note. Drilling under the CCBM agreement, started in August 2001. As of May 31, 2002, CCBM has spent approximately $2,245,000 of the $5,000,000 work commitment on the drilling of 22 wells at Clearmont, 4 wells at Oyster Ridge, 1 well at Arvada, and has funded $225,000 of the drilling conducted by SENGAI in Montana as part of the Quaneco agreement. Amounts remaining out of the $5,000,000 will be used for drilling during the remainder of fiscal 2002 and on into fiscal year 2003, or applied to property acquisitions, as agreed upon by the parties. If less than the entire $5,000,000 is spent within two years (subject to extensions due to force majeure), CCBM shall pay RMG one-half the unspent portion of the $5,000,000. However, this payment obligation back to RMG is subject to RMG complying with all of the terms and provisions of thesee "Carrizo - Purchase and Sale Agreement,Agreement" in the joint operating agreement, andAnnual Report (Form 10-K/A1) for the procedures therein set forth regarding authorizations for expenditures to drill $5,000,000 worth of "reasonable wells." This means wells which meet these economic criteria: (1) individual well cost (including hook-up to sales) must meet a projected internal rate of return in excess of 15% at prevailing market prices; (2) the wells must be on acreage blocks that are touching and contain minimum sizes (Kirby prospect, at least 2,560 acres; Clearmont, at least 640 acres; and Arvada, at least 480 acres); and (3) no more than 10 wells per calendarformer fiscal year at Oyster Ridge will qualify as reasonable. The intent is for CCBM to spend $2,500,000 on behalf of RMG on drilling and completing "reasonable wells." If CCBM fails to do this despite a total of $5,000,000 of reasonable well 11 proposals by RMG, then CCBM shall be obligated to pay any remaining unspent portion of the $2,500,000 directly to RMG.ended May 31, 2002. In addition to its one-half share of revenues in proportion to its one-half share of the working interest, CCBM will bewas entitled to a credit (applied as a prepayment of the purchase price for the undivided 50% interest in RMG's acreage), equal to 20% of RMG's net revenue interest from wells drilled with the $5,000,000 drilling budget, until the amount of that credit in favor of CCBM equals $1,250,000. At the formation of Pinnacle, CCBM paid RMG approximately $1.8 million to complete is the designated operator under a Joint Operating Agreement between RMG and CCBM, which governs all operationspurchase value on the properties subjectcontracts properties. The payment of $1.8 million was a reduction to the Purchase and Sale Agreement between RMG andprincipal on the original $7.5 million note from CCBM. The $1.25 million that CCBM subjectwas to pre-existing JOA's with other entities, and operations orrecover from 20% of RMG's revenue interest on the contributed properties inwas netted against the area of mutual interest ("AMI"). The AMI four-year term ends June 30, 2005. It covers the entire state of Wyoming, and the Powder River Basin of Montana, but will be reduced if CCBM does not obtain at least $20 million for future property acquisitions (see below). A management committee oversees all operations subject to the Purchase and Sale Agreement, with two members each from CCBM and RMG, however, RMG shall have a tie-breaking vote until the $5,000,000 drilling commitment has been expended and until thetotal purchase price has been paid. Onceon the $5,000,000 drilling commitment has been expended andcontributed properties which yielded the full purchase price$1.8 million cash payment. CCBM is paid, RMG will allocate (with Quaneco's consent) to CCBM one of RMG's managing member positions with Powder River Gas LLC, which is the operative entity for the Montana acreage RMG holds with Quaneco L.L.C. With respect to the Castle Rock prospect in Montana, which was subject to the agreement with SENGAI, RMG wasnot entitled to have CCBM pay for $225,000 of RMG's drilling obligations; for this funding (part of the $5,000,000 drilling program with CCBM), CCBM received an undivided 6.25% working interest on each well so drilled and the 80 acre spacing allocated to each such well, i.e. one-half of our 12.5% working interest, during the SENGAI drilling program. CCBM made the $225,000 payment to RMG on March 26, 2002, and RMG has subsequently paid SENGAI that amount to fulfill its obligations to SENGAI and Quaneco. See "Quaneco - Agreement" and "SENGAI - Option and Farmin Agreement." Under the Purchase and Sale Agreement with CCBM, CCBM will use its best efforts to obtain financing to raise no less than $20,000,000 to be used by RMG to acquire more properties in the AMI. CCBM would have a 50% working interest in properties so acquired. If CCBM's efforts were not successful by June 30, 2002, the AMI was to be reduced to a 6-mile radius from all existing properties held jointly by RMG and CCBM unless RMG agreed to an extension of this time frame. RMG has extended the time frame for CCBM raising the funds, to June 30, 2003.any additional disproportionate revenue distributions. QUANECO - AGREEMENT. On January 3, 2000, RMG purchased a 50% working interest and 40% net revenue interest in the Castle Rock and Kirby prospects in the Powder River Basin of southeast Montana consisting of approximately 185,000 net mineral acres from Quaneco, L.L.C. (formerly Quantum Energy, L.L.C., Cleveland, Ohio and Oklahoma City, Oklahoma). The acreage includes 88,41088,409 net acres of Bureau of Land Management ("BLM") land,land; 14,916 net acres of state land (Montana), and 82,775 net acres of fee land. -19- In fiscal 2000 and 2001, RMG paid Quaneco the cash purchase price of $5,500,000 for the acreage. A separate provisionacreage plus a drilling commitment of $2,500,000. RMG and CCBM transferred their interests in the Kirby prospect to Pinnacle in mid-2003. For information on the Quaneco agreement, required RMG to spend $2,500,000 to drill and complete 25 wells. Under the subsequent Option and Farmin Agreement with SENGAI, SENGAI paid $2,000,000 in their first drilling program on this prospect, and RMG paid $250,000. Of this amount, $225,000 was paid to RMG by CCBM and subsequently paid over to SENGAI, leaving RMG with a net obligation of $25,000, which was paid. RMG had previously performed work and paid costs for a credit of approximately $250,000 on the Castle Rock and Kirby prospects. All of RMG's drilling obligations to Quaneco therefore have been fulfilled. 12 The Kirby prospect, owned originally by RMG and Quaneco, and now CCBM as well, is operated through Powder River Gas, LLC, a Wyoming limited liability company. Initial CBM well sites have been selected by the management committee in which Quaneco and RMG currently have equal representation. USECC has the right to provide drilling services on the first 25 wells drilled by Powder River Gas, LLC based on competitive drilling ratessee "Quaneco Agreement" in the area surrounding the wells to be drilled. Thereafter, USECC will have the right to submit bids on a competitive basis to Powder River Gas LLC for drilling contracts on additional acreage. CCBM has recently acquired 50% of RMG's interest in the Kirby prospects leaving ownership interest at 25% RMG, 25% CCBM, and 50% Quaneco. SENGAI - OPTION AND FARMIN AGREEMENT. On February 8, 2001, RMG closed an Option and Farmin Agreement with Suncor Energy Natural Gas America, Inc. ("SENGAI"). SENGAI had an option on two blocks of acreage covering 111,566 net acres in southeast Montana; the option on the second block of acreage was contingent upon SENGAI exercising its option on the first block of acreage. The option on the first block of acreage expired on February 8, 2002 without exercise. Under the Option and Farmin Agreement, SENGAI committed to pay for all costs up to $2,000,000 in a $2,250,000 drilling program on the first block of acreage, starting in the fall of 2001. RMG had to pay the remaining $250,000Annual Report (Form 10-K/A1) for the drilling program (on its behalf and for Quaneco LLC, which completes RMG's drilling commitment to Quaneco; see below). SENGAI had to complete the drilling program regardless of whether it exercised the options. SENGAI completed this program in the fall of 2001. As the first option was not exercised, all of the work paid for under the drilling program will benefit RMG (and now CCBM and Quaneco in their respective working interests), and SENGAI has no rights in the Castle Rock prospect or in any wells drilled on it. The SENGAI drilling program neither established CBM reserves or condemned the drilled acreage as unproductive. RMG believes that SENGAI declined to exercise the option based on SENGAI's evaluation of incomplete data generated by SENGAI's drilling program, which SENGAI designed and executed. When SENGAI drilled the 19 exploratory wells under its option on the Castle Rock prospect, SENGAI did not utilize the best available procedures to detect possible CBM content. In addition, 6 of the wells were drilled in a pod configuration but 5 of the 6 were drilled into separate coal seams, even though efficient dewatering requires multiple close-spaced wells into the same coal. Eleven of the other SENGAI-drilled wells confirmed the presence of coal at the depths originally estimated by RMG, but otherwise insufficient data was generated by the drilling and testing of these 11 wells to determine if the coal might be productive of CBM. RMG, Quaneco and SENGAI have signed a Project Completion Agreement, whereby Powder River Gas L.L.C. (an operating company owned equally by RMG and Quaneco) will become the operator of record for the Castle Rock properties and SENGAI's working interest will revert to 0% in the project. In addition, RMG has elected to accept a 93.75% working interest in (and RMG will operate) 8 completed wells in the Castle Rock area. CCBM has a 6.25% working interest in these 8 wells. Although the data on the 8 wells to be retained by RMG is incomplete (which wells were drilled by SENGAI), RMG will further evaluate the data. If the results are favorable, RMG will start dewatering these wells and establish a pod grid to drill and complete and start dewatering more wells around each existing well to maximize dewatering efficiency. As with any CBM project, a substantial amount of dewatering of pods of wells into the same coal is necessary before the economics of the wells can be assessed. We have not prepared a budget or timetable for this future work but expect to do so by March(former) fiscal year ended May 31, 2003. This future work would start in spring 2003, subject to having the necessary funds on hand. 13 2002. DESCRIPTION OF PROSPECTS Leases of federal mineral rights are obtained from the United States Bureau of Land Management and expire from 2004 to 2009, unless RMG establishes production on the lease, in which event the lease is held so long as coalbed methane or other gas or oil is produced. A royalty interest of 12.5% on the production is paid to the BLM. State leases expire from 20032004 to 20042009 in Wyoming and Montana, unless RMG establishes production on the lease, in which event the lease is held so long as coalbed methane or other gas or oil is produced. The royalty paid to the State of Wyoming is from 12.5 % to 16.67%, and 12.5% to the State of Montana. Annual renewal fees for non-producing Federal leases is $1.50 to $2.00 per acre, and $1.00 and $1.50$2.75 for non-producing Wyoming and Montana leases. An environmental group has filed a lawsuit against the BLM, RMG and others, challenging the validity of numerous BLM leases in the Powder River Basin of Montana. See Item 3, Legal Proceedings ("Rocky Mountain Gas Litigation"). Leases on private (fee) land for coalbed methane and conventional gas expire at various times from 20032004 to 2011, unless production is established, in which event the lease is held so long as there is production. The landowner is paid a royalty from production of 12.5% to 20.0% , depending on the lease terms. Table 3 ROCKY MOUNTAIN GAS, INC.presents total acreage (developed and undeveloped) held by RMG at December 31, 2003, and the Hi-Pro acreage as of the filing date of this Annual Report. TABLE 3
- ---------------------------------------------------------------------------------------------------------------------- Gross LeasedNet Net Net Net Leased Leased Leased Gross Net Leased Netfrom from from Leased Net Leased Net Leasedfrom State of State of Private Prospect Acres Acres from BLM from State of from State of from Private Wyoming Montana Owners - ----------------------------------------------------------------------------------------------------------------------------- ------- -------- ------- ------- ------ Castle Rock 123,840 111,567 55,104 0 10,860 45,603 Kirby 80,254 74,512 33,305 0 4,056 37,151 Oyster Ridge* 21,536 21,53620,306 20,306 17,107 1,229639 0 3,200 Clearmont 6,305 3,745 0 640 0 3,105 Sussex 640 640 0 640 0 0 Finley 160 160 0 160 0 02,560 Baggs North 120 120 0 120 0 0 Gillette North 80 80Hi-Pro (undeveloped) 40,120 40,120 0 80112 0 40,008 ------- ------- ------ ----- ------ ------ Total Undeveloped Acres 184,386 172,113 72,211 871 10,860 88,171 Hi-Pro (developed) 12,620 11,818 460 280 0 Arvada 1,900 1,700 1,200 0 0 500 - ---------------------------------------------------------------------------------------------------------------------- Bobcat 1,940 1,940 0 0 0 1,940 - ----------------------------------------------------------------------------------------------------------------------11,078 ------- ------- ------ ----- ------ ------ Total Acres 197,006 183,931 72,671 1,151 10,860 99,249 ======= ======= ====== ===== ====== ======
*Does not include 43,71129,151 acres under option from Anadarko Petroleum.Petroleum and 38,184 acres under option from Kerr McGee. See "Description of Properties - Oyster Ridge." -20- RMG's properties and mineral leases of BLM, state and fee lands require annual cash payments of approximately $173,100 during 2004. CCBM is obligated for $59,600 of the $173,100 required to keep undeveloped coalbed methane leases in effect. CASTLE ROCK: The Castle Rock project consists of 123,840 gross and 111,567 net acres located in the northeastern portion of the Powder River Basin of Montana, west of Broadus, Montana. Coals present are in the Tongue River member of the Fort Union formation and appear comparable to coals currently being developed by other operators south of the Castle Rock acreage near the Montana/Wyoming border. Currently, there are no pipelines in this area. The federal leases generally have 10-year terms and fee and state leases generally have two to five year terms. 14 KIRBY: The Kirby project consists of 80,254 gross and 74,512 net acres located in the northwestern portion of the Powder River Basin in Montana located in Big Horn and Rosebud Counties, Montana, north of Sheridan, Wyoming. Coals are in the lower portion of the tertiary Fort Union formation and are similar to productive coals in the Wyoming portion of the Powder River Basin to the south. Redstone (recently acquired by Montana Dakota Utilities) has established significant coalbed methane production 12 miles south of Kirby at the CX field. At least two other operators are currently planning to drill and develop nearby acreage. CMS's Bighorn Gas Gathering recently extended a new 20" pipeline to within 10 miles of the Kirby project. Three exploration wells are currently scheduled to be drilled at Kirby during the summer of 2002. OYSTER RIDGE: The Oyster Ridge project consists of 65,247two acreage positions: (1) 49,457 gross and net acres located in southwestern Wyoming in the Ham's Fork Coal Field adjacent to the Green River Basin.Basin; RMG and CCBM have a 100% working interest (50% each) in 21,53620,765 acres within this play, which is held with Anadarko Petroleum, Inc. Oyster Ridge; and (2) 38,184 gross and net acres held by Kerr-McGee Rocky Mountain Corporation, which are at the north and south ends of the Anadarko acreage. The area is prospective for coalbed methane production from two primary Cretaceous age coals, the Frontier and the Adaville. The Kern River pipeline, which services southern California, crosses the property. Through December 31, 2003, $799,500 has been spent on drilling and completion at Oyster Ridge. (1) Anadarko Petroleum, Inc. is successor to Union Pacific Land Resources Corporation, which sold the acreage subject to UPLRC's back inback-in option to third parties, from whom RMG acquired the acreage in December 1999. The agreement with Anadarko is a drill-to-earn-acreage agreement: weWe must drill at least four wells each year, each on a new section (640 acres), to earn a lease on each drilled section, , and also to keep in force previously earned leases in the 43,71131,711 acres areas.area. Wells drilled by our seller, and by us (with CCBM), have earned 3,2002,560 acres, which are included in the 21,53620,306 acres leased presently. As of March 31, 2002, we have met our drilling obligations forAnother 29,151 gross acres in the year ended March 31, 2002. Under the terms of the agreement, we must drill 4 additional wells by March 31, 2003 to keep our agreement in force. RMG expects to meet this drilling commitment. Within this prospect, 43,711 gross acresOyster Ridge project are subject to an option held by Anadarko Petroleum, Inc. to participate as a 25% working interest owner on all wells drilled each year. Anadarko has not yet elected to participate, and has no working interest in the seven wells drilled to date on this prospect. If Anadarko elects to participate in the future, working interest ownership in affected wells would be of 37.5% RMG, 37.5% CCBM, and 25% Anadarko. (2) Effective March 31, 2004, RMG signed a letter of intent to enter into an earn-in agreement to acquire a 60% working interest from Kerr-McGee Rocky Mountain Corporation ("KM") in 38,184 gross and net mineral acres held by KM under federal and Wyoming state leases. When executed, the earn-in agreement will be for a total of six years, with three phases: drilling commitment, pilot program, and development program. The areaearn-in agreement is prospectiveexpected to be executed by March 31, 2004. The following is a summary of terms. Drilling Commitment. On or before September 30, 2004, RMG will drill, complete and attempt to produce for at least 30 days (at its sole expense) two coalbed methane production from two primary Cretaceous age coals,wells (one to the Frontier coal seams and one to the Adaville. The Kern River pipeline, which services southern California, crossesAdaville Cretaceous coal seams), to earn 60% of KM's working and net revenue interest in the property. Exploratory640 acre section surrounding each well, down to the deepest depth drilled. Drilling and completion costs for the two wells will be a minimum of $300,000. RMG will receive all production revenues from each well until RMG reaches payout (total drilling and completion operationscosts) from the wells, at which time KM will begin to participate for its 40% working interest. KM's leases will be delivered to RMG with a 82.5% net revenue interest. -21- Pilot Program. If RMG determines the drilling program results to be favorable, in its exclusive judgment, a pilot program for four wells (at RMG's sole expense) will be initiated by September 30, 2005. Development Program. If RMG determines the pilot program results to be favorable, in its exclusive judgment, RMG will notify KM by December 31, 2005 of its election to commit to a development program. If this commitment is made, RMG shall drill at least 10 wells per year on previously drilled wells resumed at Oyster RidgeKM lands beginning in June, 2001. To date, $621,128 has been spent on 7 exploratory wells. CLEARMONT: The Clearmont project consists of approximately 6,305 gross and 3,745 net acres located2006. Each well will earn for RMG a 60% working interest in the western Powder River Basin of Wyoming.640 acre section surrounding the well, and each lease will be delivered to RMG (and now CCBM jointly) ownswith a 82.5% net revenue interest. KM may elect to participate for a 40% working interests ranging from 25%interest in any development well. If KM elects not to 100%. The area is characterized by several shallow Fort Union coalbeds (most notable the Roland and Anderson coals) as well as several deeper coals that hold significant exploration potential. Substantial coalbed methane production and development is ongoingparticipate in the immediate area including Federated's Box Elder Creek project 12 miles tofirst well in the west and the Penneco/CMS Wild Horse Creek project 15 miles to the east. The Clearmont project is located at the convergence of the WBI Bitter Creek and the Bighorn Sheridan Lateral pipelines. An exploration drilling program began at Clearmont in August 2001 and could be in production in 2002 or early 2003 depending on drilling results and gas prices. To date, $2,247,000 has been spent on drilling and infrastructure at Clearmont. Nineteen of the existing 31 wells at Clearmont have been on full-scale dewatering since June 2002. These 19 wells are hooked up to a gas gathering system but no gassection, KM will be solddeemed to relinquish the 40% working (and associated net revenue) interest in the well until the compressor is set up (see below). The remaining 12 wells will start dewatering and be hooked upRMG reaches payout. If KM elects not to a gas gathering system in 15 2003. In addition, another 16 wells will be drilled and completed and put on dewater pumps; it is expected that this added 16 well project will be started in September 2002. We expect to have sufficient data to evaluate the economics of Clearmontparticipate in the second or third calendar quarter 2003. During 2003,well in any section previously earned by RMG, expects to begin selling gas produced fromthen KM shall have relinquished all of its interest in the Clearmont wells to CMS Field Services, Inc. pursuant to a gas purchase contract. However, production could be delayed if dewatering hasn't progressed sufficiently to allow production of commercial amounts of gas. In the third calendar quarter 2002,entire section. RMG will complete construction of a field gathering system (for delivery and initial compressionbe the operator for each stage of the gas)KM project. As of the filing date of this Annual Report, CCBM has not determined whether to Bighorn Gas Gathering, LLC. Bighorn has signed a gas gathering agreementparticipate with RMG to deliver gas collected from RMG's system to CMS, and Bighorn expects to have its system built from Clearmont to a gas transmission pipelineus in the fourth calendar quarter 2002. SUSSEX: RMG andKerr-McGee earn-in agreement. However, our net acreage calculations assume that CCBM hold 640 gross and net acres in this project area located in Johnson County, Wyoming. This State lease lies 3 miles south of Sussex, Wyoming. RMG has a 100% working interest. To date, RMG has not conducted any significant exploration on the property. FINLEY: RMG and CCBM hold 160 gross and net acres in this project area located in Converse County, Wyoming. This prospect is a State lease 12 miles east of Edgerton, Wyoming. Review for a two well test is underway. To date, RMG has not conducted any significant exploration on the property.will participate. BAGGS NORTH: This prospect contains 120 gross and net acres located in Carbon County, Wyoming. This State lease is located 7 miles north of Baggs, Wyoming. RMG and CCBM holdholds a 100%50% working interest in this prospect. To date, RMG has not conducted any significant exploration on the property. GILLETTE NORTH: RMG and CCBM holds a 100% working interest in 80 gross and net acres in this project area located in Campbell County, Wyoming. This State lease lies at the north end of the City of Gillette. Existing coalbed methane wells lay in the section immediately north. Permitting of two wells has begun on RMG's property. RMG intends to conduct test drilling and production techniques in this area which lies in the heart of the current coalbed methane play in the Gillette area. To date, RMG has not conducted any significant exploration on the property. ARVADA: This prospect contains 1,900 gross acres, 1,700 net acres, located in Sheridan County, Wyoming. RMG and CCBM hold a 100% working interest, and a 62% to 81.5% net revenue interest. To date, RMG and CCBM have spent $64,428 on the drilling of one 1,471' deep test well and are analyzing the drilling results. Subject to good results from further exploratory drilling, RMG anticipates constructing a field gathering system on the Arvada property in mid-calendar 2003 and begin production sales in the third calendar quarter 2003. Gas gathering and production sales are covered by agreements with Bighorn Gas Gathering, LLC and CMS Field Services, Inc. COALBED METHANE WELL PERMITTING. Drilling coalbed methane wells requires obtaining permits from various governmental agencies. The ease of obtaining the necessary permits depends on the type of mineral ownership and the state in which the property is located. Intermittent delays in the permitting process can reasonably be expected throughout the development of any play. For example, there is currently a temporary moratorium for drilling coalbed methane wells on fee and state lands in Montana. We may shift our exploration and development strategy as needed to accommodate the permitting process. As with all governmental permit processes, there is no assurance that permits will be issued in a timely fashion or in a form consistent with our plan of operations. The Northern Plains Resource Council, Inc. ("NPRC") settled its suit against the Montana Board of Oil and Gas Conservation (Board) in which the NPRC requested an order of the court compelling the 16 defendant to prepare a Draft Environmental Impact Statement ("EIS") and amendment of the Powder River and Billings Resource Management Plans for coalbed methane development. The Board agreed to limit issuance of CBM well permits to 200 (of which RMG received 79) pending completion of the draft EIS, which was completed in the summer of 2002. A record of decision is expected in December 2002 or early 2003. The Wyoming Department of Environmental Quality Supplemental Environmental Impact Statement (SEIS) for the Powder River Basin in Wyoming, issued in the fall of 1999, allowed the permitting of 5,000 CBM wells to be drilled on Federal lands in Wyoming. More CBM well applications have been submitted causing the BLM to begin a second EIS for the Powder River Basin Area in Wyoming. The new draft EIS was completed in the summer of 2002. Exploration and development on Federal lands in Wyoming has been stopped with the balance of the Wyoming Department of Environmental Quality EIS permitted wells (4,000) occurring on fee and state lands. The BLM completed an environmental assessment ("EA") in March 2001, reviewing drainage issues, which could allow an additional 1,500 new CBM well permits in the Gillette region of the Powder River Basin. The EIS may impact RMG's operations, as the Arvada prospect is within the affected area, and we expect to begin applying for permits in these prospects in late 2002. A record of decision is expected in December 2002 or early 2003. In addition, the Wyoming and Montana Departments of Environmental Quality have regulations applying to the surface disposal of water produced from CBM drilling operations. CBM operators are currently seeking changes in permit requirements and department policy that would allow operators more flexibility to discharge water on the surface. If these changes are not made, it may be necessary to install and operate treatment facilities or drill disposal wells to reinject the produced water back into the underground rock formations adjacent to the coal seams or lower sandstone horizons. If we cannot obtain the appropriate permits or if applicable laws or regulations require water to be disposed of in an alternative manner, the costs to dispose produced water will likely increase. These costs could have a material effect on operations in this area, including potentially rendering future exploration, development and production in the affected areas uneconomic. RMG has received an Environmental Assessment and Finding of No Significant Impact to drill up to 56 shallow gas sand wells. These wells are located on Federal land held with Quaneco and would be converted to production status upon receiving approval from the Montana Board of Oil and Gas. These wells would evaluate potential CBM production as well as conventional gas. Regarding other acreage held with Quaneco in Montana, the State of Montana may lift its moratorium for CBM wells on private and state ground in Montana, and start issuing new permits on these lands in summer 2002 (a voluntary moratorium is currently in place for wells on private and state ground in Montana). We have not determined to what extent we will participate in this procedure, and are evaluating how best to protect our position to have reasonable exploration for CBM wells proceed on state and fee ground. We have permits in place in order to conduct exploration in expectation that commercial production will be approved on completion of the EIS. In August 2001, Montana and Wyoming announced an agreement for water quality officials in both states to coordinate monitoring of water flows in the Powder River and Little Powder River drainages, to determine the impact of coalbed methane well water production on river water. Although usually well water is drinkable, it may contain high sodium absorption ratios, which can impair use of the water for irrigation purposes in clay-based soils. The respective agencies will propose regulations to establish thresholds for potential pollutants and require strict monitoring by local water quality officials. If test results indicate some well water flows adversely impact river water quality, operators could be required to put the water flow into holding ponds or take other steps to eliminate or reduce water flows or pollutants in the water. Implementation of the agreement may benefit continued coalbed methane exploration in these areas by opening up the water discharge permitting process in the affected areas, as water testing is completed in phases 17 on prospects within the affected drainage areas. Currently, we don't have acreage that would be impacted by these regulations but future acreage could be acquired in the affected areas. The following summarizes permits now in place. Table 4 - -------------------------------------------------------------------------------- Expiration Prospect Remaining Permits or Renewal Date - -------------------------------------------------------------------------------- Castle Rock 15 04/17/2003 and 10/17/2002 - -------------------------------------------------------------------------------- Kirby 6 01/01/03 - -------------------------------------------------------------------------------- 07/31/2002; 08/30/2002; 09/26/2002; 10/24/2002; Clearmont 59 11/01/002; 11/02/2002; 02/04/2003, 03/15/2003; 07/31/03 and 08/30/03 - -------------------------------------------------------------------------------- Arvada 3 11/12/2002 - -------------------------------------------------------------------------------- Bobcat 30 12/02/02 - -------------------------------------------------------------------------------- Total 113 - -------------------------------------------------------------------------------- Drilling permits issued by the State of Wyoming allow one year for drilling completion; permits issued by the State of Montana allow six months. Expired permits for undrilled locations are usually renewed by the agencies without difficulty. Once drilled, all wells in the Clearmont and Arvada prospects remain (and future wells in Wyoming will be) subject to a National Pollution Discharge Elimination System ("NPDES") permit relating to water testing and discharge. All wells in the Castle Rock and Kirby prospects remain subject to the Montana Board of Oil and Gas Commission approval. Upon completion of drilling, wells are subject to monthly reporting regarding status and production to the respective state agencies in which they are located. GATHERING AND TRANSMISSION OF CBM GAS Companies involved in CBM production generally outsource their gas gathering, compression and transmission. We intend to outsource compression and gathering needs as well, possibly on a competitive basis with transmission companies in the immediate area. Negotiations with various transmission companies have been initiated in order to better manage future capital investment. To date, we have a gas gathering agreement and a separate gas purchase contract for the Clearmont and Arvada properties (see above). Coalbed methane production growth in the Powder River Basin has historically been impeded by a shortage of gathering system capacity and transport capacity out of the Basin. However, two large diameter gathering pipelines were completed in September 1999 and a third was ready for service in early 2000. The two completed pipelines provide an additional 900 million cubic feet (MMcf), of daily gas capacity as set forth below: Fort Union Gas Gathering, LLC's 106-mile, 24" gathering pipeline, commenced operations September 1, 1999, with an initial capacity of 450 MMcf per day; and Thunder Creek Gas Services, LLC's 126-mile, 24" gathering pipeline, commenced operations September 1, 1999, with an initial capacity of 450 MMcf per day. Additionally, CMS Energy's 110-mile, Big Horn Gas Gathering pipeline, that connects to the northern terminus of the Fort Union pipeline, is continuing to be expanded in length and has an initial capacity of 256 18 MMcf per day which can readily be upgraded to 500 MMcf per day with the addition of booster compression. Further, on June 19, 2000, Big Horn Gas Gathering announced the extension of its pipeline to serve producers in the Sheridan area. This 50+ mile extension will place a 20" high pressure pipeline within 5 miles of the Montana border and within close proximity to the development planned by RMG, CCBM, and Quaneco on their Kirby Prospect area. Wyoming Interstate Gas Company's 143-mile, 24" Medicine Bow Lateral pipeline commenced operations in November 1999 with an initial capacity of 260 MMcf per day. This pipeline will transport natural gas from the Thunder Creek and Fort Union pipelines at the south end of the Powder River Basin to interconnect with multiple interstate pipelines accessing markets to the east and along the front range of Colorado. This system is already being expanded as demand for transportation space grows. Further transmission lines are being planned by other companies in the area. Wyoming operators have been realizing lower than expected prices for gas produced in the Powder River Basin, due in part to seasonal/supply factors, but more significantly due to a bottleneck in take away capacity. There is now ample capacity to move gas from CBM fields within the PRB but limited interstate movement capacity from the PRB to the major markets on the coasts and in the midwest, which results in a negative price differential. The newly announced Grasslands Pipeline (to be constructed to move gas to midwest and northern markets) and the additional looping (now under construction) of the Kern River Pipeline, will add 1,000 MMcf daily PRB take away capacity when completed by the end of 2003, and should reduce the negative price differential. For August, 2002, RMG received an average price of $1.33 per Mcf (1,000 cubic feet) of gas produced from the Bobcat field (its only producing field at September 2002), with prices ranging from $0.83 to $1.79 per Mcf. This represents a negative price differential of approximately 60% compared to the average price of approximately $3.30 per Mcf received by producers nationwide. While increased pipeline capacity planned or under construction is expected to reduce this negative price differential by the end of 2003, there is no guarantee that the increase will eliminate the negative price differential or even significantly reduce it. Continued low prices would impair our ability to raise capital for RMG and reduce revenues from production coming on line. GENERAL INFORMATION ABOUT COALBED METHANE. Methane is the primary commercial component of natural gas produced from conventional gas wells. Methane also exists in its natural state in coal seams. Natural gas produced from conventional wells generally contains other hydrocarbons in varying amounts which require the natural gas to be processed. Methane gas produced from coalbeds generally contains only methane and is pipeline-quality gas after simple water dehydration. Coalbed methane ("CBM") production is similar to conventional natural gas production in terms of the physical producing facilities. However, the subsurface mechanisms that allow gas movement to the wellbore are very different. Conventional natural gas wells require a porous and permeable reservoir, hydrocarbon migration and a natural structural or stratigraphic trap. Coalbed methane is stored in four ways: 1) as free gas is trapped (adsorbed)within the micropores (pores with a diameter of less than .0025 inch) and cleats (set of natural fractures in the coal; 2) as dissolved gas in water within the coal; 3) as absorbed gas held by molecular attraction on surfaces of macerals (organic constituents that comprise the coal itselfmass), micropores, and cleats in the water contained incoal; and 4) as absorbed gas within the pore space, untilmolecular structure of the coal molecules. Coals at shallower depth with good cleat development contain significant amounts of free and dissolved gas while the percentage of absorbed methane generally increases with increasing pressure (depth) and coal rank. Coalbed methane gas is released by pressure changes when the water in the coal is removed. In contrast to conventional gas wells, new coalbed methane wells initially produce water for several months. As the formation water pressure decreases, methane gas is released from the structure. -22- Methane production is a direct result of reducing the hydrostatic (water) pressure in the coal formation. Three principal stages are involved: 19 oX Drill wells (typically eight or more in a 'pod') down to the same coal formation, in contiguous 80 acre spacing per well; test the water in the formation and test coal samples taken from the formation. Water testing determines if the geochemical environment of the coal seam wasis conducive to the formation of CBM. oX Install gathering lines to hook up and put wells on pump to 'dewater'"dewater" the coal formation. Hydrostatic pressure must be reduced to about 50% of initial pressure before enough data is obtained (water flow rates, CBM gas flows) to determine how much CBM the wells may produce. This dewatering stage may take 6 to 18 months, and in some instances 24 months (where there is no dewatering of the coal seam occurring from wells drilled by others on adjacent properties). oX Installing (or have a transmission company install) a compressor and transport line to carry produced gas to a gas transmission line for sale to end users. Gas production starts gradually then continues to grow in volume as hydrostatic pressure is reduced; optimal production won't occur until hydrostatic pressure is reduced approximately 90% from initial levels. COALBED METHANE WELL PERMITTING Operators drilling for coalbed methane are subject to many rules and regulations and must obtain drilling, water discharge and other permits from various governmental agencies depending on the type of mineral ownership and location of the property. Intermittent delays in the permitting process can reasonably be expected throughout the development of all RMG projects. As with all governmental permit processes, there is no assurance that permits will be issued in a timely fashion or in a form consistent with the plan of operations. Drilling and production operations on our Powder River Basin leases in Wyoming and Montana are subject to environmental rules, requirements and permits issued by various federal authorities for drilling and operating on all land, regardless of ownership, and state and local regulatory agencies for land owned by the state or in fee by private interests. The primary Federal agency with related responsibilities is the Bureau of Land Management of the U.S. Department of the Interior ("BLM") which has imposed environmental limitations and conditions on coalbed methane drilling, production and related construction activities on federal leases in the PRB. These conditions and requirements are imposed through Records of Decision ("ROD") issued pursuant to Environmental Impact Statements ("EIS"). The BLM may also impose site-specific conditions on development activities, such as drilling and the construction of rights-of-way, before it approves required applications for permits to drill and plans of development. In April 2003 the BLM issued Records of Decision finalizing two impact statements: The Powder River Basin Oil and Gas EIS (PRB-EIS) for the Wyoming portion of the basin, and the Statewide Oil and Gas EIS and Proposed Amendment for the Powder River and Billings Resource Management Plans in Montana. Together, the impact statements authorize the development of some 77,000 coalbed methane gas wells in the Powder River Basin, most of which would be drilled on the Wyoming side of the basin. With the EIS completed, the BLM will be able to consider drilling or development proposals in the geographic areas studied, however, before any permits are approved, the BLM will conduct an additional round of environmental review to identify site-specific environmental impacts and appropriate mitigation measures. Three lawsuits have been filed challenging the Record of Decisions, however, no stays have been issued. (See I.3. Legal Proceedings, Rocky Mountain Gas, Inc.) -23- The state-based environmental agencies primarily concern themselves with the issuance of permits related to drilling, land, air quality and water discharge. The primary state-based agencies for which coalbed methane operators are subject to include: X Wyoming Department of Environmental Quality ("WDEQ") X Wyoming Oil and Gas Conservation Commission ("WOGCC") X Montana Department of Environmental Quality ("MDEQ") X Montana Board of Oil and Gas Conservation ("MBOGC") While the BLM is primarily responsible for issuing broadly based EISs for each state, its jurisdiction over related matters and the actual issuance of drilling permits is primarily reserved for federal leases. Permits for drilling on state or fee owned land are issued by the WOGCC and MBOGC. In contrast to Wyoming, Montana authorities have been very slow in undertaking CBM environmental studies and granting permits to drill wells. In fact, to date, only the Redstone (Fidelity) project is producing CBM gas in Montana. With the exception of a relatively small number of drilling permits available from earlier issuance (including those held by RMG which have allowed some drilling on the Castle Rock project), a drilling moratorium had been in effect during the last three years, prior to the approval of the two environmental impact statements. The DEQs are primarily responsible for issuing air quality and water discharge permits, among other things. Water disposal has been and is expected to continue to be a significant issue, particularly with respect to coalbed methane gas production, which typically entails substantial water production at least during the dewatering phase of completion of a new well. The primary issue of concern is the salinity content in the produced water, which is measured by the sodium absorption ratio ("SAR"), which, depending upon a location, can range from slightly less than that in surface water to a substantially greater amount. Due to the discrepancies of the SAR content found in water from coalbed methane wells, the disposal of this water is tightly regulated. If the SAR content is low, the water can be used for irrigation, livestock drinking water or even as a water supply for cities. If the SAR content is higher, the water quality does not merit use for drinking water or irrigation and, under these measures, the DEQ has outlined various other methods of water disposal. Man-made ponds may also be built right beside the wells, enabling the wells to drain their water into the ponds (called surface discharge). Additionally, there might be drainages which the produced water can flow into. Finally, the water might be reinjected through wells into the ground below levels from which the water was produced. Thus far, the vast majority of associated water produced has been discharged on the surface, primarily captured in reservoirs and ponds and allowed to evaporate. Overall, RMG has not experienced any difficulty in obtaining air quality and water discharge permits from the WDEQ, and those permits are in place for the Hi-Pro properties. RMG has not has applied for such permits in Montana. The following summarizes permits now in place. -24- Table 4 Expiration Prospect Remaining Permits or Renewal Date -------- ------------------ ----------------- Castle Rock 5 May - July 2004 Hi-Pro 9 August - September 2004 Oyster Ridge 4 September 2004 ------------------ Total 18 Drilling permits issued by the State of Wyoming allow one year for drilling completion; permits issued by the State of Montana allow six months. Once drilled, all wells in Wyoming are subject to a National Pollution Discharge Elimination System ("NPDES") permit relating to water testing and discharge. All wells in the Castle Rock prospect remain subject to the Montana Board of Oil and Gas Commission approval. Upon completion of drilling, wells are subject to monthly reporting regarding status and production to the respective state agencies in which they are located. Due to the low pressure characteristics of the coalbeds, the production of coalbed methane is dependent on the installation of multi-stage compression facilities. Gas is gathered from the wells, and transported to a low level compression station, then on to a high level compression station and finally to the transmission pipeline. The water is commonly collected through another pipeline from each of the wells and pumped into a surface reservoir. Companies involved in coalbed methane production generally outsource gas gathering, compression and transmission. RMG and industry partners have and will likely continue to outsource their compression and gathering to third parties at fixed charges per mcf transported. GAS MARKETS Gas production from the Powder River Basin is significant. Since this area is sparsely populated, most of the gas must be exported to distant markets. The existing Wyoming pipeline infrastructure is already substantial and continues to expand with gathering systems and intrastate lines, yet is ultimately dependent on large interstate pipelines. With the exception of a portion of the gathering systems, this pipeline system is typically owned and operated by independent mid-stream energy companies, rather than oil and gas operators. The pipelines generally will not be financed and constructed until appropriate amounts of gas have been proven and committed for transport on the new lines. While the total current take away capacity from the PRB is approximately 1.25 billion cubic feet per day (Bcfd), excess capacity over current production rates does not exist in all locations and not all producers have a ready market for the sale of their gas at all times. Some major producers in the region reserve portions of pipeline capacity beyond their current requirements, resulting in less than stated maximum capacity being available for other producers. In addition, total stated capacity is unavailable at times as pipelines are shut down for maintenance or construction activities. Based on the existing pipeline systems and the gas sales markets in its area of operations in Wyoming, RMG expects that, at least for the next few years, the markets in which it sells its gas, and the spot prices to which it will be subject, will be dependent upon three major sales points: X The Colorado Interstate Gas ("CIG") station near Cheyenne in southeastern Wyoming, which primarily feeds regional markets or markets in the Midwest. -25- X The Ventura market ("Ventura") located in Ventura, Iowa, which prices gas on the Northern Border pipeline where it interconnects with Northern Natural Gas and feeds markets in the Northern Plains and Midwest. X The Opal market ("Opal") in southwestern Wyoming, which delivers to the Kern River pipeline for delivery to Utah, Nevada, Arizona and California. PIPELINES THAT SERVE THE CIG MARKET Two large diameter intrastate pipelines, the Fort Union and the Thunder Creek, were constructed in the Basin in 1999, and gathering system infrastructure has continued to grow significantly. These two major intrastate pipelines currently provide almost 1.1 Bcfd capacity, flowing south out of the Basin to the CIG Hub in Southeast Wyoming. - Fort Union. The Fort Union Gas Gathering pipeline consists of a 106 ----------- mile,24 inch, 434 Mmcfd capacity line completed in August 1999 and a 20" pipeline with a capacity of 200 Mmcfd completed in September 2001. It is believed that capacity could be increased by another 200 Mmcfd by adding additional compression to this line. - Thunder Creek. Thunder Creek Gas Services pipeline is a 126-mile, 24 -------------- inch pipeline which commenced operations on September 1, 1999 with a capacity of 450 Mmcfd. The Hi-Pro production is delivered to the Thunder Creek pipeline where it is carried south and delivered to the CIG market. El Paso Corporation's subsidiary Cheyenne Plains Gas Pipeline Co. received approval from the Federal Energy Regulatory Commission in March 2004 for construction of a new 380 mile pipeline from Cheyenne, Wyoming to Greensburg, Kansas, with a capacity of 560 Mmcf per day. Cheyenne Plains has announced its intent to apply to the FERC for permission to enlarge the line to handle 760 Mmcf per day. This line, with the enlarged capacity, is expected by Cheyenne Plains to be in-service in January 2005, and may help narrow the negative price differential for CIG prices compared to national prices. PIPELINES THAT SERVE THE VENTURA MARKET There are currently only two significant pipelines capable of transporting gas out of the Basin to the north, the Bitter Creek pipeline, which connects with the Northern Border interstate pipeline and the Glasslands pipeline. However, one additional line that is well along in its planning stages, would also deliver gas to the Northern Border pipeline. Descriptions are as follows: X Bitter Creek. The Bitter Creek pipeline is owned by Williston Basin ------------- Interstate Pipeline Company ("WBI"), a subsidiary of MDU Resources Group, Inc. It was completed in 2001 with initial capacity of 150 Mmcfd. X Grasslands. In response to the need for expandable access to the ---------- Ventura market, the Grasslands pipeline, also owned by WBI, went into service in November 2003. It is a 245 mile, 16 inch line with an initial capacity of 80 Mmcfd and expandable to 200 Mmcfd. -26- THE OPAL MARKET The Opal market, in southwestern Wyoming, is a major pipeline connection point, with several intrastate and interstate lines connecting to the major interstate Kern River line (with a recently enlarged capacity of 1.73 Bcfd, delivering to markets in Utah, Nevada, Arizona and California. If the Oyster Ridge property is put into production, gas could be sold into this market. GAS PRICES Historically, spot gas prices received by producers at the Ventura, CIG and Opal markets have generally been at discounts to the NYMEX front month contract and Henry Hub spot cash prices, although with lesser discounts during the winter months. Prices at CIG can trade at a further discount to the Ventura prices, and again with an even higher discount during the second and third quarters, because CIG is partially based on local demand which can drop outside the heating season, while Ventura serves larger national markets and is highly correlated to Chicago market prices. The negative price differential in the prices realized by Powder River Basin producers in 2003, as compared to prices realized on the national gas market, ranged from 10% to 45% (higher outside the heating season). The negative price differential in the fourth quarter 2003 and first quarter 2004 narrowed in comparison to the fourth quarter 2002. However, there is no guarantee that increased capacity will eliminate the negative price differential or even significantly reduce it. INACTIVE MINING PROPERTIES - URANIUM GENERAL. We have interests in several uranium-bearing properties in Wyoming and Utah and in a uranium processing mill in southeastern Utah (the "Shootaring Mill" in Garfield County). All the uranium- bearinguranium-bearing properties are in areas which produced significant amounts of uranium in the 1970s and 1980s. At some future date, we could sell, develop andand/or operate these properties (directly or through a subsidiary company or a joint venture) with companies having the necessary capital to mine and mill the uranium bearing material to produce uranium concentrates ("U3O8") for sale to public utilities that operate nuclear powered electricity generating plants. However,Currently there is no operating uranium mill in Wyoming and it would take a substantial increase in the market price of uranium concentrate over a period of time before a company with the financial wherewithal would build a mill and place the deposits in production. Therefore, until uranium oxide prices improve significantly, all of the uranium properties are shut down, meaning work is performed to keep the mines from flooding and permitting work is done as needed (monitoring and reporting) to keep existing permits in effect. The uranium properties have beenwill remain shut down. Over a period of at least nine months, substantial and expensive work would be required to putAt the uranium properties into production, including cleaning rock and other debris from shafts and tunnels, pumping water out of the mines, extending the shafts and tunnels, and sampling to ascertain whether a commercially viable ore body exists on any of the properties. However, a decision to put the uranium properties into production will have to take into account the fact that presently uranium oxide prices are lower than mining and milling costs. These low prices are primarily due to ample supplies of uranium being produced by other companies from lower cost (and higher grade) deposits outside the United States, and also to stockpiles of uranium oxide being sold off by those producers. This low price situation has created conditions that have adversely impacted our ability to go into production. We cannot predict when uranium oxide prices might increase sufficiently to warrant putting our uranium properties into production. Such increases may not occur for several years, if at all. At May 31, 2002 and 2001 (the dates of the consolidated balance sheets in this report),Report, there are no values carried on the balance sheets for uranium properties. 20 SHEEP MOUNTAIN - WYOMING Unpatented lode mining claims, underground and open pit uranium mines and mining equipment in the Crooks Gap area are located on Sheep Mountain in Fremont County, Wyoming and are adjacent to and west of the GMMV mining claims.Wyoming. From December 21, 1988 to June 1, 1998, these properties were held by Sheep Mountain Partners ("SMP"). On June 1, 1998, the Company received back from SMP all of the Sheep Mountain mineral properties and equipment, in partial settlement of certain disputes with Nukem, Inc. ("Nukem") and its subsidiary Cycle Resource Investment Corp. ("CRIC"). The judgment against Nukem impressing the CIS uranium supply contracts in a constructive trust with SMP remains unresolved. See "Legal Proceedings." The Sheep Mountain Mines 1 and 2 were first operated by Western Nuclear, Inc., a subsidiary of Phelps Dodge Corporation, in the late 1970s. We have recorded reclamation liabilities for the SMP properties (see note K to the consolidated financial statements in this report).properties. All historical costs in the SMP properties were offset against a monetary award which was received from Nukem during fiscal 1999. THE PROPERTY INTERESTS OF USE IN-27- UTAH THROUGH PLATEAU RESOURCES LIMITED ("PLATEAU") ARE: Plateau Resources Limited ("Plateau") is a wholly-owned subsidiary of USE. See "Plateau Shootaring Canyon Mill" below. TheIn 2003, reclamation work on uranium properties (the Tony M, property contains underground uranium depositsVelvet, and Woods Complex) in San Juan County, Utah and are located partially on Utah State leases. Plateau is the lessee of the Tony M property and has posted a bond securing Plateau's obligations to reclaim these properties. The Tony M property was originally developed by Plateau at the time Plateau was owned by Consumers Power Company ("CPC"), a Michigan public utility. Significant areas of uranium mineralization have been accessed and delineated by the prior owner's underground workings. When the Tony M property was in production (while Plateau was owned by CPC), it produced ore containing from three to eight pounds of uranium concentrates per ton. Some of this ore was processed at the Shootaring Mill. In addition, low grade uranium mineralization was stockpiled at the Tony M property and at the Shootaring Mill. Plateau also acquired the Velvet property and the nearby Woods Complex in the Lisbon Valley area in southeastern Utah. The Velvet Mine was developed and permitted by its prior owner and is located approximately 178 miles by road from the Shootaring Mill. The prior owner drove several miles of access tunnels (adits) and drifts (access tunnels) and mined material from the workings. However, we cannot ascertain the amount or grade of material previously mined, nor have we ascertained by our own drilling the location and grade of remaining mineralized material in the mine. The Woods Complex was formerly an operating uranium mine with a remaining undeveloped resource. Access to this resource would be by extending a drift approximately 2,500 feet from the former Woods Mine. The Woods Mine property is not permitted, but we do not expect difficulty in obtaining a new permit, should we seek one, because the surface facilities would occupy the site that has been disturbed from previous operations. THE GREEN MOUNTAIN MINING VENTURE ("GMMV") PROJECT In fiscal 1991, we entered into an agreement to sell 50 percent of our interests in the Green Mountain uranium claims, and certain other rights, to Kennecott Uranium Company ("KUC" or "Kennecott"), a subsidiary of Kennecott Energy and Coal Company of Gillette, WY. Kennecott Energy and Coal Company is a subsidiary of Rio Tinto plc, formerly RTZ plc of London. In consideration of the sale to Kennecott, we received $15,000,000 cash and a commitment by Kennecott to fund the first $50,000,000 of GMMV expenditures under a joint venture agreement (the "GMMV Agreement") to mine and mill uranium ore and 21 market uranium oxide. For detailed explanation, please see U.S. Energy Corp.'s 1999 Form 10-K at pages 8-11 and footnote F to the financial statements. The GMMV holds 521 unpatented lode mining claims (the "Green Mountain Claims") on Green Mountain in Fremont County, Wyoming, including 105 claims on which the Round Park (Jackpot) uranium deposit is located, and the Sweetwater Mill, (approximately 23 miles south of Green Mountain ). In fiscal 2000, Kennecott filed a lawsuit to dissolve the GMMV and we counterclaimed for damages. This lawsuit was settled on September 11, 2000. Kennecott paid USECC $3,250,000 to acquire all of our (and Crested's and USECC's) interest in the GMMV, its properties and the Sweetwater Uranium Mill (with certain exceptions), and all parties' claims in the lawsuit have been dismissed. Kennecott also assumed all reclamation and other liabilities associated with the GMMV, its properties, the Sweetwater Mill and all liabilities associated with the GMMV since its inception, including the historical liabilities associated with the Sweetwater Mill prior to its acquisition by the GMMV. We and Crested together have retained a 4% net profits royalty in any future uranium oxide produced from the GMMV mining claims through the Sweetwater Mill (currently shut down and not operational). No reclamation liabilities are recorded on our balance sheet for the GMMV properties because they are solely Kennecott's responsibility (Kennecott assumed all those liabilities when we settled litigation with Kennecott in September 2000 (see "GMMV" below and note K to the consolidated financial statements)). When Kennecott has completed necessary reclamation work on the Green Mountain unpatented lode mining claims (including the Round Park uranium deposit proposed to be mined through the Jackpot Mine) Kennecott will quit claim all such mining claims to us and Crested, as well as certain equipment currently being used at the mine (including a compressor and standby generator). Kennecott plans to keep the Sweetwater Mill.completed. PLATEAU'S SHOOTARING CANYON MILL AND PROPERTIES ACQUISITION OF PLATEAU RESOURCES LIMITED ("PLATEAU"). In August 1993, USE purchased from Consumers Power Company ("CPC"), all of the outstanding stock of Plateau which owns the Shootaring Canyon uranium processing mill and support facilities in southeastern Utah (the "Shootaring Mill") for a nominal cash consideration. The Shootaring Mill holds a source materials license from the NRC. In the purchase of the stock from CPC, we agreed to various obligations, as disclosed in USE's 1998 Form 10-K at pages 15 and 16. SHOOTARING MILL AND FACILITIES. The Shootaring Mill is located in southeastern Utah and occupies 19 acres of a 265 acre plant site. The mill was designed to process 750 tpd, but only operated on a trial basis for two months in mid-summer of 1982. In 1984, Plateau placed the mill on standby because CPC had canceled the construction of an additional nuclear energy plant. Plateau also owns approximately 90,000 tons of uranium mineralized material stockpiledFor information on the Shootaring mill facility and related real estate property at the mill siteTicaboo, please see "Plateau's Shootaring Canyon Mill and approximately 172,000 tons of mineralized material stockpiled at the Tony M property. Included with mill assets are tailings cells, laboratory facilities, equipment shop and inventory. The NRC issued a license to Plateau authorizing production of uranium concentrates, however, since the mill was shut down, only maintenance and required safety and environmental inspection activities were performed and the source materials license with the NRC was for standby operations only. Plateau applied to the NRC to convert the source materials license from standby to operational and upon increasing the reclamation bond, the NRC issued the new license on May 2, 1997. Plateau has a cash bond in favor of the NRCProperties" in the amount of $8,818,600 plus and additional $1,082,300 in government securities for bonding future reclamation. 22 Plateau obtained approval of a water control permitannual report (Form 10-K/A1) for the tailings cell from the Utah Water Control Division and is awaiting the NRC's review of the operating license conditions so Plateau can continue with construction of tailing facilities if it so desires. The Shootaring Mill has remained shut down because of continued low uranium prices. Substantial expense would be incurred to upgrade the mill to operating status and fully activate the NRC permit, and substantial work would be needed to put the Velvet and Woods Complex properties into production for material to run through this mill. This work would include cleaning out adits and drifts, dewatering, and sampling to ascertain the location and grade of mineralized material. TICABOO TOWNSITE Plateau owns Canyon Homesteads, Inc., a Utah corporation, which developed the Ticaboo, Utah townsite 3.5 miles south of the Shootaring Mill. The townsite includes a motel, restaurant, lounge, convenience store and single family, mobile home and recreational vehicle sites (all with utility access), located on a State of Utah lease near Lake Powell. An amendment was entered into on April 1, 1997former fiscal year ended May 31, 2002. THE GREEN MOUNTAIN MINING VENTURE ("GMMV") PROJECT For information on the Utah State lease coveringGMMV agreement, see "Green Mountain Mining Venture" in the Ticaboo Townsite wherebyannual report (Form 10-K/A1) for the State will convey portions of the Townsite lease to Canyon on a sliding scale basis as they are sold. USE and Crested are developing the Townsite in limited fashion and are selling home and mobile home sites.(former) fiscal year ended May 31, 2002. SHEEP MOUNTAIN PARTNERS ("SMP") SMP PARTNERSHIP. In February 1988, USE acquired uranium mines, mining equipment and mineralized properties (Sheep Mountain Mines) at Crooks Gap in south-central Fremont County, Wyoming, from Western Nuclear, Inc. These Crooks Gap mining properties are adjacent to the Green Mountain uranium properties. USECC mined and milled uranium ore from one of the underground Sheep Mines during fiscal 1988 and 1989. In December 1988, USECC sold 50 percent of the interests in the Crooks Gap properties to Nukem's subsidiary Cycle Resource Investment Corporation ("CRIC") for cash. The parties thereafter contributed the properties to and formed Sheep Mountain Partners ("SMP"), in which USECC received an undivided 50 percent interest. SMP is a Colorado general partnership formed on December 21, 1988, between USECC and Nukem, Inc. then of Stamford, CT ("Nukem") through its wholly-owned subsidiary CRIC. SMP was directed by a management committee, with three members appointed by USECC and three members appointed by Nukem/CRIC. The committee has not met since 1991 as a result of the SMP arbitration/litigation. During fiscal 1991, disputes arose between the SMP partners which resulted in litigation. See Item 3, Legal Proceedings. PROPERTIES. USE, Crested and/or USECC own 98 unpatented lode mining claims and a 644 acre Wyoming State Mineral Lease in the Crooks Gap area. An ion exchange plant located on the properties (to remove natural soluble uranium from mine water) was reclaimed and the plant disposed of at the Sweetwater Mill impoundment facility in fiscal 2002. -28- Permits to operate existing mines (now shut down) on the Crooks Gap properties havehad been issued by the State of Wyoming. Amendments areWyoming, but amendments would be needed to open new mines within the permit area. As a condition to issuance of the permits, are-open them. A NPDES water discharge permit under the Clean Water Act has been obtained. Monitoringobtained; monitoring and treatment of water removed from the mines and discharged in nearby Crooks Creek is generally required. DuringHowever, for the past twolast three years, USECC didhas not dischargedischarged wastewater into Crooks Creek, and the mine water instead is presently being discharged into the USECC McIntosh Pit. 23 URANIUM MARKET INFORMATION. URANIUM SPOT MARKET. Uranium exchange value spot price as reportedPit at the Sweetwater mill owned by Tradetech was $9.85/lb. U3O8 on July 31, 2002, an increase from an unrestricted valueKennecott (the Sweetwater mill had been part of $7.95/lb U3O8 and restricted value of $8.95/ U3O8 at July 31, 2001. During the first half of 2002, total spot market volume was approximately 8.4 million lbs. U3O8 which was 3.8 million lbs. for the first half of 2001, or an increase of 4.5 million lbs. U3O8. URANIUM LONG-TERM MARKET. The long-term market has been active in 2002 with the long-term contracts reported by market analysts to have exceeded 10.9 million pounds of U3O8 during the first half of 2002. The uranium price indicator published by Tradetech was at $10.75 per pound U3O8 at July 31, 2002, up from the $10.00/lb. at July 31, 2001.Green Mountain Mining venture). INACTIVE MINING PROPERTIES - GOLD SUTTER PROPERTY (CALIFORNIA) SUTTER GOLD MINING COMPANY. In fiscal 1991, USE acquired an interest in Sutter properties located in the Mother Lode Mining District of Amador County, California. The entire Lincoln Project (which is the name we use for the properties) is owned by Sutter Gold Mining Company, a Wyoming corporation ("SGMC"), and a majority-owned subsidiary of USE. This property has never been in production. Persistent low prices for gold have made financing difficult, and in fiscal 1999 resulted in a substantial write down of the SGMC properties. Due to the depressed gold prices in the past, litigation (since resolved) and lack of available funding, SGMC has deferred the start of construction of a gold mill complex and extension of existing underground workings. A tourist visitors center has been set up (see below) and leased to a third party for $1,500 per month plus a 4% gross royalty on revenues. There is one caretaker employee at the Sutter operation. Except for limited infrastructure improvements in 2000, the properties are shut down so far as possible mining operations are concerned. The exploration permits areconditional use permit is being kept current as necessary to allow for possible mining activities on the properties in the future. In 1998 and 1999, the companyCompany took impairments (write-downs) in the amounts of $1,500,000 and $10,718,800, respectively, of the carrying value of the gold properties. These two impairments wrote off almost 85% of our investment in these properties. As a result of low market prices for gold at the time, we determined that we could not produce gold from these properties at a profit. The impairments taken in 1998 and 1999 resulted in no value for mine exploration, and the remaining assets relating to this property include raw land which is no longer needed for mining activity, and buildings and equipment. A significant portion of the raw land has been sold. We have not obtained a final feasibility study to support a determination that the Sutter property contains proven or probable reserves of gold. In late 2003, SGMC signed a letter of intent for an acquisition of SGMC by Globemin Resources Inc., a British Columbia corporation listed on the TSX-V. Completion of the acquisition is subject to negotiation and execution of a share exchange agreement, approval by the TSX-V, Canadian regulatory authorities, and the boards of directors and if necessary, shareholders of SGMC and Globemin. If the acquisition is consummated, a majority of the stock of Globemin would be owned by the (former) SGMC shareholders. Globemin thereafter would seek to raise financing in Canada to begin mining the Lincoln Project and build a mill. PROPERTIES. SGMC holds approximately 216435 acres of surface and mineral rights (owned), 54rights: (87 acres of surface rights (owned), 5573 acres of surface rights (leased), 154146 acres of mineral rights (leased), and 366289 acres of mineral rights (owned), all on patented mining claims near Sutter Creek, Amador County, California. The properties are located in the western Sierra Nevada Mountains at from 1,000 to 1,500 feet in elevation; year round climate is temperate. Access is by California State Highway 16 from Sacramento to California State Highway 49, then by paved county road approximately .4 mile outside of Sutter Creek. 24-29- Surface and mineral rights holding costs, and property taxes, will be approximately $90,000 from June 1, 2002 through May 31, 2003. Property taxes$130,000 and $9,900 for fiscal 2003 are estimated to be $20,000.2004. The leases are for varying terms and require rental fees, advance production royalties,annual royalty payments and payment of real property taxes and insurance. PERMITS. The Amador County Board of Supervisors has issued a Conditional Use Permit ("CUP") allowing mining of the SGM and milling of production, subject to conditions relating to land use, environmental and public safety issues, road construction and improvement, and site reclamation. Applications will be made in the second quarter of 2004 to California regulatory authorities for a waste water discharge permit to allow the Company to utilize mill tails as mine backfill and to store tails in a surface fill unit. VISITORS CENTER. In fiscal 2000, SGMC spent approximately $298,000 for surface infrastructure related to improving access to the mine site, and to a lesser extent tourist related improvements. The visitors center is being operated by a third party. The visitors center is an exhibit of the pictures and memorabilia from mining operations on other properties in the Sutter district in the nineteenth century, and a guided tour of the underground workings at the Lincoln Project. Revenues from this tourist operation were $41,200 and $105,400 in fiscal$48,800 for 2003, $49,200 for the seven months ended December 31, 2002, and 2001, respectively,$41,200 in (former) fiscal year 2002, and are included in "motel, real estate and airport operations""real estate" in the consolidated statements of operations included in this report. These revenues offset a majority of costs for holding the Sutter properties. MOLYBDENUM As a holder of royalty, reversionary and certain other interests in properties located at Mt. Emmons near Crested Butte, Colorado, USE and Crested are entitled to receive annual advance royalties of 50,000 pounds of molybdenum, or cash equivalent. AMAX Inc. (which was acquired by Cyprus Minerals Company and was renamed Cyprus Amax Minerals Company in November 1993, and wasthen later acquired later by Phelps Dodge) delineated a deposit of molybdenum containing approximately 146,000,000 tons of mineralization averaging 0.43% molybdenum disulfide on the properties of USE and Crested. Advance royalties are required to be paid in equal quarterly installments until: (i) commencement of production; (ii) failure to obtain certain licenses, permits, etc., that are required for production; or (iii) AMAX's return of the properties to USE and Crested. The advance royalty payments reduce the operating royalties (6% of gross production proceeds) which would otherwise be due out of production. There is no obligation to repay the advance royalties if the property is not placed in production. USE recognized $108,500 and $132,600 ofadvance royalty revenues in (former) fiscal 2001 and 2000 related to this royalty interest.2001. Phelps Dodge ceased making the quarterly installmentspayments in July 2001. The Agreement with AMAX also provides that USE and Crested also are entitled to receive $2,000,000 if the Mt. Emmons properties are put into production and, in the event AMAX sells its subsidiary,of a sale of Mt. Emmons Mining Company (which owns the properties) or of its interest in the molybdenum properties, USE and Crested are entitled to receive 15% of the first $25,000,000 received by AMAX.of sale proceeds. AMAX Inc. and its successor companies have sought to put the Mt. Emmons molybdenum property into production for 20 years. Due to local opposition to mining (the property is close to the Crested Butte, Colorado recreational resort area) and AMAX's successors' failure to diligently pursue obtaining the permits needed to start mining, we know of no plans at this time to put the property into production. USE and Crested are in litigation with Phelps Dodge concerning the Agreementproperties and the properties,related agreements, see "Item 3 - Legal Proceedings." 25-30- OIL AND GAS AND OTHER PROPERTIES FORT PECK LUSTRE FIELD (MONTANA). We operate a small oil production facility (three wells) at the Lustre Oil Field on the Ft. Peck Indian Reservation in northeastern Montana. We receive a fee based on oil produced. This fee and other assets of the Company collateralize a $750,000 line of credit from a bank. MOTEL, REAL ESTATE AND AIRPORT OPERATIONS WYOMING. We own varying interests, alone and with Crested, in affiliated companies engaged in real estate, and other commercial businesses. Activities of these and other subsidiaries include ownership and management of a commercial office building, the townsite of Jeffrey City, Wyoming (which has been sold), and the townsite, motel, convenience store and other commercial facilities in Ticaboo, Utah. The Company and Crested own a 14-acre tract in Riverton, Wyoming, with a two-story 30,400 square foot office building (including underground parking). The first floor is rented to affiliates, nonaffiliatesnon-affiliates and government agencies; the second floor is occupied by the Company and Crested.Company. The property is mortgaged to the WDEQ as security for future reclamation work on the Sheep Mountain Crooks Gap uranium properties. The Company and Crested also ownowns a fixed base aircraft facility at the Riverton Regional Airport, including a 10,000 square foot aircraft hangar and 7,000 square feet of associated offices and facilities. This facility is on land leased from the City of Riverton for a term ending December 16, 2005, with an option to renew on mutually agreeable terms for five years. The aircraft fueling operation for services to the public was shut down late in fiscal 2002. The Company and Crested also own 17 semi-developed lots on 26.8 acres and 63 acres of undeveloped land near the Riverton Regional Airport, andowns three mountain sites covering 16 acres in Fremont County, Wyoming. Also inIn Riverton, Wyoming, the Company owns four city lots and a 9-acre tract with improvements including two smaller office buildings and two other buildings with 12,000 square feet of office facilities, and repair and maintenance shops containing 8,000 square feet.buildings. COLORADO. USECC owns 182 acres of undeveloped land in and near Gunnison, Colorado. UTAH. On August 14, 2003, USE's wholy-owned subsidiary Plateau Resources Limited (and Plateau's wholly-owned subsidiary Canyon Homesteads, Inc. (a Plateau subsidiary) owns) sold all of the outstanding stock of Canyon Homesteads to The Cactus Group, LLC, for $3,470,000: $349,250 cash and $3,120,750 with The Cactus Group's five year promissory note. The note is secured with all the assets of The Cactus Group and Canyon (and is personally guaranteed by the six principals of The Cactus Group). The note is payable monthly (with annual interest at 7.5%) with a majority interest$2,940,581 balloon payment due in a joint venture which holds the Ticaboo TownsiteAugust 2008. The sold properties are in Ticaboo, Utah, (see "Minerals - Uranium-Shootaring Canyon Mill - Ticaboo Townsite" above). In fiscal 1995, USE acquired the minority interest in the joint venture fromnear Lake Powell, and included a nonaffiliate. The motel, real estaterestaurant and airport operations are not dependent upon a single customer, or a few customers, the loss of which would have a materially adverse effect on the Company.lounge, convenience store, recreational boat storage and service facility, and improved residential and mobile home lots. RESEARCH AND DEVELOPMENT No research and development expenditures have been incurred, either on the Company's account or sponsored by customers, during the past three fiscal years. ENVIRONMENTAL GENERAL. Operations are subject to various federal, state and local laws and regulations regarding the discharge of materials into the environment or otherwise relating to the protection of the environment, including the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act ("RCRA"), 26 and the Comprehensive Environmental Response Compensation Liability Act ("CERCLA"). With respect to mining operations conducted in Wyoming, Wyoming's mine permitting statutes, Abandoned Mine Reclamation Act and industrial development and siting laws and regulations also impact us. Similar laws and regulations in California affect SGMC operations and Utah laws and regulations effect Plateau's operations. Management believes the Company complies in all material respects with existing environmental regulations. -31- As of MayDecember 31, 2002,2003, we have recorded estimated reclamation obligations of $8,906,800.$7,264,700. We anticipate that the reclamation efforts may not be required to be started for many years, and that when started, paying for those reclamation efforts will occur over several years. For further information on the approximate reclamation costs (decommissioning, decontamination and other reclamation efforts for which we are primarily responsible or potentially responsible), see note K to the consolidated financial statements included with this report. OTHER ENVIRONMENTAL COSTS. Actual costs for compliance with environmental laws may vary considerably from estimates, depending upon such factors as changes in environmental laws and regulation (e.g., the new Clean Air Act), and conditions encountered in minerals exploration and mining. USE does not anticipate that expenditures to comply with laws regulating the discharge of materials into the environment, or which are otherwise designed to protect the environment, will have any substantial adverse impact on the competitive position of the Company. EMPLOYEES As of the filing date of this Annual Report, USE has approximately 33had 34 full-time employees, down from 55 in July 2001.including 11 employees working only for RMG. Crested uses approximately 50 percent of the time of USE employees, and reimburses USE on a cost reimbursement basis. MINING CLAIM HOLDINGS TITLE. Nearly all the uranium mining properties held by the GMMV, USE, USECC and PlateauCompany are on federal unpatented claims. Unpatented claims are located upon federal public land pursuant to procedure established by the General Mining Law. Requirements for the location of a valid mining claim on public land depend on the type of claim being staked, but generally include discovery of valuable minerals, erecting a discovery monument and posting thereon a location notice, marking the boundaries of the claim with monuments, and filing a certificate of location with the county in which the claim is located and with the BLM. If the statutes and regulations for the location of a mining claim are complied with, the locator obtains a valid possessory right to the contained minerals. To preserve an otherwise valid claim, a claimant must also pay certain rental fees annually to the federal government (currently $100 per claim) and make certain additional filings with the county and the BLM. Failure to pay such fees or make the required filings may render the mining claim void or voidable. Because mining claims are self-initiated and self-maintained, they possess some unique vulnerabilities not associated with other types of property interests. It is impossible to ascertain the validity of unpatented mining claims solely from public real estate records and it can be difficult or impossible to confirm that all of the requisite steps have been followed for location and maintenance of a claim. If the validity of an unpatented mining claim is challenged by the government, the claimant has the burden of proving the present economic feasibility of mining minerals located thereon. Thus, it is conceivable that during times of falling metal prices, claims which were valid when located could become invalid if challenged. 27 RMG's properties and mineral leases of BLM, state and fee lands require annual cash payments of approximately $286,300 during fiscal 2003. RMG is obligated for $96,400 of this amount to keep the leases in effect. PROPOSED FEDERAL LEGISLATION. The U.S. Congress has, in legislative sessions in recent years, actively considered several proposals for major revision of the General Mining Law, which governs mining claims and related activities on federal public lands. If any of the recent proposals become law, it could result in the imposition of a royalty upon production of minerals from federal lands and new requirements for mined land reclamation and other environmental control measures. It remains unclear whether the current Congress will pass such legislation and, if passed, the extent such new legislation will affect existing mining claims and operations. The effect of any revision of the General Mining Law on operations cannot be determined conclusively until such revision is enacted; however, such legislation could materially increase the carrying costs of mineral properties which are located on federal unpatented mining claims, and could increase both the capital and operating costs for such projects and impair the ability to hold or develop such properties. -32- ITEM 3. LEGAL PROCEEDINGS Material pending proceedings are summarized below. Certain of the Company's affiliates are involved in ordinary routine litigation incidental to their business. Other proceedings which were pending in fiscal 2002during the year ended December 31, 2003 have been settled or otherwise finally resolved. SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION In 1991, disputes arose between USE/Crested d/b/a/ USECC, and Nukem, Inc. and its subsidiary Cycle Resource Investment Corp. ("CRIC"), concerning the formation and operation of thetheir equally owned Sheep Mountain Partners partnership for uranium mining and marketing, and activities of the parties outside SMP.(SMP) partnership. Arbitration proceedings were initiated by CRIC in June 1991 and in July 1991, USECC filed a lawsuit against Nukem, CRIC and others in the U.S. District Court (District of Colorado)Colorado in Civil No. 91B1153. Later, USECC filed another suit for the standby costs at the SMP mines against SMP in the Colorado State Court. The Federal Court stayed both the arbitration proceedings and the State Court case.discovery proceeded. In February 1994, all of the parties agreed to exclusiveconsensual and binding arbitration of theall of their disputes over SMP before the American Arbitration Association ("AAA"), for which the legal claims made by both sides included fraud and misrepresentation, breach of contract, breach of duties owed to the SMP partnership, and other claims. The AAAan arbitration panel (the "Panel"). After 73 hearing days, the Panel entered an Order and Award (the "Order") inon April 18, 1996 and clarified the Order on July 3, 1996, finding generally in favor of USE and Crested on certain of their claims (including the claims for reimbursement for standby maintenance expenses and profits denied SMP in Nukem's trading of uranium), and in favor of Nukem/CRIC and against USE and Crested on certain other claims, and imposingimposed a constructive trust in favor of Sheep Mountain Partners on uranium contracts Nukem entered into to purchase uranium from CIS republics. The Panel also awarded SMP damages of $31,355,070 against Nukem. USECC filed a petition for confirmation of the Order and on June 30,27, 1997, and the U.S. District Court confirmed the OrderPanel's Orders in its Second Amended Judgment (the "Judgment").Judgment. Thereafter, Nukem/CRIC appealed the Judgment to the 10th Circuit Court of Appeals ("CCA"). A three judge panel ofOn October 22, 1998, the 10th CCA issued an Order and Judgment on October 22, 1998, which unanimously affirmedaffirming the FederalU.S. District Court's Second Amended Judgment without modification. The ruling affirmed (i) the imposition of a constructive trust in favor of SMP on Nukem's rights to purchase CIS uranium, the uranium acquired pursuant to those rights, and the profits therefrom; and (ii) the damage award in favor of SMP against Nukem/CRIC. AsNukem. The 10th CCA held that the Panel's Awards "clearly retains both a resultconstructive trust and a damage award," and the --- Arbitration Awards and the Second Amended Judgment were "clear and unambiguous." On February 8, 1999, the U.S. District Court ordered Nukem to pay USECC the balance of the rulingdamage award. Nukem did so, but then moved for a satisfaction of judgment without accounting for the monies earned in the Constructive Trust. The District Court denied Nukem's motion and Nukem filed its second appeal to the 10th CCA. On October 16, 2000, the 10th CCA USE and Crested received an additional $6,077,264 (including interest and court costs) from Nukem in February 1999 for a total net monetary award of $15,468,625 in the arbitration/litigation, and equitable relief in the form of USE's and Crested's interest in SMP, which holds the constructive trust over the CIS contracts. Nukem/CRIC filed two motions for entry of final satisfaction of Judgment. The U.S. District Court denied both motions, Nukem again appealed to the 28 10th CCA, which again affirmed the order of the District Court's ruling, andCourt. The 10th CCA held that Nukem/CRICNukem had not demonstrated that the Judgment had been satisfied because they had not provided USECC with"provided an accounting of the partnerships assets. Inpartnership assets," finding that "the district court order presented for our review does not decide which CIS contracts are covered by the constructive trust." On November 3, 2000, USECC filed a motion for a further accounting of the Constructive Trust. On February 15, 2001, the District Court entered an Order of Reference appointing a Special Master to "conduct an accounting" of the Constructive Trust. The accounting was conducted and on May 1, 2003, the Special Master filed his Report with the District Court. Both parties filed objections to the Report. On July 30, 2003, the U.S. District Court appointed a Special Master to determineadopted the amounts, if any, owedReport in part and rejected it in part. Judgment was then entered by Nukem to SMP pursuant to the constructive trust. The Special Master has ordered an accounting to identify all deliveries of CIS uranium made directly or indirectly to Nukem and any Nukem affiliates; to identify the ultimate disposition of all uranium purchased under the CIS contracts; to identify the location, number of pounds, and associated cost of uranium purchased under the CIS contracts at December 31, 2001, and to calculate the profits realized from the sale of CIS uranium. At a status hearing held before the U.S. District Court on August 23, 2002,1, 2003 in favor of USECC and against Nukem in the amount of $20,044,183. On August 15, 2003, Nukem filed a "Motion to Remand to the Arbitration Panel or in the Alternative, to Alter, Amend and/or Correct the Court's August 1, 2003 Judgment and July 30, 2003 Order," and a "Motion to Correct Certain Findings or Statements in the Court's Order of July 30, 2003." On the same day, USECC filed a motion under Fed.R.Civ.P. 52(b) and 59(e) to alter or amend the July 30, 2003 Order and the -33- August 1, 2003 Judgment. The District Court ordereddenied the Special Masterparties' motions on September 10 and 11, 2003, respectively. Nukem's appeal and USECC's cross-appeal followed. Nukem's opening brief was filed on January 16, 2004 and on February 24, 2004, USECC filed an opening brief in its cross-appeal and an answer to Nukem's brief. Nukem has until March 29, 2004 or any extension thereof to file his reportan answer to USECC's opening brief. USECC may then file a reply brief 14 days after service of Nukem's answer. Management believes that the ultimate outcome of this matter will not have an adverse affect on the Company's financial condition or before December 6, 2002 and a further hearing to schedule arguments will be held on December 13, 2002.result of operations. CONTOUR DEVELOPMENT LITIGATION On July 28, 1998, USE and Crested filed a lawsuit in the United StatesU. S. District Court Denver,of Colorado in Case No. 98WM1630, against Contour Development Company, L.L.C. and entities and persons associated with Contour Development Company, L.L.C. (together, "Contour") seeking compensatory and consequential damages of more than $1.3 million from the defendants for dealings in real estate owned by USE and Crested in Gunnison, Colorado. The Contour defendants asserted a counterclaim asking for payment of attorneys fee and costs. The matterparties settled the litigation in 2004. In the settlement, USE and Crested received $25,000 in cash; two lots in the City of Gunnison, Colorado (one of which has been settled, with USE receiving $25,000 cashsold for a net of $65,326 and unencumbered titlethe other lot is under contract to two commercial real estate lots covering seven acres in Gunnison, Colorado,sell for $180,000), and unencumbered title toan additional five development lots covering 175 acres north of Gunnison, Colorado. See "Business - Commercial Operations - Real Estate and Other Commercial Operations - Colorado Properties" above. PHELPS DODGE LITIGATION U.S. Energy Corp. (USE) and its majority-owned subsidiary, Crested Corp. (Crested), d/b/a USECC, were served with a lawsuit on June 19, 2002, filed in the U.S. District Court of Colorado (Case No. 02-B-0796(PAC)) by Phelps Dodge Corporation (PD) and its subsidiary, Mt. Emmons Mining Company (MEMCO), over contractual obligations fromin USECC's agreement with Phelps Dodge'sPD's predecessor companies, concerning a mining property inproperties on Mt. Emmons, near Crested Butte, Colorado. The litigation stems from agreements that date back to 1974 when U.S. EnergyUSE and Crested Corp. leased the mining claims on Mt. Emmons near Crested Butte, Colorado to AMAX Inc., Phelps Dodge'sPD's predecessor company. The mining claims cover one of the world's largest and richest deposits of molybdenum.molybdenum discovered by AMAX. AMAX reportedly spent over $200 million on the acquisition, exploration and mine planning activities on the Mt. Emmons properties. In counter and cross-claims filed in the U.S. District Court of Colorado, USECC contends that Phelps Dodge and its subsidiaries committed several breaches of contracts related to the agreements, including breach of fiduciary obligations and covenants of good faith and fair dealing. USECC also contends Phelps Dodge is guilty of violating federal and state antitrust laws when it purchased Cyprus Amax Minerals Company (Cyprus Amax). The complaint filed by Phelps DodgePD and MEMCO seeks a determination that Phelps Dodge'sPD's acquisition of Cyprus Amax was not a sale. Under a 1986 agreement between USECC and AMAX, if AMAX sold MEMCO or its interest in the mining properties, U.S. EnergyUSE and Crested would receive 15% (7.5% each) of the first $25 million of the purchase price ($3.75 million). In 1991, Cyprus Minerals Company acquired AMAX to form Cyprus Amax Minerals Co. USECC's counter and cross-claims allege that in 1999, Phelps DodgePD formed a wholly-owned subsidiary CAV Corporation, for the purpose of purchasing the 29 controlling interest of Cyprus Amax and its subsidiaries (including MEMCO) at an estimated value in cash and Phelps DodgePD stock exceeding $1 billion and making Cyprus Amax a subsidiary of Phelps Dodge.PD. Therefore, USECC asserts the acquisition of Cyprus Amax by Phelps DodgePD was a sale of MEMCO and the properties that triggers the obligation of Cyprus Amax to pay USECC the $3.75 million plus interest. A second counterclaim by USECC rejects the claim by Phelps Dodge that it and its predecessors, Cyprus Amax and AMAX Inc., had mistakenly paid royalties to USECC since January 1991. In 1984, AMAX began paying the cash equivalent (half each to U.S. Energy and Crested Corp.) of 700,000 pounds of molybdenum per year as an advance royalty prior to the mine beginning production. In 1986, USECC agreed to assist financially troubled AMAX and substantially reduced the annual advance royalty to 50,000 pounds of molybdenum, so that AMAX could continue to hold the properties and eventually bring them into production. AMAX, Cyprus Amax and Phelps Dodge continued paying the annual advance royalties to U.S. Energy and Crested Corp. until the payment due in July 2001, when Phelps Dodge unilaterally ceased making the payments. Phelps Dodge and MEMCO seek a declaratory judgment that the advance royalty payment obligation has terminated, and further, that USECC should repay $948,109 of royalties paid to USECC from 1993 through 2000, because those payments were made by mistake. The thirdother issue in the litigation is whether USECC must, under terms of a 1987 royalty deed,Royalty Deed, accept Phelps Dodge'sPD's and MEMCO's forth-coming conveyance of the Mt. Emmons properties back to USECC, which properties now include a plant to treat mine water, costing in excess of $1 million a year to operate in compliance with State of Colorado regulations. Phelps Dodge'sPD's and MEMCO's threatened reconveyance would requireclaim seek to obligate USECC to assume the operating costs of the water treatment plant. USECC refuses to have the water treatment plant included in the return of the properties because, the USECC counterclaim argues, the properties must be in the same condition as when they were acquired by AMAX before the water treatment plant was constructed by AMAX. The properties are comprised of 10 unpatented lode mining claims (for which patents are expected to be issued by the BLM in the near future), and 770 unpatented lode mining claims, for a total of 15,600 acres.-34- As added counterclaims, USECC seeks (i) damages for defendants'PD's breach of covenants of good faith and fair dealing; (ii) damages for defendants'PD's failure to develop the Mt. Emmons properties and not protecting USECC's rights as a revisionary owner of the mining rights to the properties, (iii) damages for unjust enrichment of defendants;PD; (iv) damages for breach of the defendants'PD's fiduciary duties owed to USECC as revisionary owner of the property, and for neglecting to maintain the mining rights and interests in the properties; and (v) damages relating to defendants' actions in violation of federal and Colorado anti-trust and constraint of trade laws. USECC also seeks a declaratory judgment of its rights and liabilities under the agreements affecting the Mt. Emmons properties; an injunction against defendants prohibiting the conveyance of the properties to USECC with the water treatment plan; an injunction against further waste of the properties by the defendants; an injunction requiring defendants to divest their molybdenum holdings (including the Mt. Emmons properties); and an injunction requiring defendants to assist USECC in mining molybdenum from the Mt. Emmons properties. On August 2, 2002, Phelps Dodge ad MEMCOMarch 17, 2003, PD filed a reply toadditional motions for partial summary judgment on various claims. On January 22, 2004, the counterclaimsDistrict Court heard the motions and responses of USECC and Cyprus Amax filed an answer to the counterclaims and third party complaint of USECC, generally denying the allegations of USECC. CAV Corporation filed a motion for summary judgment seeking dismissal of USECC's cross complaint and is pending. An order has been entered by the Court setting the Scheduling/Planning Conference in the case for September 12, 2002. 30 Except for the parties' claims regarding payment of the $3.75 million due on the sale of MEMCO, payments of royalties, and responsibility going forward for payment of the operating costs of the water treatment plan, the financial impact to U.S. Energy Corp. and Crested Corp. of favorable or unfavorable outcomes in the litigation presently is not determinable. SUTTER PROPERTY LITIGATION On or about March 13, 2002, the Company's subsidiary, Sutter Gold Mining Company ("SGMC"), was served with a complaint filed in the Superior Court of Amador County, California, Case Number 02CU2051. The plaintiff is Edward A. Swift individually and as a trustee and the other defendant is Meridian Minerals Company (Meridian). The litigation involves a mining lease entered into in 1989 between Plaintiffs and Defendant Meridian on the rental of Plaintiffs' land. Plaintiffs contend Defendants owe them $136,186 for past due rent and some $12,000 in unpaid taxes and for fence repair. Defendant SGMC, has filed an answer generally denying the complaint and the case is pending. We have negotiated the terms of a settlement but due to the death of one of the essential parties in the matter, finalization of the settlement has been delayed. We hope to finalize a settlement in calendar 2002. ROCKY MOUNTAIN GAS LITIGATION On or about April 1, 2002, the Company's subsidiary, Rocky Mountain Gas, Inc. ("RMG") was served with a Second Amended Complaint wherein the Northern Plains Resource Council had filed suit in the U.S. District Court of Montana, Billings Division in Case No. CV-01-96-BLG-RWA, against the United States Bureau of Land Management ("BLM"), RMG and certain of its affiliates (including U.S. Energy Corp. and Crested Corp.), and joined some 20 other defendants. The plaintiff is seeking to cancel oil and gas leases issued to RMG et al by the BLM in the Powder River Basin of Montana and for other relief. RMG and its affiliates have not yet answered or otherwise pled to the complaint. The basis for the complaint appears to be that the BLM's regulations require the BLM to respond to objections filed by persons owning land or lease rights adjacent to the coalbed properties which the BLM is offering to lease to the public. The argument of plaintiff appears to be that if objections are not responded to by the BLM prior to issuing CBM leases, the leases are invalid. Based on this argument, the plaintiff appears to have been successful in forcing cancellation of some CBM leases granted to others in the Powder River Basin of Montana, because the BLM did not respond to some objecting adjacent landowners. However, all of the BLM leases in Montana held by RMG (none are held by U.S. Energy Corp. or Crested Corp. in their own corporate names) are at least four years old, and there is no record of any objections being made to the issue of those leases. Based on filings in the case to date, it appears that the BLM is taking the initiative in responding to the plaintiff. We believe RMG's leasesadditional briefs were validly issued in compliance with BLM procedures, and do not believe the plaintiff's lawsuit will adversely affect any of RMG's Montana BLM leases. However, RMG holds BLM leases on 88,411 gross acres in Montana (in the Castle Rock and Kirby prospects), which equals 31.5% of RMG's total coalbed methane leases. An adverse court ruling to the effect that all or a substantial portion of the BLM leases in Montana are invalid could materially and adversely impact RMG. No trial date has been set. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 31 PART II ITEM 5. MARKET FOR COMMON SHARES AND RELATED STOCKHOLDER MATTERS (a) Market Information Shares of USE common stock are traded on the over-the-counter market, and prices are reported on a "last sale" basis by the National Market System ("NMS") of the National Association of Securities Dealers Automated Quotation System ("Nasdaq"). The range by quarter of high and low sales prices is set forth below for fiscal 2002 and 2001. High Low ---- --- Fiscal year ended May 31, 2002 ------------------------------ First quarter ended 8/31/01 $ 6.05 $ 3.56 Second quarter ended 11/30/01 4.15 3.09 Third quarter ended 2/29/02 5.27 3.50 Fourth quarter ended 5/31/02 4.30 3.29 Fiscal year to ended May 31, 2001 --------------------------------- First quarter ended 8/31/00 $ 3.00 $ 1.75 Second quarter ended 11/30/00 3.38 1.75 Third quarter ended 2/28/01 4.00 2.00 Fourth quarter ended 5/31/01 6.25 3.56 (b) Holders (1) At August 15, 2002, the closing market price was $3.05 per share and there were approximately 714 shareholders of record. As of August 26, 2002, we have 12,075,493 shares of common stock issued and outstanding, including shares owned by our subsidiaries and shares in officers' and directors' names that are subject to forfeiture. (2) Not applicable. (c) We have not paid any cash dividends with respect to common stock. There are no contractual restrictions on our present or future ability to pay cash dividends, however, we intend to retain any earnings in the near future for operations. ITEM 6. SELECTED FINANCIAL DATA. The following tables show certain selected historical financial data for USE for the five years ended May 31, 2002. The selected financial data is derived from and should be read with the financial statements for USE included in this Report. 32
May 31, --------------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Current assets $ 4,897,600 $ 3,330,000 $ 3,456,800 $ 12,718,900 $ 14,301,000 Current liabilities 1,406,400 2,396,700 6,617,900 5,355,600 6,062,100 Working capital (deficit) 3,491,200 933,300 (3,161,100) 7,363,300 8,238,900 Total assets 30,537,900 30,465,200 30,876,100 33,391,000 45,019,100 Long-term obligations(1) 14,949,100 14,981,500 14,025,200 14,526,900 14,468,600 Shareholders' equity 10,597,200 7,320,600 4,683,800 10,180,300 17,453,500
(1)Includes $8,906,800, $8,906,800, $8,906,800, $8,860,900, and $8,778,800, of accrued reclamation costs on mining properties at May 31, 2002, 2001, 2000, 1999 and 1998, respectively. See Note K of Notes to Consolidated Financial Statements.
For Years Ended May 31, ---------------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Operating revenues $ 2,004,100 $ 3,263,000 $ 3,303,900 $ 3,788,600 $ 6,132,600 Loss from continuing operations (7,454,200) (7,517,800) (11,356,100) (22,713,300) (4,984,900) Other income & expenses 1,319,500 8,730,800 802,200 6,655,500 5,349,900 (Loss) income before minority interests, equity in (loss) income of affiliates, discontinued operations, and income taxes (6,134,700) 1,213,000 (10,553,900) (16,057,800) (365,000) Minority interest in loss (income) of consolidated subsidiaries 39,500 220,100 509,300 4,468,400 (772,500) Equity in loss of affiliates -- -- (2,900) (59,100) (575,700) Income taxes -- -- -- -- -- Discontinued operations net of tax (85,900) 488,100 (594,300) - - Preferred stock dividends (86,500) (150,000) (20,800) -- -- ------------ ------------- ------------- ------------- ----------- Net (loss) income to common shareholders $ (6,267,600) $ 1,771,200 $ (10,662,600) $ (11,648,500) $ (983,200) ============ ============ ============= ============= ===========
33
For Years Ended May 31, ---------------------------------------------------------------------- 2002 2001 2000 1999 1998 ---- ---- ---- ---- ---- Per share financial data Operating revenues $ 0.22 $ 0.42 $ 0.43 $ 0.53 $ 0.92 Loss from continuing operations (0.80) (0.96) (1.39) (3.18) (0.75) Other income & expenses 0.14 1.11 0.01 0.93 0.80 (Loss) income before minority interests, equity in income (loss) of affiliates, discontinued operations, and income taxes (0.66) 0.15 $ (1.38) $ (2.25) $ 0.05 Minority interest in loss (income) of consolidated subsidiaries 0.01 0.03 0.07 0.63 (0.12) Equity in loss of affiliates -- -- -- (0.01) (0.08) Discontinued operations (0.01) 0.06 (0.08) -- -- Income taxes -- -- -- -- -- Preferred stock dividends (0.01) (0.01) -- -- -- -------- -------- -------- -------- -------- Net income (loss) per share, basic $ (0.67) $ 0.23 $ (1.39) $ (1.63) $ (0.15) ======== ======== ======== ======== ======== Net income (loss) per share diluted $ (0.67) $ 0.21 $ (1.39) $ (1.63) $ (0.15) ======== ======== ======== ======== ======== Cash dividends per share $ -0- $ -0- $ -0- $ -0- $ -0- ======== ======== ======== ======== ========
34 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is Management's Discussion and Analysis of significant factors which have affected our liquidity, capital resources and results of operations during the periods included in the accompanying financial statements. The discussion contains forward-looking statements that involve risks and uncertainties. Due to uncertainties in our business, actual results may differ materially from the discussion below. CRITICAL ACCOUNTING POLICIES OIL AND GAS PRODUCING ACTIVITIES We follow the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration, and development of oil and gas reserves, including directly related overhead costs, are capitalized. Once we begin production, all capitalized costs of oil and gas properties including the estimated future costs to develop proved reserves, will be amortized on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major exploration and development projects are not amortized until proved reserves associated with the projects can be determined. Unproved properties are assessed periodically to ascertain whether impairment has occurred. Such assessments could cause the Company to reduce the carrying values of the properties. In addition, the capitalized costs are subject to a "ceiling test," which basically limits such costs to the aggregate of the "estimated present value,"discounted at a 10-percent interest rate of future net revenues from proved reserves, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in income. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized. LIQUIDITY AND CAPITAL RESOURCES During fiscal 2002, our cash position increased by $1,878,800 over the prior balance at May 31, 2001 to a cash balance of $2,564,300. This increase came as a result of $1,822,300 and $3,391,300 being generated in investing activities and financing activities, respectively. This increase in cash of $5,213,600 was offset by a reduction of $3,334,800 which was consumed in operations. Operations for the fiscal year ended May 31, 2002, resulted in a net loss of $6,267,600. The major noncash components of the net loss for the year were: Depreciation of $541,500; impairment of goodwill of $1,622,700; services which were paid for with our common stock $787,700; gain on the sale of assets of $812,700; provision for bad debts of $171,200; noncash compensation of $535,200; and the net change in assets and liabilities of $115,200. During December 2001, we purchased equity in Rocky Mountain Gas, Inc. ("RMG") from certain minority shareholders under the terms of their initial investment which allowed for a conversion to shares of our common stock if certain conditions were not met. Subject to those conversion terms, we purchased 1,105,499 shares of RMG stock (adding to our original consolidated ownership an additional 8.7% ownership interest in RMG), by issuing a total of 912,233 shares of our common stock at $3.92 per share. An impairment of $1,622,700 was taken on this investment in RMG during the third quarter of fiscal 2002 as 35 RMG had no production and to bring the total investment in RMG carried on our books in line with the fair market value of RMG assets, the impairment was taken. During fiscal 2002, there were shares of our common stock and warrants issued to our outside directors and consultants, which were valued at a total of $787,700 in a noncash payment for services rendered. Our directors received 3,429 shares of our common stock valued at $14,400 for annual director's fees; consultants received 45,000 shares of our common stock in exchange for $148,100 in consulting services and other consultants and investors received warrants valued at $625,200. The $535,200 in noncash compensation was through the funding of our ESOP with 70,075 shares of our common stock valued at $236,900 and the amortization of various Company stock bonus plans in the amount of $298,300. We sold our controlling interest in Ruby Mining Company ("Ruby") to Admiralty Corporation ("Admiralty") of Atlanta, Georgia in fiscal 2001. Admiralty has developed technology that differentiates ferrous from non-ferrous metals in sea water. This technology is used to explore for and recover sunken treasures. Admiralty paid us $100,000 and signed a promissory note for $225,000 for the purchase of Ruby. Admiralty defaulted on the payment of the promissory note. As a result, we recorded a provision for doubtful accounts for the balance due under the Admiralty note of $171,200. Investing activities provided $1,822,300 during fiscal 2002. The primary components of this source of cash was the sale of an interest in RMG's coalbed methane properties to CCBM, Inc. ("CCBM") of Houston, Texas for $1,125,000; proceeds of $752,000 from the sale of various surplus equipment, and a net change of $406,500 in the investment we have in affiliated companies. Uses of cash in Investing Activities were the expenses incurred in the exploration of RMG's coalbed methane properties of $142,100; increased value of restricted investments of $236,800 through the reinvestment of interest earned on those investments, and the purchase of $82,300 of equipment. RMG assigned CCBM an undivided 50% interest in all of RMG's existing coalbed methane properties (with the exception of Castle Rock of which only a 6.25% working interest was assigned) for the purchase price of $7,500,000 by a promissory note payable in principal amounts of $125,000 per month plus interest at 8% per annum over 41 months (starting on July 31, 2001) with a balloon payment due on the forty-second month. The note is secured by a pledge of CCBM's interest in the properties of RMG being purchased by CCBM. All payments on the promissory note principal, $1,125,000 were taken against our full cost pool of coalbed methane gas properties. CCBM has made all payments due under the terms of the promissory note. CCBM also agreed to pay $5,000,000 to drill and complete coalbed methane wells on RMG's properties. One half of this amount, $2,500,000 will be credited against any drilling or property exploration and development costs that are the obligation of RMG. As of May 31, 2002, the total amount expended by CCBM towards this work commitment was $2,245,000 leaving a balance under the work commitment of $2,755,000 approximately half of which will be spent to cover RMG's commitments in the exploration and development of the joint properties. RMG did expend $142,100 in the exploration of coalbed methane properties during fiscal 2002, which were outside the work commitment of CCBM. We maintain cash investments in the amount of $10,015,500, that are dedicated to reclamation liabilities and cannot be used for operations of the Company. These investments earn interest annually which is used to pay licensing fees on our uranium mill in southern Utah. Any unused earned interest proceeds are reinvested into the restricted investments. During fiscal 2002, restricted investments increased by $236,800. Financing activities during fiscal 2002 provided $3,391,300. These proceeds were generated from the sale of common stock of the Company and its subsidiary RMG in the amount of $3,957,400 and proceeds from long term debt, $1,000,000. These cash proceeds from financing activities were partially offset by 36 repayments of the Company's line of credit and other long term debt in the amounts of $650,000 and $547,800, respectively. The Company sold 871,592 shares of it common stock in private placements for a total of $2,350,500. Employees of the Company also exercised options to purchase 253,337 shares of the Company's common stock for $602,500. RMG sold 333,333 shares of its common stock in a private placement to outside investors for $1,000,000. These shares of RMG stock were converted to common shares of the Company's common stock as discussed above. On May 30, 2002, the Company entered into a debt financing agreement with an independent company. The Company secured $1,000,000 in debt through this transaction which bears interest of 8% per annum and is due quarterly commencing on September 1, 2002. Collateral for the loan is a junior security interest in the assets of the Company. The entire debt is due on or before May 30, 2004. At the option of the lending company, all or any portion of the debt may be repaid with the common stock of the Company or RMG, at the rate of $3.00 per share for Company shares, or $1.50 per share for RMG shares. In addition, the lending company received detached warrants to purchase 120,000 shares of the Company and 120,000 shares of RMG's common stock at $3.00 and $1.50 per share, respectively and a beneficial conversion provision. The Company therefore recognized a discount on the $1,000,000 loan in the total amount of $670,100. The balance of the increase in long term debt was for the financing of prepaid insurance and the financing of miscellaneous assets. Working capital increased by $2,557,900 from $933,300 at May 31, 2001 to working capital of $3,491,200 at May 31, 2002. This increase in working capital was primarily as a result of the increased cash receipts discussed above. CAPITAL RESOURCES The primary sources of our capital resources are cash on hand; collection of receivables; receipt of monthly payments from CCBM for the purchase of an interest in RMG's coalbed methane properties; CCBM funding of drilling and development programs; projected production from RMG's coalbed methane properties; sale of excess mine, construction and drilling equipment; sale of real estate properties which are no longer needed in the core business of the Company; sale of partial ownership interest in mineral properties; proceeds under the line of credit; equity financing of the Company's subsidiaries; and the final determination of the Sheep Mountain Partners ("SMP") arbitration/litigation. We will also continue to receive revenues from our motel and real estate operations in southern Utah. Drilling and development capital requirements will be satisfied for the majority of fiscal 2003 from the CCBM work commitment of which there is $2,755,000 remaining as of May 31, 2002. Approximately one-half of this amount will be paid by CCBM on behalf of RMG for its obligations for drilling and property development of coalbed methane properties. There is also a balance of $6,375,000 due from CCBM under its purchase agreement. Under the terms of the promissory note, this amount will continue to be paid at the rate of $125,000 per month plus interest until November 2004 at which time a balloon payment of $2,375,000 is due. CCBM's interest in RMG's coalbed methane properties is pledged as security for the note to RMG. After CCBM has paid $2,500,000 (33%) of the principal amount of the promissory note, RMG will release 25% of the undivided interest in the coalbed methane properties purchased by CCBM; another 25% when $5,000,000 (66.6%) of the principal is paid, and the balance of the total 50% undivided interest when all of the principal amount of $7,500,000 of the purchase price has been paid. Under the agreement with CCBM, CCBM also agreed to use its best efforts to obtain financing to raise no less than $20 million to be used by RMG to acquire more coalbed methane properties. CCBM has 37 not been successful in raising these funds within the terms of the agreement due to market conditions for coalbed methane gas. RMG has extended the time for CCBM to raise the funds to June 30, 2003. If CCBM is unsuccessful in raising the funds to purchase additional coalbed methane properties or for any reason determines to discontinue participation in the exploration and development of RMG's coalbed methane properties, RMG will continue to seek equity or industry funding to develop its properties. The Company has shut down it mines and has discontinued its mining and construction operations. It therefore has surplus equipment and buildings from these operations. During fiscal 2001 and 2002, the Company sold the majority of its surplus equipment. In addition, the Company owns various raw land which is held as investment property or were intended to be used in mining operations. These properties are no longer needed for the core business of the Company and will be sold. The Company currently has an offer to sell a piece of property in California which was previously held for the development of a mill tailings site for its subsidiary Sutter Gold Mining Company, ("SGMC"). This property was never developed for a tailings site so has no reclamation liability. The Company continues to market home and mobile home lots in southern Utah. These fully developed properties are not important to the operations of the Company. The lots were a portion of the assets that the Company acquired when it purchased the Shootaring uranium mill and Ticaboo Townsite. The Company has also listed the commercial operations at Ticaboo for sale. It is the intention of management of the Company to sell this commercial property. The Company also has determined to sell the Shootaring uranium mill. It is the goal of the Company's management to sell the mill as a unit but proposals to sell the mill parts have also been considered. No firm proposal is currently being considered on the mill. To assist in financing the holding costs of the SGMC properties (which are shut down), the Company developed a mine tour business. After operating the mine tour business for approximately one year, it was determined to lease out the tour business. Proceeds under the lease agreement partially defray the holding costs of the mine property. The Company is currently discussing the potential of either a sale of the property to an industry partner or a possible joint venture agreement to operate the property. Equity financing will be required to develop the mine and mill complex. A decision to further develop the property at Sutter is contingent on the price of gold. We currently have a $750,000 line of credit with a commercial bank. As of May 31, 2002, this line of credit has been drawn down by $200,000. The line of credit will be renewed in September of 2002. Due to the sale of mining equipment, which was held as collateral for the line of credit, the limit of the line of credit may be reduced. We also have a $500,000 line of credit through our affiliate Plateau Resources. This line of credit is for the development of the Ticaboo Townsite in southern Utah. Plateau has drawn down $300,000 of this financing facility which is repayable over 10 years. All payments on these lines of credit are current as of the filing date of this report. We have been involved in litigation with Nukem, Inc. involving SMP for the past eleven years. The U.S. District Court of Colorado has appointed a Special Master to determine the value of the purchase rights, the pounds of uranium and the profits under certain contracts Nukem entered into with 3 CIS Republics, which contracts have been placed in a constructive trust. The Special Master is currently performing the accounting. The Federal Court has ordered that the accounting be completed andthereafter filed with the Court. The Court by December 6, 2002 with a further status hearing to be held on December 13, 2002. Theis considering the motions. Management believes that the ultimate outcome of this litigation cannot be determined but management of the Company believes that itmatter will be beneficial to the Company. We believe that these cash resources will be sufficient to sustain operations during fiscal 2003. 38 CAPITAL REQUIREMENTS The primary capital requirements during fiscal 2003 are expected to be exploration and development of coalbed methane properties; the cost of maintaining our uranium properties that are shut down; the shut down SGMC properties holding costs; and general and administrative costs. Estimated capital requirements for fiscal 2003 are: $873,500 for the exploration and holding costs of coalbed methane properties; costs to hold uranium properties that are shut down and associated real estate assets in the amount of $600,000; shut down SGMC properties holding costs of $230,000, and general and administrative costs of $3,885,000. These allocations and estimates may vary depending on the level of acquisition and drilling RMG participates in during the year. EXPLORATION OF COALBED METHANE PROPERTIES ----------------------------------------- The majority of the fiscal 2003 exploration costs associated with the coalbed methane properties of RMG has been funded through the CCBM agreement. Under the CCBM purchase and sale agreement, if properties are drilled that are owned 50% by RMG, we may be required to fund the drilling costs for the interest ownership of the remaining non-participating parties. Should we be required to fund any non- participating entities portion of the exploration programs, there is a back-in provision on each property which gives RMG a disproportionate amount of the production revenues until our cost and additional amounts are recovered before the non-participating parties begin to receive production funds. HOLDING COSTS OF SHUT DOWN MINERAL PROPERTIES --------------------------------------------- SMP URANIUM PROPERTIES The holding costs associated with the uranium mineral properties formerly owned by Sheep Mountain Partners ("SMP"), are approximately $28,000 per month. We continue to implement cost cutting measures to reduce the holding costs. We have begun the process of reclamation on certain of these mine properties and will continue to do work during fiscal 2003. It is estimated that $50,000 in reclamation work will be completed on the SMP mine properties during fiscal 2003. The Company is seeking final approval from the regulatory agencies of the reclamation work completed on the GMIX water treatment plant during fiscal 2002. PLATEAU RESOURCES URANIUM PROPERTIES Plateau owns the Ticaboo Townsite, which includes a motel, convenience store, boat storage, restaurant and lounge. Prior to fiscal 2002, we operated all of these entities. A decision was made to lease out all but the motel operations during fiscal 2002. This decision relieved us of the obligation and expense of employees, inventory and risk of loss from the business operations. Additionally, Plateau owns and maintains the Tony M uranium property and Shootaring Canyon uranium mill. The uranium property and mill are both shut down. We are pursuing alternative uses for these properties including the potential sale of the uranium mill. There are no major reclamation projects anticipated on the mill or mine properties during fiscal 2003. SUTTER GOLD MINING COMPANY PROPERTIES Due to the depressed market price of gold, further work on the SGMC properties has been deferred until the price of gold improves. In the meantime, SGMC developed a tourism business to cover the holding costs of the properties. A decision was made to lease out the tourism business to a third party. The revenues received from the lease cover a majority of our holding costs associated with the mine, shop and mineral leases. We have one employee at the SGMC properties to preserve the core assets and properties. SGMC is 39 in the process of evaluating the potential of selling certain of the nom-essential land positions that it has acquired in developing a mine plan. SGMC is also considering other alternatives such as equity financing or obtain industry partners to develop the property in the event that market prices reach to the level to warrant placing the properties into production. Carrying values for the SGMC properties, as of May 31, 2002, are lower than the fair market value of the properties. These properties consist primarily of raw land that was purchased for a mill tailings cell but is no longer needed under the new mine development plan. The land is in the path of a proposed highway development project by the State of California. DEBT PAYMENTS ------------- Debt to non-related parties at May 31, 2002 was $2,559,000 as compared with $2,294,500 at May 31, 2001. The increase in debt to non-related parties of $264,500 consists of debt incurred to finance annual insurance premiums of $250,500; purchase of equipment of $180,600; and the convertible debt in the amount of $1,000,000 from an independent company which was discounted by $670,100 for detached warrants and a beneficial conversion provision, which will be amortized over the life of the debt. During fiscal 2002 the Company made payments on outstanding debt in the amount of $496,500. Payment requirements on this debt during fiscal 2003 is $80,000 of interest on the convertible debt and $205,700 in principal payments on the balance of the debt. Principal requirements of long term debt are $205,700, $540,200, $182,200, $199,000, $1,036,600 and $394,000 for fiscal 2003 through 2008, respectively. At May 31, 2002, the Company borrowed $200,000 under its $750,000 line of credit with a commercial bank. The line of credit is to be renewed in September of 2002. FEDERAL INCOME TAX ISSUES ------------------------- During fiscal 2002, the Internal Revenue Service ("IRS") audited our books and records for the fiscal years ended May 31, 1999 and 2000. The audits have been completed and all issues agreed to. There were no changes in the amount of taxes due as a result of these audits. All issues through May 31, 2000 are now settled and the years through then are closed. RECLAMATION COSTS ----------------- The reclamation obligations are long term and are either bonded through the use of cash bonds or the pledge of assets. It is anticipated that only $50,000 of reclamation work will be performed during fiscal 2003. The reserves to pay the reclamation obligations are either real estate holdings of the Company that are pledged or restricted cash investments. The reclamation liability on the Plateau uranium mining and milling properties in Utah is $7,382,100 which is reflected on the Balance Sheet as a reclamation liability. This liability is fully funded by cash investments that are recorded as long term restricted assets. The reclamation costs of the Sheep Mountain uranium properties in Wyoming are $1,496,800 and are covered by a reclamation bond which is secured by a pledge of certain of our real estate assets. The reclamation requirements for the SGMC properties is approximately $27,900. This reclamation obligation is bonded with a cash bond. 40 RESULTS OF OPERATIONS --------------------- FISCAL 2002 COMPARED TO FISCAL 2001 - ----------------------------------- Revenues: - --------- Revenues from operations decreased by $1,258,900 to $2,004,100 during fiscal 2002 from the $3,263,000 recognized during fiscal 2001. Components of this decrease are reductions of $426,500 in motel, real estate and airport operations; mineral sales of $334,300; mineral royalties of $108,500; and management fees of $389,600. Mineral sales during fiscal 2001 resulted from purchase of uranium oxide on the open market to fill uranium sales contracts and the sale of a uranium contract to a third party. We did not supply any of the uranium sold under the contracts from production out of our mines. We have not produced any minerals from mines for several years. The uranium contracts expired and no molybdenum advance royalties have been received since 2001. The reduction of motel, real estate and airport operations of $426,500 was primarily as a result of reduced revenues at our Ticaboo motel in southern Utah. The reduction in revenues in the tourism business is attributed to the general decline in the economy as well as the negative effect that the terrorist attacks have had on people's desire to travel. There were no mineral sales during fiscal 2002 while there was one delivery under a uranium contract as well as the sale of one of the Company's uranium contracts to a third party during fiscal 2001. Currently the Company does not have any delivery contracts for uranium or any other mineral. Depending on the outcome of the SMP litigation, the Company may well have CIS pounds of uranium for which it will need to obtain delivery contracts. The Company holds a 6% royalty on the Mt. Emmons molybdenum deposit near Crested Butte, CO. Under the provisions of the royalty agreement, the Company and Crested are to receive 50,000 pounds of molybdenum or its cash equivalent annually as an advance royalty. The royalty agreement was originally made with AMAX, Inc., which was purchased by Cyprus Minerals Company in 1993 and changed its name to Cyprus Amax Minerals Company ("Cyprus Amax"). In 1999, Cyprus Amax was purchased by Phelps Dodge Corporation. AMAX and Cyprus had made the advance royalty payments to USECC on a timely basis. Phelps Dodge made one advance royalty payment and ceased making payments in fiscal 2001. Phelps Dodge has suspended payments under the advance royalty agreement and has sued the Company. The Company has filed counter claims against Phelps Dodge requesting that the advance royalty and other issues be reinstated. It is not known what the outcome of this litigation will be. Management fees were reduced by $389,600 in fiscal 2002 from the prior period due to reduced activity in the entities from which management fees are collected. Costs and Expenses: - ------------------- During fiscal 2002, costs and expenses were reduced by $1,322,500. This reduction was as a result of reduced activity in our commercial operations in southern Utah because some of the operations were leased to third parties, and the general economy turned down as a result of terrorist attacks. This reduced both revenues as discussed above and costs and expenses of $1,307,300. The holding costs of mineral properties were reduced by $1,661,500 as a result of the Company reducing costs associated with mineral properties that are shut down. The general and administrative costs were reduced by $104,700. In addition to these reductions in costs and expenses, the Company recognized an expense of $123,800 in abandonment of mining equipment during fiscal 2001. There was no abandonment expense in fiscal 2002. 41 These reductions in costs and expenses were offset by increases in impairment of goodwill of $1,622,700; provision for doubtful accounts of $171,200 and other expenses of $80,900. The impairment of goodwill came as a result of the Company purchasing an additional 8.7% of RMG equity or 1,105,499 shares of RMG stock by issuing 912,233 shares of the Company's common stock. The shares of the Company's common stock were valued at $3.92 per share. An impairment of $1,622,700 was taken on this investment in RMG as RMG had no gas production and the impairment brought the total investment in RMG in line with the fair market value of the RMG assets. A provision for doubtful accounts was provided on the balance of a note receivable that the Company held for the sale of Ruby Mining Company to Admiralty Corporation. The note was in the original amount of $225,000 and had been reduced to $171,200. The note went in default during fiscal 2002 at which time the Company began negotiations with Admiralty to resolve the issue of the outstanding balance. Terms were reached which required Admiralty to pay interest on the note, plus accrued interest, through August 2003, at which time the entire note balance would come due. Due to the financial condition of Admiralty, it is not known if that company will be able to pay off the balance of the note. The entire amount of the note was therefore reserved. Other Income and Expenses: - -------------------------- Gain on sale of assets income decreased by $350,900 during fiscal 2002 to $812,700. This decrease was as a result of the sale of a majority of the surplus mining equipment that the Company had for sale during the prior year. During fiscal 2002, there was no income from litigation settlements while during fiscal 2001 there was $7,132,800 in litigation settlement as a result of the Company settling all issues appertaining to the Kennecott litigation. Interest income increased by $152,400 during fiscal 2002 over fiscal 2001 as did interest expense which increased by $80,000 for the same period. These increases were as a result of larger amounts invested in interest bearing accounts and increased debt. Operations for the twelve months ended May 31, 2002 resulted in a net loss of $6,267,600 or $0.67 per share as compared to net income of $1,771,200 or $0.23 per share for the previous year. FISCAL 2001 COMPARED TO FISCAL 2000 - ----------------------------------- Revenues: - --------- Operating revenues during fiscal 2001 decreased $40,900 from revenues for the previous year to $3,263,000. This decrease was primarily as a result of a decrease in revenues from motel, real estate and airport operations. This decrease was offset by increases in mineral sales and management fees. During fiscal 2001, we recorded $334,300 in revenues from mineral sales compared with no mineral sales revenue during the previous year. The increase was the result of the sale of a uranium delivery contract to a non-affiliated company, and a delivery of uranium made under that market related contract before the sale of the contract. There were no similar sales of uranium during the same period of the prior year. The Company purchased the uranium necessary to deliver to its contract. The Company has not produced uranium for several years. Revenues from motel, real estate and airport operations decreased from $2,734,800 at May 31, 2000 to $2,222,400 at May 31, 2001. This decrease is as result of the mine tour at SGMC and the boat storage, restaurant and convenience store operations being leased to third parties by Plateau during fiscal 2001. Management fees increased $161,300 to $597,800 during fiscal 2001. This increase was due to RMG operations on which we receive a management fee. 42 Costs and Expenses: - ------------------- Costs and expenses decreased by $3,879,200 during fiscal 2001 to $10,780,800 from $14,660,000 during the previous year. This reduction in costs and expenses came as a result of reduced motel, real estate and airport operations expense of $151,100, and general and administrative costs and expenses of $3,805,900. These reductions in costs and expenses were offset by increases in mineral holding costs and expenses of $662,600; and abandonment of mining equipment of $123,800. General and administrative costs during fiscal 2000 were significantly higher than those experienced during fiscal 2001 due to a noncash charge to operations of $3,139,100 as a result of the issuance of common shares of RMG stock below the market. Other reductions in general and administrative costs and expenses during fiscal 2001 were related to a reduction of staff. Other Income and Expenses: - -------------------------- As a result of the settlement of the Kennecott litigation, $7,132,800 was recorded as revenue during fiscal 2001. This revenue has two components: (1) Noncash revenues as a result of the recognition of $4,000,000 of a deferred GMMV purchase option payment that was received in 1997 and (2) the receipt of cash from Kennecott as a result of the settlement, $3,132,800 - net of accounts receivable from GMMV. During the fiscal 2001, we recognized a gain of $1,163,600 from the sale of equipment that was determined to be surplus. One component of this amount was the sale of certain GMMV assets that were distributed to the Company from the GMMV upon the resolution of the Kennecott litigation. The other main components of this increase are the final royalty payment received from the sale of The Brunton Company of $233,000, and the sale of a real estate property in Colorado of $264,600. Operations for the fiscal year ended May 31, 2001, resulted in earnings of $1,771,200 or $0.21 per share fully diluted as compared to a loss of $10,621,000 or $1.33 per share fully diluted for the fiscal year ended May 31, 2000. FUTURE OPERATIONS ----------------- We have generated operating losses in each of the last three years as a result of costs associated with shut down mineral properties. We have maintained some of our investments in gold and uranium properties that have not generated operating revenues. These properties require expenditures for items such as permitting, care and maintenance, holding fees, corporate overhead and administrative expenses. Success in the minerals industry is dependent on the price that a producer can receive for its minerals. We cannot predict what the long term price for gold and uranium will be and therefore cannot predict when, or if, we will generate net income from these operations. At May 31, 2002 we are committed to be in the coalbed methane business well into the future. Uranium prices and market projections are being evaluated. Decisions to liquidate part or all of the Company's uranium holdings are being considered. We are also evaluating its commitment to the gold business depending on the price for gold recovering. 43 EFFECTS OF CHANGES IN PRICES ---------------------------- Mineral operations are significantly affected by changes in commodity prices. As prices for a particular mineral increase, prices for prospects for that mineral also increase, making acquisitions of such properties costly, and sales advantageous. Conversely, a price decline facilitates acquisitions of properties containing that mineral, but makes sales of such properties more difficult. Operational impacts of changes in mineral commodity prices are common in the mining industry. NATURAL GAS. Our decision to expand into the coalbed methane gas industry were predicated on the projections for natural gas demand and prices. URANIUM AND GOLD. Changes in the prices of uranium and gold willadverse affect our operational decisions in the future. Currently, both gold and uranium are at low prices. We continually evaluate market trends and data. We do not plan to go forward with any work on our uranium and gold properties until the market price for these metals increase and remain at profitable levels. MOLYBDENUM AND OIL. Changes in prices of molybdenum and petroleum are not expected to materially affect our operations during fiscal 2003. ITEM 8. FINANCIAL STATEMENTS Financial statements meeting the requirements of Regulation S-X for the Company follow immediately. Please note that the financial information contained in these financial statements for the year ended May 31, 2000 was audited by Arthur Andersen LLP who has ceased operations. A copy of Arthur Andersen's previously issued audit report, dated September 11, 2000 is included in this filing. This report has not been revised. This report refers to financial information for the two years ended May 31, 2000. However, only the information for the year ended May 31, 2000 is included in the financial statements filed with this report. 44 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To U.S. Energy Corp.: We have audited the accompanying consolidated balance sheets of U.S. ENERGY CORP. (a Wyoming corporation) AND SUBSIDIARIES as of May 31, 2002 and May 31, 2001, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the two years in the period ended May 31, 2002. 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. The financial statements of U.S. ENERGY CORP. AND SUBSIDIARIES as of and for the year ended May 31, 2000, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements before the reclassifications described in Notes B and L in their report dated September 11, 2000. As described in Notes B and L, the financial statements include certain reclassifications. We have audited the reclassifications that were applied to the 2000 financial statements. In our opinion, such reclassification adjustments are appropriate and have been properly applied. However, we were not engaged to audit, review, or apply any procedures to the 2000 financial statements of the Company other than with respect to such reclassification adjustments and accordingly, we do not express an opinion or any form of assurance on the 2000 financial statements taken as a whole. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 2002 and 2001 consolidated financial statements referred to above present fairly, in all material respects, the financial position of U.S. Energy Corp. and subsidiaries as of May 31, 2002 and 2001, and the results of their operations and their cash flows for each of the two years ended May 31, 2002, in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note A to the financial statements, the Company has experienced recurring losses from operations and has a substantial accumulated deficit. These factors raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans in regards to these matters are also described in Note A. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. GRANT THORNTON LLP Denver, Colorado, July 18, 2002 45 The report that appears below is a copy of the report issued by the Company's previous independent auditor, Arthur Andersen, LLP. That firm has discontinued performing auditing and accounting services. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ---------------------------------------- To U.S. Energy Corp.: We have audited the accompanying balance sheet of U.S. Energy Corp. (a Wyoming corporation) as of May 31, 2000, and the related consolidated statements of operations, shareholders' equity and cash flows for the year ended May 31, 2000. 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 auditing standards generally accepted in the United States. 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 financial position of U.S. Energy Corp. as of May 31, 2000, and the results of operations and cash flows for the year ended May 31, 2000, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Denver, Colorado September 11, 2000 46 U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS
May 31, ------------------------------- 2002 2001 ------------ ------------- CURRENT ASSETS: Cash and cash equivalents $ 2,564,300 $ 685,500 Accounts receivable: Trade, net of allowance of $27,800 768,800 1,319,300 Affiliates 132,800 74,200 Current portion of long-term notes 229,000 225,000 Assets held for resale and other 1,111,100 983,800 Inventory 86,600 42,200 ------------ ------------ Total current assets 4,897,600 3,330,000 INVESTMENTS AND ADVANCES: Affiliates -- 16,200 Restricted investments 10,015,500 9,778,700 ------------ ------------ Total investments and advances 10,015,500 9,794,900 PROPERTIES AND EQUIPMENT: Land 1,764,100 1,771,800 Buildings and improvements 8,501,300 8,425,400 Machinery and equipment 5,107,700 5,536,900 Proved oil and gas properties, full cost method 1,773,600 1,773,600 Unproved coalbed methane properties, excluded from amortization 4,995,600 5,881,700 ------------ ------------ Total property and equipment 22,142,300 23,389,400 Less-accumulated depreciation, depletion and amortization (7,584,200) (7,285,100) ------------ ------------ Net property and equipment 14,558,100 16,104,300 OTHER ASSETS: Accounts and notes receivable: Real estate and equipment sales 36,800 42,400 Employees 65,000 180,300 Deposits and other 969,900 1,013,300 ------------ ------------ Total other assets 1,071,700 1,236,000 ------------ ------------ Total assets $ 30,537,900 $ 30,465,200 ============ ============
The accompanying notes to consolidated financial statements are an integral part of these statements. 47 U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND SHAREHOLDERS' EQUITY
May 31, ------------------------------ 2002 2001 ------------ ------------ CURRENT LIABILITIES: Accounts payable and accrued expenses $ 758,600 $ 1,404,300 Prepaid drilling costs 242,100 -- Current portion of long-term debt 205,700 142,400 Line of credit 200,000 850,000 ------------ ------------ Total current liabilities 1,406,400 2,396,700 LONG-TERM DEBT 2,353,300 2,152,100 RECLAMATION LIABILITY 8,906,800 8,906,800 OTHER ACCRUED LIABILITIES 2,544,200 2,777,800 DEFERRED TAX LIABILITY 1,144,800 1,144,800 MINORITY INTERESTS 575,300 1,177,800 COMMITMENTS AND CONTINGENCIES FORFEITABLE COMMON STOCK, $.01 par value; 500,788 and 433,788 shares issued, forfeitable until earned 3,009,900 2,748,600 PREFERRED STOCK, $.01 par value; 1,000 shares authorized, 0 and 200 shares issued and outstanding respectively -- 1,840,000 SHAREHOLDERS' EQUITY: Common stock, $.01 par value; unlimited shares authorized; 11,720,818 and 8,989,047 and shares issued, respectively 117,200 90,000 Additional paid-in capital 48,278,500 38,681,600 Accumulated deficit (34,567,600) (28,300,000) Treasury stock at cost, 959,725 and 949,725 shares, respectively (2,740,400) (2,660,500) Unallocated ESOP contribution (490,500) (490,500) ------------ ------------ Total shareholders' equity 10,597,200 7,320,600 ------------ ------------ Total liabilities and shareholders' equity $ 30,537,900 $ 30,465,200 ============ ============
The accompanying notes to consolidated financial statements are an integral part of these statements. 48 U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended May 31, ------------------------------------------------ 2002 2001 2000 ------------ ------------ ------------ OPERATING REVENUES: Motel, real estate and airport operations $ 1,795,900 $ 2,222,400 $ 2,734,800 Mineral sales -- 334,300 -- Mineral royalties -- 108,500 132,600 Management fees 208,200 597,800 436,500 ------------ ------------ ------------ 2,004,100 3,263,000 3,303,900 OPERATING COSTS AND EXPENSES: Motel, real estate and airport operations 1,928,900 3,236,200 3,387,300 Mineral holding costs 1,707,800 3,369,300 2,706,700 General and administrative 3,946,800 4,051,500 7,857,400 Abandonment of mining equipment -- 123,800 -- Provision for doubtful accounts 171,200 -- 708,600 Other 80,900 -- -- Impairment of goodwill 1,622,700 -- -- ------------ ------------ ------------ 9,458,300 10,780,800 14,660,000 ------------ ------------ ------------ OPERATING LOSS (7,454,200) (7,517,800) (11,356,100) OTHER INCOME & EXPENSES Gain on sales of assets 812,700 1,163,600 71,400 Litigation settlements, net -- 7,132,800 -- Interest income 852,100 699,700 813,600 Interest expense (345,300) (265,300) (82,800) ------------ ------------ ------------ 1,319,500 8,730,800 802,200 ------------ ------------ ------------ (LOSS) INCOME BEFORE MINORITY INTEREST AND EQUITY IN LOSS OF AFFILIATES (6,134,700) 1,213,000 (10,553,900) MINORITY INTEREST IN LOSS OF CONSOLIDATED SUBSIDIARIES 39,500 220,100 509,300 EQUITY IN LOSS OF AFFILIATES -- -- (2,900) ------------ ------------ ------------
The accompanying notes to consolidated financial statements are an integral part of these statements. 49 U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)
Year Ended May 31, ------------------------------------------------- 2002 2001 2000 ------------ ------------- ------------- (LOSS) INCOME BEFORE INCOME TAXES (6,095,200) 1,433,100 (10,047,500) PROVISION FOR INCOME TAXES -- -- -- ------------ ------------ ------------ NET (LOSS) INCOME FROM CONTINUING OPERATIONS (6,095,200) 1,433,100 (10,047,500) DISCONTINUED OPERATIONS, NET OF TAX (85,900) 488,100 (594,300) ------------ ------------ ------------ NET (LOSS) INCOME (6,181,100) 1,921,200 (10,641,800) ------------ ------------ ------------ PREFERRED STOCK DIVIDENDS (86,500) (150,000) (20,800) ------------ ------------ ------------ NET (LOSS) INCOME TO COMMON SHAREHOLDERS $ (6,267,600) $ 1,771,200 $(10,662,600) ============ ============ ============ NET (LOSS) INCOME PER SHARE BASIC FROM CONTINUED OPERATIONS $ (0.66) $ 0.17 $ (1.31) FROM DISCONTINUED OPERATIONS (0.01) 0.06 (0.08) ------------ ------------ ------------ $ (0.67) $ 0.23 $ (1.39) ============ ============ ============ NET (LOSS) INCOME PER SHARE DILUTED FROM CONTINUED OPERATIONS $ (0.66) $ 0.15 $ (1.31) FROM DISCONTINUED OPERATIONS (0.01) .06 (0.08) ------------ ------------ ------------ $ (0.67) $ 0.21 $ (1.39) ============ ============ ============ BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 9,299,359 7,826,001 7,673,475 ============ ============ ============ DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 9,299,359 8,487,680 7,673,475 ============ ============ ============
The accompanying notes to consolidated financial statements are an integral part of these statements. 50 U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional -------------------------- Paid-In Accumulated Shares Amount Capital Deficit ------ ------ ------------ ------------- Balance May 31, 1999 8,550,624 $ 85,600 $ 33,014,900 $(19,408,600) Funding of ESOP 123,802 1,200 370,200 -- Issuance of common stock to outside directors 6,020 100 21,000 -- Issuance of common stock for purchase of subsidiary stock 73,109 700 259,900 -- Forfeitable shares earned 9,600 100 88,000 -- Treasury stock from consolidation of subsidiaries Ruby Mining Co. and Northwest Gold, Inc. -- -- -- -- Unrealized gain on sale of subsidiary stock -- -- 1,053,700 -- Noncash compensation paid by subsidiary -- -- 2,990,000 -- Writedown of unallocated ESOP contribution -- -- -- -- Net Loss -- -- -- (10,662,600) --------- ------------ ------------ ------------ Balance May 31, 2000 8,763,155 $ 87,700 $ 37,797,700 $(30,071,200) ========= ============ ============ ============
51a U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
Treasury Stock Unallocated Total ------------------------- ESOP Shareholders' Shares Amount Contribution Equity ------ ------ ------------- ------------- Balance May 31, 1999 930,532 $ (2,584,600) $ (927,000) $ 10,180,300 Funding of ESOP -- -- -- 371,400 Issuance of common stock to outside directors -- -- -- 21,100 Issuance of common stock for purchase of subsidiary stock -- -- -- 260,600 Forfeitable shares earned -- -- -- 88,100 Treasury stock from consolidation of subsidiaries Ruby Mining Co. and Northwest Gold, Inc. 14,193 (55,300) -- (55,300) Unrealized gain on sale of subsidiary stock -- -- -- 1,053,700 Noncash compensation paid by subsidiary -- -- -- 2,990,000 Writedown of unallocated ESOP contribution -- -- 436,500 436,500 Net Loss -- -- -- (10,662,600) ------- ------------ ------------ ------------ Balance May 31, 2000 944,725 $ (2,639,900) $ (490,500) $ 4,683,800 ======= ============ ============ ============
Total Shareholders' Equity at May 31, 2001 does not include 433,788 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which, in consolidation, are treated as treasury shares. The accompanying notes to consolidated financial statements are an integral part of these financial statements. 51b U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
Common Stock Additional -------------------------- Paid-In Accumulated Shares Amount Capital Deficit ------ ------ ------------ -------------- Balance May 31, 2000 8,763,155 $ 87,700 $ 37,797,700 $(30,071,200) Funding of ESOP 53,837 500 287,500 -- Issuance of common stock to outside directors 8,532 100 19,100 -- Forfeitable shares earned 29,820 300 193,900 -- Issuance of common stock for services rendered 15,000 200 70,400 -- Treasury stock from payment on balance of note receivable -- -- -- -- Sale of Ruby Mining -- -- 25,800 -- Issuance of common stock for exercised options 118,703 1,200 287,200 -- Net income -- -- -- 1,771,200 --------- ------------ ------------ ------------ Balance May 31, 2001 8,989,047 $ 90,000 $ 38,681,600 $(28,300,000) ========= ============ ============ ============
52a
Treasury Stock Unallocated Total ------------------------- ESOP Shareholders' Shares Amount Contribution Equity ------ ------ ------------- ------------- Balance May 31, 2000 944,725 $ (2,639,900) $ (490,500) $ 4,683,800 Funding of ESOP -- -- -- 288,000 Issuance of common stock to outside directors -- -- -- 19,200 Forfeitable shares earned -- -- -- 194,200 Issuance of common stock for services rendered -- -- -- 70,600 Treasury stock from payment on balance of note receivable 5,000 (20,600) -- (20,600) Sale of Ruby Mining -- -- -- 25,800 Issuance of common stock for exercised options -- -- -- 288,400 Net income -- -- -- 1,771,200 --------- ------------ ------------ ------------ Balance May 31, 2001 949,725 $ (2,660,500) $ (490,500) $ 7,320,600 ========= ============ ============ ============
Total Shareholders' Equity at May 31, 2001 does not include 433,788 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which, in consolidation, are treated as treasury shares. The accompanying notes to consolidated financial statements are an integral part of these statements. 52b U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (CONTINUED)
Common Stock Additional -------------------------- Paid-In Accumulated Shares Amount Capital Deficit ------ ------ ------------ -------------- Balance May 31, 2001 8,989,047 $ 90,000 $ 38,681,600 $(28,300,000) Funding of ESOP 70,075 700 236,200 -- Issuance of common stock to outside directors 3,429 -- 14,400 -- Issuance of common stock for services rendered 45,000 500 147,600 -- Issuance of common stock warrants for services rendered -- -- 592,900 -- Treasury stock from payment on balance of note receivable -- -- -- -- Issuance of common stock in exchange for preferred stock 513,140 5,100 1,846,400 -- Issuance of common stock in exchange for subsidiary stock 912,233 9,100 3,566,900 -- Issuance of common stock to purchase property 61,760 600 246,200 -- Issuance of common stock through private placement 871,592 8,700 2,341,800 -- Issuance of common stock for exercised stock warrants 1,205 -- 4,500 -- Issuance of common stock for exercised options 253,337 2,500 600,000 -- Net loss -- -- -- (6,267,600) ---------- ------------ ------------ ------------ Balance May 31, 2002 11,720,818 $ 117,200 $ 48,278,500 $(34,567,600) ========== ============ ============ ============
53a
Treasury Stock Unallocated Total -------------------------- ESOP Shareholders' Shares Amount Contribution Equity ------ ------ ------------- ------------- Balance May 31, 2001 949,725 $ (2,660,500) $ (490,500) $ 7,320,600 Funding of ESOP -- -- -- 236,900 Issuance of common stock to outside directors -- -- -- 14,400 Issuance of common stock for services rendered -- -- -- 148,100 Issuance of common stock warrants for services rendered -- -- -- 592,900 Treasury stock from payment on balance of note receivable 10,000 (79,900) -- (79,900) Issuance of common stock in exchange for preferred stock -- -- -- 1,851,500 Issuance of common stock in exchange for subsidiary stock -- -- -- 3,576,000 Issuance of common stock to purchase property -- -- -- 246,800 Issuance of common stock through private placement -- -- -- 2,350,500 Issuance of common stock for exercised stock warrants -- -- -- 4,500 Issuance of common stock for exercised options -- -- -- 602,500 Net loss -- -- -- (6,267,600) ------- ------------ ------------ ------------ Balance May 31, 2002 959,725 $ (2,740,400) $ (490,500) $ 10,597,200 ======= ============ ============ ============
Total Shareholders' Equity at May 31, 2002 does not include 500,788 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which, in consolidation, are treated as treasury shares. The accompanying notes to consolidated financial statements are an integral part of these statements. 53b U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended May 31, ------------------------------------------------ 2002 2001 2000 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (6,267,600) $ 1,771,200 $(10,662,600) Adjustments to reconcile net income (loss) to net cash used in operating activities: Minority interest in loss of consolidated subsidiaries (39,500) (220,100) (509,300) Depreciation and amortization 541,500 1,254,000 1,273,000 Impairment of goodwill 1,622,700 -- -- Impairment of mineral interests -- 123,800 -- Noncash services 787,700 19,100 21,100 Noncash dividend 11,500 -- -- Equity in loss from affiliates -- -- 2,900 Gain on sale of assets (812,700) (1,163,600) (71,400) Provision for doubtful accounts 171,200 -- 708,600 Noncash compensation 535,200 501,700 3,361,400 Deferred income -- (4,000,000) -- Net changes in assets and liabilities: Accounts and notes receivable 799,900 1,241,000 (536,500) Other assets (47,500) (112,700) 92,200 Prepaid drilling costs 242,100 -- -- Accounts payable and accrued expenses (879,300) (887,300) (217,200) Reclamation and other -- -- 82,100 ------------ ------------ ------------ NET CASH USED IN OPERATING ACTIVITIES (3,334,800) (1,472,900) (6,491,900) CASH FLOWS FROM INVESTING ACTIVITIES: Exploration of coalbed methane gas properties (142,100) (1,187,800) (4,727,200) Proceeds from sale of property and equipment 752,000 2,608,000 78,300 Proceeds from sale of gas interests 1,125,000 -- -- Increase in restricted investments (236,800) (417,700) (200,600) Purchase of property and equipment (82,300) (311,400) (2,240,000) Net change in investments in affiliates 406,500 292,400 (12,500) ------------ ------------ ------------ NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 1,822,300 983,500 (7,102,000) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 2,957,400 288,400 -- Proceeds from issuance of preferred stock -- -- 1,840,000 Proceeds from sale of stock by subsidiary 1,000,000 -- 2,160,000 Proceeds from long-term debt 631,700 619,100 886,400 Net activity from lines of credit (650,000) 200,000 650,000 Purchase of treasury stock -- (20,600) -- Repayments of long-term debt (547,800) (828,400) (1,246,300) Cash acquired in purchase of subsidiary -- -- 47,200 ------------ ------------ ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES $ 3,391,300 $ 258,500 $ 4,337,300 ------------ ------------ ------------
The accompanying notes to consolidated financial statements are an integral part of these statements. 54 U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Year Ended May 31, ----------------------------------------------- 2002 2001 2000 ------------ ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS $ 1,878,800 $ (230,900) $ (9,256,600) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 685,500 916,400 10,173,000 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 2,564,300 $ 685,500 $ 916,400 ============ ============ ============ SUPPLEMENTAL DISCLOSURE Income tax paid $ -- $ -- $ -- ============ ============ ============ Interest paid $ 345,300 $ 265,300 $ 35,800 ============ ============ ============ NONCASH INVESTING AND FINANCING ACTIVITIES: Issuance of stock to invest in subsidiary $ 3,568,500 $ -- $ -- ============ ============ ============ Issuance of stock to retire preferred stock $ 1,840,000 $ -- $ -- ============ ============ ============ Sale of assets through notes and accounts receivable $ 442,200 $ 1,164,500 $ -- ============ ------------ ============ Issuance of stock as deferred compensation $ 261,300 $ 358,400 $ 201,000 ============ ============ ============ Acquisition of assets through issuance of debt $ 180,600 $ 1,631,700 $ 506,000 ============ ============ ============ Acquisition of assets through issuance of stock $ 96,800 $ -- $ -- ============ ============ ============ Satisfaction of receivable - employee with stock in company $ 79,900 $ -- $ -- ============ ============ ============ Issuance of stock for services $ 14,400 $ 70,500 $ -- ============ ============ ============ Issuance of stock for retired employees $ -- $ 194,400 $ 88,100 ============ ============ ============ Satisfaction of receivable - affiliate with stock in affiliate $ -- $ 3,000,000 $ 196,700 ============ ============ ============ Issuance of stock warrants in conjunction with notes payable $ 592,900 $ -- $ -- ============ ============ ============
The accompanying notes to consolidated financial statements are an integral part of these statements. 55 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 A. BUSINESS ORGANIZATION AND OPERATIONS: U.S. Energy Corp. and subsidiaries (the "Company" or "USE") was incorporated in the State of Wyoming on January 26, 1966. The Company engages in the acquisition, exploration, holding, sale and/or development of mineral and coalbed methane gas properties, the production of petroleum properties and marketing of minerals and methane gas. Principal mineral interests are in uranium, gold, molybdenum and the Company's mineral properties are currently in a shut down status. The Company holds various real and personal properties used in commercial activities. Most of these activities are conducted through the joint venture discussed below and in Note D. The Company was engaged in the maintenance of two uranium properties, one in southern Utah, and the second known as Sheep Mountain Partners ("SMP"). Both of these ventures have been involved in significant litigation (see Note K). Sutter Gold Mining Company ("SGMC"), a Wyoming corporation owned 66.3% by the Company at May 31, 2002, manages the Company's interest in gold properties. The Company also owns 100% of the outstanding stock of Plateau Resources Limited ("Plateau"), which owns a nonoperating uranium mill and support facilities in southeastern Utah. Currently, the mill is nonoperating but has been granted a license to operate subject to certain conditions. Rocky Mountain Gas, Inc. ("RMG") was formed in fiscal 2000 to consolidate all methane gas operations of the Company. The Company owns and controls 91.7% of RMG as of May 31, 2002. MANAGEMENT'S PLAN ----------------- The Company has generated significant net losses during two of the past three fiscal years ending May 31, 2002 and has an accumulated deficit of approximately $34,567,600 at May 31, 2002. The Company has working capital of approximately $3,491,200 at May 31, 2002 and its cash balance has increased from $685,500 at the prior year end to $2,564,300 at May 31, 2002. Although the cash position of the Company improved during the year ended May 31, 2002, the Company has experienced negative cash flows during fiscal 2001 and 2000 in the amounts of $230,900 and $9,256,600, respectively. After the CCBM work commitment has been fully funded, the Company does not have current funds available to fund its portion of the anticipated exploration and development activities on its coalbed methane properties. Additionally, the Company's known cash flows through May 31, 2003 for current operations and associated overhead are negative based on current projections. In order to improve liquidity of the Company, management intends to do the following: o Increase production from the Bobcat coalbed methane property which was purchased during fiscal 2003. Management believes that production can be increased as the coals are de- watered and more gas wells are placed on production. The Company is also working to assist in reducing the price differential that affects Wyoming gas production. These two factors along with anticipated higher production demand pushing methane gas prices higher should have a significant impact on the Company's cash flows. 56 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) o Continue to reduce its mining and construction activities resulting in surplus equipment and buildings. The Company sold a portion of this equipment during fiscal 2002 and 2001 and plans to continue selling the balance of the surplus equipment and buildings during fiscal 2003. This reduction in equipment and buildings will improve cash flow of the Company. o Sell home and mobile home lots at its commercial operations in southern Utah. These lots are no longer needed for current operations and will provide cash flows to the Company. o Sell the Ticaboo Townsite in southern Utah. Included in the townsite is a motel, C store, restaurant/lounge, boat storage and repair facility and undeveloped land. The sale of this property would increase cash position of the Company significantly and would allow the employees of the Company to concentrate on the Company's core business of coalbed methane. o Sell raw land in Riverton, Wyoming and Sutter Creek, California. Management intends to sell this land at its fair market value. The land is not needed for the operations of the Company now or into the future. The land in California was originally purchased to be used as a mill tailings cell site. Although the property was permitted for that purpose, no actual construction of the tailings cell has occurred. The State of California has plans to build a highway through the property and has made an offer to purchase the property. The Company has other property for a proposed tailings site. o Seek equity funding or a joint venture partner to place the SGMC property into production or sell the entire property to an industry partner. Currently, the Company has several third party companies who are looking at options. o Raise additional capital through a private placement and a public offering on its subsidiary Rocky Mountain Gas, Inc. The timing of such a public offering will depend on the market prices for methane gas. o Reduce overhead expenses and concentrate on its primary business - coalbed methane. Additionally, management of the Company believes that funds will be received as a result of the accounting that is currently being conducted by the Special Master under the direction of the U.S. District Court, District of Colorado in the litigation with Nukem, Inc. The Court ordered that the final accounting be delivered to the Court no later than December 6, 2002. Management cannot predict the ultimate outcome of the litigation, however, management of the Company believes it will be beneficial to the Company. As a result of these plans, management believes that they will generate sufficient cash flows to meet its current obligations in fiscal 2003. 57 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF CONSOLIDATION The consolidated financial statements of USE and subsidiaries include the accounts of the Company, the accounts of its majority-owned or controlled subsidiaries Plateau (100%), Energx, Ltd ("Energx") (90%), Four Nines Gold, Inc. ("FNG") (50.9%), SGMC (66.3%), Crested Corp. ("Crested") (70.5%), Yellowstone Fuels Corp. ("YSFC") (35.9%) Rocky Mountain Gas ("RMG") (91.7%), Northwest Gold, Inc. ("NWG") (96%) and the USECC Joint Venture ("USECC"), a consolidated joint venture which is equally owned by U.S. Energy Corp. and Crested, through which the bulk of their operations are conducted. Prior to fiscal 2001, Ruby Mining Company ("Ruby") which was 91% owned by the Company, was also consolidated. During 2001, Ruby was sold to a third party and therefore is no longer consolidated. With the exception of YSFC, investments in joint ventures and all 20% to 50% owned companies are accounted for using the equity method (see Note E). YSFC was an equity investee through February 1999, at which time the Company purchased the majority of the shares of common stock of YSFC owned by outside shareholders by issuing 677,167 shares of Company's common stock. As a result of the common directors and control of YSFC by USE and its employees, YSFC was consolidated as of March 1, 1999. Investments of less than 20% are accounted for by the cost method. All material intercompany profits, transactions and balances have been eliminated. CASH EQUIVALENTS The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. RESTRICTED INVESTMENTS Based on the provisions of Statement of Financial Accounting Standards No. 115 ("SFAS 115"), the Company accounts for its restricted investment in certain securities as held-to-maturity. Held-to-maturity securities are measured at amortized cost. If a decline in fair value of such investments is determined to be other than temporary, the investment is written down to fair value. INVENTORIES Inventories consist primarily of retail inventory of aviation and automobile fuel and associated aircraft parts for motel and airport operations and mining supplies. Retail inventories are stated at lower of cost or market using the average cost method. Inventories used in operations are stated at the lower of cost or market. 58 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) PROPERTIES AND EQUIPMENT Land, buildings, improvements, machinery and equipment are carried at cost. Depreciation of buildings, improvements, machinery and equipment is provided principally by the straight-line method over estimated useful lives ranging from 3 to 45 years. Following is a breakdown of the lives over which assets are depreciated. Office Equipment 3 to 5 years Field Tools and Hand Equipment 5 to 7 years Vehicles and Trucks 3 to 7 years Heavy Equipment 7 to 10 years Service Buildings 20 years Corporate Headquarter's Building 45 years The Company capitalizes all costs incidental to the acquisition and exploration of mineral properties as incurred. Costs are changed to operations if the Company determines that the property is not economical. Costs ad expenses related to general corporate overhead are expensed as incurred. The Company has acquired substantial mining properties and associated facilities at minimal cash cost, primarily through the assumption of reclamation and environmental liabilities. Certain of these properties are owned by various ventures in which the Company is either a partner or venturer. (See Note K.) OIL AND GAS PROPERTIES The Company follows the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration, and development of oil and gas reserves, including directly related overhead costs, are capitalized. All capitalized costs of oil and gas properties including the estimated future costs to develop proved reserves, will be amortized on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major exploration and development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the capitalized cost of the property will be written off. After there are proven reserves, the capitalized costs associated with those reserves are subject to a "ceiling test," which basically limits such costs to the aggregate of the "estimated present value," discounted at a 10-percent interest rate of future net revenues from proved reserves, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. As of May 31, 2002 the Company had begun the dewatering process on exploratory wells it had drilled. Until sufficient wells are dewatered, the amount of reserves (if any) cannot be determined. This process can take up to 24 months from when the first few wells are drilled. The Company therefore cannot determine at May 31, 2002 if an impairment of acquisition and impairment costs has occurred. In the event 59 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) that the drilling and dewatering efforts do not produce economic reserves, the acquisition, exploration and development costs associated with the property will be written off. Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in income. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized. LONG-LIVED ASSETS The Company evaluates its long-lived assets (other than oil and gas properties which are discussed above) for impairment when events or changes in circumstances indicate that the related carrying amount may not be recoverable. If the sum of estimated future cash flows on an undiscounted basis is less than the carrying amount of the related asset, an asset impairment is considered to exist. The related impairment loss is measured by comparing estimated future cash flows on a discounted basis to the carrying amount of the asset. Changes in significant assumptions underlying future cash flow estimates may have a material effect on the Company's financial position and resultscondition or result of operations. An uneconomic commodity market price, if sustained for an extended period of time, or an inability to obtain financing necessary to develop mineral interests, may result in asset impairment. During fiscal 2002, the Company recorded $1,622,700 impairment of goodwill that arose as part of the purchase of an additional 1,105,499 shares of RMG common stock. These shares of stock were purchased by issuing 910,320 shares of the Company's common stock pursuant to conversion rights granted RMG private placement investors. During fiscal 2001, the Company recorded an impairment on its mineral properties of $123,800 in YSFC. As of May 31, 2002, management believes no further impairment is necessary and that the fair market of remaining assets exceeds the carrying value. See Note F for further discussion. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash equivalents, receivables, other current assets, accounts payable and accrued expenses approximates fair value because of the short-term nature of those instruments. The recorded amounts for short-term and long-term debt, approximate fair market value due to the variable nature of the interest rates on the short term debt, and the fact that interest rates remain general unchanged from issuance of the long term debt. REVENUE RECOGNITION Revenues from motel, real estate and airport operations are for the rental of motel rooms, boat storage facilities and mobile home lots at the Company's operations in southern Utah as well as the rental of office space in office buildings in Riverton, Wyoming. Airport operations consist of the sale of aviation fuel, repair 60 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) and maintenance of aircraft and rental of hanger space. All these revenues are reported on a gross revenue basis and are recorded at the time the service is provided. Revenues from mineral sales consist of the sale of uranium to a delivery contract and the sale of that contract to a third party supplier. The sale of uranium is reported on a net basis. The Company has not produced any uranium from its properties during the period covered by the enclosed financial statements and has purchased all uranium delivered under its supply contracts from the open market as all the Company's uranium operations are shut down. Mineral royalties which are non-refundable are recognized as revenue when received (see Note F). Management fees are recorded as a percentage of actual costs for services provided for subsidiaries and partnerships for which the Company provides management services. The Company is also paid a management fee for overseeing oil production on the Fort Peck Reservation in Montana. Management fees are recorded when the service is provided. INCOME TAXES The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes". This statement requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets, liabilities and carryforwards. SFAS 109 requires recognition of deferred tax assets for the expected future effects of all deductible temporary differences, loss carryforwards and tax credit carryforwards. Deferred tax assets are reduced, if deemed necessary, by a valuation allowance for any tax benefits which, based on current circumstances, are not expected to be realized. NET (LOSS) INCOME PER SHARE The Company reports net (loss) income per share pursuant to Statement of Financial Accounting Standards No. 128 ("SFAS 128"). SFAS 128 specifies the computation, presentation and disclosure requirements for earnings per share. Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock, if dilutive. Potential common shares relating to options and warrants are excluded from the computation of diluted earnings (loss) per share, because they were antidilutive, totaled 466,000, 661,679 and 335,420 for the years ended May 31, 2002, 2001 and 2000, respectively. 61 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) COMPREHENSIVE INCOME There are no components of comprehensive income which have been excluded from net income and, therefore, no separate statement of comprehensive income has been presented. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The statement requires entities to record the fair value of a liability for legal obligations associated with the retirement of obligations of tangible long-lived assets in the period in which it is incurred. When the liability is initially recorded, the entity increases the carrying amount of the related long-lived asset. Accretion of the liability is recognized each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. The Company is currently evaluating the effect of adopting SFAS No. 143 on its financial statements and has not determined the timing of adoption. The Company has reviewed other current outstanding statements from the Financial Accounting Standards Board and does not believe that any of those statements will have a material adverse affect on the financial statements of the Company when adopted. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions 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. RECLASSIFICATIONS Certain reclassifications have been made in the prior years financial statements in order to conform with the presentation for the current year. C. RELATED-PARTY TRANSACTIONS: The Company provides management and administrative services for affiliates under the terms of various management agreements. Revenues from services by the Company to unconsolidated affiliates were $78,800, $132,500, and $39,900 and in fiscal 2002, 2001, and 2000, respectively. The Company has $132,800 of receivables from unconsolidated subsidiaries as of May 31, 2002. As of May 31, 2002, the Company had notes receivable due from certain directors and employees of the Company totaling $65,000 due December 31, 2002. This indebtedness is secured by 144,000 shares of the Company's common stock. During fiscal 2002, this debt was reduced by $115,300. 62 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) D. USECC JOINT VENTURE: The Company operates the Glen L. Larsen office complex; an aircraft hangar with a fixed base operation, office space and certain aircraft; holds interests in various mineral operations; conducts oil and gas operations; and transacts all operating and payroll expenses through a joint venture with Crested, the USECC joint venture. E. INVESTMENTS IN AND ADVANCES TO AFFILIATES: The Company's restricted investments secure various decommissioning, reclamation and holding costs. Investments are comprised of debt securities issued by the U.S. Treasury that mature at varying times from three months to one year from the original purchase date. As of May 31, 2002 and 2001, the cost of debt securities was a reasonable approximation of fair market value. These investments are classified as held-to- maturity under SFAS 115 and are measured at amortized cost. The Company's investment in and advances to affiliates are as follows:
Carrying Value at May 31, Consolidated --------------------------- Ownership 2002 2001 ------------ ----------- ----------- Powder River Gas LLC -- $ -- $ 16,200
Equity loss from investments accounted for by the equity method are as follows:
Year Ended May 31, ------------------------------------------- 2002 2001 2000 ---------- ----------- ------------ Ruby Mining Company** $ -- $ -- $ (2,900)**
** Consolidated beginning December 1, 1999. This represents the equity loss through November 30, 1999. Ruby was sold during fiscal 2001 and is no longer consolidated. Condensed combined balance sheets and statements of operations of the Company's equity investees for fiscal 2000 include Ruby Mining Company. F. MINERAL CLAIMS TRANSACTIONS: GMMV - ---- During fiscal 1990, the Company entered into an agreement with Kennecott, a wholly-owned, indirect subsidiary of The RTZ Corporation plc, for Kennecott to acquire a 50% interest in certain uranium mineral properties in Wyoming known as the Green Mountain Properties. During the life of the venture, the parties entered into various amendments to the GMMV agreement. 63 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) As a result of sustained depressed uranium prices, the GMMV properties were maintained on a shut down basis. During fiscal 2000, certain disputes arose in the GMMV venture and Kennecott sued the Company. On September 11, 2000, the parties settled all disputes by Kennecott paying the Company $3.25 million and Kennecott assuming all reclamation liabilities of the GMMV Properties. SMP - --- During fiscal 1989, the Company, through USECC, entered into an agreement to sell a 50% interest in their Sheep Mountain properties to Nukem's subsidiary CRIC. USECC and CRIC immediately contributed their 50% interests in the properties to a newly-formed partnership, Sheep Mountain Partners ("SMP"). SMP was established to further explore uranium mineralization on the claims on Sheep Mountain, acquire uranium supply contracts and market uranium. Certain disputes arose among USECC, CRIC and its parent Nukem, Inc. over the operation of SMP. These disputes have been in litigation/arbitration for the past ten years. See Note K for a description of the investment and a discussion of the related litigation/arbitration. Due to the litigation and arbitration proceedings involving SMP for the past ten years, the Company has expensed all of its costs related to SMP and has no carrying value of its investment in SMP as proceeds from litigation and arbitration proceedings were accounted for under the cost recovery method of accounting as discussed in Note K. The Company's direct loss generated from its investment in SMP, which represents mine holding costs incurred directly by the Company, was $508,600, $399,300, and $711,300 for the years ended May 31, 2002, 2001 and 2000, respectively. As part of a partial settlement agreement dated June 1, 1998, the Company was awarded the return of its Sheep Mountain uranium mines and certain other properties. Accordingly, all mine holding costs were expensed by the Company during fiscal 2002, 2001 and 2000. PHELPS DODGE - ------------ During prior years, the Company conveyed interests in mining claims to AMAX Inc. ("AMAX") in exchange for cash, royalties, and other consideration. There are no remaining values on the balance sheets of the Company at May 31, 2002 or 2001, relating to these claims. AMAX merged with Cyprus Minerals ("Cyprus Amax") which was purchased by Phelps Dodge Mining Company ("Phelps Dodge") in December of 1999. The properties have not been placed into production as of May 31, 2002. AMAX and later Cyprus Amax, paid the Company an annual advance in royalty of 50,000 pounds of molybdenum (or its cash equivalent). During fiscal 2000, Phelps Dodge assumed this obligation and made payments to the Company during fiscal 2001. Phelps Dodge is entitled to a partial credit against future royalties for any advance royalty payments made, but such royalties are not refundable if the properties are not placed into production. The Company recognized $0, $108,500, and $132,600 of revenue from the advance royalty payments in fiscal 2002, 2001, and 2000, respectively. Phelps Dodge did not make the payment of the advance royalty during 2002. The Company considers this a breach of Phelps Dodge's contractual obligations and has filed suit against Phelps Dodge. See Note K for further discussion. 64 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) Phelps Dodge may elect to return the properties to the Company, which would cancel future obligations under the advance royalty obligation. If Phelps Dodge formally decides to place the properties into production, it is obligated to pay $2,000,000 to the Company. Also, per the contract with AMAX, the Company is to receive 15% of the first $25,000,000, or $3,750,000, if the molybdenum properties are sold, which the Company believes has occurred. SUTTER GOLD MINE COMPANY - ------------------------ SGMC was established in 1990 to conduct operations on mining leases and to produce gold from the Lincoln properties in California. SGMC has not generated any significant revenue and has no assurance of future revenue. All acquisition and mine exploration costs since inception were initially capitalized. Due to the decline in the spot price for gold and the lack of adequate financing, SGMC has the mine on a shut down status and written down the associated properties. Management believes that the fair market value of the remaining assets exceeds the carrying value. The remaining SGMC assets include raw land which is no longer needed in the mining operations, buildings and equipment. Primarily as a result of the sustained decline in gold prices and the uncertainty of when prices might recover, the Company evaluated the carrying value of its SGMC properties for impairment, and in fiscal 1999 and 1998, the Company recorded an impairment in the amount of $10,718,300 and $1,500,000 respectively. This impairment, which was taken as required under the provisions of SFAS # 121, resulted in a write- off of nearly 85% of the cost of these properties to values that were estimated to be fair market values at that time based on the salvage values of equipment and the local tax assessor's assessed values of the land, buildings and improvements. Since the date of the last impairment in 1999, the Company has annually determined whether or not events or changes in circumstances had occurred suggesting that additional impairment of the assets of Sutter under SFAS # 121 was necessary. The Company did not deem it necessary to further impair the assets in 2002 or 2001 based on the assessed valuations of the property. An offer to purchase a portion of the land in Sutter during 2002 and current assessed valuations of the property and improvements suggest that the Sutter property is still valued at or below fair market value. The Company will continue to evaluate the carrying value of its long-lived assets and long-lived assets to be disposed of under the provisions of SFAS # 121 and will obtain third-party appraisals of the properties during fiscal 2003 as additional support for the carrying values of the property. 65 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) YELLOW STONE FUELS CORP. - ------------------------ In fiscal 1998, the Company became contractually obligated to exchange its common stock for common stock of YSFC, plus interest, because certain conditions were not met (See Note J). As a result of depressed market prices for uranium, YSFC was not successful in the public offering of its common stock. As a result, the terms of the exchange agreement became effective between the Company and YSFC shareholders. The Company therefore issued 677,167 shares of its common stock. The exchange offer for YSFC remained effective until September 13, 1999. Due to continued low uranium market prices and the inability to raise financing to place the YSFC properties into production, the Company recorded an impairment of $123,800 in fiscal 2001 and $2,506,100 in 1999 related to YSFC's properties, which is classified as abandonment of mining equipment in the accompanying Consolidated Statements of Operations. The impairment was specifically related to the YSFC mining equipment in fiscal 2001. PLATEAU RESOURCES LIMITED - ------------------------- During fiscal 1994, the Company entered into an agreement with Consumers Power Company to acquire all the issued and outstanding common stock of Plateau, a Utah corporation. Plateau owns a uranium processing mill and support facilities and certain other real estate assets through its wholly-owned subsidiary Canyon Homesteads, Inc. in southeastern Utah. The Company paid nominal cash consideration for the Plateau stock and agreed to assume all environmental liabilities and reclamation bonding obligations. At May 31, 2002, Plateau had a cash security in the amount of $9,900,900 to cover reclamation of the properties (see Note K). The Company is currently evaluating the best utilization of Plateau's properties. Evaluations are ongoing to determine when, or if, the mine and mill properties should be placed into production. The primary factor in these evaluations relates to the current depressed uranium market. Revenues are being generated from the townsite assets which include a motel, C-store, lounge, restaurant, boat storage facility and housing. The convenience store, lounge and restaurant, and boat storage facility are leased to third party companies. The Company receives rent on these facilities and a percentage of the revenues of each operation. The Company is also considering the possibility of selling the mill facility. RUBY MINING COMPANY - ------------------- During fiscal 2001, the Company sold its controlling interest in Ruby Mining Company to Admiralty Company. The Company retained 900,000 shares of Ruby Mining common stock; received $100,000 upon closing, and a promissory note in the amount of $225,000. Because the promissory note is currently in default, the Company has written off the note and will account for any future collection on a cash basis. 66 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) ROCKY MOUNTAIN GAS, INC. - ------------------------ During fiscal 2000, the Company organized RMG to enter into the coalbed methane gas business. RMG is engaged in the acquisition of coalbed methane gas leases and the exploration for methane gas on those properties. The Company owns and controls 91.7% of RMG. RMG sold 333,333, 53,000 and 1,203,333 shares, respectively, of its common stock in private placements during fiscal 2002, 2001 and 2000, respectively, for total proceeds of approximately $4,669,000. RMG entered into an agreement with Quantum Energy, L.L.C. (Quantum has since changed its name to ("Quaneco")) on January 3, 2000 to purchase a 50% working interest and 40% net revenue interest in approximately 185,000 acres of unproven leasehold interests in the Powder River Basin of southeastern Montana. The terms of the Quantum agreement were payments of $3,200,000 on closing, $1,000,000 on or before May 1, 2000 and $1,300,000 on or before December 31, 2000. RMG also had a $2,500,000 work commitment to drill approximately 25 wells on the Quantum properties by November 30, 2000. During fiscal 2001, RMG and Quaneco entered into an Option and Farmin Agreement with Suncor (Natural Gas) America, Inc. ("SENGAI") on 112,000 acres in southeast Montana. SENGAI paid $1,705,000 for the right to exercise the option, of which $1,278,800 was due to RMG. These funds were applied to the final payment due under the Quaneco agreement. All amounts due to Quaneco had been paid as of May 31, 2002. SENGAI also committed to assume $2,000,000 of the remaining $2,250,000 drilling commitment that RMG had under its drilling commitment to Quaneco. SENGAI made the decision not to exercises its option on the acreage. RMG also acquired a 100% working interest (82% revenue interest) in 63,000 net mineral acres in southwest Wyoming. On July 10, 2001, RMG closed a Purchase and Sale Agreement with CCBM, Inc. ("CCBM"), a wholly-owned subsidiary of Carrizo Oil & Gas, Inc. of Houston, Texas. CCBM purchased an undivided 50% interest in all of RMG's existing coalbed properties. CCBM signed a $7,500,000 Promissory Note payable in principal amounts of $125,000 per month plus interest at annual rate of 8% over 41 months (starting July 31, 2001) with a balloon payment due on the forty-second month. The 50% undivided interest is pledged back to RMG to secure the purchase price, and will be released 25% when 33.3% of the principal amount of the purchase price is paid, another 25% when the total principal payments reach 66% of the principal amount of the purchase price and the balance when the total principal amount is paid. CCBM has also agreed to fund $5,000,000 for an initial drilling program. If CCBM fails to expend $5,000,000 in the drilling program or $2,500,000 for RMG's benefit, CCBM will be obligated to pay any remaining unspent portions of the $2,500,000 directly to RMG. If CCBM defaults on its purchase obligation CCBM will still earn a 50% working interest in each well location (80 acres) and production therefrom. CCBM's ownership will be earned on these wells regardless of the status of the payments on the promissory note. 67 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) CCBM will be entitled to a credit (applied as a prepayments of the purchase price for the production of the undivided 50% interest in RMG's acreage), equal to 20% of RMG's net revenue interest from wells drilled with the $5,000,000 until CCBM equals $1,250,000 from production proceeds. OIL AND GAS PROPERTIES AND EQUIPMENT INCLUDED THE FOLLOWING: - ------------------------------------------------------------
May 31, --------------------------------------------- 2002 2001 2000 ----------- ----------- ------------ Oil and gas properties: Subject to amortization $ 1,773,600 $ 1,773,600 $ 1,773,600 Not subject to amortization: Acquired in fiscal 2002 363,900 -- -- Acquired in fiscal 2001 1,154,500 1,154,500 -- Acquired in fiscal 2000 4,727,200 4,727,200 4,727,200 ----------- ----------- ----------- 8,019,200 7,655,300 6,500,800 Sale of gas interests (1,250,000) -- -- ----------- ----------- ----------- 6,769,200 7,655,300 6,500,800 Accumulated depreciation, depletion and amortization (1,773,600) (1,773,600) (1,773,600) ----------- ----------- ----------- Net oil and gas properties $ 4,995,600 $ 5,881,700 $ 4,727,200 =========== =========== ===========
The Company began drilling of its coalbed methane properties during 2001. At such time as production begins on these properties the cost associated with the development of such production will be added to the amortization base. Production is projected to begin in fiscal 2003. G. DEBT: LINES OF CREDIT - --------------- The Company has a $750,000 line of credit from a commercial bank. The line of credit has a variable interest rate (5.75% as of May 31, 2002). The weighted average interest rate for 2002 was 6.5%. As of May 31, 2002, $200,000 was outstanding on this line of credit. The line of credit is collateralized by certain real property and a share of the net proceeds of fees from production from certain oil wells. 68 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) LONG-TERM DEBT - -------------- The components of long-term debt as of May 31, 2002 and 2001 are as follows:
May 31, ---------------------------- 2002 2001 ----------- ----------- USECB installment notes - collateralized by equipment; interest at 8.1% to 11.0%, matures in 2002-2015 $ 1,611,600 $ 1,670,200 SGMC installment notes - secured by certain properties, interest at 7.5% to 8.0%, maturity from 2002 - 2007 579,500 624,300 USE convertible note - net of discount of $670,100 collateralized by equipment and real estate, interest at 8.0%; matures in fiscal 2004 329,900 -- PLATEAU installment note - collateralized by PLATEAU equipment, interest at 8.0%; matures in fiscal 2004 38,000 -- ----------- ----------- 2,559,000 2,294,500 Less current portion (205,700) (142,400) ----------- ----------- $ 2,353,300 $ 2,152,100 =========== ===========
Principal requirements on long-term debt are $205,700, $540,200; $183,200; $199,000; $1,036,600; $394,300 for the years 2003 through 2008, respectively. H. INCOME TAXES: The components of deferred taxes as of May 31, 2002 and 2001 are as follows:
May 31, ------------------------------ 2002 2001 ------------ ------------ Deferred tax assets: Deferred compensation $ 273,400 $ 279,000 Net operating loss carryforwards 9,028,600 8,180,000 Tax Credits -- 15,000 Non-deductible reserves and other 622,800 840,000 Tax basis in excess of book basis 250,000 2,850,400 ------------ ------------ Total deferred tax assets 10,174,800 12,164,400 ------------ ------------ Deferred tax liabilities: Development and exploration costs 2,753,800 2,157,200 ------------ ------------ Total deferred tax liabilities 2,753,800 2,157,200 ------------ ------------ 7,421,000 10,007,200 Valuation allowance (8,565,800) (11,152,000) ------------ ------------ Net deferred tax liability $ (1,444,800) $ (1,144,800) ============ ============
69 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) A valuation allowance for deferred tax assets is required when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of this deferred tax asset depends on the Company's ability to generate sufficient taxable income in the future. Management believes it is more likely than not that the net deferred tax asset will not be realized by future operating results. The Company has established a valuation allowance of $8,565,800 and 11,152,000 against deferred tax assets due to the losses incurred by the Company in past fiscal years. The Company's ability to generate future taxable income to utilize the NOL carryforwards is uncertain. The income tax provision (benefit) is different from the amounts computed by applying the statutory federal income tax rate to income before taxes. The reasons for these differences are as follows:
Year Ended May 31, ---------------------------------------------- 2002 2001 2000 ------------ ------------ ------------ Expected federal income tax $(2,131,000) $ 602,200 $(3,618,200) Net operating losses not previously benefitted and other 4,717,200 2,213,300 (10,600) Valuation allowance (2,586,200) (2,815,500) 3,628,800 ----------- ----------- ----------- Income tax provision $ -- $ -- $ -- =========== =========== ===========
There were no taxes currently payable as of May 31, 2002, 2001 or 2000 related to continuing operations. At May 31, 2002, the Company and its subsidiaries had available, for federal income tax purposes, net operating loss carryforwards of approximately $22,500,000 which will expire from 2006 to 2022. The Internal Revenue Code contains provisions which limit the NOL carryforwards available which can be used in a given year when significant changes in company ownership interests occur. In addition, the NOL amounts are subject to examination by the tax authorities. The Internal Revenue Service has audited the Company's and subsidiaries tax returns through the year ended May 31, 2000. The Company's income tax liabilities are settled through fiscal 2000. 70 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) I. SEGMENTS AND MAJOR CUSTOMERS: The Company's primary business activity is coalbed methane gas property acquisition and exploration (and holding shut down mining properties). The Company has no producing mines. The other reportable industry segment is commercial activities through motel, real estate and airport operations. The Company discontinued its drilling/construction segment in the third quarter of fiscal 2002. The following is information related to these industry segments:
Year Ended May 31, 2002 ------------------------------------------------------------ Coalbed Methane Motel/ (and holding Real Estate/ costs for inactive Airport mining properties) Operations Consolidated ------------------ ---------- ------------ Revenues $ -- $ 1,795,900 $ 1,795,900 ============= =========== Other revenues 208,200 ------------- Total revenues $ 2,004,100 ============= Operating loss $ (1,707,800) $ (133,000) $ (1,840,800) ============= =========== Other revenue 208,200 General corporate and other expenses (5,821,600) Other income and expenses 1,319,500 Discontinued operations, net of tax (85,900) Equity in loss of affiliates and minority interest in subsidiaries 39,500 ------------- Loss before income taxes $ (6,181,100) ============= Identifiable net assets at May 31, 2002 $ 18,138,500 $ 4,351,600 $ 22,490,100 ============= =========== Investments in affiliates -- Corporate assets 8,047,800 ------------- Total assets at May 31, 2002 $ 30,537,900 ============= Capital expenditures $ 151,300 $ 101,500 ============= =========== Depreciation, depletion and amortization $ 167,600 $ 254,300 ============= ===========
71 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED)
Year Ended May 31, 2001 --------------------------------------------------------------------- Coalbed Methane Motel Contract (and holding Real Estate/ Drilling/ costs for inactive Airport Construction mining properties Operations Operations Consolidated ----------------- ---------- ---------- ------------ Revenues $ 442,800 $ 2,222,400 $ 2,238,600 $ 4,903,800 ============= ============= ============ Other revenues 597,800 ------------- Total revenues $ 5,501,600 ============= Operating (loss) profit $ (2,866,400) $ (1,013,800) $ 488,100 $ (3,392,100) ============= ============= ============ Other revenue, income and expenses 9,328,600 General corporate and other expenses (4,235,400) Equity in loss of affiliates and minority interest in subsidiaries 220,100 ------------- Income before income taxes $ 1,921,200 ============= Identifiable net assets at May 31, 2001 $ 18,424,900 $ 5,616,400 $ 1,050,500 $ 25,091,800 ============= ============= ============ Investments in affiliates 16,200 Corporate assets 5,357,200 ------------- Total assets at May 31, 2001 $ 30,465,200 ============= Capital expenditures $ 1,280,200 $ 1,326,800 $ 256,000 ============= ============= ============ Depreciation, depletion and amortization $ 129,700 $ 271,100 $ 324,700 ============= ============= ============
72 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED)
Year Ended May 31, 2000 ---------------------------------------------------------------------- Coalbed Methane Motel Contract (and holding Real Estate/ Drilling/ costs for inactive Airport Construction mining properties Operations Operations Consolidated ----------------- ---------- ---------- ------------ Revenues $ 132,600 $ 2,734,800 $ 3,584,900 $ 6,452,300 ============= ============= ============ Other revenues 436,500 -------------- Total revenues $ 6,888,800 ============== Operating (loss) profit $ (2,518,600) $ (652,500) $ (594,300) $ (3,765,400) ============= ============= ============ Other revenue, income and expenses 530,100 General corporate and other expenses (7,912,900) Equity in loss of affiliates and minority interest in subsidiaries 506,400 -------------- Loss before income taxes $ (10,641,800) ============== Identifiable net assets at May 31, 2000 $ 17,543,700 $ 4,880,900 $ 2,163,300 $ 24,587,900 ============= ============= ============ Investments in affiliates 9,600 Corporate assets 6,278,600 -------------- Total assets at May 31, 2000 $ 30,876,100 ============== Capital expenditures $ 4,749,300 $ 944,600 $ 1,551,800 ============= ============= ============ Depreciation, depletion and amortization $ 72,600 $ 148,100 $ 155,400 ============= ============= ============
73 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) J. SHAREHOLDERS' EQUITY: STOCK OPTION PLANS The Board of Directors adopted the U.S. Energy Corp. 1989 Stock Option Plan for the benefit of USE's key employees. The Option Plan, as amended and renamed the 1998 Incentive Stock Option Plan ("1998 ISOP"), reserved 2,750,000 shares of the Company's $.01 par value common stock for issuance under the 1998 ISOP. Options which expired without exercise were available for reissue. During fiscal 1992, the Company issued 371,200 non-qualified options to certain of its executive officers, Board members and others at prices ranging from $2.75 to $2.90 per share. Unexercised options expired on April 14, 2002 and April 30, 2002. During fiscal 1996, the Company issued options to purchase 360,000 common shares at $4.00 per share. Unexercised options expired on December 31, 2000. During fiscal 1999, the Company issued 837,500 options under the 1998 ISOP, including 299,462 non-qualified and 538,038 qualified options. The non- qualified options were issued at a price below fair market value, resulting in the recognition of $262,000 in compensation expense at the time of issuance. During fiscal 2001, the Company issued 1,499,000 options under the 1998 ISOP, including 918,763 non-qualified and 580,237 qualified options. Various employees exercised 118,703 of the outstanding options raising $288,400 of capital. During fiscal 2002, various employees exercised 253,337 of the outstanding options raising $602,500 of capital. In December 2001, the Board of Directors adopted (and the shareholders approved) the U.S. Energy Corp. 2001 Incentive Stock Option Plan (the "2001 ISOP") for the benefit of USE's key employees. The 2001 ISOP reserves 3,000,000 shares of the Company's $.01 par value common stock for issuance for a period of 10 years. During fiscal 2002, the Company issued 1,030,000 options to certain of its employees, executive officers, and board members at $3.90 per share. These options will expire in December, 2011. The 2001 ISOP replaces the 1998 ISOP, however, options granted under the 1998 ISOP remain exercisable until their expiration date under the terms of that Plan. EMPLOYEE STOCK OWNERSHIP PLAN The Board of Directors of USE adopted the U.S. Energy Corp. 1989 Employee Stock Ownership Plan ("ESOP") in 1989, for the benefit of USE employees. During fiscal 2002, 2001 and 2000, the Board of Directors of USE contributed 70,075, 53,837, and 123,802 shares to the ESOP at prices of $3.29, $5.35, and $3.00 per share, respectively. The Company has expensed $236,900, $288,000, and $371,400 in fiscal 2002, 2001, and 2000, respectively related to these contributions. USE has loaned the ESOP $1,014,300 to purchase 125,000 shares from the Company and 38,550 shares on the open market. These loans, which are secured by pledges of the stock purchased, bear interest at the rate of 10% per annum. The loans are reflected as unallocated ESOP contribution in the equity section of the accompanying Consolidated Balance Sheets. EXECUTIVE OFFICER COMPENSATION In May 1996, the Board of Directors of USE approved an annual incentive compensation arrangement ("1996 Stock Award Program") for its CEO and four other officers of the Company payable in shares of the 74 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) Company's common stock. The 1996 Stock Award Program was subsequently modified to reflect the intent of the directors which was to provide incentive to the officers of the Company to remain with USE. The shares are to be issued annually pursuant to the recommendation of the Compensation Committee on or before January 15 of each year, beginning January 15, 1997, as long as each officer is employed by the Company. The officers will receive up to an aggregate total of 67,000 shares per year for the years 1997 through 2002. The shares under the plan are forfeitable until retirement, death or disability of the officer. The shares are held in trust by the Company's treasurer and are voted by the Company's non-employee directors. As of May 31, 2002, 349,158 total shares have been issued to the five officers of the Company under the 1996 Stock Award Plan. In December 2001, the Board of Directors adopted (and the shareholders approved) the 2001 Stock Award Plan to compensate five of its executive officers and the president of RMG. Under the Plan, an aggregate of 60,000 shares may be issued each year from 2002 through 2006. No shares were issued under this Plan is fiscal 2002. OPTIONS AND WARRANTS TO OTHERS During fiscal 1998, the Company and YSFC entered into an Exchange Rights Agreement (the "Agreement"). Under the Agreement the YSFC private placement shareholders and related broker agent had the right, but not the obligation, to exchange their shares in YSFC for USE common stock if YSFC's common shares were not listed and available for quotation on the NASDAQ marketing system by March 1998. The Company exchanged 677,167 shares of its common stock during fiscal 1999, at a fair value of $2,591,500, for 1,131,500 shares of YSFC common stock or 9% of the outstanding shares of YSFC. During fiscal 2000, the Company issued an additional 57,752 shares of its common stock valued at $206,900 for an additional 96,250 shares of YSFC common stock or an additional 1% of the outstanding shares of YSFC common stock. The exchange rate for USE shares was the price paid for the YSFC's common shares plus 10% per annum return to the investor from the date of purchase. The number of USE shares exchanged was based on the exchange rate for a share of USE common stock for the five business days prior to the date of notice given by the YSFC shareholder to exchange their shares. In January 1998, the Company entered into a warrant purchase agreement with another investment advisory firm to purchase 200,000 shares of the Company's common stock at an exercise price of $7.50/share expiring January 20, 2000. The warrants were issued in exchange for services to be provided during the period from January 1998 to January 1999. The Company determined the fair value associated with these warrants to be $264,000, which was recognized ratably over the term of the related advisory agreement. Accordingly, $27,000 was recognized as an expense in fiscal 2000 and $176,000 in fiscal 1999. In February of 1999, the Company entered into a warrant purchase agreement with a consulting firm to purchase 20,000 shares of the Company's common stock at an exercise price of $2.62 expiring January 31, 2002 (extended to October 15, 2002). The warrants were issued in exchange for services to be provided during the period from February 1999 to February 2000. The Company determined the fair value associated with these warrants to be $36,000, which is recognized ratably over the term of the consulting agreement. Accordingly, $9,000 was recognized as an expense in fiscal 1999 and $27,000 in fiscal 2000. 75 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) Also, during fiscal 1999, the Company issued warrants in exchange for outstanding YSFC warrants, which were originally issued for services provided by outside consultants in connection with the agreement discussed above. The Company issued 67,025 warrants at an exercise price of $3.64 expiring September 19, 2002. The Company determined the fair value associated with these warrants to be $167,000, which was recorded as an additional investment in YSFC during fiscal 1999. During fiscal 2002, a warrant for 6,703 shares was canceled and 20,000 shares were issued to its holder in exchange for services provided during fiscal 2002. In February 1999, the Company entered into a consulting agreement with an individual to provide consulting and other services for a period of 24 months, commencing on February 8, 1999 and ending on January 31, 2001. As consideration for services to be performed, the Company granted the individual 25,000 shares of the Company's common stock at a grant price of $2.75 per share and entered into a 5 year warrant purchase agreement to purchase up to 75,000 shares of the Company's common stock at an exercise price of $2.25 per share, expiring February 8, 2004. The Company determined the fair value associated with the stock grant to be $68,750 and the warrants to be $140,000, which were recognized ratably over the term of the consulting agreement. Accordingly, $69,550; $104,400; and $34,800 were recognized as an expense in fiscal 2001, 2000 and 1999, respectively related to this agreement. During fiscal 2000, the Company issued 200 shares of its $.01 par value mandatorily convertible preferred stock for $2,000,000. A commission of $160,000 was paid to an independent broker on this transaction. This preferred stock was mandatorily convertible into either 677,667 shares of common stock of RMG or into shares of common stock of the Company at the market price of the Company's common stock on the date of conversion. The preferred shares were convertible at the earlier of the date RMG completed an initial public offering of its common stock or April 11, 2002. During December 2001, the Company converted this preferred stock to common stock by issuing 513,140 shares of its common stock to the holder of the preferred stock. Dividends of $80,500, $150,000 and $20,800 were paid on the preferred stock in 2002, 2001 and 2000, respectively. During fiscal 2001, the Company entered into a consulting agreement with a company to provide consulting services for a period of two years, commencing on April 11, 2001. In addition to a monthly cash payment of $2,000, the Company issued the consultant an option to purchase up to 20,000 shares of the Company's common stock at $3.98 per share. The option expires on April 10, 2006. The fair value of the grant was $65,180. Also during fiscal 2001, the Company entered into a consulting agreement with a company to provide consulting and other services for a period of 18 months, commencing on May 14, 2001 and ending on November 14, 2002. As consideration for services to be performed, the Company issued the consultant 15,000 shares of the Company's common stock at a grant price of $4.70 per share and entered into two stock option agreements to purchase up to 30,000 shares of the Company's common stock at an exercise price of $4.70, expiring May 14, 2003. The first option for 10,000 shares, is exercisable upon the condition that the Company's common stock market price closes at or above $6.50 per share for ninety (90) consecutive days prior to the expiration date of May 14, 2003. The exercise price of this option equaled or exceeded market price of the stock at the date of grant. The second option for 20,000 shares is exercisable if and when the 76 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) Company's common stock market price closes at or above $10.00 per share for ninety (90) consecutive days prior to its expiration date on May 14, 2003. During fiscal 2002, the Company raised $2,350,500 by issuing 871,592 shares of common stock with 437,511 detached warrants in two separate private placements. In May 2002, the Company issued warrants to purchase 120,000 shares of the Company's common stock at $3.00 per share, and warrants to purchase 120,000 shares of the Company's subsidiary, RMG at $1.50 per share in connection with a $1 million convertible debt issue. The warrants expire on May 30, 2005. The fair value of the warrants was $271,700 which has been recorded as a discount on the debt which will be amortized over the term of the convertible debt. Additionally, a discount of $398,400 has been recorded against the convertible debt resulting from allocation of proceeds to the beneficial conversion feature of the debt instrument. The fair value of the warrants was estimated on the date of the grant using the Black-Scholes Options Pricing Model with the following weighted average assumptions: No expected dividends; expected volatility 51.3%; risk factor interest rate of 5% and expected life of three years. FORFEITABLE SHARES Certain of the shares issued to officers, directors, employees and third parties are forfeitable if certain conditions are not met. Therefore, these shares have been reflected outside of the Shareholders' Equity section in the accompanying Consolidated Balance Sheets until earned. During fiscal 1993, the Company's Board of Directors amended the stock bonus plan. As a result, the earn-out dates of certain individuals were extended until retirement. For the years ended May 31, 2001, 2000 and 1999, the Company had compensation expense of $298,300; $201,000; and $173,300, respectively, resulting from these issuances. A schedule of total forfeitable shares for the Company is set forth in the following table: 77 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) Issue Number Issue Total Date of Shares Price Compensation ------------- --------- ----- ------------ May 1990 40,300 $ 9.75 $ 392,900 June 1990 66,300 11.00 729,300 November 1992 10,660 N/A N/A May 1993 20,000 3.375 67,500 November 1993 18,520 3.00 55,600 January 1994 18,520 4.00 74,100 January 1995 13,520 3.75 50,700 February 1996 7,700 15.125 116,500 December 1996 28,380 10.875 308,600 December 1996 8,452 11.50 97,200 August 1997 7,320 10.875 79,600 August 1997 5,706 10.875 62,100 May 1998 67,000 6.56 439,500 ------- ------------ Balance at May 31, 1998 312,378 2,473,600 May 1999 67,000 $ 4.00 268,000 Shares earned (40,170) -- (269,900) ------- ------------ Balance at May 31, 1999 339,208 2,471,700 May 2000 67,000 $ 3.00 201,000 Shares earned (9,600) -- (88,100) ------- ------------ Balance at May 31, 2000 396,608 2,584,600 May 2001 67,000 $ 5.35 358,400 Shares earned (29,820) -- (194,400) ------- ------------ Balance at May 31, 2001 433,788 2,748,600 May 2002 67,000 $ 3.90 261,300 ------- ------------ Balance at May 31, 2002 500,788 $ 3,009,900 ======== ============ During 2002, 2001, and 2000; 0, 29,820, and 9,600 shares were earned, respectively. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 ("SFAS 123") SFAS 123, "Accounting for Stock-Based Compensation," defines a fair value based method of accounting for employee stock options or similar equity instruments. However, SFAS 123 allows the continued measurement of compensation cost for such plans using the intrinsic value based method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), provided that pro forma 78 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) disclosures are made of net income or loss and net income or loss per share, assuming the fair value based method of SFAS 123 had been applied. The Company has elected to account for its stock-based compensation plans under APB 25; accordingly, for purposes of the pro forma disclosures presented below, the Company has computed the fair values of all options granted using the Black-Scholes pricing model and the following weighted average assumptions (no options were granted during 2000): 2002 2001 2000 ---- ---- ---- Risk-free interest rate 5.6% 4.29% -- Expected lives 10 years 10 years -- Expected volatility 62.65 73.1% -- Expected dividend yield -- -- -- To estimate expected lives of options for this valuation, it was assumed options will be exercised upon expiration at the end of the ten years. All options are initially assumed to vest. Cumulative compensation cost recognized in pro forma net income or loss with respect to options that are forfeited prior to vesting is adjusted as a reduction of pro forma compensation expense in the period of forfeiture. Pro forma stock-based compensation, net of the effect of forfeitures, was $3,079,700, $2,746,600 and $0 for 2002, 2001 and 2000, respectively. If the Company had accounted for its stock-based compensation plans in accordance with SFAS 123, the Company's net loss and pro forma net loss per common share would have been reported as follows:
Year Ended May 31, ----------------------------------------------- 2002 2001 2000 ------------- ------------ -------------- Net loss to common shareholders As reported $ (6,267,600) $ 1,771,200 $ (10,662,600) Pro forma $ (9,347,300) $ (975,400) $ (10,662,600) Net loss per common share As reported, Basic $ (.67) $ .23 $ (1.39) As reported, Diluted $ (.67) $ .21 $ (1.39) Pro forma, Basic $ (1.01) $ (.12) $ (1.39) Pro forma, Diluted $ (1.01) $ (.12) $ (1.39)
Weighted average shares used to calculate pro forma net loss per share were determined as described in Note B, except in applying the treasury stock method to outstanding options, net proceeds assumed received upon exercise were increased by the amount of compensation cost attributable to future service periods and not yet recognized as pro forma expense. 79 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) A summary of the Employee Stock Option Plan activity for the years ended May 31, 2002 and 2001 is as follows:
Year Ended May 31, ----------------------------------------------------------------------------- 2002 2001 2000 ------------------------ ------------------------ ------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------- ----- ------- ----- ------- ----- Outstanding at beginning of year 2,449,000 $2.49 1,300,200 $2.79 1,300,200 $2.79 Granted 1,030,000 3.90 1,499,000 2.69 -- -- Forfeited (75,000) 2.49 (82,500) 2.88 -- -- Expired (253,833) 2.89 (149,000) -- -- -- Exercised (253,337) 2.48 (118,700) -- -- -- ---------- -------- --------- Outstanding at end of year 2,896,830 2.96 2,449,000 2.49 1,300,200 2.79 ========== ========= ========= Exercisable at end of year 2,896.830 2.96 2,449,000 2.49 1,300,200 2.79 ========== ========= ========= Weighted average fair value of options granted during the year $2.99 $1.83 --
The following table summarized information about employee stock options outstanding and exercisable at May 31, 2002:
Weighted Weighted Number of Average Number Average Options Remaining of Options Exercise Outstanding at Contractual Exercisable at Price May 31, 2002 Life in years May 31, 2002 -------- -------------- ------------- -------------- $2.00 278,808 6.33 278,808 2.40 1,201,548 8.60 1,201,548 2.88 386,474 6.33 386,474 3.90 1,030,000 8.52 1,030,000 ---- --------- --------- 2,896,830 2,896,830 ========= =========
80 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) K. COMMITMENTS, CONTINGENCIES AND OTHER: LEGAL PROCEEDINGS Material pending proceedings are summarized below. Certain of the Company's affiliates are involved in ordinary routine litigation incidental to their business. Other proceedings which were pending in fiscal 2001 have been settled or otherwise finally resolved. SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION In 1991, disputes arose between the Company, Crested, Nukem, Inc. and its subsidiary Cycle Resource Investment Corp. ("CRIC"), concerning the formation and operation of the Sheep Mountain Partners partnership. Arbitration proceedings were initiated by CRIC in June 1991 and in July 1991, USECC filed a lawsuit against Nukem, CRIC and others in the U.S. District Court (District of Colorado) in Civil No. 91B1153. Later, USECC filed another suit for the standby costs at the SMP mines against SMP in the Colorado State Court. The Federal Court stayed both the arbitration proceedings and the State Court case. In February 1994, all of the parties agreed to consensual and binding arbitration of the disputes before the American Arbitration Association ("AAA"), for which the legal claims made by both sides included fraud and misrepresentation, breach of contract, breach of duties owed to the SMP partnership, and other claims. The AAA panel (the "Panel") entered an Order and Award (the "Order") in April 1996 and clarified the Order on July 3, 1996, finding generally in favor of USE and Crested on certain of their claims (including the claims for reimbursement for standby maintenance expenses and profits denied SMP in Nukem's trading of uranium), and in favor of Nukem/CRIC and against USE and Crested on certain other claims, and imposing a constructive trust in favor of Sheep Mountain Partners on uranium contracts Nukem entered into to purchase uranium from CIS republics. USECC filed a petition for confirmation of the Order and on June 30, 1997, and the U.S. District Court confirmed the Order in its Second Amended Judgment (the "Judgment"). Thereafter, Nukem/CRIC appealed the Judgment to the 10th Circuit Court of Appeals ("CCA"). A three judge panel of the 10th CCA issued an Order and Judgment on October 22, 1998, which unanimously affirmed the Federal District Court's Second Amended Judgment without modification. The ruling affirmed (i) the imposition of a constructive trust in favor of SMP on Nukem's rights to purchase CIS uranium, the uranium acquired pursuant to those rights, and the profits therefrom; and (ii) the damage award against Nukem/CRIC. As a result of the ruling of the 10th CCA, USE and Crested received an additional $6,077,264 (including interest and court costs) from Nukem in February 1999 for a total net monetary award of $15,468,625 in the arbitration/litigation, and equitable relief in the form of USE's and Crested's interest in SMP, which holds the constructive trust over the CIS contracts. Nukem/CRIC filed two motions for entry of final satisfaction of Judgment. The U.S. District Court denied both motions, Nukem again appealed to the 10th CCA, which again affirmed the District Court's ruling, and held that Nukem/CRIC had not demonstrated that the Judgment had been satisfied because they had not provided USECC with an accounting of the partnerships assets. 81 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) In February 2001, the U.S. District Court appointed a Special Master to determine the amounts, if any, owed by Nukem to SMP pursuant to the constructive trust. The Special Master has ordered an accounting to identify all deliveries of CIS uranium made directly or indirectly to Nukem and any Nukem affiliates; to identify the ultimate disposition of all uranium purchased under the CIS contracts; to identify the location, number of pounds, and associated cost of uranium purchased under the CIS contracts at December 31, 2001, and to calculate the profits realized from the sale of CIS uranium. At a status hearing held before the U.S. District Court on August 23, 2002, the Court ordered the Special Master to file his report on or before December 6, 2002 and a further hearing to schedule arguments will be held before the Court on December 13, 2002. CONTOUR DEVELOPMENT LITIGATION On July 28, 1998, USE filed a lawsuit in the United States District Court, Denver, Colorado, Case No. 98WM1630, against Contour Development Company, L.L.C. and entities and persons associated with Contour Development Company, L.L.C. (together, "Contour") seeking compensatory and consequential damages of more than $1.3 million from the defendants for dealings in real estate owned by USE and Crested in Gunnison, Colorado. The Contour defendants asserted a counterclaim asking for payment of attorneys fee and costs. The matter has been settled, with USE receiving $25,000 cash and unencumbered title to two commercial real estate lots covering seven acres in Gunnison, Colorado, and unencumbered title to five development lots covering 175 acres north of Gunnison, Colorado. See "Business - Commercial Operations - Real Estate and Other Commercial Operations - Colorado Properties" above. PHELPS DODGE LITIGATION U.S. Energy Corp. and its majority-owned subsidiary, Crested Corp., d/b/a USECC, were served with a lawsuit on June 19, 2002, filed in the U.S. District Court of Colorado (Case No. 02-B-0796(PAC)) by Phelps Dodge Corporation and its subsidiary, Mt. Emmons Mining Company (MEMCO), over contractual obligations from USECC's agreement with Phelps Dodge's predecessor companies, concerning a mining property in Colorado. The litigation stems from agreements that date back to 1974 when U.S. Energy and Crested Corp. leased mining claims on Mt. Emmons near Crested Butte, Colorado to AMAX Inc., Phelps Dodge's predecessor company. The claims cover one of the world's largest and richest deposits of molybdenum. AMAX reportedly spent over $200 million on the acquisition, exploration and mine planning activities on the Mt. Emmons properties. In counter and cross-claims filed in the U.S. District Court of Colorado, USECC contends that Phelps Dodge and its subsidiaries committed several breaches of contracts related to the agreements, including breach of fiduciary obligations and covenants of good faith and fair dealing. USECC also contends Phelps Dodge is guilty of violating federal and state antitrust laws when it purchased Cyprus Amax Minerals Company (Cyprus Amax). 82 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) The complaint filed by Phelps Dodge and MEMCO seeks a determination that Phelps Dodge's acquisition of Cyprus Amax was not a sale. Under a 1986 agreement between USECC and AMAX, if AMAX sold MEMCO or its interest in the mining properties, U.S. Energy and Crested would receive 15% (7.5% each) of the first $25 million of the purchase price ($3.75 million). In 1991, Cyprus Minerals Company acquired AMAX to form Cyprus Amax Minerals Co. USECC's counter and cross-claims allege that in 1999, Phelps Dodge formed a wholly-owned subsidiary CAV Corporation, for the purpose of purchasing the controlling interest of Cyprus Amax and its subsidiaries (including MEMCO) at an estimated value in cash and Phelps Dodge stock exceeding $1 billion and making Cyprus Amax a subsidiary of Phelps Dodge. Therefore, USECC asserts the acquisition of Cyprus Amax by Phelps Dodge was a sale of MEMCO and the properties that triggers the obligation of Cyprus Amax to pay USECC the $3.75 million plus interest. A second counterclaim by USECC rejects the claim by Phelps Dodge that it and its predecessors, Cyprus Amax and AMAX Inc., had mistakenly paid royalties to USECC since January 1991. In 1984, AMAX began paying the cash equivalent (half each to U.S. Energy and Crested Corp.) of 700,000 pounds of molybdenum per year as an advance royalty prior to the mine beginning production. In 1986, USECC agreed to assist financially troubled AMAX and substantially reduced the annual advance royalty to 50,000 pounds of molybdenum, so that AMAX could continue to hold the properties and eventually bring them into production. AMAX, Cyprus Amax and Phelps Dodge continued paying the annual advance royalties to U.S. Energy and Crested Corp. until the payment due in July 2001, when Phelps Dodge unilaterally ceased making the payments. Phelps Dodge and MEMCO seek a declaratory judgment that the advance royalty payment obligation has terminated, and further, that USECC should repay $948,109 of royalties paid to USECC from 1993 through 2000, because those payments were made by mistake. The third issue in the litigation is whether USECC must, under terms of a 1987 royalty deed, accept Phelps Dodge's and MEMCO's forth-coming conveyance of the Mt. Emmons properties back to USECC, which properties now include a plant to treat mine water, costing in excess of $1 million a year to operate in compliance with State of Colorado regulations. Phelps Dodge's and MEMCO's threatened reconveyance would require USECC to assume the operating costs of the water treatment plant. USECC refuses to have the water treatment plant included in the return of the properties because, the USECC counterclaim argues, the properties must be in the same condition as when they were acquired by AMAX before the water treatment plant was constructed by AMAX. The properties are comprised of 10 unpatented lode mining claims (for which patents are expected to be issued by the BLM in the near future), and 770 unpatented lode mining claims, for a total of 15,600 acres. As added counterclaims, USECC seeks (i) damages for defendants' breach of covenants of good faith and fair dealing; (ii) damages for defendants' failure to develop the Mt. Emmons properties and not protecting USECC's rights as revisionary owner of the mining rights to the properties, (iii) damages for unjust enrichment of defendants; (iv) damages for breach of the defendants' fiduciary duties owed to USECC as revisionary owner of the property, and for neglecting to maintain the mining rights and interests in the properties; and (v) damages relating to defendants' actions in violation of federal and Colorado anti-trust and constraint of trade laws. 83 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) USECC also seeks a declaratory judgment of its rights and liabilities under the agreements affecting the Mt. Emmons properties; an injunction against defendants prohibiting the conveyance of the properties to USECC with the water treatment plan; an injunction against further waste of the properties by the defendants; an injunction requiring defendants to divest their molybdenum holdings (including the Mt. Emmons properties); and an injunction requiring defendants to assist USECC in mining molybdenum from the Mt. Emmons properties. On August 2, 2002, Phelps Dodge and MEMCO filed a reply to the counterclaims of USECC and Cyprus Amax filed an answer to the counterclaims and third party complaint of USECC, generally denying the allegations of USECC. CAV Corporation filed a motion for summary judgment seeking dismissal of USECC's cross complaint and is pending. An order has been entered by the Court setting the Scheduling/Planning Conference in the case for September 12, 2002. Except for the parties' claims regarding payment of the $3.75 million due on the sale of MEMCO, payments of royalties, and responsibility going forward for payment of the operating costs of the water treatment plan, the financial impact to U.S. Energy Corp. and Crested Corp. of favorable or unfavorable outcomes in the litigation presently is not determinable.(RMG) LITIGATION INVOLVING LEASES ON COALBED METHANE PROPERTIES IN MONTANA On or about April 1, 2001, the Company'sRMG, a subsidiary Rocky Mountain Gas, Inc. (RMG)of USE and Crested, was served with a Second Amended Complaint wherein the Northern Plains Resource Council had filed suit in the U.S. District Court of Montana, Billings Division in Case No. CV-01-96-BLG-RWA against the United States Bureau of Land Management ("BLM"), RMG, certain of its affiliates (including U.S. Energy Corp.USE and Crested Corp.)Crested) some 20 other defendants. The plaintiff is seeking to cancel oil and gas leases issued to RMG et. al. by the BLM in the Powder River Basin of Montana and for other relief. The basis for the complaint appears to be that the BLM's regulations require the BLM to respond to objections filed by persons owning land or lease rights adjacent to the coalbed properties which the BLM is offering to lease to the public. The argument of plaintiff appears to be that if objections are not responded to by the BLM prior to issuing CBM leases, the leases are invalid. Based on this argument, the plaintiff appears to have been successful in forcing cancellation of some CBM leases granted to others in the Powder River Basin of Montana, because the BLM did not respond to some objecting adjacent landowners. However, all of the BLM leases in Montana held by RMG (none are held by U.S. Energy Corp. or Crested Corp. in their own corporate names) are at least four years old, and there is no record of any objections being made to the issue of those leases. Based on filings in the case to date, it appears that the BLM is taking the initiative in responding to the plaintiff. We believe RMG's leases were validly issued in compliance with BLM procedures, and do not believe the plaintiff's lawsuit will adversely affect any of RMG's Montana BLM leases. 84LAWSUITS CHALLENGING BLM'S RECORDS OF DECISIONS Three lawsuits are currently pending in the Montana Federal District Court challenging BLM's Records of Decisions for the Powder River Basin Oil and Gas EIS (PRB-EIS) for the Wyoming portion of the basin, and the Statewide Oil and Gas EIS and Proposed Amendment for the Powder River and billings Resource Management Plans in Montana. Neither the Company, nor RMG is a party to any of these lawsuits. LITIGATION INVOLVING DRILLING ON A COALBED METHANE LEASE A drilling company, Eagle Energy Services, LLC filed a lien on RMG's leasehold in southwestern Wyoming for drilling services performed at RMG's Oyster Ridge Property and filed a lawsuit foreclosing the lien. Eagle Energy's bank, Community First National Bank of Sheridan, Wyoming, filed a similar suit for the same amount on an assignment from Eagle Energy against RMG, Eagle Energy Services, LLC and others -35- who guaranteed a loan to Eagle Energy in Civil Action No. C02-9-328 in the 4th Judicial District of Sheridan County, Wyoming. Eagle Energy's claim is for a contract to drill a well for coalbed methane. RMG terminated the agreement because of the dangerous conditions of Eagle Energy's equipment and other reasons. The claim against RMG is for approximately $49,300. Negotiations to settle the lien and lawsuits are pending. Management believes that the ultimate outcome of this matter will not have an adverse affect on the Company's financial condition or result of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On June 6, 2003, the annual meeting of shareholders was held for voting on the re-election of two directors: John L. Larsen and Keith G. Larsen. These directors were re-elected for a term expiring on the third succeeding Annual Meeting of Shareholders and until their successors are duly elected or appointed and qualified. With respect to the re-election of the two directors, the votes cast were as follows: Name of Director For Abstain ------------------ --- ------- John L. Larsen 9,243,517 61,281 Keith G. Larsen 9,243,517 61,281 -36- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES (a) Market Information Shares of USE common stock are traded on the over-the-counter market, and prices are reported on a "last sale" basis on the Nasdaq Small Cap of the National Association of Securities Dealers Automated Quotation System ("Nasdaq"). The range by quarter of high and low sales prices was:
High Low ----- ----- Fiscal year ended December 31, 2003 - ----------------------------------- First quarter ended 3/31/03 $3.85 $2.95 Second quarter ended 6/30/03 5.92 3.12 Third quarter ended 9/30/03 5.70 3.15 Fourth quarter ended 12/31/03 3.68 2.30 Transition period ended December 31, 2002 - ----------------------------------------- First quarter 8/31/02 $3.95 $2.00 Second quarter ended 11/30/02 4.20 3.38 Month ended 12/31/02 3.98 3.08 Fiscal year ended May 31, 2002 - ------------------------------ First quarter ended 8/31/01 $6.05 $3.56 Second quarter ended 11/30/01 4.15 3.09 Third quarter ended 2/29/02 5.27 3.50 Fourth quarter ended 5/31/02 4.30 3.29 Fiscal year to ended May 31, 2001 - --------------------------------- First quarter ended 8/31/00 $3.00 $1.75 Second quarter ended 11/30/00 3.38 1.75 Third quarter ended 2/28/01 4.00 2.00 Fourth quarter ended 5/31/01 6.25 3.56
(b) Holders (1) At March 23, 2004 the closing market price was $2.54 per share and there were approximately 660 shareholders of record, with 13,992,750 shares of common stock issued and outstanding, including shares owned by our subsidiaries and shares in officers' and directors' names that are subject to forfeiture. (2) Not applicable. c) We have not paid any cash dividends with respect to common stock. There are no contractual restrictions on our present or future ability to pay cash dividends, however, we intend to retain any earnings in the near future for operations. -37- d) Equity Plan Compensation Information - Information about Compensation Plans as of December 31, 2003: Plan category Number of securities to Weighted average Number of securities be issued upon exercise exercise price of remaining available of outstanding options outstanding future issuance options under equity compensation plans (excluding securities reflected in column (a)) (a) (b) (c) - -------------------------------------------------------------------------------- Equity compensation plans approved by security holders 1998 USE SOP 3,250,000 shares of common stock on exercise of outstanding options 1,464,646 $2.69 -0- 2001 USE ISOP 3,000,000 shares of common stock on exercise of outstanding options 1,409,000 $3.09 1,464,664 - -------------------------------------------------------------------------------- Equity compensation plans not approved by security holders None -- -- -- - -------------------------------------------------------------------------------- Total 2,873,646 $2.74 1,464,664 Sales of Unregistered Securities in 2003: As of December 31, 2003, pursuant to the shareholder-approved 2001 Stock Compensation Plan, 100,000 shares were issued to officers of the Company at the rate of 20,000 shares each: John L. Larsen, Keith G. Larsen, Harold F. Herron, Robert Scott Lorimer, and Daniel P. Svilar. The shares were issued at the closing market price of $3.10 on December 19, 2003. On March 24, 2003, 43,378 shares were issued to four officers (John L. Larsen, Daniel P. Svilar, Harold F. Herron and Robert Scott Lorimer) being the balance of shares issuable under the 1996 stock award program (now closed out). Options to purchase 18,000 shares at $3.00 were issued to Robert A. Nicholas on February 3, 2003 and expiring February 2, 2004, as partial payment for legal services. Mr. Nicholas is not an accredited investor, and prior to the filing date of this Annual Report, he was an employee of the Company. He was -38- provided all information about the Company prior to the issuance of the options. This transaction is believed to be exempt under section 4(2) of the Securities Act of 1933. The expiration date of the options has been extended to August 9, 2004. On October 28, 2003, the Company and Caydal, LLC and Tsunami Partners, L.P. amended separate secured convertible loans to the Company from Caydal ($1,000,000) and Tsunami Partners ($500,000) in 2002, to (i) reduce the interest rate, starting September 1, 2003, from the original 8% annual rate, to be equal to the Federal Short Term Rate for annual compounding (the "Federal Short Term Rate" as defined in section 1274(d) of the Internal Revenue Code), as that rate changes from time to time; (ii) allow conversion of interest, as well as principal, to shares; (iii) not require quarterly payment of interest with cash, but add accruing interest to principal; (iv) extend the maturity date for the loan to December 31, 2004; (v) reduce the conversion rate for principal to (and establish the conversion rate for interest at) 1 share for each $2.25 of principal and interest; and (vi) provide for mandatory conversion of principal and accrued interest outstanding at maturity to shares at the same conversion rate of 1 share for each $2.25 of principal and interest. Optional conversion of principal and accrued interest prior to maturity is permitted. Also, in connection with the restructuring of debt, the expiration date of warrants on 120,000 shares (at $3.00 per share) which were issued to Caydal, and warrants on 60,000 shares (at $3.00 per share) issued to Tsunami Partners, in 2002, was extended 12 months (from the original May 30, 2005 to the new date of May 30, 2006). In 2003, Caydal converted $500,000 of debt to 211,109 shares of common stock (33,333 shares at the original $3.00 conversion price, and 177,776 shares at the restructured price of $2.25). The outstanding principal balance on the debts owed to Caydal and Tsunami Partners was $500,000 and $500,000, convertible at December 31, 2003 into 222,220 and 222,220 shares, respectively. Tsunami Partners did not convert any debt to shares in 2003. Caydal and Tsunami Partners are accredited investors. On July 7, 2003, the Company issued 50,000 shares, and warrants to purchase an additional 50,000 shares (exercisable at $5.00 per share, expiring June 30, 2006) to Sanders Morris Harris Inc. ("SMH"), a financial advisory firm and registered broker-dealer, in partial payment of SMH's services provided to RMG in connection with RMG's transfer of certain coalbed methane properties to Pinnacle Gas Resources, Inc. SMH is an accredited investor. These securities were not issued in connection with the sale of any securities by SMH. On May 30, 2003, the Company entered into a consulting agreement with Riches In Resources, Inc., a financial consulting firm. In June 2003, 7,920 shares were issued to Riches In Resources, Inc. for services to the Company provided from November 15, 2002 through July 15, 2003. Up to another 7,080 shares may be issued for services during the remaining term of the agreement (through May 15, 2004) with this consultant. Riches In Resources, Inc. is not an accredited investor. Riches In Resources, Inc. was provided all information about the Company prior to the issuance of the shares. This transaction is believed to be exempt under section 4(2) of the Securities Act of 1933. In March 2003, 24,000 shares were issued to C.C.R.I. Corporation, a financial consulting firm, for services to the Company provided through September 2003. Pursuant to the same agreement, the Company issued to C.C.R.I. warrants to purchase 75,000 shares, 25,000 exercisable at $3.75 per share, 25,000 shares exercisable at $4.50 per share and 25,000 shares exercisable at $5.50 per share; and issued to an individual (Jason Wayne Assad) associated with C.C.R.I. a warrant to purchase 12,500 shares, exercisable at $3.75 per share. All of these warrants expire March 16, 2006. CCRI and Mr. Assad are not accredited investors. Each was provided all information about the Company prior to the issuance of the securities These transactions are believed to be exempt under section 4(2) of the Securities Act of 1933. In June 2003, 34,000 shares were issued to Burg Simpson Eldredge Hersh Jardine PC, a law firm representing the Company in litigation, in partial payment of legal services provided to the Company. This -39- firm is not an accredited investor. The firm was provided all information about the Company prior to the issuance of the securities. This transaction is believed to be exempt under section 4(2) of the Securities Act of 1933. 10,000 shares were issued to Tim and Betty Crotty in June 2003 in settlement of a lease obligation relating to a property owned by the Company's subsidiary, Sutter Gold Mining Company. Mr. and Mrs. Crotty are not accredited investors. They were provided all information about the Company prior to the issuance of the securities. This transaction is believed to be exempt under section 4(2) of the Securities Act of 1933. In June and July 2003, Caydal, LLC and five individuals invested $750,000 in the Company's majority-owned subsidiary Rocky Mountain Gas, Inc. ("RMG") for 333,333 shares of RMG stock (at $2.25 per share); warrants on 62,500 RMG shares at $3.00 per share, exercisable until June 3, 2006; and warrants on 46,875 shares of the Company at $4.00 per share, exercisable until June 3, 2006. Under the terms of the original transaction, each share of RMG stock was convertible into that number of shares of the Company obtained by dividing (i) $2.25 (subject to anti-dilution adjustments) by (ii) 85% of the then-current market price of the Company's shares, provided that (a) the conversion price cannot exceed $5.00, and (b) the exchange rights expire 20 business days after the Company's stock price exceeds $7.50 for 20 consecutive trading days. None of the RMG shares had been converted to shares of the Company at December 31, 2003. Caydal and each of the five individuals are accredited investors. In partial compensation for services provided by McKim & Company, LLC (a registered broker-dealer) to RMG and USE in connection with the foregoing investments in RMG, the Company paid a cash commission of $30,000 to McKim & Company, and issued to McKim & Company warrants to purchase 19,500 shares of USE common stock, exercisable at $4.00 per share. The warrants expire June 3, 2006. Warrants to purchase an additional 3,000 shares, on the same terms, were issued to John Schlie, an employee of McKim & Company. On October 28, 2003, Caydal and one individual (James McCaughey) accepted the Company's and RMG's offer, made to all of the investors in RMG in June and July 2003 (see above), to restructure that transaction by (i) refunding 50% of the investment (Caydal was refunded $250,000 and Mr. McCaughey was refunded $50,000), and reducing the conversion rate for their remaining total of 133,333 RMG shares down to 77.5%. The other four individuals elected to remain fully invested, for which election the Company and RMG reduced the conversion rate for their remaining total of 66,666 RMG shares down to 70%. On December 12, 2003, a non-qualified option was granted to Karl Eppich to purchase 10,000 shares at $2.90 per share for one year. Mr. Eppich provides title services to RMG. This transaction is believed to be exempt under section 4(2) of the Securities Act of 1933. All of the foregoing securities have been issued with restrictive legend under the Securities Act of 1933. ITEM 6. SELECTED FINANCIAL DATA. The selected financial data is derived from and should be read with the financial statements for USE included in this Report. -40-
December 31, May 31, ------------------------------------- --------------------------------------------------- 2003 2002 2001 2002 2001 2000 1999 ----------- ----------- ----------- ----------- ----------- ------------ ----------- (Unaudited) Current assets $ 5,191,400 $ 4,755,300 $ 4,597,900 $ 4,892,600 $ 3,330,000 $ 3,456,800 $12,718,900 Current liabilities 1,909,700 2,044,400 2,563,800 1,406,400 2,396,700 6,617,900 5,355,600 Working capital (deficit) 3,281,700 2,710,900 2,034,100 3,486,200 933,300 (3,161,100) 7,363,300 Total assets 23,929,700 28,190,600 30,991,700 30,537,900 30,465,200 30,876,100 33,391,000 Long-term obligations(1) 12,036,600 14,047,300 13,596,400 13,804,300 13,836,700 14,025,200 14,526,900 Shareholders' equity 6,760,800 8,501,600 8,018,700 11,742,000 8,465,400 4,683,800 10,180,300 (1)Includes $7,657,900, of accrued reclamation costs on properties at December 31, 2003, and $8,906,800, at December 31, 2002, 2001 and May 31, 2002, 2001, 2000, and 1999, respectively. See Note K of Notes to Consolidated Financial Statements.
Year Ended Seven Months Ended December 31, December 31, For Former Fiscal Years Ended May 31, ------------ -------------------------- ---------------------------------------- 2003 2002 2001 2002 2001 2000 ------------ ------------ ------------ ------------ ------------ ------------- (Unaudited) Operating revenues $ 837,300 $ 673,000 $ 545,900 $ 2,004,100 $ 3,263,000 $ 3,303,900 ----------- ----------- ----------- ----------- ----------- ------------ Loss from continuing operations (7,237,900) (3,524,900) (3,914,900) (7,454,200) (7,517,800) (11,356,100) Other income & expenses (73,000) (387,100) 1,005,000 1,319,500 8,730,800 802,200 (Loss) income before minority interest, equity in income (loss) of affiliates, income taxes, discontinued operations, and cumulative effect of ----------- ----------- ----------- ----------- ----------- ------------ accounting change (7,310,900) (3,912,000) (2,909,900) (6,134,700) 1,213,000 (10,553,900) Minority interest in loss (income) of consolidated subsidiaries 235,100 54,800 24,500 39,500 220,100 509,300 Equity in loss of affiliates -- -- -- -- -- (2,900) Income taxes -- -- -- -- -- -- Discontinued operations, net of tax (349,900) 17,100 175,000 (85,900) 488,100 (594,300) Cumulative effect of accounting change 1,615,600 -- -- -- -- -- Preferred stock dividends -- -- (75,000) (86,500) (150,000) (20,800) ------------ ----------- ----------- ----------- ----------- ------------ Net (loss) income to common shareholders $(5,810,100) $(3,840,100) $(2,785,400) $(6,267,600) $ 1,771,200 $(10,662,600) ============ ============ ============ ============ ============ ============= 1999 ------------- Operating revenues $ 3,788,600 ------------ Loss from continuing operations (22,713,300) Other income & expenses 6,655,500 (Loss) income before minority interest, equity in income (loss) of affiliates, income taxes, discontinued operations, and cumulative effect of ----------- accounting change (16,057,800) Minority interest in loss (income) of consolidated subsidiaries 4,468,400 Equity in loss of affiliates (59,100) Income taxes -- Discontinued operations, net of tax -- Cumulative effect of accounting change -- Preferred stock dividends -- ------------ Net (loss) income to common shareholders $(11,648,500) =============
-41-
Year Ended Seven Months Ended For Former December 31, December 31, Fiscal Years Ended May 31, ------------ ---------------- ---------------------------------- (Unaudited) 2003 2002 2001 2002 2001 2000 1999 -------- ------- ------- ------- ------- ------- ------- Per share financial data Operating revenues $ 0.07 $ 0.06 $ 0.07 $ 0.22 $ 0.42 $ 0.43 $ 0.53 ------ ------ ------ ------ ------ ------ ------ Loss from continuing operations (0.64) (0.33) (0.47) (0.80) (0.96) (1.39) (3.18) Other income & expenses (0.01) (0.03) 0.12 0.14 1.11 0.01 0.93 (Loss) income before minority interest, equity in income (loss) of affiliates, income taxes, discontinued operations, and cumulative effect of ------ ------ ------ ------ ------ ------ ------ accounting change (0.65) (0.36) (0.35) (0.66) 0.15 (1.38) (2.25) Minority interest in loss (income) of consolidated subsidiaries 0.02 -- -- 0.01 0.03 0.07 0.63 Equity in loss of affiliates -- -- -- -- -- -- (0.01) Income taxes -- -- -- -- -- -- -- Discontinued operations, net of tax (0.03) -- 0.02 (0.01) 0.06 (0.08) -- Cumulative effect of accounting change 0.14 -- -- -- -- -- -- Preferred stock dividends -- -- (0.01) (0.01) (0.01) -- -- ------- ------- ------- ------- ------- ------- ------- Net (loss) income per share, basic $(0.52) $(0.36) $(0.34) $(0.67) $ 0.23 $(1.39) $(1.63) ======= ======= ======= ======= ======= ======= ======= Net (loss) income per share, diluted $(0.52) $(0.36) $(0.34) $(0.67) $ 0.21 $(1.39) $(1.63) ======= ======= ======= ======= ======= ======= =======
-42- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is Management's Discussion and Analysis of significant factors, which have affected the Company's liquidity, capital resources and results of operations during the periods included in the accompanying financial statements. The discussion contains forward-looking statements that involve risks and uncertainties. Due to uncertainties in the minerals business, the Company's actual results may differ materially from the results discussed in any such forward-looking statements. GENERAL OVERVIEW U.S. Energy Corp. ("USE" or the "Company") and its subsidiaries historically have been involved in the acquisition, exploration, development and production of properties prospective for hard rock minerals including lead, zinc, silver, molybdenum, gold, uranium, oil and gas and commercial real estate. The Company manages all of its operations through a joint venture, USECC Joint Venture ("USECC"), with one of its subsidiary companies, Crested Corp. ("Crested") of which it owns a consolidated 71.5%. The narrative discussion of this MD&A refers only to USE or the Company but includes the consolidated financial statement of Crested, Rocky Mountain Gas, Inc. ("RMG"), Plateau Resources Ltd. ("Plateau"), USECC and other subsidiaries. The Company has entered into partnerships through which it either joint ventured or leased properties with non-related parties for the development and production of certain of its mineral properties. Due to either depressed metal market prices or disputes in certain of the partnerships, all mineral properties have either been sold, reclaimed or are shut down. See Items 2 and 3 above except coalbed methane. The Company has had no production from any of its mineral properties during the periods from May 31, 2001 through December 31, 2003, except coalbed methane. The Company formed RMG to enter into the coalbed methane (CBM) business in 1999. The acquisition of leases and acreage for the exploration, development and production of coalbed methane has become the primary business focus of the Company. At December 31, 2003, the Company on a consolidated basis, owned 90.1% of RMG. RMG has purchased or leased acreage for CBM exploration and development. RMG has entered into various agreements and joint operating agreements to develop and produce coalbed methane from these properties. Management of the Company plan to create value in RMG by growing RMG into an industry recognized producer of CBM. Management believes the fundamentals of natural gas supply and demand are, and will remain favorable well into the future. Management further believes that the investments the Company has made in RMG will provide a solid base of cash flows into the future. The price that RMG receives for the sale of its coalbed methane is based on the Colorado Interstate Gas Index ("CIG") for the Northern Rockies. Historically, the highest prices realized on the CIG over a twelve-month period are during the months of December and January and the lowest prices realized are during the months of late summer or early fall. Calendar 2003 did not follow this trend as gas prices rose from a low of $3.14 per mcf (thousand cubic feet) in January 2003 to a high of $5.01 per mcf in March 2003. The following table represents a summary of historical CIG prices:
Prices per mcf ---------------- 2003 2002 2001 2000 ----- ----- ----- ----- 12 Month High $5.01 $3.33 $8.63 $5.95 12 Month Low $3.14 $1.09 $1.05 $2.15 12 Month Average $3.98 $1.97 $3.50 $3.37 December 31 $4.44 $3.33 $2.13 $5.95
Although management believes that gas prices will increase over the long term from present levels, no assurance can be given that will happen. Gas prices are directly affected by 1) weather conditions, which -43- impact heating and cooling requirements; 2) electrical generation needs and 3) the amount of gas being produced by those companies in the gas production business. All of these factors are variable and cannot be accurately predicted. Many of the Company's industry competitors are very large international companies that are well funded. CRITICAL ACCOUNTING POLICIES Asset Impairments - We assess the impairment of property and equipment whenever events or circumstances indicate that the carrying value may not be recoverable. Oil and Gas Producing Activities - We follow the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration and development of oil and gas reserves, including directly related overhead costs, are capitalized. Reclamation Liabilities - The Company's policy is to accrue the liability for future reclamation costs of its mineral properties based on the current estimate of the future reclamation costs as determined by internal and external experts. Revenue Recognition - Revenues are reported on a gross revenue basis and are recorded at the time services are provided or the commodity is sold. Use of Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions 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. RECENT ACCOUNTING PRONOUNCEMENTS SFAS 143 Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligation." The statement requires the Company to record the fair value of the reclamation liability on its shut-down mining and gas properties as of the date the liability is incurred. The statement further requires the Company to review the liability each quarter and determine if a change is required as well as accrete the total liability on a quarterly basis for the future liability. The Company will also deduct any actual funds expended for reclamation during the quarter in which it occurs. As a result of the Company taking impairment allowances in prior periods on its shut-down mining properties, it has no remaining book value for these properties. See Note B. LIQUIDITY AND CAPITAL RESOURCES During the year ended December 31, 2003, operations resulted in a loss of $5,810,100 and consumed $5,673,600 of cash. The Company increased cash and cash equivalents during the same period by $2,343,800. Investing activities provided $6,964,000 as a result of the sale of CBM properties, sale of property and the reduction, after the approval of the Nuclear Regulatory Commission ("NRC"), of the cash bond for reclamation obligations. The increase in cash from investing activities of $1,053,400 was as a result of the sale of the Company's and RMG's common stock. Cash provided by investing activities was partly used to pay down third party debt. During the year ended December 31, 2003, the Company contributed its interest in producing methane gas properties to a new entity, Pinnacle Gas Resources, Inc. ("Pinnacle") See Item 2 above and Note -44- F. The Company will therefore not be receiving revenues from those properties. RMG continues to evaluate CBM properties and plans on generating cash flows from methane gas production. See Note P. CAPITAL RESOURCES A major component of the Company's future cash flow projections is the ultimate resolution of litigation with Nukem, Inc. ("Nukem") over issues relating to Sheep Mountain Partners ("SMP") Partnership. On August 1, 2003, the U.S. District Court of Colorado entered a Judgment in favor of the Company against Nukem in the amount of $20,044,200. Nukem has appealed this Judgment to the 10th Circuit Court of Appeals ("CCA"). The Company has filed a cross-appeal and answer to Nukem's appeal. See Item 3 above. Should the 10th CCA affirm the District Court's Order and Judgment and/or grant the additional claims made by the Company, the liquidity of the Company will be significantly improved. Although no assurance can be given as to the outcome of the appeal, Nukem was required to post a supersedeas bond in the full amount of the Judgment with interest. During the year ended December 31, 2003, the Company sold its interests in the town site operations to a non-affiliated entity, The Cactus Group ("Cactus"). As a result of the sale of the town site, USE received cash of $349,300 and a promissory note from Cactus in the amount of $3,120,700. USE is to receive $203,000 in payments from Cactus during calendar 2004. All of these payments will be applied to interest only. Cactus will continue to make monthly payments, primarily interest, until August 2008 at which time a balloon payment of $2.8 million is due. Other sources of capital are cash on hand; collection of receivables; receipt of monthly payments from an industry partner for the purchase of an interest in RMG's CBM properties; contractual funding of drilling and development programs by non-affiliates; sale of excess equipment and real estate properties; a line of credit with a commercial bank, and equity financing of the Company's subsidiaries. The Company has a $750,000 line of credit with a commercial bank. The line of credit is secured by certain real estate holdings and equipment. At December 31, 2003, the full line of credit was available. The line of credit could be used for short-term working capital needs associated with operations. CAPITAL REQUIREMENTS The Company will continue to maintain its uranium properties in a shut down mode during 2004 unless an industry partner funds the development costs of the properties. The Company anticipates funding its gold property through 2004 and completing an equity funding in Canada which will provide the funds necessary to place that property into production. The Company will also use its capital resources during 2004 to pay down debt and general and administrative expenses and reclamation costs associated with the SMP and Plateau uranium properties. MAINTAINING URANIUM PROPERTIES ------------------------------ SMP URANIUM PROPERTIES The care and maintenance costs associated with the Sheep Mountain uranium mineral properties decreased by $11,500 from $28,000 as of December 31, 2002 to approximately $16,500 per month at December 31, 2003. Included in the average monthly cost during the year ended December 31, 2003, is ongoing reclamation work on the SMP properties. It is anticipated that a total of $125,000 in reclamation costs will be incurred during 2004. -45- PLATEAU RESOURCES URANIUM PROPERTIES Plateau owns and maintains the Shootaring Canyon Uranium Mill (the "Shootaring Mill"). During the year ended December 31, 2003, Plateau requested a change in the status of the Shootaring Mill from active to reclamation from the NRC. The NRC granted the change in license status, which generated a surplus in the cash bond account of approximately $2.9 million, which was released to Plateau. During the year ended December 31, 2003, Plateau performed approximately $209,600 in reclamation on the Velvet and Tony M mines and the Shootaring Mill. No further reclamation expenses are anticipated on the Velvet and Tony M mine properties. It is estimated that the Company will incur approximately $500,000 in reclamation costs at the Shootaring Mill during calendar 2004. Although reclamation has been initiated on the Plateau properties, management of the Company continues to evaluate the future of the properties as a result of the significant increases in the market price for uranium to approximately $17.50/lb. U3O8 in March 2004 from approximately $10.10/lb. in March 2003. The cash costs per month, including reclamation costs, at the Plateau properties during calendar 2003 were approximately $100,000 per month. These costs are projected to decrease to $55,000 per month during the year ending December 31, 2004. SUTTER GOLD MINING COMPANY (SGMC)PROPERTIES Due to the recent increase in the price of gold, management of SGMC has decided to place its properties into production. No extensive development work or mill construction will be initiated until such time as funding from either debt or equity sources is in place. The goal of the Company's management is to have SGMC properties be self-supporting and not require any capital resources commitment from the Company. Until such time as SGMC is able to raise its own capital, the Company will continue to fund SGMC. Management projects that the total cash costs to be incurred in getting SGMC funded either through debt or equity will not exceed $120,000. (See Note P). No reclamation costs are projected to be incurred on the SGMC properties during 2004. DEVELOPMENT OF COALBED METHANE PROPERTIES ----------------------------------------- The majority of the costs during the year ended December 31, 2003 for the development of RMG's CBM properties, was funded through an agreement that RMG entered into with CCBM, Inc. ("CCBM") a subsidiary of Carrizo Oil and Gas of Houston, Texas. At December 31, 2003, the balance remaining under this arrangement was $610,200, one half of which was for the benefit of RMG. See Part 2 above. After this drilling commitment is completed by CCBM, RMG will have to fund its working interest amount on wells drilled. During the year ended December 31, 2003, RMG and CCBM entered into a Subscription and Contribution Agreement with Credit Suisse First Boston Private Equity parties ("CSFB") to form Pinnacle Gas Resources, Inc. ("Pinnacle"). As a result of the formation of Pinnacle, RMG and CCBM contributed certain undeveloped and producing CBM properties to Pinnacle. RMG has the opportunity to increase its ownership in Pinnacle by purchasing common stock in Pinnacle through the exercise of options. Any increase in RMG's equity would be offset by contributions made by the other owners of Pinnacle. See Part I "Transaction with Pinnacle Gas Resources, Inc." Management of the Company does not anticipate exercising these options during calendar 2004 unless surplus capital resources are received. RMG has no capital commitments on the properties contributed to Pinnacle. See Note F. -46- RMG continues to pursue other investment and production opportunities in the CBM business. On January 30, 2004, RMG purchased the assets of a non-affiliated entity, which included both producing and non-producing properties. The purchase of these CBM assets was accomplished by the issuance of common stock and warrants of both RMG and USE and cash, the majority of which was borrowed as a result of mezzanine financing through Petrobridge Investment Management, LLC ("Petrobridge"). See Part I "Acquisition of Producing and Non-Producing Properties from Hi-Pro Production, LLC" and Note P. All cash flows from the sale of gas from the Hi-Pro properties are pledged to Petrobridge for the loan to purchase the Hi-Pro property. See Note P and Part I, Acquisition of Producing and Non-Producing Properties from Hi-Pro Production, LLC . The Hi-Pro acquisition debt also requires minimum net production volumes through June 30, 2006 and maintenance of financial ratios. The Hi-Pro properties are held by RMG I, LLC, a wholly-owned subsidiary of RMG and are the sole collateral of the debt financing entity. In addition, we don't expect the lenders under the mezzanine credit facility to fund more than the drilling and completion of five wells on proved undeveloped locations on the properties. Future equity financing by RMG, or industry financings, will be needed for RMG I, LLC to drill and complete wells on the substantial undeveloped acreage acquired from Hi-Pro. New production from this acreage could be needed to service the acquisition debt to offset the impact of declining production from the producing properties and/or low gas prices. The Petrobridge credit facility will fund the drilling and completion of five wells on proved undeveloped locations on the Hi-Pro properties. Future equity financing by RMG, or industry financings, will be needed for RMG I, LLC to drill and complete wells on the substantial undeveloped acreage acquired from Hi-Pro. As a result of RMG's sale of property interests and the formation of joint operating ventures with industry partners, it is not anticipated that the Company's capital resources will be used to fund RMG operations during the balance of 2004. LIQUIDITY SUMMARY The Company's capital resources on hand at December 31, 2003 were sufficient to fund mine standby costs, limited reclamation and general and administrative expenses. Development of our gold property and undeveloped CBM properties will require funding from either debt or equity sources. RESULTS OF OPERATIONS --------------------- During the periods presented, the Company has discontinued certain operations. Reclassifications to previously published financial statements have therefore been made to reflect ongoing operations and the effect of the discontinued operations. The Company changed its year end to December 31 effective December 31, 2002. The Company began focusing its direction on the coal bed methane industry during the year ended May 31, 2002. At the same time the Company began selling its other assets that produced revenues from commercial real estate operations, construction and drilling operations and the commercial repair of aircraft. The Company has entered the coal bed methane industry and anticipates revenues from the production of coal bed methane during calendar 2004. Cash flows are projected to begin being recognized in calendar 2005 after debt on the Company's newly acquired coal bed methane properties is retired. -47- YEAR ENDED DECEMBER 31, 2003 COMPARED TO THE YEAR ENDED MAY 31, 2002 Revenues: - --------- Revenues for the twelve months ended December 31, 2003 consisted of $334,300 from real estate operations, $287,400 from gas sales and $215,600 from management fees. Revenues from real estate operations during the fiscal year ended May 31, 2002 were $1,276,200. The decrease in real estate revenues was as a result of reduced sales of commercial real estate during the twelve months ended December 31, 2003. During fiscal 2002 the Company sold a tract of land in California which was no longer needed for the SGMC development plan for operations. During the year ended December 31, 2003 the Company reported $287,400 in gas sales. There were no similar revenues during the twelve months ended May 31, 2002 as the Company had no production of coal bed methane gas at May 31, 2002. The Company recognized a minimal increase in management fee revenues during the year ended December 31, 2003 to $215,600 over the $208,200 recognized in management fee revenues during the twelve months ended May 31, 2002. Management fee revenues were actually reduced after June 2003 when RMG contributed its producing and certain undeveloped properties to Pinnacle. Although RMG provided the transitional accounting services for Pinnacle through December 31, 2003, it received only its actual cost for those services. Costs and Expenses: - -------------------- Costs and expenses for the year ended December 31, 2003 were $8,075,200 as compared to $8,877,800 for the year ended May 31, 2002. Costs and expenses of real estate operations and the cost of real estate sold decreased by $1,045,500 during that twelve months ended December 31, 2003 when compared to the costs and expenses incurred during the fiscal year ended May 31, 2002. This decrease was primarily as a result of a tract of no longer needed. Real estate was sold by SGMC during the year ended May 31, 2002 while no similar sales occurred during the year ended December 31, 2003. During the year ended December 31, 2003 the Company recognized $313,100 in gas operating expenses. No similar expenses were recorded during the fiscal year ended May 31, 2002 as the Company had not yet begun producing gas at that time. Mineral holding costs decreased by $246,100 to $1,461,700 at December 31, 2003 from $1,707,800 at May 31, 2002. This decrease was as a result of the Company placing all its mining properties on a shut-down status and reducing costs of holding those properties. General and administrative costs increased by $2,050,700 during the twelve months ended December 31, 2003 over the twelve months ended May 31, 2002. This increase was as a result of several non cash items. Non cash items which were expensed during the year ended December 31, 2003 were: depreciation and amortization of $554,200; accretion of asset retirement obligations of $366,700; amortization of debt discount of $537,700; amortization of non cash services of $134,700, and non cash compensation of $893,500 for a total of $2,486,800. The amortization of debt discount increased primarily as a result of the acceleration in the discount amortization due to the conversion of approximately one half of the debt under the terms of $1.0 million of debt to common shares of the Company's common stock. -48- On January 1, 2003, the Company adopted SFAS 143, Accounting for Asset Retirement Obligation. Under the terms of this accounting standard, the Company is required to record the fair value of the reclamation liability on its shut-down mining and gas properties as of the date that the liability was incurred. The accounting standard further requires the Company to review the liability and determine if a change in estimate is required as well as accrete the total liability for the future liability. As a result of the adoption of this accounting standard, the Company recorded the non cash accretion of $366,700. Non cash compensation increased as a result of the initial funding of the 2001 Stock Award Plan whereby five of the executive officers of the company were granted a total of 100,000 shares of common stock at $3.10 per share. Under the plan, each officer is to receive 10,000 shares of common stock annually under the condition that the shares cannot be sold until the officer's death or retirement. The plan was effective in 2001 and had not been funded. The funding for the twelve months ended December 2003 was therefore retroactive for two years. In addition to the increase due to the funding of the 2001 Stock Award Plan, the funding for the ESOP as well as the amortization of the deferred compensation recorded in prior periods were both for a full twelve months as compared to only seven months in the prior period. The increase in the amortization of non cash services during the year ended December 31, 2003 resulted from the issuance of additional stock and warrants for legal and financial consulting services. These services related to the formation of Pinnacle and litigation with Phelps Dodge. Other Income and Expenses: - ---------------------------- During the fiscal year ended May 31, 2002 the Company recognized $812,700 in gains from the sale of assets while during the year ended December 31, 2003 the Company recognized only $198,200. The Company was selling the majority of its construction equipment during the years ended May 31, 2002 and 2001. The majority of the surplus equipment to be sold was sold during those two years. Interest Income decreased $291,800 during the year ended December 31, 2003 when compared to the year ended May 31, 2002. This reduction in revenues occurred as a result of the company having less amounts of cash invested in interest bearing accounts during the year ended December 31, 2003. In May of 2002 the Company borrowed $1.5 million from third party lenders. During the year ended December 31, 2003 the Company recorded interest on this debt while there was not interest paid on this debt during fiscal 2002. Effective January 1, 2003 the Company adopted SFAS 143 "Accounting for Asset Retirement Obligations" which requires the Company to record the fair value of the reclamation liability on its shut down mining and gas properties as of the date that the liability is incurred. The Company is further required to accrete the total liability for the full value of the future liability. As a result of adopting this new accounting policy the Company recorded a cumulative effect of accounting change of $1,615,600 as well as an accretion expense of 366,700. Operations for the year ended December 31, 2003 resulted in a loss of $5,810,100 or $0.52 per share as compared to a loss of $6,181,100 or $0.66 per share during fiscal 2002. SEVEN MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THE SEVEN MONTHS ENDED DECEMBER 31, 2001 Revenues: - --------- During the seven months ended December 31, 2002, the Company recognized $673,000 in revenues as compared to $545,900 in revenues during the seven months ended December 31, 2001. This increase of $127,100 in revenues was primarily as a result of the production and sale of CBM gas during the seven -49- months ended December 31, 2002 of $119,400 while no revenues from CBM production were recognized during the same period of the previous year. Through the purchase of the Bobcat Field, RMG began selling CBM gas during the seven months ended December 31, 2002. As anticipated, production from these newly developed wells was lower than it will be in the future. Additionally, the market price for natural gas was very low during the summer and fall months of 2002. These reasons along with high start up and operating costs of $355,200, resulted in a loss from operations for CBM of $235,800. Management believes with increased production volumes, reduced ongoing operating costs and increased market prices for natural gas, the CBM properties will show profits and cash flows during 2003. Costs and Expenses: - -------------------- Costs and expenses during the seven months ended December 2002 were $4,197,900 as compared to costs and expenses of $4,460,800 during the seven months ended December 31, 2001. This reduction of $262,900 was as a result of a reduction in the holding costs of shut-down mineral properties and an ongoing cost cutting program. These reductions in operating costs were offset primarily by the operating costs associated with CBM. Other Income and Expenses: - ---------------------------- During the seven months ended December 31, 2002, the Company recognized a loss on the sale of assets of $342,600 while it recognized a gain on the sale of assets during the seven months ended December 31, 2001 of $592,600. The Company also had an increase in interest expense of $234,500 during the seven months ended December 31, 2002 over the same period of the previous year as a result of the interest on the Company's convertible debt. Operations for the seven months ended December 31, 2002, resulted in a loss of $3,840,100 or $0.36 per share as compared to a loss of $2,785,400 or $0.34 per share for the seven months ended December 31, 2001. FISCAL 2002 COMPARED TO FISCAL 2001 - ---------------------------------------- Revenues: - --------- Revenues from operations decreased by $1,038,400 to $1,484,400 during fiscal 2002 from the $2,522,800 recognized during fiscal 2001. Components of this decrease are reductions mineral sales of $334,300; mineral royalties of $108,500; and management fees of $389,600. Mineral sales during fiscal 2001 resulted from the purchase of uranium oxide on the open market to fill uranium sales contracts and the sale of a uranium contract to a third party. We did not supply any of the uranium sold under the contracts from production out of our mines. We have not produced any minerals from mines for several years. The uranium contracts expired and no molybdenum advance royalties have been received since 2001. There were no mineral sales during fiscal 2002 while there was one delivery under a uranium contract as well as the sale of one of the Company's uranium contracts to a third party during fiscal 2001. Currently, the Company does not have any delivery contracts for uranium or any other mineral. Depending on the outcome of the SMP litigation, the Company may well have CIS pounds of uranium for which it will need to obtain delivery contracts. The Company holds a 6% gross royalty on the Mt. Emmons molybdenum deposit near Crested Butte, CO. Under the provisions of the royalty agreement, the Company and Crested are to receive 50,000 pounds -50- of molybdenum or its cash equivalent annually as an advance royalty. The royalty agreement was originally made with AMAX Inc. ("AMAX"), which was purchased by Cyprus Minerals Company in 1993 and changed its name to Cyprus Amax Minerals Company ("Cyprus Amax"). In 1999, Cyprus Amax was purchased by Phelps Dodge Corporation ("PD"). AMAX and Cyprus Amax had made the advance royalty payments to USECC on a timely basis. PD made one advance royalty payment and ceased making payments in fiscal 2001. PD suspended payments under the advance royalty agreement and has sued the Company. The Company has filed counter claims against Phelps Dodge requesting that the advance royalty be reinstated and other issues. It is not known what the outcome of this litigation will be. Management fees were reduced by $389,600 in fiscal 2002 from the prior period due to reduced activity in the entities from which management fees are collected. Costs and Expenses: - -------------------- During fiscal 2002, costs and expenses were reduced by $1,061,100. This reduction came about as a result of holding costs of mineral properties being reduced by $1,661,500 as a result of the Company reducing costs associated with mineral properties that are shut down. The general and administrative costs were reduced by $104,700. In addition to these reductions in costs and expenses, the Company recognized an expense of $123,800 in abandonment of mining equipment during fiscal 2001. There was no abandonment expense in fiscal 2002. These reductions in costs and expenses were offset by increases in impairment of goodwill of $1,622,700; provision for doubtful accounts of $171,200, and other expenses of $80,900. The impairment of goodwill came as a result of the Company purchasing an additional 8.7% of RMG equity or 1,105,499 shares of RMG stock by issuing 912,233 shares of the Company's common stock. The shares of the Company's common stock were valued at $3.92 per share. An impairment of $1,622,700 was taken on this investment in RMG as RMG had no gas production and the impairment brought the total investment in RMG in line with the fair market value of the RMG assets. A provision for doubtful accounts was provided on the balance of a note receivable that the Company held for the sale of Ruby Mining Company to Admiralty Corporation. The note was in the original amount of $225,000 and had been reduced to $171,200. The note went in default during fiscal 2002 at which time the Company began negotiations with Admiralty to resolve the issue of the outstanding balance. Terms were reached which required Admiralty to pay interest on the note, plus accrued interest, through August 2003, at which time the entire note balance would come due. Because of the financial condition of Admiralty, it is not known if that company will be able to pay the balance of the note when due. The entire amount of the note was therefore reserved. Other Income and Expenses: - ---------------------------- Gain on sale of assets income decreased by $350,900 during fiscal 2002 to $812,700. This decrease was as a result of the sale of a majority of the surplus mining equipment that the Company had for sale during the prior year. During fiscal 2002, there was no income from litigation settlements while during fiscal 2001 there was $7,132,800 in litigation settlement as a result of the Company settling all issues pertaining to the litigation initiated by Kennecott. Interest income increased by $152,400 during fiscal 2002 over fiscal 2001 as did interest expense which increased by $80,000 for the same period. These increases were as a result of larger amounts of cash invested in interest bearing accounts and increased debt. Operations for the twelve months ended May 31, 2002, resulted in a net loss of $6,267,600 or $0.67 per share as compared to net income of $1,771,200 or $0.23 per share for the previous year. -51- FUTURE OPERATIONS ----------------- We have generated operating losses for the year ended December 31, 2003, the seven months ended December 31, 2002 and in each of the three fiscal years ended May 31, 2002 as a result of costs associated with shut down mineral properties. We have discontinued our focus on these properties and at December 31, 2003, we are committed to be in the CBM business well into the future. EFFECTS OF CHANGES IN PRICES ---------------------------- Mineral operations are significantly affected by changes in commodity prices. As prices for a particular mineral increase, prices for prospects for that mineral also increase, making acquisitions of such properties costly, and sales advantageous. Conversely, a price decline facilitates acquisitions of properties containing that mineral, but makes sales of such properties more difficult. Operational impacts of changes in mineral commodity prices are common in the mining industry. NATURAL GAS. Our decision to expand into the CBM gas industry was predicated on the projections for natural gas demand and prices. The Company is confident that it can maintain its costs at CBM industry standards but cannot predict what will happen to the price of CBM gas. URANIUM AND GOLD. Changes in the prices of uranium and gold are not expected to materially affect our operations during 2004. MOLYBDENUM AND OIL. Changes in prices of molybdenum and petroleum are not expected to materially affect our operations during 2004. CONTRACTUAL OBLIGATIONS. The Company had two divisions of contractual obligations as of December 31, 2003: Debt to third parties of $2,249,800, the payments are $932,200, $112,800, $116,600, $1,056,500, $22,600 and $9,200 for the years ended December 31, 2004 through 2008, and thereafter, respectively, and asset retirement obligations of $7,264,700 which will be paid over a period of five to seven years. ITEM 8. FINANCIAL STATEMENTS Financial statements meeting the requirements of Regulation S-X for the Company follow immediately. -52- REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS -------------------------------------------------- To U.S. Energy Corp.: We have audited the accompanying consolidated balance sheets of U.S. Energy Corp. and subsidiaries as of December 31, 2003 and 2002 and May 31, 2002, and the related consolidated statements of operations, shareholders' equity and cash flows for the year ended December 31, 2003, the seven months ended December 31, 2002 and the fiscal years ended May 31, 2002 and 2001. 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 auditing standards generally accepted in the United States of America. 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 consolidated financial statements present fairly, in all material respects, the financial position of U.S. Energy Corp. and subsidiaries as of December 31, 2003 and 2002 and May 31, 2002, and the results of their operations and their cash flows for the year ended December 31, 2003, the seven months ended December 31, 2002 and the fiscal years ended May 31, 2002 and 2001 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note B to the financial statements effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, and changed its method of accounting for asset retirement obligations. As discussed in Note A to the financial statements, certain errors resulting in overstatement of previously reported deferred tax liability as of December 31, 2002 and prior, were discovered by Company management during the year ended December 31, 2003. Accordingly, an adjustment has been made to accumulated deficit as of June 1, 2000 to correct the error. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note A to the financial statements, the Company has experienced significant losses from operations and has a substantial accumulated deficit. These factors raise substantial doubt about the ability of the Company to continue as a going concern. Management's plans in regards to these matters are also described in Note A. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. GRANT THORNTON LLP Oklahoma City, Oklahoma February 27, 2004 -53-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS December 31, December 31, May 31, 2003 2002 2002 ------------------- -------------- ------------ (Restated, Note A)(Restated, Note A) CURRENT ASSETS: Cash and cash equivalents $ 4,084,800 $ 1,741,000 $ 2,564,300 Accounts receivable Trade, net of allowance of $27,800 300,900 1,655,700 768,800 Affiliates 96,800 117,600 132,800 Current portion of long-term notes receivable, net 102,500 165,900 229,000 Assets held for resale -- 532,800 532,800 Prepaid Expenses 584,700 528,300 578,300 Inventories 21,700 14,000 86,600 ------------------ ------------- ----------- Total current assets 5,191,400 4,755,300 4,892,600 INVESTMENTS: Non-affiliated company 957,700 -- -- Restricted investments 6,874,200 9,911,700 10,015,500 ------------------- -------------- ------------ Total investments and advances 7,831,900 9,911,700 10,015,500 PROPERTIES AND EQUIPMENT: Land 570,000 576,300 1,764,100 Buildings and improvements 5,777,700 7,811,300 8,501,300 Machinery and equipment 4,762,800 4,737,100 5,107,700 Proved oil and gas properties, full cost method 1,773,600 2,423,600 1,773,600 Unproved coal bed methane properties excluded from amortization 1,204,400 4,254,000 4,995,600 ------------------ ------------- ----------- Total property and equipment 14,088,500 19,802,300 22,142,300 Less accumulated depreciation, depletion and amortization (6,901,400) (7,214,800) (7,584,200) ------------------- -------------- ------------ Net property and equipment 7,187,100 12,587,500 14,558,100 OTHER ASSETS: Notes receivable trade 2,950,600 -- 36,800 Notes receivable employees -- 48,800 65,000 Deposits and other 768,700 887,300 969,900 ------------------ ------------- ----------- Total other assets 3,719,300 936,100 1,071,700 ------------------- -------------- ------------ Total assets $ 23,929,700 $ 28,190,600 $30,537,900 =================== ============== ============
The accompanying notes are an integral part of these statements. -54-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS LIABILITIES AND SHAREHOLDERS' EQUITY December 31, December 31, May 31, 2003 2002 2002 ------------------- -------------- ------------- (Restated, Note A)(Restated, Note A) CURRENT LIABILITIES: Accounts payable and accrued expenses $ 977,500 $ 1,592,800 $ 758,600 Prepaid drilling costs -- 134,400 242,100 Current portion of long-term debt 932,200 317,200 205,700 Line of credit -- -- 200,000 ------------------- -------------- ------------- Total current liabilities 1,909,700 2,044,400 1,406,400 LONG-TERM DEBT 1,317,600 2,820,600 2,353,300 ASSET RETIREMENT OBLIGATIONS 7,264,700 8,906,800 8,906,800 OTHER ACCRUED LIABILITIES 2,158,600 2,319,900 2,544,200 DEFERRED GAIN ON SALE OF ASSET 1,295,700 -- -- MINORITY INTERESTS 496,000 587,400 575,300 COMMITMENTS AND CONTINGENCIES FORFEITABLE COMMON STOCK, $.01 par value 465,880, 500,788 and 500,788 shares issued, forfeitable until earned 2,726,600 3,009,900 3,009,900 PREFERRED STOCK, $.01 par value; 100,000 shares authorized No shares issued or outstanding; -- -- -- SHAREHOLDERS' EQUITY: Common Stock, $.01 par value; unlimited shares authorized; 12,824,698, 11,826,396, and 11,720,818 shares issued respectively 128,200 118,300 117,200 Additional paid-in capital 52,961,200 48,877,100 48,278,500 Accumulated deficit (43,073,000) (37,262,900) (33,422,800) Treasury stock at cost, 966,306, 959,725 and 959,725 shares respectively (2,765,100) (2,740,400) (2,740,400) Unallocated ESOP contribution (490,500) (490,500) (490,500) ------------------- -------------- ------------- Total shareholders' equity 6,760,800 8,501,600 11,742,000 ------------------- -------------- ------------- Total liabilities and shareholders' equity $ 23,929,700 $ 28,190,600 $ 30,537,900 =================== ============== =============
The accompanying notes are an integral part of these statements. -55-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year ended Seven months ended December 31, December 31, Year Ended May 31, ------------ ------------ -------------------------- 2003 2002 2002 2001 ------------ ------------ ------------ ------------ OPERATING REVENUES: Real estate operations $ 334,300 $ 394,500 $ 1,276,200 $ 1,482,200 Gas sales 287,400 119,400 -- -- Mineral sales -- -- -- 334,300 Mineral royalties -- -- -- 108,500 Management fees 215,600 159,100 208,200 597,800 ----------- ----------- ----------- ----------- 837,300 673,000 1,484,400 2,522,800 OPERATING COSTS AND EXPENSES: Real estate operations 302,900 189,700 1,348,400 2,394,300 Gas operations 313,100 355,200 -- -- Mineral holding costs 1,461,700 737,200 1,707,800 3,369,300 General and administrative 5,997,500 2,915,800 3,946,800 4,051,500 Impairment of goodwill -- -- 1,622,700 -- Abandonment of mining equipment -- -- -- 123,800 Other -- -- 80,900 -- Provision for doubtful accounts -- -- 171,200 -- ----------- ----------- ----------- ------------ 8,075,200 4,197,900 8,877,800 9,938,900 ------------ ------------ ------------ ------------ OPERATING LOSS: (7,237,900) (3,524,900) (7,393,400) (7,416,100) OTHER INCOME & EXPENSES: Gain on sales of assets 198,200 (342,600) 812,700 1,163,600 Gain on sale of investment (32,400) (207,800) -- -- Litigation settlements, net -- -- -- 7,132,800 Interest income 560,300 524,500 852,100 699,700 Interest expense (799,100) (361,200) (345,300) (265,300) ----------- ----------- ----------- ----------- (73,000) (387,100) 1,319,500 8,730,800 ------------ ------------ ------------ ------------ (LOSS) INCOME BEFORE MINORITY INTEREST PROVISION FOR INCOME TAXES, DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE: (7,310,900) (3,912,000) (6,073,900) 1,314,700 MINORITY INTEREST IN LOSS OF CONSOLIDATED SUBSIDIARIES 235,100 54,800 39,500 220,100 ------------ ------------ ------------ ------------ (LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES DISCONTINUED OPERATIONS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE (7,075,800) (3,857,200) (6,034,400) 1,534,800 PROVISION FOR INCOME TAXES -- -- -- -- ------------ ------------ ------------ ------------ (continued)
The accompanying notes are an integral part of these statements. -56-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Year ended Seven months ended December 31, December 31, Year Ended May 31, ------------ ------------ ------------------------- 2003 2002 2002 2001 ------------ ------------ ------------ ----------- NET (LOSS) INCOME FROM CONTINUING OPERATIONS (7,075,800) (3,857,200) (6,034,400) 1,534,800 DISCONTINUED OPERATIONS, NET OF TAX (349,900) 17,100 (146,700) 386,400 CUMULATIVE EFFECT OF ACCOUNTING CHANGE 1,615,600 -- -- -- ------------ ------------ ------------ ----------- NET (LOSS) INCOME: (5,810,100) (3,840,100) (6,181,100) 1,921,200 PREFERRED STOCK DIVIDENDS $ -- $ -- $ (86,500) $ (150,000) ------------ ------------ ------------ ----------- NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS $(5,810,100) $(3,840,100) $(6,267,600) $1,771,200 ============ ============ ============ =========== NET (LOSS) INCOME PER SHARE BASIC CONTINUED OPERATIONS (0.63) (0.36) (0.65) 0.20 DISCONTINUED OPERATIONS (0.03) -- (0.01) 0.05 PREFERRED DIVIDENDS -- -- (0.01) (0.02) EFFECT OF ACCOUNTING ACCOUNTING CHANGE 0.14 -- -- -- ------------ ------------ ------------ ----------- $ (0.52) $ (0.36) $ (0.67) $ 0.23 ============ ============ ============ =========== NET (LOSS) INCOME PER SHARE DILUTED CONTINUED OPERATIONS (0.63) (0.36) (0.65) 0.18 DISCONTINUED OPERATIONS (0.03) -- (0.01) 0.05 PREFERRED DIVIDENDS -- -- (0.01) (0.02) EFFECT OF ACCOUNTING ACCOUNTING CHANGE 0.14 -- -- -- ------------ ------------ ------------ ----------- $ (0.52) $ (0.36) $ (0.67) $ 0.21 ============ ============ ============ =========== BASIC WEIGHTED AVERAGE SHARES OUTSTANDING 11,180,975 10,770,658 9,299,359 7,826,001 ============ ============ ============ =========== DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING 11,180,975 10,770,658 9,299,359 8,487,680 ============ ============ ============ ===========
The accompanying notes are an integral part of these statements. -57-
U.S. ENERGY & AFFILIATES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (RESTATED, NOTE A) Additional Unallocated Total Common Stock Paid-In Accumulated Treasury Stock --------------- ESOP Shareholders' Shares Amount Capital Deficit Shares Amount Contribution --------- ------- ----------- ------------- ------- ------------ -------------- Balance June 1, 2000 as previously presented 8,763,155 $87,700 $37,797,700 $(30,071,200) 944,725 $(2,639,900) $ (490,500) Adjustment for deferred taxes See note A -- -- -- 1,144,800 -- -- -- --------- ------- ----------- ------------- ------- ------------ -------------- Balance June 1, 2000 as restated 8,763,155 87,700 37,797,700 (28,926,400) 944,725 (2,639,900) (490,500) Funding of ESOP 53,837 500 287,500 -- -- -- -- Issuance of common stock to outside directors 8,532 100 19,100 -- -- -- -- Issuance of common stock for services rendered 15,000 200 70,400 -- -- -- -- Forfeitable shares earned 29,820 300 193,900 -- -- -- -- Treasury stock from payment on balance of note receivable -- -- -- -- 5,000 (20,600) -- Sale of Ruby Mining -- -- 25,800 -- -- -- -- Issuance of common stock from employee options 118,703 1,200 287,200 -- -- -- -- Net income -- -- -- 1,771,200 -- -- -- --------- ------- ----------- ----------- ------- ----------- -------------- Balance May 31, 2001 8,989,047 $90,000 $38,681,600 $(27,155,200) 949,725 $(2,660,500) $ (490,500) ========= ======= =========== ============= ======= ============ ============== Equity ----------- Balance June 1, 2000 as previously presented $4,683,800 Adjustment for deferred taxes See note a 1,144,800 ----------- Balance June 1, 2000 as restated 5,828,600 Funding of ESOP 288,000 Issuance of common stock to outside directors 19,200 Issuance of common stock for services rendered 70,600 Forfeitable shares earned 194,200 Treasury stock from payment on balance of note receivable (20,600) Sale of Ruby Mining 25,800 Issuance of common stock from employee options 288,400 Net income 1,771,200 ---------- Balance May 31, 2001 $8,465,400 =========== Total Shareholders' Equity at May 31, 2001 does not include 433,788 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which, in consolidation, are treated as treasury shares.
The accompanying notes are an integral part of this statement. -58-
U.S. ENERGY & AFFILIATES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (RESTATED, NOTE A) (CONTINUED) Additional Unallocated Total Common Stock Paid-In Accumulated Treasury Stock ESOP --------------- Shareholders' Shares Amount Capital Deficit Shares Amount Contribution ---------- -------- ----------- ------------- ------- ------------ -------------- Balance May 31, 2001 8,989,047 $ 90,000 $38,681,600 $(27,155,200) 949,725 $(2,660,500) $ (490,500) Funding of ESOP 70,075 700 236,200 -- -- -- -- Issuance of common stock to outside directors 3,429 -- 14,400 -- -- -- -- Issuance of common stock for services rendered 45,000 500 147,600 -- -- -- -- Issuance of common stock warrants for services rendered -- -- 592,900 -- -- -- -- Treasury stock from payment on balance of note receivable -- -- -- -- 10,000 (79,900) -- Issuance of common stock in exchange for preferred stock 513,140 5,100 1,846,400 -- -- -- -- Issuance of common stock in exchange for subsidiary stock 912,233 9,100 3,566,900 -- -- -- -- Issuance of common stock to purchase property 61,760 600 246,200 -- -- -- -- Issuance of common stock through private placement 871,592 8,700 2,341,800 -- -- -- -- Issuance of common stock for exercised stock warrants 1,205 -- 4,500 -- -- -- -- Issuance of common stock from employee options (1) 253,337 2,500 600,000 -- -- -- -- Net loss -- -- -- (6,267,600) -- -- -- ---------- -------- ----------- ------------ ------ ------------ -------------- Balance May 31, 2002(2) 11,720,818 $117,200 $48,278,500 $(33,422,800) 959,725 $(2,740,400) $ (490,500) ========== ======== =========== ============= ======= ============ ============== Equity ------------ Balance May 31, 2001 $ 8,465,400 Funding of ESOP 236,900 Issuance of common stock to outside directors 14,400 Issuance of common stock for services rendered 148,100 Issuance of common stock warrants for services rendered 592,900 Treasury stock from payment on balance of note receivable (79,900) Issuance of common stock in exchange for preferred stock 1,851,500 Issuance of common stock in exchange for subsidiary stock 3,576,000 Issuance of common stock to purchase property 246,800 Issuance of common stock through private placement 2,350,500 Issuance of common stock for exercised stock warrants 4,500 Issuance of common stock from employee options (1) 602,500 Net loss (6,267,600) ------------ Balance May 31, 2002(2) $11,742,000 ============ (1)Net of 15,285 shares surrendered by employees for the exercise of 268,622 employee stock options. (2)Total Shareholders' Equity at May 31, 2002 does not include 500,788 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which, in consolidation, are treated as treasury shares.
The accompanying notes are an integral part of this statement. -59-
U.S. ENERGY & AFFILIATES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (RESTATED, NOTE A) (CONTINUED) Additional Unallocated Total Common Stock Paid-In Accumulated Treasury Stock --------------- ESOP Shareholders' Shares Amount Capital Deficit Shares Amount Contribution ---------- -------- ------------ ------------- ------- ------------ -------------- Balance May 31, 2002 11,720,818 $117,200 $48,278,500 $(33,422,800) 959,725 $(2,740,400) $ (490,500) Funding of ESOP 43,867 400 134,700 -- -- -- -- Issuance of common stock to outside consultants 15,000 200 60,700 -- -- -- -- Issuance of common stock warrants -- -- 325,900 -- -- -- -- Issuance of common stock for settlement of law suit 20,000 200 77,600 -- -- -- -- Issuance of common stock from employee options (1) 26,711 300 (300) -- -- -- -- Net loss -- -- -- (3,840,100) -- -- -- ---------- -------- ----------- ------------ ------- ----------- -------------- Balance December 31, 2002(2) 11,826,396 $118,300 $48,877,100 $(37,262,900) 959,725 $(2,740,400) $ (490,500) ========== ======== ============ ============= ======= ============ ============== Equity ------------ Balance May 31, 2002 $11,742,000 Funding of ESOP 135,100 Issuance of common stock to outside consultants 60,900 Issuance of common stock warrants 325,900 Issuance of common stock for settlement of law suit 77,800 Issuance of common stock from employee options (1) -- Net loss (3,840,100) ------------ Balance December 31, 2002(2) $ 8,501,600 ============ (1)Net of 44,456 shares surrendered by employees for the exercise of 71,167 employee stock options. (2)Total Shareholders' Equity at December 31, 2002 does not include 500,788 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which, in consolidation, are treated as treasury shares.
The accompanying notes are an integral part of this statement. -60-
U.S. ENERGY & AFFILIATES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (RESTATED, NOTE A) (CONTINUED) Additional Unallocated Total Common Stock Paid-In Accumulated Treasury Stock ESOP --------------- Shareholders' Shares Amount Capital Deficit Shares Amount Contribution ---------- -------- ----------- ------------- ------- ------------ -------------- Balance December 31, 2002 11,826,396 $118,300 $48,877,100 $(37,262,900) 959,725 $(2,740,400) $ (490,500) Funding of ESOP 76,294 700 235,700 -- -- -- -- Issuance of common stock to outside directors 3,891 -- 14,400 -- -- -- -- Issuance of common stock by release of forfeitable stock 78,286 800 434,400 -- -- -- -- Issuance of common stock from stock warrants 131,596 1,300 465,300 -- -- -- -- Issuance of common stock in stock compensation plan 100,000 1,000 309,000 -- -- -- -- Treasury stock from sale of subsidiary -- -- -- -- 1,581 (4,200) -- Treasury stock from payment on balance of note receivable -- -- -- -- 5,000 (20,500) -- Issuance of common stock to outside consultants 121,705 1,200 581,600 -- -- -- -- Issuance of common stock warrants to outside consultants -- -- 886,300 -- -- -- -- Issuance of common stock for settlement of lawsuit 10,000 100 49,900 -- -- -- -- Issuance of common stock in payment of debt 211,109 2,100 497,900 -- -- -- -- Issuance of common stock from employee options (1) 265,421 2,700 609,600 -- -- -- -- Net loss -- -- -- (5,810,100) -- -- -- ---------- -------- ----------- ------------ ------- ----------- -------------- Balance December 31, 2003(2) 12,824,698 $128,200 $52,961,200 $(43,073,000) 966,306 $(2,765,100) $ (490,500) ========== ======== =========== ============= ======= ============ ============== Equity ------------ Balance December 31, 2002 $ 8,501,600 Funding of ESOP 236,400 Issuance of common stock to outside directors 14,400 Issuance of common stock by release of forfeitable stock 435,200 Issuance of common stock from stock warrants 466,600 Issuance of common stock in stock compensation plan 310,000 Treasury stock from sale of subsidiary (4,200) Treasury stock from payment on balance of note receivable (20,500) Issuance of common stock to outside consultants 582,800 Issuance of common stock warrants to outside consultants 886,300 Issuance of common stock for settlement of lawsuit 50,000 Issuance of common stock in payment of debt 500,000 Issuance of common stock from employee options (1) 612,300 Net Loss (5,810,100) ------------ Balance December 31, 2003(2) $ 6,760,800 ============ (1)Net of 10,200 shares surrendered by employees for the exercise of 275,621 employee stock options. (2)Total Shareholders' Equity at December 31, 2003 does not include 465,880 shares currently issued but forfeitable if certain conditions are not met by the recipients. "Basic and Diluted Weighted Average Shares Outstanding" also includes 814,496 shares of common stock held by majority-owned subsidiaries, which in consolidation, are treated as treasury shares.
The accompanying notes are an integral part of this statement. -61-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended Seven Months Ended Year Ended December 31, December 31, May 31, ------------ ------------ ------- 2003 2002 2002 2001 ------------ ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net (loss) income $(5,810,100) $(3,840,100) $(6,267,600) $ 1,771,200 Adjustments to reconcile net (loss) income to net cash used in operating activities: Minority interest in loss of consolidated subsidiaries (235,100) (54,800) (39,500) (220,100) Depreciation and amortization 554,200 360,100 541,500 1,254,000 Accretion of asset retirement obligations 366,700 -- -- -- Amortization of debt discount 537,700 211,200 -- -- Impairment of goodwill -- -- 1,622,700 -- Impairment of mineral interests -- -- -- 123,800 Noncash services 134,700 31,500 787,700 19,100 Noncash dividend -- -- 11,500 -- Provision for doubtful accounts -- -- 171,200 -- Deferred income -- -- -- (4,000,000) (Gain) loss on sale of assets (199,300) 342,600 (812,700) (1,163,600) Write off of properties -- 21,500 -- -- Cumulative effect of accounting change (1,615,600) -- -- -- Noncash compensation 893,500 314,800 535,200 501,700 Lease holding costs 50,000 -- -- -- Net changes in assets and liabilities: Accounts and notes receivable (461,500) (755,600) 799,900 1,241,000 Other assets 1,466,000 8,700 (47,500) (112,700) Accounts payable and accrued expenses (827,200) 609,900 (879,300) (887,300) Prepaid drilling costs (134,400) (107,700) 242,100 -- Decrease in asset retirement obligation (393,200) -- -- -- ----------- ----------- ----------- ------------ NET CASH USED IN OPERATING ACTIVITIES (5,673,600) (2,857,900) (3,334,800) (1,472,900)
The accompanying notes are an integral part of these statements. -62-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Year Ended Seven Months Ended Year Ended December 31, December 31, May 31, ----------- ----------- ------------------------- 2003 2002 2002 2001 ----------- ----------- ----------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Exploration of coalbed methane gas properties (176,400) (883,400) (142,100) (1,187,800) Proceeds from sale of gas interests 2,813,800 1,125,000 1,125,000 -- Proceeds from sale of property and equipment 1,604,400 1,566,000 752,000 2,608,000 Net change in restricted investments 3,037,500 66,100 (236,800) (417,700) Purchase of property and equipment (92,700) (411,200) (82,300) (311,400) Net change in investments in affiliates (222,600) 104,600 406,500 292,400 --------- --------- --------- ---------- NET CASH PROVIDED BY INVESTING ACTIVITIES 6,964,000 1,567,100 1,822,300 983,500 CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 1,078,900 -- 2,957,400 288,400 Proceeds from issuance of stock by subsidiary 650,000 -- 1,000,000 -- Proceeds from third party debt 2,600 892,800 631,700 619,100 Net activity from lines of credit -- (200,000) (650,000) 200,000 Purchase of treasury stock -- -- -- (20,600) Repayments of third party debt (678,100) (225,300) (547,800) (828,400) ---------- ---------- ---------- ------------ NET CASH PROVIDED BY FINANCING ACTIVITIES 1,053,400 467,500 3,391,300 258,500 ----------- ----------- ----------- ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,343,800 (823,300) 1,878,800 (230,900) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,741,000 2,564,300 685,500 916,400 ----------- ----------- ----------- ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $4,084,800 $1,741,000 $2,564,300 $ 685,500 =========== =========== =========== ============ SUPPLEMENTAL DISCLOSURES: Income tax paid $ -- $ -- $ -- $ -- =========== =========== =========== ============ Interest paid $ 799,100 $ 361,200 $ 345,300 $ 265,300 =========== =========== =========== ============
The accompanying notes are an integral part of these statements. -63-
U.S. ENERGY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Year Ended Seven Months Ended Year Ended December 31, December 31, May 31, ------------ ------------ ---------------------- 2003 2002 2002 2001 -------- -------- ---------- ---------- NON-CASH INVESTING AND FINANCING ACTIVITIES: Sale of assets through issuance of a note receivable $ -- $ -- $ 442,200 $1,164,500 ======== ======== ========== ========== Acquisition of assets through issuance of debt $ 26,300 $ -- $ 180,600 $1,631,700 ======== ======== ========== ========== Acquisition of assets through issuance of stock $ -- $150,000 $ 96,800 $ - ======== ======== ========== ========== Issuance of stock warrants for services $563,400 $ 26,100 $ -- $ -- ======== ======== ========== ========== Issuance of stock warrants in conjunction with notes payable $ -- $299,800 $ 592,900 $ -- ======== ======== ========== ========== Issuance of stock as deferred compensation $151,900 $ -- $ 261,300 $ 358,400 ======== ======== ========== ========== Issuance of stock to satisfy debt $500,000 $ -- $3,568,500 $ -- ======== ======== ========== ========== Issuance of stock to retire preferred stock $ -- $ -- $1,840,000 $ - ======== ======== ========== ========== Issuance of stock for retired employees $435,200 $ -- $ - $ 194,400 ======== ======== ========== ========== Issuance of stock for services $582,800 $ 60,900 $ 14,400 $ 70,500 ======== ======== ========== ========== Satisfaction of receivable - affiliate with stock in affiliate $ -- $ -- $ -- $3,000,000 ======== ======== ========== ========== Satisfaction of receivable - employee with stock in company $ 20,500 $ -- $ 79,900 $ -- ======== ======== ========== ==========
The accompanying notes are an integral part of these statements. -64- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 (CONTINUED)AND MAY 31, 2001 A. BUSINESS ORGANIZATION AND OPERATIONS: U.S. Energy Corp. was incorporated in the State of Wyoming on January 26, 1966. U.S. Energy Corp. and subsidiaries (the "Company" or "USE") engages in the acquisition, exploration, holding, sale and/or development of mineral and coalbed methane gas properties, the production of petroleum properties and marketing of minerals and methane gas. Principal mineral interests are in coalbed methane, uranium, gold and molybdenum. The Company's uranium and gold properties are currently all in a shut down status. The Company holds various real and personal properties used in commercial activities. Most of the Company's activities are conducted through subsidiaries and through the joint venture discussed below and in Note D. The Company was engaged in the maintenance of two uranium properties, one in southern Utah, and the second in Wyoming known as Sheep Mountain Partners ("SMP"). SMP has been involved in significant litigation (see Note K). Sutter Gold Mining Company ("SGMC"), a Wyoming corporation owned 78.5% by the Company at December 31, 2003, manages the Company's interest in gold properties. The Company also owns 100% of the outstanding stock of Plateau Resources Limited ("Plateau"), which owns a nonoperating uranium mill in southeastern Utah. Currently, the mill is nonoperating but has been granted a license to operate subject to certain conditions. Rocky Mountain Gas, Inc. ("RMG") was formed in November 1999 to consolidate all methane gas operations of the Company. The Company owns and controls 90.1% of RMG as of December 31, 2003. The Company's Board of Directors changed the Company's year end to December 31 effective December 31, 2002. RESTATEMENT OF BALANCE SHEETS AND SHAREHOLDERS' EQUITY ------------------------------------------------------------ The balance sheets at December 31, 2002 and May 31, 2002 and statements of shareholders' equity have been restated to reflect the correction of an overstatement in deferred tax liability of $1,144,800. Accumulated deficit at June 1, 2000 has been decreased by $1,144,800. The liability overstatement occurred prior to any accompanying statements of operations presented; therefore, there was no effect on net earnings for any periods presented in the accompanying financial statements. Therefore, the statements of operations and cash flows for the years ended December 31, 2003, seven months ended December 31, 2002 and the years ended May 31, 2002 and 2001 have not been restated. MANAGEMENT'S PLAN ------------------ The Company has generated significant net losses during recent years and has an accumulated deficit of approximately $43,073,000 at December 31, 2003. The Company has working capital of approximately $3,281,700 at December 31, 2003 and its cash balance has increased from $1,741,000 at December 31, 2002 to $4,084,800 at December 31, 2003. The Company used cash in its operating activities of $5,673,700 and $3,334,800 during the years ended December 31, 2003 and May 31, 2002 and used cash of $2,857,800 during the seven moths ended December 31, 2002. During the year ended December 31, 2003 and the fiscal year ended May 31, 2002 the Company experienced positive cash flow of $2,343,800 and $1,878,800 respectively. The Company experienced negative cash flow of $823,300 and $230,900, respectively, for the seven months ended December 31, 2002 and the fiscal year ended May 31, 2001. -65- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) The Company has entered into agreements to provide funding for the development of coalbed methane properties (See Note F). After these work commitments are fully funded, the Company does not have sufficient capital available to fund its portion of the anticipated exploration and development activities on its coalbed methane properties. Additionally, the Company's known cash flows through December 31, 2004 from current operations and associated overhead are negative based on current projections. In order to improve liquidity of the Company, management intends to do the following: X Continue to reduce its mining activities. X Sell raw land in Riverton, Wyoming and Gunnison, Colorado. Management intends to sell this land at its fair market value. The land is not needed for the operations of the Company now or into the future. X Seek equity funding or a joint venture partner to place the SGMC property into production or sell the entire property to an industry partner. X Raise additional capital through a private placement and a public offering of its subsidiary Rocky Mountain Gas, Inc. The timing of such a public offering will depend on the market prices for methane gas. X Reduce overhead expenses and concentrate on its primary business - coalbed methane. X Successfully resolve disputes relating to SMP assets. (See Note K) As a result of these plans, management believes that they will generate sufficient cash flows to meet its cash requirements in calendar 2004, although there is no assurance the plans will be accomplished. B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF CONSOLIDATION The consolidated financial statements of USE and subsidiaries include the accounts of the Company, the accounts of its majority-owned or controlled subsidiaries Plateau (100%), Energx, Ltd ("Energx") (90%), Four Nines Gold, Inc. ("FNG") (50.9%), SGMC (78.5%), Crested Corp. ("Crested") (71.5%), Yellowstone Fuels Corp. ("YSFC") (35.9%) Rocky Mountain Gas ("RMG") (88.5%) and the USECC Joint Venture ("USECC"), a consolidated joint venture which is equally owned by U.S. Energy Corp. and Crested, through which the bulk of their operations are conducted. Investments in all 20% to 50% owned companies are accounted for using the equity method. Investments of less than 20% are accounted for by the cost method. All material intercompany profits, transactions and balances have been eliminated. -66- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) CASH EQUIVALENTS The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company maintains its cash and cash equivalents in bank deposit accounts which exceed federally insured limits. At December 31, 2003, the Company had approximately 99% of its cash and cash equivalents with one financial institution. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant credit risk on cash and cash equivalents. RESTRICTED INVESTMENTS Based on the provisions of Statement of Financial Accounting Standards No. 115 ("SFAS 115"), the Company accounts for its restricted investment in certain securities as held-to-maturity. Held-to-maturity securities are measured at amortized cost. If a decline in fair value of such investments is determined to be other than temporary, the investment is written down to fair value. ACCOUNTS RECEIVABLE The majority of the Company's accounts receivable are due from industry partners for drilling and operating expenses associated with coalbed methane gas wells for which RMG acts as operator and from sales of land. The Company determines any required allowance by considering a number of factors including length of time trade accounts receivable are past due and the Company's previous loss history. The Company writes off accounts receivable when they become uncollectable, and payments subsequently received on such receivables are credited to the allowance for doubtful accounts. In addition, the Company is due $863,200 from CCBM under a non-recourse promissory note receivable which arose as part of the sale of a portion of RMG's coalbed methane properties to CCBM. The note receivable is fully reserved due to its non-recourse nature with payments received credited against natural gas properties in accordance with the full cost method of accounting. INVENTORIES Inventories consist of aviation fuel and well casing and tubing. Inventories are stated at lower of cost or market using the average cost method. PROPERTIES AND EQUIPMENT Land, buildings, improvements, machinery and equipment are carried at cost. Depreciation of buildings, improvements, machinery and equipment is provided principally by the straight-line method over estimated useful lives ranging from 3 to 45 years. Following is a breakdown of the lives over which assets are depreciated. -67- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) Office Equipment 3 to 5 years Field Tools and Hand Equipment 5 to 7 years Vehicles and Trucks 3 to 7 years Heavy Equipment 7 to 10 years Service Buildings 20 years Corporate Headquarter's Building 45 years The Company capitalizes all costs incidental to the acquisition of mineral properties as incurred. Costs are charged to operations if the Company determines that the property is not economical. Mineral exploration costs are expensed as incurred. When it is determined that a mineral property can be economically developed as a result of establishing proved and probable reserves, costs subsequently incurred are capitalized and amortized using units of production over the estimated recoverable proved and probable reserves. Costs and expenses related to general corporate overhead are expensed as incurred. The Company has acquired substantial mining properties and associated facilities at minimal cash cost, primarily through the assumption of reclamation and environmental liabilities. Certain of these properties are owned by various ventures in which the Company is either a partner or venturer. (See Note F). OIL AND GAS PROPERTIES The Company follows the full cost method of accounting for oil and gas properties. Accordingly, all costs associated with acquisition, exploration, and development of oil and gas reserves, including directly related overhead costs, are capitalized. All capitalized costs of oil and gas properties subject to amortization and the estimated future costs to develop proved reserves, are amortized on the unit-of-production method using estimates of proved reserves. Investments in unproved properties and major exploration and development projects are not amortized until proved reserves associated with the projects can be determined or until impairment occurs. If the results of an assessment indicate that the properties are impaired, the capitalized cost of the property will be added to the costs to be amortized. After there are proven reserves, the capitalized costs associated with those reserves are subject to a "ceiling test," which basically limits such costs to the aggregate of the "estimated present value," discounted at a 10-percent interest rate of future net revenues from proved reserves, based on current economic and operating conditions, plus the lower of cost or fair market value of unproved properties. Sales of proved and unproved properties are accounted for as adjustments of capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves of oil and gas, in which case the gain or loss is recognized in income. Abandonments of properties are accounted for as adjustments of capitalized costs with no loss recognized. LONG-LIVED ASSETS The Company evaluates its long-lived assets (other than oil and gas properties which are discussed above) for impairment when events or changes in circumstances indicate that the related carrying amount may not be recoverable. If the sum of estimated future cash flows on an undiscounted basis is less than the carrying amount of the related asset, an asset impairment is considered to exist. The related impairment loss is -68- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) measured by comparing estimated future cash flows on a discounted basis to the carrying amount of the asset. Changes in significant assumptions underlying future cash flow estimates may have a material effect on the Company's financial position and results of operations. An uneconomic commodity market price, if sustained for an extended period of time, or an inability to obtain financing necessary to develop mineral interests, may result in asset impairment. During the fiscal year ended May 31, 2002, the Company recorded a $1,622,700 impairment of goodwill that arose as part of the purchase of an additional 1,105,499 shares of RMG common stock. These shares of stock were purchased by issuing 910,320 shares of the Company's common stock pursuant to conversion rights granted RMG private placement investors. During fiscal 2001, the Company recorded an impairment on its mineral properties of $123,800 in YSFC. As of December 31, 2003, management believes no further impairment is necessary and that the fair market of remaining assets exceeds the carrying value. See Note F for further discussion. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash equivalents, receivables, other current assets, accounts payable and accrued expenses approximates fair value because of the short-term nature of those instruments. The recorded amounts for short-term and long-term debt, approximate fair market value due to the variable nature of the interest rates on the short term debt, and the fact that interest rates remain generally unchanged from issuance of the long term debt. REVENUE RECOGNITION Revenues from real estate operations are from the rental of office space in office buildings in Riverton, Wyoming. Airport operations consist of the sale of aviation fuel, repair and maintenance of aircraft and rental of hanger space. All these revenues are reported on a gross revenue basis and are recorded at the time the service is provided. The Company, through its subsidiary, RMG, utilizes the entitlements method of accounting for natural gas revenues whereby revenues are recognized as the Company's share of the gas is produced and delivered to a purchaser based upon its working interest in the properties. The Company will record a receivable (payable) to the extent that it receives less (more) than its proportionate share of the gas revenues. Revenues from mineral sales consist of the sale of uranium to a delivery contract and the sale of that contract to a third party supplier. The sale of uranium is reported on a net basis. The Company has not produced any uranium from its properties during the period covered by the enclosed financial statements and during the year ended May 31, 2001 purchased all uranium delivered under its supply contracts from the open market as all the Company's uranium operations are shut down. Mineral royalties which are non-refundable are recognized as revenue when received (see Note F). Management fees are recorded as a percentage of actual costs for services provided for subsidiaries and partnerships for which the Company provides management services. The Company is also paid a management fee for overseeing oil production on the Fort Peck Reservation in Montana. Management fees are recorded when the service is provided. -69- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) STOCK BASED COMPENSATION SFAS 123, "Accounting for Stock-Based Compensation," ("SFAS 123") defines a fair value based method of accounting for employee stock options or similar equity instruments. However, SFAS 123 allows the continued measurement of compensation cost for such plans using the intrinsic value based method prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), provided that pro forma disclosures are made of net income or loss and net income or loss per share, assuming the fair value based method of SFAS 123 had been applied. The Company has elected to account for its stock-based compensation plans under APB 25; accordingly, for purposes of the pro forma disclosures presented below, the Company has computed the fair values of all options granted using the Black-Scholes pricing model and the following weighted average assumptions:
Year Ended Seven Months ended December 31, December 31, Year ended May 31, ------------- ------------- --------------------- 2003 2002 2002 2001 ------ ------ ------ ----- Risk-free interest rate 5.61% 4.4% 5.6% 4.29% Expected lives (years) 7 8.5 10 10 Expected volatility 58.95% 50.38% 62.65% 73.1% Expected dividend yield -- -- -- --
To estimate expected lives of options for this valuation, it was assumed options will be exercised at the end of their expected lives. All options are initially assumed to vest. Cumulative compensation cost recognized in pro forma net income or loss with respect to options that are forfeited prior to vesting is adjusted as a reduction of pro forma compensation expense in the period of forfeiture. If the Company had accounted for its stock-based compensation plans in accordance with SFAS 123, the Company's net (loss) income and pro forma net loss per common share would have been reported as follows:
Year Ended Seven Months Ended December 31, December 31, Year Ended May 31, ----------------------------- 2003 2002 2002 2001 -------------- -------------- --------------- ------------ Net (loss) income to common shareholders as reported $ (5,810,100) $ (3,840,100) $ (6,267,600) $ 1,771,200 Deduct: Total stock based employee expense determined under fair value based method (652,900) (1,410,850) (3,079,700) (2,746,600) -------------- -------------- --------------- ------------ Pro forma net loss $ (6,463,000) $ (5,250,950) $ (9,347,300) $ (975,400) ============== ============== =============== ============ As reported, Basic $ (.52) $ (.36) $ (.67) $ .23 As reported, Diluted $ (.52) $ (.36) $ (.67) $ .21 Pro forma, Basic $ (.58) $ (.49) $ (1.01) $ (.12) Pro forma, Diluted $ (.58) $ (.49) $ (1.01) $ (.12)
Weighted average shares used to calculate pro forma net loss per share were determined as described in Note B, except in applying the treasury stock method to outstanding options, net proceeds assumed received upon exercise were increased by the amount of compensation cost attributable to future service periods and not yet recognized as pro forma expense. -70- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) INCOME TAXES The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes". This statement requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets, liabilities and carryforwards. SFAS 109 requires recognition of deferred tax assets for the expected future effects of all deductible temporary differences, loss carryforwards and tax credit carryforwards. Deferred tax assets are reduced, if deemed necessary, by a valuation allowance for any tax benefits which, based on current circumstances, are not expected to be realized. NET (LOSS) INCOME PER SHARE The Company reports net (loss) income per share pursuant to Statement of Financial Accounting Standards No. 128 ("SFAS 128"). SFAS 128 specifies the computation, presentation and disclosure requirements for earnings per share. Basic earnings per share is computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based on the weighted average number of common shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock, if dilutive. Potential common shares relating to options and warrants are excluded from the computation of diluted earnings (loss) per share, because they were antidilutive, totaled 3,790,370, 4,910,900, 3,999,468 and 3,316,011 at December 31, 2003 and 2002 and May 31, 2002 and 2001, respectively. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions 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. RECLASSIFICATIONS Certain reclassifications have been made in the prior years financial statements in order to conform with the presentation for the current year. RECENT ACCOUNTING PRONOUNCEMENTS - ---------------------------------- SFAS 143 Effective January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligation." The statement requires the Company to record the fair value of the reclamation liability on its shut down mining and gas properties as of the date that the liability is incurred. The statement further requires that the Company review the liability each quarter and determine if a change is estimate is required as well as accrete the total liability on a quarterly basis for the future liability. -71- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) The Company will also deduct any actual funds expended for reclamation during the quarter in which it occurs. As a result of the Company taking impairment allowances in prior periods on its shut down mining properties, it has no remaining book value for these properties. The following is a reconciliation of the total liability for asset retirement obligations Balance December 31, 2002 $ 8,906,800 Impact of adoption of SFAS No. 143 (1,615,600) Addition to Liability -0- Liability Settled (393,200) Accretion Expense 366,700 --------------- Balance December 31, 2003 $ 7,264,700 =============== The following table shows the Company's net income (loss) and net income (loss) per share on a pro forma basis as if the provisions of SFAS No. 143 had been applied retroactively in all periods presented.
Seven Month Year ended ended December 31, December 31, Year ended 2003 2002 2002 2001 -------------- -------------- ------------ ----------- NET INCOME (LOSS): Reported net income (loss) from continuing operations $ (7,075,800) $ (3,857,200) $(6,034,400) $1,534,800 Pro-forma adjustments net of tax -- (200,000) (333,000) (317,000) -------------- -------------- ------------ ----------- Pro-forma net income (loss) $ (7,075,800) $ (4,057,200) $(6,367,400) $1,217,800 ============== ============== ============ =========== PER SHARE OF COMMON STOCK: Reported net income (loss) basic from continuing operations $ (0.63) $ (0.36) $ (0.65) $ 0.20 Pro-forma adjustments net of tax -- (0.02) (0.03) (0.04) -------------- -------------- ------------ ----------- Pro-forma net income (loss) basis $ (0.63) $ (0.38) $ (0.68) $ 0.16 ============== ============== ============ =========== Reported net income (loss) diluted $ (0.63) $ (0.36) $ (0.65) $ 0.18 Pro-forma adjustments -- (0.02) (0.03) (0.04) -------------- -------------- ------------ ----------- Pro-forma net income (loss) diluted $ (0.63) $ (0.38) $ (0.68) $ 0.14 -------------- ============== ============ ===========
Computed on a pro-forma basis, the provisions of SFAS No. 143 would have been $7,291,200, $7,091,200, $6,758,200 and $6,441,200 at December 31, 2002, May 31, 2002 and 2001 and June 1, 2000, respectively. The Company has reviewed other current outstanding statements from the Financial Accounting Standards Board and does not believe that any of those statements will have a material adverse affect on the financial statements of the Company when adopted. -72- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) C. RELATED-PARTY TRANSACTIONS: The Company provides management and administrative services for affiliates under the terms of various management agreements. Revenues from services provided by the Company to unconsolidated affiliates were $33,400 during the year ended December 31, 2003, $55,900 during the seven months ended December 31, 2002, and $78,800 and $132,500 for the years ended May 31, 2002 and 2001, respectively. The Company has $96,800 of receivables from unconsolidated subsidiaries as of December 31, 2003. D. USECC JOINT VENTURE: The Company operates the Glen L. Larsen office complex; holds interests in various mineral operations; conducts oil and gas operations; and transacts all operating and payroll expenses through a joint venture with Crested, the USECC joint venture. E. INVESTMENTS IN AND ADVANCES TO AFFILIATES: The Company's restricted investments secure various decommissioning, reclamation and holding costs. Investments are comprised of debt securities issued by the U.S. Treasury that mature at varying times from three months to one year from the original purchase date. As of December 31, 2003, December 31, 2002 and May 31, 2002, the cost of debt securities was a reasonable approximation of fair market value. These investments are classified as held-to-maturity under SFAS 115 and are measured at amortized cost. F. MINERAL CLAIMS TRANSACTIONS: GMMV During fiscal 1990, the Company entered into an agreement with Kennecott, a wholly-owned, indirect subsidiary of The RTZ Corporation PLC, for Kennecott to acquire a 50% interest in certain uranium mineral properties in Wyoming known as the Green Mountain Properties. During the life of the venture, the parties entered into various amendments to the GMMV Agreement. As a result of sustained depressed uranium prices, the GMMV properties were maintained on a shut down basis. During fiscal 2000, certain differences arose in the GMMV and Kennecott sued the Company and USE. On September 11, 2000, the parties settled all disputes and Kennecott paid the Company and USE $3.25 million and assumed reclamation liability for the Sweetwater Mill, Jackpot and Big Eagle Mine properties. (Note K.) SMP During fiscal 1989, USE and Crested, through USECC, entered into an agreement to sell a 50% interest in their Sheep Mountain properties to a subsidiary of Nukem Inc., CRIC. USECC and CRIC immediately contributed their 50% interests in the properties to a newly-formed partnership, SMP. SMP was established to further develop and mine the uranium claims on Sheep Mountain, acquire uranium supply contracts and market uranium. Certain disputes arose among USECC, CRIC and its parent Nukem, Inc. over the operation of SMP. These disputes have been in litigation/arbitration for the past thirteen years. See Note K for the status of the related litigation/arbitration. -73- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) Due to the litigation and arbitration proceedings involving SMP, the Company has expensed all of its costs related to SMP and has no carrying value of its investment in SMP at December 31, 2003, December 31, 2002 and May 31, 2002. (see Note K). PHELPS DODGE During prior years, the Company conveyed interests in mining claims to AMAX Inc. ("AMAX") in exchange for cash, royalties, and other consideration. AMAX merged with Cyprus Minerals ("Cyprus Amax") which was purchased by Phelps Dodge Mining Company ("Phelps Dodge") in December of 1999. The properties have not been placed into production as of December 31, 2003. Amax and later Cyprus Amax paid the Company an annual advance royalty of 50,000 pounds of molybdenum (or its cash equivalent). During fiscal 2000, Phelps Dodge assumed this obligation and made its first advance royalty payment to USE during the first quarter of 2001. Phelps Dodge is entitled to a partial credit against future royalties for any advance royalty payments made, but such royalties are not refundable if the properties are not placed into production. The Company recognized $60,300 of revenue from the advance royalty payments during the year ended May 31, 2001. If Phelps Dodge formally decides to place the properties into production, it is obligated to pay $2,000,000 to the Company. Per the contract with AMAX, the Company is to receive 15% of the first $25,000,000, or $3,750,000, if the properties are sold, which the Company believes occurred when Phelps Dodge purchased Cyprus Amax. Phelps Dodge filed suit against the Company on June 19, 2002 regarding these matters (See Note K). SUTTER GOLD MINING COMPANY Sutter Gold Mining Company ("SGMC") was established in 1990 to conduct operations on mining leases and to produce gold from the Lincoln Project in California. SGMC has not generated any significant revenue and has no assurance of future revenue. All acquisition and mine development costs since inception were capitalized. Due to the decline in the spot price for gold and the lack of adequate financing, SGMC has put the property on a shut down status and has impaired the associated assets. During fiscal 2000, a visitor's center was developed and became operational. Management has leased the visitor's center to partially cover stand-by costs of the property. At December 31, 2003, the spot market price for gold had attained levels management believe that will allow SGMC to produce gold from the property on an economic basis. This conclusion is based on engineering analysis completed on the property. Management of SGMC is therefore pursuing the equity capital market and non-affiliated industry partners to obtain sufficient capital to complete the development of the mine, construct a mill and place the property into production. (See Note P). PLATEAU RESOURCES LIMITED During fiscal 1994, USE entered into an agreement with Consumers Power Company to acquire all the issued and outstanding common stock of Plateau Resources Limited ("Plateau"), a Utah corporation. Plateau owns a uranium processing mill and support facilities and certain other real estate assets through its wholly-owned subsidiary, Canyon Homesteads, Inc., in southeastern Utah. USE paid nominal cash consideration for -74- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) the Plateau stock and agreed to assume all environmental liabilities and reclamation bonding obligations. At December 31, 2003, Plateau had a cash security in the amount of $6.8 million to cover reclamation and annual licensing of the properties (see Note K). The Company is currently evaluating the best utilization of Plateau's assets. Evaluations are ongoing to determine when, or if, the mine and mill properties should be placed into production. The primary factor in these evaluations relates to uranium market prices. Due to uranium market conditions in 2002, Plateau decided to change the license status from operational back to reclamation and filed a new reclamation plan. The Nuclear Regulatory Commission (NRC) reviewed the revised reclamation and decommissioning plan and agreed to a $6.1 million reclamation plan. Therefore, Plateau received about $2.9 Million of excess reclamation bond funds on the Shootaring Canyon Uranium Mill. During the year ended December 31, 2003, management of Plateau determined that the mine and mill properties should be reclaimed. On August 1, 2003, the Company sold all of the stock of Canyon Resources as a result of Plateau entering into a Stock Purchase Agreement to sell all the outstanding shares of Canyon Homesteads, Inc. ("Canyon") to The Cactus Group LLC, a newly formed Colorado limited liability company. The Cactus Group purchased all of the outstanding stock of Canyon for $3,370,000. Of that amount, $349,300 was paid in cash at closing and the balance of $3,120,700 is to be paid under the terms of a promissory note. The sale did not qualify for gain recognition under the full accrual method. A gain of $1,295,700 was deferred and reported in the consolidated balance sheet at December 31, 2003. The sale will be recognized by the installment method as cash payments are received from the purchaser. An installment note receivable of $2,988,000 at December 31, 2003 will be reduced as payments are received. Pursuant to the promissory note, the Company is to receive $5,000 per month for the months of November 2003 to March 2004 and $10,000 for the months of November 2004 to March 2005 and $24,000 per month for the months of April to October 2004 and $24,000 per month on a monthly basis after March of 2005 from The Cactus Group until August of 2008, at which time, a balloon payment of $2.8 million is due. The note is secured with all the assets of The Cactus Group and Canyon along with personal guarantees by the six principals of The Cactus Group. As additional consideration for the sale, the Company will also receive the first $210,000 in gross proceeds from the sale of either single family or mobile home lots in Ticaboo. ROCKY MOUNTAIN GAS, INC. During fiscal 2000, the Company organized Rocky Mountain Gas, Inc. ("RMG") to enter into the coalbed methane gas/natural gas business. RMG is engaged in the acquisition of coalbed methane gas properties and the future exploration, development and production of methane gas from those properties. At December 31, 2003, RMG is owned 90.1% by the Company. On January 3, 2000, RMG entered into an agreement with Quantum Energy, L.L.C. (Quantum formed a subsidiary "Quaneco" to conduct its business with RMG) to purchase a 50% working interest and 40% net revenue interest in approximately 185,000 acres of unproven leasehold interests in the Powder River Basin of southeastern Montana. -75- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) RMG also acquired a 100% working interest (82% revenue interest) in 65,247 net mineral acres in southwest Wyoming during the year ended May 31, 2000. CCBM - ---- On July 10, 2001, RMG completed a sale of gas properties to CCBM, Inc., a Delaware corporation, which is wholly-owned by Carrizo Oil & Gas, Inc., Houston, Texas (NMS "CRZO"). The agreement between CCBM and RMG is to finance the further development of coalbed methane acreage currently owned by RMG in Montana and Wyoming, and to acquire and develop more acreage in Wyoming and the Powder River Basin of Montana. RMG is the designated operator under a Joint Operating Agreement ("JOA") between RMG and CCBM., which will govern all operations on the properties subject to a Purchase and Sale Agreement between RMG and CCBM, subject to pre-existing JOA's with other entities, and operations or properties in the area of mutual interest ("AMI"). CCBM has the right to participate in other properties RMG may acquire under the area of mutual interest ("AMI"). RMG assigned CCBM an undivided 50% interest in all of RMG's existing coalbed methane properties (with the exception of Castle Rock of which only a 6.25% working interest was assigned) for a sales price of $7,500,000 in the form of a non-recourse promissory note payable in principal amounts of $125,000 per month plus interest at an annual rate of 8% over 41 months (starting July 31, 2001) with a balloon payment due on the forty-second month. This note is accounted for on a cash basis because it is non-recourse with its principle payments reducing the natural gas properties in accordance with the full cost method of accounting. The balance due under the note at December 31, 2003 is $863,200. (See Pinnacle below) Interest income of $232,100, $269,700 and $505,000 was recognized for the year ended December 31, 2003, the nine months ended December 31, 2002 and the year ended March 31, 2002, respectively. These properties sold to CCBM consisted of the Kirby, Oyster Ridge, Clearmont, Sussex, Finley, Baggs North, and Gillette North properties. CCBM's 50% undivided interest is pledged back to RMG to collateralize the promissory note. To start development, and as part of the consideration for the acquisition, CCBM agreed to pay $5,000,000 to drill and complete from 30 to 60 wells on the coalbed properties. RMG is "carried" for its 50% interest in these wells, and will not be required to pay any of such costs. After the initial $5,000,000 has been spent, RMG and CCBM each will pay for their 50% share of costs in subsequent wells, and also will pay for their 50% share of operating costs for the wells drilled and completed in this drilling program. Without CCBM's consent, none of the drilling funds can be used for operations associated with water disposal wells, gas compression beyond 100 PSIG, or for facilities downstream of compression beyond 100 PSIG. CCBM will earn a 50% working interest in each well location (80 acres) and gas production therefrom, regardless of the status of payments on the promissory note. The balance under the work commitment at December 31, 2003 was $305,100. In 2003, a portion of these interests were exchanged for common stock of Pinnacle Gas Resources. (See Pinnacle below). Bobcat - ------ On April 12, 2002, RMG signed an agreement to purchase working interests in approximately 1,940 gross acres of coalbed methane properties in the Powder River Basin of Wyoming. The contract closed on June 4, 2002. RMG paid the seller $500,000 cash and another $150,000 by having USE issue 37,500 shares of its restricted common stock to the seller; CCBM paid $500,000 cash to the seller and CRZO issued its -76- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) restricted shares of common stock valued at $150,000. The properties are located approximately 25 miles north of Gillette, in Campbell County, Wyoming. In 2003 these interests were exchanged for common stock of Pinnacle Gas Resources. (See Pinnacle below). Pinnacle - -------- On June 23, 2003, a Subscription and Contribution Agreement was executed by RMG, CCBM, and the seven affiliates of Credit Suisse First Boston Private Equity ("CSFB Parties"). Under the Agreement, RMG and CCBM contributed certain of their respective interests, having an estimated fair value of approximately $7.5 million each, carried on RMG's books at a cost of $922,600, comprised of (1) leases in the Clearmont, Kirby, Arvada and Bobcat CBM project areas and (2) oil and gas reserves in the Bobcat project area, to a newly formed entity, Pinnacle Gas Resources, Inc., a Delaware corporation ("Pinnacle"). In exchange for the contribution of these assets, RMG and CCBM each received 37.5% of the common stock of Pinnacle ("Pinnacle Common Stock") as of the closing date and options to purchase Pinnacle Common Stock ("Pinnacle Stock Options"). The CSFB Parties contributed $5.0 million for 25% of the common stock in Pinnacle. CSFB Parties also contributed approximately $13 million of cash to Pinnacle in return for the Redeemable Preferred Stock of Pinnacle ("Pinnacle Preferred Stock"), 25% of the Pinnacle Common Stock as of the closing date and warrants to purchase Pinnacle Common Stock ("Pinnacle Warrants"). The CSFB Parties also agreed to contribute additional cash, under certain circumstances, of up to approximately $11.8 million to Pinnacle to fund future drilling, development and acquisitions. The CSFB Parties currently have greater than 50% of the voting power of the Pinnacle capital stock through their ownership of Pinnacle Common Stock and Pinnacle Preferred Stock. Currently, on a fully diluted basis, assuming that all parties exercised their Pinnacle Warrants and Pinnacle Options, the CSFB Parties, RMG and CCBM would have ownership interest of approximately 46.2%, 26.9% and 26.9%, respectively. On a fully-diluted basis, assuming the additional $11.8 million of cash was contributed by the CSFB Parties and all Pinnacle Warrants and Pinnacle Options were exercised by all parties, the CSFB Parties would own 54.6% of Pinnacle and RMG and CCBM would each own 22.7% of Pinnacle. Prior to and in connection with its contribution of assets to Pinnacle, CCBM paid RMG approximately $1.8 million in cash as part of its outstanding purchase obligation on the coalbed methane property interests CCBM previously acquired from RMG. CCBM was also given a credit of $1,250,000 against the note payable pursuant to the original Purchase and Sale Agreement which allowed CCBM to recover $1,250,000 from 20% of RMG's net revenue interest from any production from the properties contributed to Pinnacle. After these payments and credits, there was a balance of approximate $1.2 million remaining on the obligation from CCBM to RMG at December 31, 2003, the balance on the note receivable for CCBM was $863,200. The principal reductions to the note receivable from CCBM are accounted for on a cash basis because it is non-recourse. Pinnacle is a private corporation. Only such information about Pinnacle as its board of directors elects to release is available to the public. All other information about Pinnacle is subject to confidentiality agreements between Pinnacle, RMG, and the other parties to the June 2003 transaction. -77- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) OIL AND GAS PROPERTIES AND EQUIPMENT INCLUDED THE FOLLOWING: - --------------------------------------------------------------------
December 31, May 31, -------------------------- -------------------------- 2003 2002 2002 2001 ------------ ------------ ------------ ------------ Oil and gas properties: Subject to amortization $ 1,773,600 $ 1,773,600 $ 1,773,600 $ 1,773,600 Acquired in calendar 2003 -- -- -- -- Acquired in calendar 2002 650,000 650,000 -- -- ------------ ------------ ------------ ------------ 2,423,600 2,423,600 1,773,600 1,773,600 Not subject to amortization: Acquired in calendar 2003 265,400 -- -- -- Acquired in calendar 2002 508,400 508,400 -- -- Acquired in fiscal 2002 363,900 363,900 363,900 -- Acquired in fiscal 2001 1,154,500 1,154,500 1,154,500 1,154,500 Acquired in fiscal 2000 4,727,200 4,727,200 4,727,200 4,727,200 Less prior year's sales (2,500,000) (1,250,000) -- -- ------------ ------------ ------------ ------------ 4,519,400 5,504,000 6,245,600 5,881,700 Sale of gas property interests (3,815,600) (1,250,000) (1,250,000) -- ------------ ------------ ------------ ------------ 703,800 4,254,000 4,995,600 5,881,700 ------------ ------------ ------------ ------------ Total oil and gas properties 3,127,400 6,677,600 6,769,200 7,655,300 Accumulated depreciation, depletion and amortization (1,923,000) (1,834,100) (1,773,600) (1,773,600) ------------ ------------ ------------ ------------ Net oil and gas properties $ 1,204,400 $ 4,843,500 $ 4,995,600 $ 5,881,700 ============ ============ ============ ============
The Company began drilling of its coalbed methane properties during 2001 and acquired producing properties in June of 2002. The following sets forth costs incurred for oil and gas property acquisition and development activities, whether capitalized or expensed:
December 31, May 31, -------------------- -------------------- 2003 2002 2002 2001 -------- ---------- -------- ---------- Acquisition of properties/facilities $107,100 $ 936,200 $192,600 $ 870,600 Development 158,300 97,200 87,400 283,900 -------- ---------- -------- ---------- $265,400 $1,033,400 $280,000 $1,154,500 ======== ========== ======== ==========
As of February 27, 2004, the Company had approximately 128,200 net acres for the potential development of coalbed methane ("CBM") natural gas production in Wyoming and Montana with a cost basis of $1,204,400. These properties were mostly acquired in 2000 and drilling projects on these properties are in the early stage of evaluation and thus no reserves are recorded at year end associated with these properties. -78- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) The results from operations of oil and gas activities for the year ended December 31, 2003 and the seven months ended December 31, 2002 are as follows:
Year Ended Seven Months Ended December 31, 2003 December 31, 2002 ------------------- ------------------- Sales to third parties $ 287,400 $ 119,400 Production costs (224,200) (355,200) Depreciation, depletion and amortization (88,900) (65,200) ------------------- ------------------- Loss from oil and gas production activities $ (25,700) $ (301,000) =================== ===================
Depreciation, depletion and amortization was $1.09 and $1.14 per equivalent mcf of production for the year ended December 31, 2003 and the seven months ended December 31, 2002, respectively. G. DEBT: LINES OF CREDIT - ----------------- The Company has a $750,000 line of credit from a commercial bank. The line of credit has a variable interest rate (5.0% as of December 31, 2003). The weighted average interest rate for the year ended December 31, 2003 was 5.12%. As of December 31, 2003, none of the line of credit had been borrowed. The line of credit is collateralized by certain real property and a share of the net proceeds of fees from production from certain oil wells. LONG-TERM DEBT - --------------- The components of long-term debt as of December 31, 2003, 2002 and May 31, 2002 are as follows:
December 31, May 31, ------------------------ ----------- 2003 2002 2002 ----------- ----------- ----------- USECC installment notes - collateralized by equipment; interest at 5.0% to 9.0%, matures in 2004 - 2009 $1,407,900 $1,839,400 $1,611,600 SGMC installment notes - collateralized by certain properties, interest at 7.5% to 8.0% maturity from 2004 - 2007 62,900 531,100 579,500 USE convertible notes - net of discount of 221,000 at December 31, 2003, $620,100 at December 31, 2002 and $620,100 at May 31, 2002 collateralized by equipment and real estate, interest at 8.0%; 779,000 741,300 329,900 PLATEAU installment note - collateralized by equipment, interest at 8.0% -- 26,000 38,000 ----------- ----------- ----------- 2,249,800 3,137,800 2,559,000 Less current portion (932,200) (317,200) (205,700) ----------- ----------- ----------- $1,317,600 $2,820,600 $2,353,300 =========== =========== ===========
Principal requirements on long-term debt are $932,200, $112,800; $116,600; $1,056,500; $22,600 and $9,100 for the years ended December 31, 2004 through 2008, and thereafter, respectively. -79- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) In 2003, Caydal converted $500,000 of debt to 211,109 shares of commons stock (33,333 shares at the original $3.00 conversion price, and 177,776 shares at the restructured price of $2.25). The outstanding principal balance on the debts owed to Caydal and Tsunami Partners was $500,000 and $500,000, convertible at December 31, 2003 into 222,220 and 222,220 shares, respectively. Tsunami Partners did not convert any debt to shares in 2003. Caydal and Tsunami Partners are accredited investors. H. INCOME TAXES: The components of deferred taxes as of December 31, 2003, 2002 and May 31, 2002 are as follows:
December 31, May 31, --------------------------- ------------ 2003 2002 2002 ------------- ------------ ------------ Deferred tax assets: Deferred compensation $ 445,400 $ 345,500 $ 273,400 Net operating loss carryforwards 11,596,000 9,560,000 9,028,600 Non-deductible reserves and other 437,200 622,800 622,800 Tax basis in excess of book basis 106,700 250,000 250,000 ------------- ------------ ------------ Total deferred tax assets 12,585,300 10,778,300 10,174,800 ------------- ------------ ------------ Deferred tax liabilities: Book basis in excess of tax basis 486,200 721,300 767,700 Development and exploration costs 107,600 107,600 107,600 ------------- ------------ ------------ Total deferred tax liabilities 593,800 828,900 875,300 ------------- ------------ ------------ 11,991,500 9,949,400 9,299,500 Valuation allowance (11,991,500) (9,949,400) (9,299,500) ------------- ------------ ------------ Net deferred tax liability $ -- $ -- $ -- ============= ============ ============
A valuation allowance for deferred tax assets is required when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of this deferred tax asset depends on the Company's ability to generate sufficient taxable income in the future. Management believes it is more likely than not that the net deferred tax asset will not be realized by future operating results. Deferred tax component for December 31, 2002 and May 31, 2002 have been restated (Note A). The valuation allowance increased $2,042,100 for the year ended December 31, 2003, increased $649,900 for the seven months ended December 31, 2002 and decreased $2,740,300 and $2,641,300 for the years ended May 31, 2002 and 2001, respectively. The income tax provision (benefit) is different from the amounts computed by applying the statutory federal income tax rate to income before taxes. The reasons for these differences are as follows:
December 31, Year Ended May 31, -------------------------- -------------------------- 2003 2002 2002 2001 ------------ ------------ ------------ ------------ Expected federal income tax $(2,405,800) $(1,305,600) $(2,131,000) $ 602,200 Net operating losses not previously benefited and other 363,700 655,700 4,871,300 2,039,100 Valuation allowance 2,042,100 649,900 (2,740,300) (2,641,300) ------------ ------------ ------------ ------------ Income tax provision $ -- $ -- $ -- $ -- ============ ============ ============ ============
There were no taxes currently payable as of December 31, 2003, December 31, 2002, May 31, 2002, or May 31,2001 related to continuing operations. -80- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) At December 31, 2003, the Company and its subsidiaries had available, for federal income tax purposes, net operating loss carryforwards of approximately $33,300,000 which will expire from 2006 to 2023. The Internal Revenue Code contains provisions which limit the NOL carryforwards available which can be used in a given year when significant changes in Company ownership interests occur. In addition, the NOL amounts are subject to examination by the tax authorities. The Internal Revenue Service has audited the Company's and subsidiaries tax returns through the year ended May 31, 2000. The Company's income tax liabilities are settled through fiscal 2000. I. SEGMENTS AND MAJOR CUSTOMERS: The Company's primary business activity is coalbed methane gas property acquisition and exploration and production (and holding shut down mining properties). The Company has no producing mines. The other reportable industry segment is commercial activities through motel, real estate and airport operations. The Company discontinued its drilling/construction segment in the third quarter of fiscal 2002. The following is information related to these industry segments:
Year Ended December 31, 2003 ------------------------------------------------ Coalbed Methane Motel/ (and holding Real Estate/ costs for inactive Airport mining properties) Operations Consolidated ------------------- ----------- -------------- Revenues $ 287,400 $ 334,300 $ 621,700 ================== =========== Other revenues 215,600 ------------- Total revenues $ 837,300 ============= Operating (loss) income $ (1,487,400) $ 31,400 $ (1,456,000) ================== =========== Other revenue 215,600 General corporate and other expenses (5,997,500) Other income and expenses (73,000) Minority interest in loss of affiliates 235,100 ------------- Loss before income taxes $ (7,075,800) ============= Identifiable net assets at December 31, 2003 $ 9,365,000 $ 3,030,100 $ 12,395,100 ================== =========== Investment in non-affiliated company 957,600 Corporate assets 10,577,100 ------------- Total assets at December 31, 2003 $ 23,929,800 ============= Capital expenditures $ 176,400 $ -- =================== =========== Depreciation, depletion and amortization $ 217,600 $ 102,400 =================== ===========
-81- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued)
Seven Months Ended December 31, 2002 ------------------------------------------------ Coalbed Methane Motel/ (and holding Real Estate/ costs for inactive Airport mining properties) Operations Consolidated ------------------- ----------- -------------- Revenues $ 119,400 $ 749,100 $ 868,500 ================== =========== Other revenues 159,100 ------------- Total revenues $ 1,027,600 ============= Operating (loss) income $ (973,000) $ 221,900 $ (751,100) =================== =========== Other revenue 159,100 General corporate and other expenses (2,915,800) Other income and expenses (387,100) Discontinued operations, net of tax -- Equity in loss of affiliates and minority interest in subsidiaries 54,800 ------------- Loss before income taxes $ (3,840,100) ============= Identifiable net assets at December 31, 2002 $ 16,022,800 $ 4,564,700 $ 20,587,500 =================== =========== Corporate assets 7,603,100 ------------- Total assets at December 31, 2002 $ 28,190,600 ============= Capital expenditures $ 1,033,400 $ 37,800 =================== =========== Depreciation, depletion and amortization $ 94,800 $ 78,200 =================== ===========
-82- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued)
Year Ended May 31, 2002 ------------------------------------------------- Coalbed Methane Motel/ (and holding Real Estate/ costs for inactive Airport mining properties) Operations Consolidated ------------------- ------------ -------------- Revenues $ -- $ 1,795,900 $ 1,795,900 =================== ============ Other revenues 208,200 ------------- Total revenues $ 2,004,100 ============= Operating loss $ (1,707,800) $ (133,000) $ (1,840,800) =================== ============ Other revenue 208,200 General corporate and other expenses (5,821,600) Other income and expenses 1,319,500 Discontinued operations, net of tax (85,900) Equity in loss of affiliates and minority interest in subsidiaries 39,500 ------------- Loss before income taxes $ (6,181,100) ============= Identifiable net assets at May 31, 2002 $ 18,138,500 $ 4,351,600 $ 22,490,100 =================== ============ Investments in affiliates -- Corporate assets 8,047,800 ------------- Total assets at May 31, 2002 $ 30,537,900 ============= Capital expenditures $ 151,300 $ 101,500 =================== ============ Depreciation, depletion and amortization $ 167,600 $ 254,300 =================== ============
-83- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued)
Year Ended May 31, 2001 -------------------------------------------------------------- Coalbed Methane Motel Contract (and holding Real Estate/ Drilling/ costs for inactive Airport Construction mining properties) Operations Operations Consolidated ------------------- ------------ ----------- -------------- Revenues $ 442,800 $ 2,222,400 $ 2,238,600 $ 4,903,800 =================== ============ =========== Other revenues 597,800 ------------- Total revenues $ 5,501,600 ============= Operating (loss) profit $ (2,866,400) $(1,013,800) $ 488,100 $ (3,392,100) =================== ============ =========== Other revenue, income and expenses 9,328,600 General corporate and other expenses (4,235,400) Equity in loss of affiliates and minority interest in subsidiaries 220,100 ------------- Income before income taxes $ 1,921,200 ============= Identifiable net assets at May 31, 2001 $ 18,424,900 $ 5,616,400 $ 1,050,500 $ 25,091,800 =================== ============ =========== Investments in affiliates 16,200 Corporate assets 5,357,200 -------------- Total assets at May 31, 2001 $ 30,465,200 ============= Capital expenditures $ 1,280,200 $ 1,326,800 $ 256,000 =================== ============ =========== Depreciation, depletion and amortization $ 129,700 $ 271,100 $ 324,700 =================== ============ ===========
-84- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) J. SHAREHOLDERS' EQUITY: STOCK OPTION PLANS The Board of Directors adopted the U.S. Energy Corp. 1989 Stock Option Plan for the benefit of USE's key employees. The Option Plan, as amended and renamed the 1998 Incentive Stock Option Plan ("1998 ISOP"), reserved 3,250,000 shares of the Company's $.01 par value common stock for issuance under the 1998 ISOP. Options which expired without exercise were available for reissue. During the year ended December 31, 2003, the seven months ended December 31, 2002 and the years ended May 31, 2002 and 2001 the following activity occurred under the 1998 ISOP:
Year Ended Seven Months December 31, Ended December 31, Year Ended May 31, ------------------ ------------------- -------------------- 2003 2002 2002 2001 ------------------ ------------------- -------- ---------- Grants - ------ Qualified -- -- -- 542,726 Non-Qualified -- -- -- 888,774 ------------------ ------------------ --------- ---------- -- -- -- 1,431,500 ================== ================== ========= ========== Price of Grants - --------------- High -- -- -- $ 2.40 Low -- -- -- $ 2.40 Exercises - --------- Qualified 77,832 71,166 243,250 56,985 Non-Qualified 71,453 1 55,372 31,718 ------------------ ------------------ --------- ---------- 149,285 71,167 298,622 88,703 ================== =================== ======== ========== Total Cash Received $ 364,200 $ 170,800 $742,000 $ 216,400 ================== =================== ======== ========== Forfeitures/Cancellations - ------------------------- Qualified 34,782 -- 78,244 75,000 Non-Qualified 64,233 -- 346,018 42,000 ------------------ ------------------ -------- ---------- 99,015 -- 424,262 117,000 ================== =================== ======== ==========
In December 2001, the Board of Directors adopted (and the shareholders approved) the U.S. Energy Corp. 2001 Incentive Stock Option Plan (the "2001 ISOP") for the benefit of USE's key employees. The 2001 ISOP reserves 3,000,000 shares of the Company's $.01 par value common stock for issuance for a period of 10 years. -85- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) The following table represents the activity in the 2001 ISOP for the periods covered by the Annual Report for the year ended December 31, 2003:
Year Ended Seven Months Year Ended ----------- December 31, Ended December 31, May 31, ------------------- -------- 2003 2002 2002 ------------ ------------------- -------- Grants - ------------------- Qualified -- 459,996 10,000 Non-Qualified -- 473,004 950,000 ------------- ------------------- -------- -- 933,000 960,000 ============= =================== ======== Price of Grant - ------------------- High -- $2.25 $3.90 Low -- $2.25 $3.82 Exercises - ------------------- Qualified 73,780 -- -- Non-Qualified 52,556 -- -- ------------- ------------------- -------- 126,336 -- -- ============= =================== ======== Total Cash Received $ 284,300 $ -- $ -- ============= =================== ======== Forfeited - ------------------- Qualified 65,108 -- -- Non-Qualified 252,556 50,000 -- ------------- ------------------- -------- 317,664 50,000 -- ============= =================== ========
The 2001 ISOP replaces the 1998 ISOP, however, options granted under the 1998 ISOP remain exercisable until their expiration date under the terms of that Plan. -86- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) The following table represents the activity in employee options for the periods covered by the Annual Report for the year ended December 31, 2003 that are not in employee stock option plans:
Year Ended Seven Months Year Ended December 31, Ended December 31, May 31, 2003 2002 2002 ------------- ------------------- -------- Grants - ------ Qualified -- -- 10,000 Non-Qualified 10,000 -- -- ------------- ------------------- -------- 10,000 -- 10,000 ============= =================== ======== Price of Grant - -------------- High $ 2.90 -- $ 3.82 Low $ 2.90 -- $ 3.82 Exercises - --------- Qualified -- -- -- Non-Qualified -- -- -- ------------- ------------------- -------- -- -- -- ============= =================== ======== Total Cash Received $ -- $ -- $ -- ============= =================== ======== Forfeited - --------- Qualified -- -- -- Non-Qualified 10,000 100,000 200,000 ------------- ------------------- -------- 10,000 100,000 200,000 ============= =================== ========
-87- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) A summary of the Employee Stock Option Plans activity in all plans for the year ended December 31, 2003; the seven months ended December 31, 2002 and the years ended May 31, 2002 and 2001 is as follows:
Year Ended Seven Months December 31, Ended December 31, Year Ended May 31, -------------------------------------- 2003 2002 2002 2001 ---------------------- --------------------- -------------------- ----------------- Weighted Weighted Weighted Weighted Average Average Average Average Exercise Exercise Exercise Exercise Options Price Options Price Options Price Options Price ----------- --------- ----------- -------- ---------- -------- ---------- ----- Outstanding at beginning of the period 3,565,946 $ 2.76 2,854,113 $ 2.92 2,606,997 $ 2.69 1,581,200 $ 3.40 Granted 10,000 2.90 933,000 2.25 970,000 3.90 1,431,500 2.40 Forfeited (426,679) 3.17 (150,000) 2.63 (424,262) 3.30 (317,000) 6.03 Expired -- -- -- -- -- -- -- -- Exercised (275,621) 2.35 (71,167) 2.40 (298,622) 2.84 ( 88,703) 2.44 ----------- ----------- ---------- ---------- Outstanding at period end 2,873,646 2.74 3,565,946 2.76 2,854,113 2.92 2,606,997 2.56 =========== =========== ========== ========== Exercisable at period end 2,873,646 2.74 2,612,946 2.94 1,984,113 2.49 1,478,463 2.69 =========== =========== ========== ========== Weighted average fair value of options granted during the period $ 0.68 $ 1.15 $ 1.99 $ 1.36
The following table summarized information about employee stock options outstanding and exercisable at December 31, 2003: Weighted Weighted Number of Average Number Average Options Remaining of Options Exercise Outstanding at Contractual Exercisable at Price December 31, 2003 Life in years December 31, 2003 -------- ------------------- --------------- ------------------ $2.74 2,873,646 7.02 2,873,646 EMPLOYEE STOCK OWNERSHIP PLAN The Board of Directors of USE adopted the U.S. Energy Corp. 1989 Employee Stock Ownership Plan ("ESOP") in 1989, for the benefit of USE employees. During the year ended December 31, 2003 the Board of Directors of USE contributed 76,294 shares to the ESOP at the price of $3.10 for a total expense of $236,400. This compares to contributions to the ESOP during the seven months ended December 31, 2002 and fiscal years ended May 31, 2002 and 2001 of 43,867, 70,075 and 53,837 shares to the ESOP at prices of $3.08, $3.29 and $5.35 per share, respectively. The Company has expensed $236,400, $135,100, $236,900 and $288,000 during the year ended December 31, 2003; the seven months ended December 31, 2002 and the fiscal years ended May 31, 2002 and 2001, respectively related to these contributions. As of December 31, 2003, all shares of the USE stock that have been contributed to the ESOP have been allocated. The estimated fair value of shares that are not vested is approximately $84,800. USE has loaned the ESOP $1,014,300 to purchase 125,000 shares from the Company and 38,550 shares on the open market. During the year ended May 31, 1996, 10,089 of these shares were used to fund the Company's annual funding commitment and reduce the loan -88- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) to the Company by $87,300. These loans, which are secured by pledges of the stock purchased, bear interest at the rate of 10% per annum. The loans are reflected as unallocated ESOP contribution in the equity section of the accompanying Consolidated Balance Sheets. EXECUTIVE OFFICER COMPENSATION In May 1996, the Board of Directors of USE approved an annual incentive compensation arrangement ("1996 Stock Award Program") for its CEO and four other officers of the Company payable in shares of the Company's common stock. The 1996 Stock Award Program was subsequently modified to reflect the intent of the directors which was to provide incentive to the officers of the Company to remain with USE. The shares were issued annually pursuant to the recommendation of the Compensation Committee on or before January 15 of each year, beginning January 15, 1997, as long as each officer is employed by the Company. The officers received up to an aggregate total of 67,000 shares per year for the years 1997 through 2002. The shares under the plan are forfeitable until retirement, death or disability of the officer. The shares are held in trust by the Company's treasurer and are voted by the Company's non-employee directors. As of December 31, 2003, 392,536 shares had been issued to the five officers of the Company under the 1996 Stock Award Plan and 62,536 shares had been released to the estate of one of the officers. The 1996 Stock award program was closed out in the year ended December 31, 2003. In December 2001, the Board of Directors adopted (and the shareholders approved) the 2001 Stock Award Plan to compensate five of its executive officers and the president of RMG. Under the Plan, an aggregate of 100,000 shares may be issued each year from 2002. 100,000 shares were issued under the Plan during the year ended December 31, 2003. No shares were issued under this Plan during the seven month ended December 31, 2002 and the fiscal year ended May 31, 2002. OPTIONS AND WARRANTS TO OTHERS As of December 31, 2003, there are 906,724 options and warrants outstanding to purchase shares of the Company's common stock. The Company values these warrants using the black-scholes option pricing model and expenses that value over the life of the service period. Activity for the periods ended December 31, 2003 for warrants is represented in the following table: -89- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued)
Year Ended Seven Months December 31, Ended December 31 Year Ended May 31, ----------------------------------- 2003 2002 2002 2001 ----------------- -------------------- ----------------- ---------------- Weighted Weighted Weighted Weighted Average Average Average Average Exercise Exercise Exercise Exercise Warrants Price Warrants Price Warrants Price Warrants Price --------- ------ --------- --------- --------- ------ -------- ------ Outstanding at beginning of the period 989,908 $3.367 859,677 $ 3.427 313,683 $3.048 253,683 $2.960 Granted 224,875 $4.323 145,147 $ 2.950 572,364 $3.620 60,000 $3.310 Forfeited (176,453) $3.671 (14,916) (25,165) $2.880 Expired Exercised (131,596) $3.546 (1,205) $3.750 --------- --------- --------- -------- Outstanding at period end 906,734 $3.506 989,908 $ 3.355 859,677 $3.427 313,683 $3.027 ========= ========= ========= ======== Exercisable at period end 831,724 $3.409 979,908 $ 3.367 859,677 $3.427 303,683 $3.048 ========= ========= ========= ======== The following table presents summarized information about warrants outstanding and exercisable at December 31, 2003. Weighted Average Number of Average Number of Options Remaining Options Exercise Outstanding at Contractual Exercisable at Price December 31, 2003 Life in Years December 31, 2003 $ 3.506 906,734 2.94 831,724
These options and warrants are held by persons or entities other than employees, officers and directors of the Company. FORFEITABLE SHARES Certain of the shares issued to officers, directors, employees and third parties are forfeitable if certain conditions are not met. Therefore, these shares have been reflected outside of the Shareholders' Equity section in the accompanying Consolidated Balance Sheets until earned. During fiscal 1993, the Company's Board of Directors amended the stock bonus plan. As a result, the earn-out dates of certain individuals were extended until retirement. The Company recorded $284,700 of compensation expense for the year ended December 31, 2003 compared to $178,300 for the seven months ended December 31, 2002; $298,300 and $201,000 for the years ended May 31, 2002 and 2001, respectively. A schedule of total forfeitable shares for the Company is set forth in the following table: -90- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued)
Issue Number Issue Total Date of Shares Price Compensation --------------- --------- --------- ------------ Balance at June 1, 2000 396,608 $ 2,584,600 May 2001 67,000 $ 5.35 358,400 Shares earned (29,820) -- (194,400) -------- --------- Balance at May 31, 2001 433,788 2,748,600 May 2002 67,000 $ 3.90 261,300 -------- --------- Balance at May 31, 2002 and December 31, 2002 500,788 3,009,900 March 24, 2003 43,378 $ 3.50 151,900 Shares earned (78,286) -- (435,200) -------- --------- Balance at December 31, 2003 465,880 $ 2,726,600 ======== ===========
K. COMMITMENTS, CONTINGENCIES AND OTHER: LEGAL PROCEEDINGS Material pending proceedings are summarized below. Certain of the Company's affiliates are involved in ordinary routine litigation incidental to their business. Other proceedings which were pending during the year ended December 31, 2003 have been settled or otherwise finally resolved. SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION In 1991, disputes arose between the U.S. Energy Corp. ("USE")/Crested Corp. ("Crested") d/b/a/ USECC, and Nukem, Inc. and its subsidiary Cycle Resource Investment Corp. ("CRIC"), concerning the formation and operation of their equally owned Sheep Mountain Partners (SMP) partnership. Arbitration proceedings were initiated by CRIC in June 1991 and in July 1991, USECC filed a lawsuit against Nukem, CRIC and others in the U.S. District Court of Colorado in Civil No. 91B1153. The Federal Court stayed the arbitration proceedings and discovery proceeded. In February 1994, all of the parties agreed to consensual and binding arbitration of all of their disputes over SMP before an arbitration panel (the "Panel"). After 73 hearing days, the Panel entered an Order and Award on April 18, 1996 and clarified the Order on July 3, 1996, finding generally in favor of USE and Crested on certain of their claims and imposed a constructive trust in favor of Sheep Mountain Partners on uranium contracts Nukem entered into to purchase uranium from CIS republics. The Panel also awarded SMP damages of $31,355,070 against Nukem. USECC filed a petition for confirmation of the Order and on June 27, 1997, the U.S. District Court confirmed the Panel's Orders in its Second Amended Judgment. Thereafter, Nukem/CRIC appealed the Judgment to the 10th Circuit Court of Appeals ("CCA"). On October 22, 1998, the 10th CCA issued an Order and Judgment affirming the U.S. District Court's Second Amended Judgment without modification. The ruling affirmed (i) the imposition of a constructive trust in favor of SMP on Nukem's rights to purchase CIS uranium, the uranium acquired pursuant to those rights, and the profits therefrom; and (ii) the damage award in favor of SMP against Nukem. The 10th CCA held that the -91- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) Panel's Awards "clearly retains both a constructive trust and a damage award," --- and the Arbitration Awards and the Second Amended Judgment were "clear and unambiguous." On February 8, 1999, the U.S. District Court ordered Nukem to pay USECC the balance of the damage award. Nukem did so, but then moved for a satisfaction of judgment without accounting for the monies earned in the Constructive Trust. The District Court denied Nukem's motion and Nukem filed its second appeal to the 10th CCA. On October 16, 2000, the 10th CCA again affirmed the order of the District Court. The 10th CCA held that Nukem had not "provided an accounting of the partnership assets," finding that "the district court order presented for our review does not decide which CIS contracts are covered by the constructive trust." On November 3, 2000, USECC filed a motion for a further accounting of the Constructive Trust. On February 15, 2001, the District Court entered an Order of Reference appointing a Special Master to "conduct an accounting" of the Constructive Trust. The accounting was conducted and on May 1, 2003, the Special Master filed his Report with the District Court. Both parties filed objections to the Report. On July 30, 2003, the U.S. District Court adopted the Report in part and rejected it in part. Judgment was then entered by the Court on August 1, 2003 in favor of USECC and against Nukem in the amount of $20,044,183. On August 15, 2003, Nukem filed a "Motion to Remand to the Arbitration Panel or in the Alternative, to Alter, Amend and/or Correct the Court's August 1, 2003 Judgment and July 30, 2003 Order," and a "Motion to Correct Certain Findings or Statements in the Court's Order of July 30, 2003." On the same day, USECC filed a motion under Fed.R.Civ.P. 52(b) and 59(e) to alter or amend the July 30, 2003 Order and the August 1, 2003 Judgment. The District Court denied the parties' motions on September 10 and 11, 2003, respectively. Nukem's appeal and USECC's cross-appeal followed. Nukem's opening brief was filed on January 16, 2004 and on February 24, 2004, USECC filed an opening brief in its cross-appeal and an answer to Nukem's brief. Nukem has until March 29, 2004 or any extension thereof to file an answer to USECC's opening brief. USECC may then file a reply brief 14 days after service of Nukem's answer. Management believes that the ultimate outcome of this matter will not have an adverse affect on the Company's financial condition or result of operations. CONTOUR DEVELOPMENT LITIGATION On July 28, 1998, USE and Crested filed a lawsuit in the U. S. District Court of Colorado in Case No. 98WM1630, against Contour Development Company, L.L.C. and entities and persons associated with Contour Development Company, L.L.C. (together, "Contour") seeking compensatory and consequential damages of more than $1.3 million from the defendants for dealings in real estate owned by USE and Crested in Gunnison, Colorado. The Contour defendants asserted a counterclaim asking for payment of attorneys fee and costs. The parties settled the litigation in 2004. In the settlement, USE and Crested received $25,000 in cash; two lots in the City of Gunnison, Colorado (one of which has been sold for a net of $65,326 and the other lot is under contract to sell for $180,000), and an additional five development lots covering 175 acres north of Gunnison, Colorado. PHELPS DODGE LITIGATION U.S. Energy Corp. (USE) and Crested Corp. (Crested), d/b/a USECC, were served with a lawsuit on June 19, 2002, filed in the U.S. District Court of Colorado (Case No. 02-B-0796(PAC)) by Phelps Dodge Corporation (PD) and its subsidiary, Mt. Emmons Mining Company (MEMCO), over contractual obligations -92- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) in USECC's agreement with PD's predecessor companies, concerning mining properties on Mt. Emmons, near Crested Butte, Colorado. The litigation stems from agreements that date back to 1974 when USE and Crested leased the mining claims from AMAX Inc., PD's predecessor company. The mining claims cover one of the world's largest and richest deposits of molybdenum discovered by AMAX. AMAX reportedly spent over $200 million on the acquisition, exploration and mine planning activities on the Mt. Emmons properties. The complaint filed by PD and MEMCO seeks a determination that PD's acquisition of Cyprus Amax was not a sale. Under a 1986 agreement between USECC and AMAX, if AMAX sold MEMCO or its interest in the mining properties, U.S. Energy and Crested would receive 15% (7.5% each) of the first $25 million of the purchase price ($3.75 million). In 1991, Cyprus Minerals Company acquired AMAX to form Cyprus Amax Minerals Co. USECC's counter and cross-claims allege that in 1999, PD formed a wholly-owned subsidiary CAV Corporation, for the purpose of purchasing the controlling interest of Cyprus Amax and its subsidiaries (including MEMCO) at an estimated value in cash and PD stock exceeding $1 billion and making Cyprus Amax a subsidiary of PD. Therefore, USECC asserts the acquisition of Cyprus Amax by PD was a sale of MEMCO and the properties that triggers the obligation of Cyprus Amax to pay USECC the $3.75 million plus interest. The other issue in the litigation is whether USECC must, under terms of a 1987 Royalty Deed, accept PD's and MEMCO's conveyance of the Mt. Emmons properties back to USECC, which properties now include a plant to treat mine water, costing in excess of $1 million a year to operate in compliance with State of Colorado regulations. PD's and MEMCO's claim seek to obligate USECC to assume the operating costs of the water treatment plant. USECC refuses to have the water treatment plant included in the return of the properties because, the USECC counterclaim argues, the properties must be in the same condition as when they were acquired by AMAX before the water treatment plant was constructed by AMAX. As added counterclaims, USECC seeks (i) damages for PD's breach of covenants of good faith and fair dealing; (ii) damages for PD's failure to develop the Mt. Emmons properties and not protecting USECC's rights as a revisionary owner of the mining rights to the properties, (iii) damages for unjust enrichment of PD; (iv) damages for breach of the PD's fiduciary duties owed to USECC as revisionary owner of the property, and for neglecting to maintain the mining rights and interests in the properties. On March 17, 2003, PD filed additional motions for partial summary judgment on various claims. On January 22, 2004, the District Court heard the motions and responses of USECC and additional briefs were thereafter filed with the Court. The Court is considering the motions. Management believes that the ultimate outcome of this matter will not have an adverse affect on the Company's financial condition or result of operations. ROCKY MOUNTAIN GAS, INC. (RMG) LITIGATION INVOLVING LEASES ON COALBED METHANE PROPERTIES IN MONTANA On or about April 1, 2001, Rocky Mountain Gas, Inc. (RMG), a subsidiary of USE and Crested, was served with a Second Amended Complaint wherein the Northern Plains Resource Council had filed suit in the U.S. District Court of Montana, Billings Division in Case No. CV-01-96-BLG-RWA against the United States Bureau of Land Management ("BLM"), RMG, certain of its affiliates (including U.S. Energy Corp. and -93- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) Crested Corp.) and some 20 other defendants. The plaintiff is seeking to cancel oil and gas leases issued to RMG et. al. by the BLM in the Powder River Basin of Montana and for other relief. The basis for the complaint appears to be that the BLM's regulations require the BLM to respond to objections filed by persons owning land or lease rights adjacent to the coalbed properties which the BLM is offering to lease to the public. The argument of plaintiff appears to be that if objections are not responded to by the BLM prior to issuing CBM leases, the leases are invalid. Based on this argument, the plaintiff appears to have been successful in forcing cancellation of some CBM leases granted to others in the Powder River Basin of Montana, because the BLM did not respond to some objecting adjacent landowners. However, all of the BLM leases in Montana held by RMG (none are held by USE in its corporate name) are at least four years old, and there is no record of any objections being made to the issue of those leases. Based on filings in the case to date, it appears that the BLM is taking the initiative in responding to the plaintiff. We believe RMG's leases were validly issued in compliance with BLM procedures, and do not believe the plaintiff's lawsuit will adversely affect any of RMG's Montana BLM leases. LAWSUITS CHALLENGING BLM'S RECORDS OF DECISIONS Three lawsuits are currently pending in the Montana Federal District Court challenging BLM's Records of Decisions for the Powder River Basin Oil and Gas EIS (PRB-EIS) for the Wyoming portion of the basin, and the Statewide Oil and Gas EIS and Proposed Amendment for the Powder River and billings Resource Management Plans in Montana. Neither the Company, nor RMG is a party to any of these lawsuits. LITIGATION INVOLVING DRILLING ON A COALBED METHANE LEASE A drilling company, Eagle Energy Services, LLC filed a lien on RMG's leasehold in southwestern Wyoming for drilling services performed at RMG's Oyster Ridge Property and filed a lawsuit foreclosing the lien. Eagle Energy's bank, Community First National Bank of Sheridan, Wyoming, filed a similar suit for the same amount on an assignment from Eagle Energy against RMG, Eagle Energy Services, LLC and others who guaranteed a loan to Eagle Energy in Civil Action No. C02-9-328 in the 4th Judicial District of Sheridan County, Wyoming. Eagle Energy's claim is for a contract to drill a well for coalbed methane. RMG terminated the agreement because of the dangerous conditions of Eagle Energy's equipment and other reasons. The claim against RMG is for $49,309.50. Negotiations to settle the lien and lawsuits are pending. Management believes that the ultimate outcome of the matters will not have a material effect on the Company's financial condition or results of operations. RECLAMATION AND ENVIRONMENTAL LIABILITIES Most of the Company's and Crested's exploration activities are subject to federal and state regulations that require the Company and Crested to protect the environment. The Company and Crested conduct theirconducts its operations in accordance with these regulations. The Company's and Crested's current estimates of theirits reclamation obligations and theirits current level of expenditures to perform ongoing reclamation may change in the future. At the present time, however, the Company and Crested cannot predict the outcome of future regulation or impact on costs. Nonetheless, the Company and Crested havehas recorded theirits best estimate of future reclamation and closure costs based on currently available facts, technology and enacted laws and regulations. Certain regulatory agencies, such as the Nuclear Regulatory Commission ("NRC"), the Bureau of Land Management ("BLM") and the Wyoming Department of Environmental Quality ("WDEQ") review the Company's and Crested's reclamation, environmental and decommissioning -94- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) liabilities, and the Company and Crested believebelieves the recorded amounts are consistent with those reviews and related bonding requirements. To the extent that planned production on theirits properties is delayed, interrupted or discontinuedordiscontinued because of regulation or the economics of the properties, the future earnings of the Company and Crested would be adversely affected. The Company and Crested believe they havebelieves it has accrued all necessary reclamation costs and there are no additional contingent losses or unasserted claims to be disclosed or recorded. The majority of the Company's and Crested's environmental obligations relate to former mining properties acquired by the Company and Crested.Company. Since the Company and Crested currently dodoes not have any properties in production, the Company's and Crested's policy of providing for future reclamation and mine closure costs on a unit-of-production basis has not resulted in any significant annual expenditures or costs. For the obligations recorded on acquired properties, including site-restoration, closure and monitoring costs, actual expenditures for reclamation will occur over several years, and since these properties are all considered future production properties, those expenditures, particularly the closure costs, may not be incurred for many years. The Company and Crested also dodoe not believe that any significant capital expenditures to monitor or reduce hazardous substances or other environmental impacts are currently required. As a result, the near term reclamation obligations are not expected to have a significant impact on the Company's liquidity. As of MayDecember 31, 2002,2003, estimated reclamation obligations related to the above mentioned mining properties total $8,906,800. Crested's portion of this obligation is $748,400, which is reflected on the balance sheet of the Company. The remaining balance of $7,614,700 is an obligation of USE and its other affiliates, (excluding Crested).$7,264,700. The Company is obligated for 50% of any reclamation costs in excess of current estimated reclamation obligations. The Company, however, does not expect that estimated reclamation costs will be exceeded. The Company and Crested currently havehas three mineral properties or investments that account for most of their environmental obligations, SMP, Plateau and SGMC. The environmental obligations and the nature and extent of cost sharing arrangements with other potentially responsible parties, as well as any uncertainties with respect to joint and several liability of each are discussed in the following paragraphs: 85 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED) SMP --- The Company and Crested are equallyis responsible for the reclamation obligations, environmental liabilities and liabilities for injuries to employees in mining operations with respect to the Sheep Mountain properties. The reclamation obligations, which are established by regulatory authorities, were reviewed by the Company Crested and the regulatory authorities during fiscal 2002 and they jointly determined that the reclamation liability was $1,496,800.$2,106,600. The Company and Crested areis self bonded for this obligation by mortgaging certain of their real estate assets, including the Glen L. Larsen building, and by posting cash bonds. GMMV ---- During fiscal 1991, the Company and Crested acquired mineral properties on Green Mountain known as the Big Eagle Property. The GMMV also acquired a uranium mill known as the Sweetwater Mill. As part of the settlement of the GMMV litigation with Kennecott in September 2000, the Company was released from any and all reclamation and environmental obligations related to the GMMV except the Ion Exchange Plant. During fiscal 2002, the Company and Crested completed the required reclamation on the Ion Exchange Plant. The reclamation work has been completed and a final report has been submitted to and is being reviewed by the regulatory agencies. No further monitoring of the site is required and no additional reclamation work is anticipated. SUTTER GOLD MINING COMPANY ------------------------------------------------------- SGMC's mineral properties are currently on shut down status and have never been in production. There has been minimal surface disturbance on the Sutter properties. Reclamation obligations consist of -95- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) closing the mine entry and removal of a mine shop. The reclamation obligation to close the property has been set by the State of California at $27,800 which is covered by a cash reclamation bond. This amount was recorded by SGMC as a reclamation liability as of MayDecember 31, 2002.2003. PLATEAU RESOURCES LIMITED ----------------------------------------------------- The environmental and reclamation obligations acquired with the acquisition of Plateau include obligations relating to the Shootaring Mill. Based on the bonding requirements, Plateau transferred $2,500,000 to a trust account as financial surety to pay future costs of mill decommissioning, site reclamation and long-term site surveillance. In fiscal 1997, Plateau requested that the mill be place on operational status. The NRC increased the reclamation liability to $6,784,000 as a result of this request. As of MayDecember 31, 2002,2003, a cash deposit for reclamation in the amount of $8,818,600$6,874,200 was held by Plateau's escrow agent to satisfy the obligation of reclamation. 86 U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MAY 31, 2002 (CONTINUED)reclamation of $5,130,300. EXECUTIVE COMPENSATION - --------------------------------------------- The Company is committed to pay the estatessurviving spouse or dependant children of certain of their officers one years' salary and an amount to be determined by the Boards of Directors, for a period of up to five years thereafter. This commitment applies only in the event of the death or total disability of those officers who are full-time employees of the Company at the time of total disability or death. Certain officers and employees have employment agreements with the Company. The maximum compensation due under these agreements for the officers covered by the agreement for the first year after their deaths, should they die in the same year, is $311,400 at December 31, 2003. L. DISCONTINUED OPERATIONS. In February 1996, the Company completed the sale of 100% of the 8,267,450 outstanding shares of common stock of Brunton to a third party for $4,300,000 in accordance with a Stock Purchase Agreement dated January 30, 1996 (the "Purchase Agreement"). The Company received $300,000 at execution of the Purchase Agreement and approximately $3,000,000 at closing. The Company has also since been paid in full on the $1,000,000 balance. In addition, the Company was entitled to receive 45% of the profits before taxes as defined in the Purchase Agreement related to Brunton products existing at the time the Purchase Agreement was executed for a period of 4 years and three months, beginning February 1, 1996. The Company received payments of $297,100 and $52,000 for profits in 2001 and 2000, respectively. During the third quarter of the fiscal year ended May 31, 2002, the Company made the decision to discontinue its drilling/construction segment. The assets associated with this business segment are being sold and or converted for use elsewhere in the Company. The financial statements for the fiscal year ended May 31, 2001 and 2000 have been revised to present the effect of discontinued operations. There is no material income or loss from discontinued operations from the measurement date to MayDecember 31, 2002. M. SUBSEQUENT EVENT Subsequent to May 31, 2002,During the Company's subsidiary RMG purchased an average 25% net revenue interest and an average 31% working interest in 18 coalbed methane wells drilled on 930 net acres in the Powder River Basin. Thirteenthird quarter of the 18 drilled wells are currently hooked upyear ended December 31, 2003, the Company sold its motel and produce at a combined gross rate of 878,000 cubic feet of gas per day (878 mcf) (288 Mcf net rate to our working interest) from the two primary coals on the property: the Cook coal (11 wells) at 650 feet, and the Canyon Coal (2 wells) at 450 feet. Oneretail operations in southern Utah. The financial statements for all of the 18 wells is usedperiods presented have been revised to present these operations as a water injection well.discontinued. M. SUPPLEMENTAL NATURAL GAS RESERVE INFORMATION (UNAUDITED): The purchase price for this property was $1,300,000following estimates of which $1,000,000 was paid in cashproved gas reserves, both developed and $300,000 in common stock. RMG and CCBM each paid one half of the purchase priceundeveloped, represent interests owned by paying $500,000 in cash and issuance of common stock valued at $150,000. In the case of RMG, the Company issued 37,500 shareslocated solely within the United States. Proved reserves represent estimated quantities of its common stocknatural gas which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed gas reserves are the quantities expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells for this part of the purchase price. This net rate reflects the average 32.8% working interest (26.2% net revenue interest) in the 13 wells now producing. Our working interest in all the Bobcat acreage is an average of 27.6% (net revenue interest 22%). 87which relatively major expenditures are required for completion. -96- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 (CONTINUED)AND MAY 31, 2001 (Continued) The Company began natural gas production in June, 2002. Disclosures of gas reserves which follow are based on estimates prepared by independent engineering consultants as of December 31, 2002. Such estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and in the projection of future rates of production and the timing of development expenditures. These estimates do not include probable or possible reserves. The information provided does not represent Management's estimate of the Company's expected future cash flows or value of proved oil and gas reserves. RMG's sales volumes of gas produced, average sales prices received for gas sold, and average production costs for those sales, for the seven months ended December 31, 2002, and for the year ended December, 2003, all from the Bobcat property which was transferred to Pinnacle in June 2003 are as follows:
Year Ended Seven Months Ended December 31, 2003 December 31, 2002 ------------------ ------------------ Sales volumes (mcf) 81,516 64,315 Average sales price per mcf $ 3.71 $ 1.86 Average cost (per mcf) $ 1.91 $ 1.91
Changes in estimated reserve quantities The net interest in estimated quantities of proved developed and undeveloped reserves of crude oil and natural gas and changes in such quantities and discounted future net cash flow were as follows:
(Unaudited) - Unescalated ---------------------------------------------------------- Discounted MCF Future Net Cash Flow Cubic Feet (10% Discount) -------------------------------------- ------------------ Seven Months Seven Months Year Ended Ended Ended December 31, 2003 December 31, 2002 December 31, 2002 ------------------ ------------------ ------------------ Proved developed and undeveloped reserves: Beginning of period 585,603 -- Purchase of reserves in place -- 649,918 Exchange of reserves in place (1) (504,087) -- Production (81,516) (64,315) ------------------ ------------------ End of period -- 585,603 ================== ================== Proved developed producing -- 489,684 $ 793,481 Proved undeveloped -- 95,919 94,947 ------------------ ------------------ ------------------ Total proved reserves -- 585,603 $ 888,428 ================== ================== ==================
The standardized measure has been prepared assuming year end sales prices adjusted for fixed and determinable contractual price changes, current costs. No provision has been made for income taxes due to available operating loss carryforwards. No deduction has been made for depletion, depreciation or any indirect costs such as general corporate overhead or interest expense. -97- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) Standardized measure of discounted future net cash flows from estimated production of proved gas reserved: Seven Months Ended December 31, 2002 ------------------- Future cash inflows $ 1,756,809 Future production and development costs (705,505) ----------------- Future net cash flows 1,051,304 10% annual discount for estimated timing of cash flows (162,876) --------------- Standardized measure of discounted future net cash flows $ 888,428 =============== Changes in standard measure of discounted future net cash flows from proved gas reserves:
Seven Months Year Ended Ended December 31, 2003 December 31, 2002 ------------------- ------------------ Standardized measure - beginning of period $ 888,428 $ -- Purchase of reserves in place -- 652,628 Exchange of reserves in place (1) (825,228) -- Sales of gas produced, net of production costs (63,200) 235,800 ------------------- ------------------ Standardized measure - end of period $ -- $ 888,428 =================== ==================
(1) During June 2003, RMG contributed proved and unproved properties in exchange for a 37.5% interest in Pinnacle (See Note F). -98- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) N. TRANSITION PERIOD COMPARATIVE DATA The following table presents certain financial information for the seven months ended December 31, 2002 and 2001, respectively:
Seven Months Ended December 31, -------------------------- 2002 2001 ------------ ------------ (Unaudited) Revenues $ 673,000 $ 545,900 Costs and expenses 4,197,900 4,460,800 ------------ ------------ Operating loss (3,524,900) (3,914,900) Other income and expenses (387,100) 1,005,000 ------------ ------------ Loss before minority interest (3,912,000) (2,909,900) Minority interest in loss of subsidiaries 54,800 24,500 ------------ ------------ Loss before income taxes (3,857,200) (2,885,400) Provision for income taxes -- -- ------------ ------------ Net loss from continuing operations (3,857,200) (2,885,400) Discontinued operations, net of tax 17,100 175,000 ------------ ------------ Net loss (3,840,100) (2,710,400) Preferred stock dividends -- (75,000) ------------ ------------ Net loss available to common stock shareholders $(3,840,100) $(2,785,400) ============ ============ PER SHARE DATA: Revenues $ 0.06 $ 0.07 Operating loss (0.33) (0.47) =========== =========== Loss from continuing operations (0.36) (0.35) =========== =========== Net loss (0.36) (0.33) Preferred Stock dividends -- (0.01) ------------ ------------ Net loss available to common stock shareholders $ (0.36) $ (0.34) ============ ============ Weighted average common shares outstanding Basic 10,770,658 8,386,672 ============ ============ Diluted 10,770,658 8,386,672 ============ ============
-99- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued) O. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended ------------------------------------------------------------------------------------------------------------------------------ December 31, September 30, June 30, March 31, 2003 2003 2003 2003 -------------- --------------- ------------ ------------ Operating Revenues $ 109,000 $ 119,300 $ 241,300 $ 367,700 ============= ============== =========== =========== Operating loss $ (1,664,800) $ (1,988,400) $(2,418,800) $(1,165,900) ============= ============== =========== =========== (Loss) income from continuing operations $ (1,780,800) $ (1,893,000) $(2,214,100) $(1,187,900) Discontinued operations, net of tax $ (124,800) $ (88,700) $ (17,400) $ (119,000) Cumulative effect of accounting change $ -- $ -- $ -- $ 1,615,600 ------------- -------------- ----------- ----------- Net (loss) income $ (1,905,600) $ (1,981,700) $(2,231,500) $ 308,700 ============= ============== =========== =========== (Loss) income per Share, basic Continuing operations $ (0.16) $ (0.17) $ (0.20) $ (0.11) Discontinued operations $ (0.01) $ (0.01) $ -- $ (0.01) Cumulative effect of accounting change $ -- $ -- $ -- $ 0.15 -------------- --------------- ------------ ------------ $ (0.17) $ (0.18) $ (0.20) $ 0.03 ============== =============== ============ ============ Basic weighted average shares outstanding 11,383,576 11,127,796 10,916,971 10,881,394 (Loss) per share, diluted Continued operations $ (0.17) $ (0.17) $ (0.20) $ (0.10) Discontinued operations $ (0.01) $ (0.01) $ -- $ (0.01) $ -- $ -- $ -- $ 0.14 -------------- --------------- ------------ ------------ $ (0.17) $ (0.18) $ (0.20) $ 0.03 ============== =============== ============ ============ Diluted weighted average shares outstanding 11,383,576 11,127,796 10,916,971 11,385,593
-100- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001 (Continued)
Month Ended Three Months Ended ---------------------------- December 31, November 30, August 31, 2002 2002 2002 -------------- -------------- ------------ Operating Revenues $ 74,300 $ 359,600 $ 221,400 ============= ============= =========== Operating (loss) $ (664,200) $ (1,487,500) $(1,390,400) ============= ============= =========== Loss from continuing operations $ (1,427,200) $ (1,195,600) $(1,252,200) Discontinued operations, net of tax $ (26,400) $ (69,100) $ 130,400 -------------- -------------- ------------ Net loss $ (1,453,600) $ (1,264,700) $(1,121,800) ============== ============== ============ Loss per Share, basic and diluted Continuing operations $ (0.14) $ (0.11) $ (0.11) Discontinued operations $ -- $ (0.01) $ 0.01 -------------- -------------- ------------ $ (0.14) $ (0.12) $ (0.10) ============== ============== ============ Basic and diluted weighted average shares outstanding 10,766,672 10,765,889 10,761,093
Three Months Ended ---------------------------------------------------------- May 31, February 28, November 30, August 31, 2002 2002 2001 2001 ------------- ------------- ------------- ------------- 2002 2002 2001 2001 ------------ -------------- -------------- ------------ Operating Revenues $ 408,800 $ 238,700 $ 724,200 $ 632,400 =========== ============= ============= =========== Operating (loss) $ (1,588,300)$(1,588,300) $ (3,066,700) $ (1,197,600) $ (1,601,600)$(1,601,600) =========== ============= ============= =========== Loss from continuing operations $ (1,109,700)$(1,109,700) $ (3,172,000) $ (550,900) $ (1,349,100)$(1,349,100) Discontinued operations, net of tax $ (22,200) $ (9,600) $ (37,300) $ (16,800) ------------ -------------- -------------- ------------ Net loss $ (1,131,900)$(1,131,900) $ (3,181,600) $ (588,200) $ (1,365,900)$(1,365,900) ============ ============== ============== ============ Loss per Share, basic and diluted Continuing operations $ (0.10) $ (0.32) $ (0.07) $ (0.17) Discontinued operations $ (0.01) $ -- $ -- $ -- ------------ ------------ -------------------------- -------------- ------------ $ (0.11) $ (0.32) $ (0.07) $ (0.17) ============ ============ ========================== ============== ============ Basic weighted average shares outstanding 10,579,828 9,837,494 8,580,904 8,192,316 Loss per share,and diluted Continued operations $ (0.11) $ (0.32) $ (0.07) $ (0.17) Discontinued operations $ (0.01) $ -- $ -- $ -- ------------ ------------ ------------ ------------ $ (0.11) $ (0.32) $ (0.07) $ (0.17) ============ ============ ============ ============ Diluted weighted average shares outstanding 10,579,828 9,837,494 8,580,904 8,192,316
88Quarterly and year to day computation of per share amounts are made independently. Therefore, the sum of quarterly per share amounts may not agree with per share amounts for the year. -101- U.S. ENERGY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2003 AND 2002, MAY 31, 2002 (CONTINUED)
Three Months Ended --------------------------------------------------------------- May 31, February 28, November 30, August 31, 2001 2001 2000 2000 ------------ ------------ ------------ ------------ Operating Revenues $ 72,000 $ 656,900 $ 900,800 $ 1,633,300 Operating (loss) $(2,760,500) $(1,679,800) $(1,772,300) $(1,305,200) (Loss) earnings from continuing operations $(2,163,400) $(1,513,500) $ 6,093,000 $(1,133,000) Discontinued operations, net of tax $ 821,600 $ (344,300) $ (416,800) $ 427,600 Net earnings (loss) $(1,341,800) $(1,857,800) $ 5,676,200 $ (705,400) Earnings (loss) per share, basic Continuing operations $ (0.28) $ (0.19) $ 0.78 $ (0.14) Discontinued operations $ 0.11 $ (0.04) $ (0.05) $ 0.05 ----------- ----------- ----------- ----------- $ 0.17) $ (0.23) $ 0.73) $ (0.09) =========== =========== =========== =========== Basic weighted average shares outstanding 7,847,680 7,819,446 7,818,430 7,818,430 Earning (loss) per share, diluted Continuing operations $ (0.28) $ (0.19) $ 0.78 $ (0.14) Discontinued operations $ 0.11 $ (0.04) $ (0.05) $ 0.05 ----------- ----------- ----------- ----------- $ (0.17) $ (.023) $ 0.73 $ (0.09) =========== =========== =========== =========== Diluted weighted average shares outstanding 7,847,680 7,819,446 8,215,038 7,818,430
89AND MAY 31, 2001 (Continued) P. SUBSEQUENT EVENT ROCKY MOUNTAIN GAS, INC. On January 30, 2004 the Company's affiliate, RMG, acquired Wyoming coalbed methane (CBM) properties from a non-affiliated party. The purchase price of $6.8 million was paid with $5.0 million of cash, $500,000 in a 30 day secured note, $600,000 in restricted USE stock and $700,000 in restricted RMG stock. RMG financed $3.7 million of the cash component from a recently established $25 million credit facility arranged by Petrobridge Investment Management, LLC (Petrobridge), a mezzanine lender headquartered in Houston, TX. As defined by the agreement, terms under the credit facility include the following: (1) Advances under the credit facility are subject to lenders approval; (2) All revenues from oil and gas properties securing the credit facility will be paid to a lock bos controlled by the lender. All disbursements for lease operating costs, revenue distributions and operating expenses will require approval by the lender before distributions are made, and (3) The Company must maintain certain financial ratios and production volume, among other things. The properties acquired include 247 completed wells of which 138 wells were producing at the time of the acquisition, approximately 6.0 million cubic feet of gas per day (mmcfd) (approximately 3.2 mmcfd net to RMG) and 40,120 undeveloped fee acres, of which RMG owns 100%. RMG will operate 89% of the wells and owns an average 58% working interest in the producing wells and a 100% working interest in all of the undeveloped acreage. The properties purchased serve as the sole collateral for the credit facility. With the acquisition, RMG's gross and net acreage holdings increase to approximately 264,300 and 128,200, respectively. SUTTER GOLD MINING CO. On January 5, 2004, the Company, through Suttter, entered into a Letter of Intent to merge, via a reverse takeover, with Globemin Resources, Inc. a public company headquartered in Vancouver, Canada. Pursuant to the Letter of Intent, after the reverse trakeover is closed, Sutter plans on raising equity funds and begin further exploration work on the properties and the construction of a new secondary access raise to comply with US Mine Safety Health Administration regulations and improve ventilation as well as to better define known mineralization. The exploration work will be run through the Comet mineralized zone as soon as funds are made available through equity or debt financing. The current resource production plan is to initially produce a stockpile of mineralized material sufficient to operate a mill at 300 tons-per-day (tpd) while the mill is being built. The second stage of development will be to construct a conventional 300 tpd mill on site, which will be designed so that it can easily be expanded to accommodate the planned production of 500 tpd. Closing of the reverse takeover is subject to negotiation and approval of the share exchange agreements by the directors and shareholders of both companies and approval by Canadian Regulatory Authorities. -102- REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULE To U.S. Energy Corp: In connection with our audit of the consolidated financial statements of U.S. ENERGY CORP. (a Wyoming Corporation) AND SUBSIDIARIESEnergy Corp. and subsidiaries referred to in our report dated July 18, 2002,February 27, 2004, which is included in the Company's annual report on Form 10-K, we have also audited Schedule II for each ofthe year ended December 31, 2003, the seven months ended December 31, 2002 and the years in the period ended May 31, 2002.2002 and 2001. In our opinion, this schedule presents fairly, in all material respects, the information to be set forth therein. GRANT THORNTON LLP Denver, Colorado July 18, 2002 90Oklahoma City, Oklahoma February 27, 2004 -103- U.S. ENERGY CORP. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance Additions beginning charged to Deductions Balance end of period expenses Deductions of period ----------- ------------ ------------ ----------- May 31, 2000 $ 27,800 $ 708,600 $ 708,600 $ 27,800 ===========of period expenses and Other of period ---------- ---------- ---------- ------------ May 31, 2001 $ 27,800 -- -- $ 27,800 ===================== ========== ========== ============ May 31, 2002 $ 27,800 171,200 171,200-- -- $ 27,800 ===================== ========== ========== ============ December 31, 2002 $ 27,800 -- -- $ 27,800 ========== ========== ========== ============ December 31, 2003 $ 27,800 -- -- $ 27,800 ========== ========== ========== ============
91 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. ITEM 9A. CONTROLS AND PROCEDURES The Company's Principal Executive Officer and Principal Financial Officer have reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 240.13a-15(e)) as of the end of the period covered by this report. Based on that evaluation, the Principal Executive Officer and the Principal Financial Officer have concluded that the Company's current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. There was no change in the Company's internal controls that occurred during the fourth quarter of the period covered by this report that has materially affected, or is reasonably likely to affect, the Company's internal controls over financial reporting. -104- PART III In the event a definitive proxy statement containing the information being incorporated by reference into this Part III is not filed within 120 days of MayDecember 31, 2002,2003, we will file such information under cover of a Form 10-K/A. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by Item 10 with respect to directors and certain executive officers inis incorporated herein by reference to our Proxy Statement for the 2002 Annual Meeting of Shareholders to be held in June 2004, under the captions "Proposal 1: Election of Directors," Filing of Reports Under Section 16(a)," and"Business Experience and Other Directorships of Directors and Nominees." The information regarding the remaining executive officers follows: The Company has adopted a Code of Ethics. A copy of the Code of Ethics will be provided to any person, without charge, upon written request addressed to Daniel P. Svilar, Secretary, 877 N. 8th W., Riverton, Wyoming 82501. INFORMATION CONCERNING EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS. The following are the two executive officers of USE as of the date of this Form 10-K; these persons devote their full time to the Company's business. ROBERT SCOTT LORIMER, age 51,53, has been the Chief Accounting Officer for both USE and Crested for more than the past five years. Mr. Lorimer also has been Chief Financial Officer for both these companies since May 25, 1991, their Treasurer since December 14, 1990, and Vice President Finance since April 1998. He serves at the will of each board of directors. There are no understandings between Mr. Lorimer and any other person, pursuant to which he was named as an officer, and he has no family relationship with any of the other executive officers or directors of USE or Crested. During the past five years, Mr. Lorimer has not been involved in any Reg. S-K Item 401(f) listed proceeding. DANIEL P. SVILAR, age 73,75, has been General Counsel for USE and Crested for more than the past five years. He also has served as Secretary and a director of Crested, and Assistant Secretary of USE. On March 25, 2002, Mr. Svilar was appointed Secretary of USE. His positions of General Counsel to, and as officers of the companies, are at the will of each board of directors. There are no understandings between Mr. Svilar and any other person pursuant to which he was named as officer or General Counsel. He has no family relationships with any of the other executive officers or directors of USE or Crested, except his nephew Nick Bebout is a USE director. During the past five years, Mr. Svilar has not been involved in any Reg. S-K Item 401(f) proceeding. ITEM 11. EXECUTIVE COMPENSATION. The information required by Item 11 is incorporated herein by reference to the Proxy Statement for the 2002 Annual Meeting of Shareholders to be held in June 2004, under the captions "Executive Compensation" and "Director's Fees and Other Compensation." 92 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.MANAGEMENT AND RELATED STOCKHOLDERS MATTERS. The information required by Item 12 is incorporated herein by reference to the Proxy Statement for the 2002 Annual Meeting of Shareholders to be held in June 2004, under the caption "Principal Holders of Voting Securities." -105- ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by Item 13 is incorporated herein by reference to the Proxy Statement for the 2002 Annual Meeting of Shareholders to be held in June 2004, under the caption "Certain Relationships and Related Transactions." ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES (1) - (4) Grant Thornton LLP billed us as follows for the year ended December 31, 2003 and the seven months ended December 31, 2002: Year Ended Seven Months Ended December 31, 2003 December 31, 2002 Audit Fees(a) $ 80,100 $ 68,900 Audit-Related Fees(b) $ -- $ -- Tax Fees(c) $ 15,800 $ 8,000 All Other Fees(d): $ 13,100 $ 11,000 (a) Includes fees for audit of the annual financial statements and review of quarterly financial information filed with the Securities and Exchange Commission ("SEC"). (b) For assurance and related services that were reasonably related to the performance of the audit or review of the financial statements, which fees are not included in the Audit Fees category. The Company had no Audit-Related Fees for the periods ended December 31, 2003, and 2002, respectively. (c) For tax compliance, tax advice, and tax planning services, relating to any and all federal and state tax returns as necessary for the periods ended December 31, 2003 and 2002, respectively. (d) For services in respect of any and all other reports as required by the SEC and other governing agencies. (5)(i) Our audit committee approves the terms of engagement before we engage Grant Thornton for audit and non-audit services, except as to engagements for services outside the scope of the original terms, in which instances the services have been provided pursuant to pre-approval policies and procedures, established by the audit committee. These pre-approval policies and procedures are detailed as to the category of service and the audit committee is kept informed of each service provided. These policies and procedures, and the work performed pursuant thereto, do not include delegation any delegation to management of the audit committees responsibilities under the Securities Exchange Act of 1934. (5)(ii) The percentage of services provided for Audit-Related Fees, Tax Fees and All Other Fees, which services were delivered pursuant to pre-approval policies and procedures established by the audit committee, in 2003 (and the seven months ended December 31, 2002) were: Audit-Related Fees 74% (78%); Tax Fees 14% (9%); and All Other Fees 12% (13%). -106- ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, REPORTS AND FORMS 8-K. (a) Financial Statements and Exhibits (1) The following financial statements are filed as a part of the Report in Item 8: Consolidated Financial Statements Page No. --------- U.S. Energy Corp. and Subsidiaries Report of Independent Public Accountants Grant Thornton LLP.......................................................45 Report of Independent Public Accountants Arthur Andersen LLP......................................................46LLP . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Consolidated Balance Sheets - December 31, 2003, and December 31, 2002 and May 31, 2002 and 2001...................47-48. . . . . . . . . . . . . . .54-55 Consolidated Statements of Operations for the Year Ended December 31, 2003, the Seven Months Ended December 31, 2002 and the Years Ended May 31, 2002 2001 and 2000.......................49-502001. . . . . . . . . . .56-57 Consolidated Statements of Shareholders' Equity for the Year Ended December 31, 2003, the Seven Months Ended December 31, 2002, and the Years Ended May 31, 2002 2001 and 2000................51-532001. . . . . . . . . . .58-61 Consolidated Statements of Cash Flows for the Year Ended December 31, 2003, the Seven Months Ended December 31, 2002, and the Years Ended May 31, 2002 2001 and 2000.......................54-552001. . . . . . . . . . .62-64 Notes to Consolidated Financial Statements............................56-89Statements . . . . . . . . . . . 65-102 Report of Independent Certified Public Accountants on Schedule...........................................90Schedule. . . . . . . . . . . . . . . . . . . .103 Schedule II - Valuation and Qualifying Accounts..........................91Accounts. . . . . . . . . .104 (2) Not applicable.All other schedules have been omitted because the required information in inapplicable or is shown in the notes to financial statements. (3) Exhibits Required to be Filed. Each individual exhibit filed herewith is sequentially paginated corresponding to the pagination of the entire Form 10-K. As a result of this pagination, the page numbers of documents filed herewith containing a table of contents will not be the same as the page number contained in the original hard copy. 93 Exhibit Sequential No. Title of Exhibit Page No. - ------- ---------------------------------------------------- ---------- 3.1 USE Restated Articles of Incorporation.............................[2] 3.1(a) USE Articles of Amendment to Restated Articles of Incorporation.................................[4] 3.1(b) USE Articles of Amendment (Second) to Restated Articles of Incorporation (Establishing Series A Convertible Preferred Stock.................[9] 3.1(c) Articles of Amendment (Third) to Restated Articles of Incorporation (Increasing number of authorized shares)..........................[14] 3.2 USE Bylaws, as amended through April 22, 1992......................[4] 4.1 Amendment to USE 1998 Incentive Stock Option Plan (To include Family Transferability of Options Under SEC Rule 16b)....................[11] 4.2 USE 1998 Incentive Stock Option Plan and Form of Stock Option Agreement 1/99............................[8] 4.3 USE Restricted Stock Bonus Plan, as amended through 2/94............................................[5] 4.4 Form of Stock Option Agreement, and Schedule Options Granted January 1, 1996....................................[6] 4.5 Form of Stock Option Agreement and Schedule, Options Granted January 10, 2001..................................[11] 4.6 [intentionally left blank] 4.7 USE 1996 Officers' Stock Award Program (Plan)......................[7] 4.8 USE Restated 1996 Officers' Stock Award Plan and Amendment to USE 1990 Restricted Stock Bonus Plan..................[7] 4.9 Warrant held by Caydal LLC........................................[13] 4.10 Warrant held by Kevin P. Daly....................................[13] 94 4.11 Rights Agreement, dated as of September 19, 2001 between U.S. Energy Corp. and Computershare Trust Company, Inc. as Rights Agent. The Articles of Amendment to Articles of Incorporation creating the Series P Preferred Stock is included herewith as an exhibit to the Rights Agreement. Form of Right Certificate (as an exhibit to the Rights Agreement)
SEQUENTIAL EXHIBIT NO. TITLE OF EXHIBIT PAGE NO. - ------------ ---------------- -------- 3.1 USE Restated Articles of Incorporation. . . . . . . . . . . . . [2] 3.1(a) USE Articles of Amendment to Restated Articles of Incorporation . . . . . . . . . . . . . . . [4] 3.1(b) USE Articles of Amendment (Second) to Restated Articles of Incorporation (Establishing Series A Convertible Preferred Stock . . . . . . . [9] -107- 3.1(c) Articles of Amendment (Third) to Restated Articles of Incorporation (Increasing number of authorized shares) . . . . . . . . . . . . [14] 3.1(d) Articles of Amendment to the Articles of Incorporation of Rocky Mountain Gas, Inc. (to establish Series A Preferred Stock in March 2004). . . . . . Summary of Rights, which will be sent to all holders of record of the outstanding shares of Common Stock of the registrant, also included as an exhibit to the Rights Agreement..................................................[12] 4.12 Form of Advisor Warrant dated October 18, 2001 and List of Holders ..............................................[14] 4.13 Form of Advisor Warrant dated November 2, 2001 and List of Holders...............................................[14] 4.14 Form of Investor Warrant dated October 18, 2001 and List of Holders...............................................[14] 4.15 Stock Option held by R. Jerry Falkner dated April 11, 2001..............................................[14] 4.16 Warrant held by Riches In Resources dated May 14, 2001................................................[14] 4.17 Stock Option held by R. Jerry Falkner dated October 11, 1999 and First Amendment thereto......................[15] 4.18 Amendment dated April 25, 2002 to October 11, 1999 Stock Option Agreement held by R. Jerry Falkner...............................[16] 4.19 USE 2001 Incentive Stock Option Plan with Form of Option Agreement.....................................[18] 4.20 USE Schedule of Options Issued - 12/7/01 and 5/20/02......................................[18] 4.21 USE 2001 Officers' Stock Compensation Plan........................[18] 10.1 USECC Joint Venture Agreement - Amended as of 1/20/89..............[1] 10.2 Management Agreement with USECC....................................[3] 10.3 Contract - R. J. Falkner & Company dated April 11, 2001..............................................[11] 95 10.4 Consulting Agreement - Riches In Resources dated May 14, 2001................................................[11] 10.5 Agreement for Strategic Services VentureRound Group LLC............................................[14] 10.6-10.60 [intentionally left blank] 10.61 Closing Agreement - Addendum to Agreement for Purchase and Sale of Assets (see Exhibit 10.62)...............[11] 10.62 Agreement for Purchase and Sale of Assets (Rocky Mountain Gas, Inc. and Quantum Energy LLC)..................[9] 10.63 Purchase and Sale Agreement CCBM, Inc. (subsidiary of Carrizo Oil & Gas, Inc.) and Rocky Mountain Gas, Inc.......................................[16] 10.64 Purchase and Sale Agreement Bobcat Property...................................................[16] 10.65 Convertible Promissory Note and Security Agreement dated May 30, 2002.............................[17] 21.1 Subsidiaries of Registrant........................................[11] 99.1 Certification Pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code................................* 3.2 USE Bylaws, as amended through April 22, 1992. . . . . . . . . . [4] 4.1 Amendment to USE 1998 Incentive Stock Option Plan .. . . . . .. [11] 4.2 USE 1998 Incentive Stock Option Plan and Form of Stock Option Agreement . . . . . . . . . . . . . . . [8] 4.3-4.8 [intentionally left blank] 4.9 Form of USE Warrant held by investors in RMG (Caydal, LLC-31,250, Karns-6,250, Monahan/Cotner-1,875, Van Buren-1,250, 2nd McCaughey-6,250). . . . . . . . . . . . . . [23] 4.10 [intentionally left blank] 4.11 Rights Agreement, dated as of September 19, 2001 between U.S. Energy Corp. and Computershare Trust Company, Inc. as Rights Agent. The Articles of Amendment to Articles of Incorporation creating the Series P Preferred Stock is included herewith as an exhibit to the Rights Agreement. Form of Right Certificate (as an exhibit to the Rights Agreement). Summary of Rights, which will be sent to all holders of record of the outstanding shares of Common Stock of the registrant, also included as an exhibit to the Rights Agreement.. . . . . . . . . . . . . . . . . . . . . . . . [12] 4.12-4.20 [intentionally left blank] 4.21 USE 2001 Officers' Stock Compensation Plan . . . . . . . . . . . [18] 4.22-4.23 [intentionally left blank] 4.24 Form of warrant held by Sanders Morris Harris, Inc.. . . . . . . . . . . . . . . . . . . [23] 4.25 [intentionally left blank] 4.26 Exchange Agreement (for conversion of RMG shares into USE shares) . . . . . . . . . . . . . . . . . [23] 4.26(a) Form of Amendment to Exchange Agreement (Caydal and McCaughey) . . . . . . . . . . . . . . . . . . . . . [23] -108- 4.26(b) Form of Amendment to Exchange Agreement (Karns, Monahan/Cotner,Van Buren). . . . . . . . . . . . . . . . [23] 4.27 Form of warrant held by McKim & Company- 19,500 and John Schlie-3,000. . . . . . . . . . [23] 4.28 Amendment to Secured Convertible Note (Caydal) . . . . . . . . . [23] 4.29 Amendment to Secured Convertible Note (Tsunami) .. . . . . . . . [23] 4.30 Form of Warrant (issued to mezzanine credit facility lenders). . * 10.1 USECC Joint Venture Agreement. . . . . . . . . . . . . . . . . . [1] 10.2 Management Agreement with USECC. . . . . . . . . . . . . . . . . [3] 10.3-10.60 [intentionally left blank] 10.61 Closing Agreement - Addendum to Agreement for Purchase and Sale of Assets (see Exhibit 10.62). . . . . . . [11] 10.62 Agreement for Purchase and Sale of Assets (Rocky Mountain Gas, Inc. and Quantum Energy LLC). . . . . . . . [9] 10.63 Purchase and Sale Agreement CCBM, Inc. (subsidiary of Carrizo Oil & Gas, Inc.) and Rocky Mountain Gas, Inc. . . . . . . . . . . . . . . . . . . [16] 10.64 [intentionally left blank] 10.65 Convertible Promissory Note and Security Agreement dated May 30, 2002. . . . . . . . . . . . . . [17] 10.66 Convertible Promissory Note and Security Agreement dated November 19, 2002 . . . . . . . . . . . [19] 10.67 Contribution and Subscription Agreement (to which RMG, Pinnacle Gas Resources and others are parties). . . . . . . [22] 10.68 Purchase and Sale Agreement, with three amendments (for purchase of Hi - Pro assets). . . . . . . . . . . . . . . . [24] 10.69 Credit Agreement (mezzanine credit facility with Petrobridge Investment Management) . . . . . . . . . . . . . . . [24] 10.70 Stock Purchase Agreement (sale of stock of subsidiary Canyon Resources, Inc., owner of Utah commercial properties). . . . . . * 14.0 Code of Ethics . . . . . . . . . . . . . . . . . . . . . . . . . * 21.1 Subsidiaries of Registrant . . . . . . . . . . . . . . . . . . . [11] -109- 23.0 Consent of Netherland, Sewell & Associates, Inc., independent petroleum engineers. . . . . . . . . . . . . . . . . . . . . . . * 31.1 Certification under Rule 13a-14(a) John L. Larsen. . . . . . . . * 31.2 Certification under Rule 13a-14(a) Robert Scott Lorimer. . . . . * 32.1 Certification under Rule 13a-14(b) John L. Larsen. . . . . . . . * 32.2 Certification under Rule 13a-14(b) Robert Scott Lorimer. . . . . *
* Filed herewith.herewith _____________ Unless otherwise indicated, the SEC File Number for each of the following documents incorporated by reference is 000-6814. [1] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1989, filed August 29, 1989. [2] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1990, filed September 14, 1990. [3] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1991, filed September 13, 1991. [4] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1992, filed September 14, 1991. [5] Incorporated by reference from the like-numbered exhibit to the Registrant's Form S-1 registration statement, initial filing (SEC File No. 333-1689) filed June 18, 1996). 96 Intentionally left blank. [6] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1996, filed September 13, 1996.Intentionally left blank. [7] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1997, filed September 15, 1997.Intentionally left blank. [8] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 1998, filed September 14, 1998. [9] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 2000, filed September 13, 2000. [10] Incorporated by reference from the like-numbered exhibit to the Registrant's Form 8-K, filed February 5, 2001.Intentionally left blank. [11] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended on May 31, 2001, filed August 29, 2001.2001, and amended on June 18, 2002 and September 25, 2002. [12] Incorporated by reference to exhibit number 4.1 to the Registrant's Form 8-A12G filed, September 20, 2001. [13] Incorporated by reference from the like-numbered exhibit to the Registrant's Form S-3 registration statement (SEC File No. 333-73546), filed November 16, 2001. [14] Incorporated by reference from the like-numbered exhibit to the Registrant's Form S-3 registration statement (SEC File No. 333-75864), filed December 21, 2001. -110- [15] Incorporated by reference from the like-numbered exhibit to the Registrant' Form S-3 registration statement (SEC File No. 333-83040), filed February 19, 2002.Intentionally left blank. [16] Incorporated by reference from the like-numbered exhibit to the Registrant's Form S-3 registration statement, amendment no. 1 (SEC File No. 333-83040), filed May 17, 2002. [17] Incorporated by reference from the like-numbered exhibit filed to the Registrant's Form 8-K, filed June 6, 2002. [18] Incorporated by reference from the like-numbered exhibit to the Registrant's Annual Report on Form 10-K for the year ended May 31, 2002, filed September 13, 2002. [19] Incorporated by reference from the like-numbered exhibit to the Registrant's Form 8-K, filed December 9, 2002. [20] Intentionally left blank. [21] Intentionally left blank. [22] Incorporated by reference from the exhibit filed with the Registrant's Form 8-K, filed July 15, 2003 [23] Incorporated by reference from the like-numbered exhibit to the Registrant's Form S-3 registration statement (SEC File No. 333-110882), filed December 3, 2003. [24] Incorporated by reference from the exhibit filed with the Registrant's Form 8-K, filed March 5, 2004. _________________ (b) Reports filed on Form 8-K. DuringIn the fourthlast quarter of the fiscal year ended on May 31, 2002,2003, the Registrant filed onefour Reports on Form 8-K, Reportall for Item 5 events, on April 23, 2002, reporting the non-exercise of the Suncor OptionNovember 5, 12 and the purchase of the Bobcat property.20, and December 24, 2003. (c) Required exhibits are attached hereto and listedSee paragraph a(3) above under Item 14 (a)(3).for exhibits. (d) Required financialFinancial statement schedules, see paragraph (a)(1) above. No other financial statements are listed and attached hereto in Item 14(a)(2). 97required to be filed. -111- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized. U.S. ENERGY CORP. (Registrant) Date: March 3, 200326, 2004 By: /s/ John L. Larsen ---------------------------------------------------------------------- John L. Larsen, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 3, 200326, 2004 By: /s/ John L. Larsen ---------------------------------------------------------------------- John L. Larsen, Director Date: March 3, 200326, 2004 By: /s/ Keith G. Larsen ---------------------------------------------------------------------- Keith G. Larsen, Director Date: March 3, 200326, 2004 By: /s/ Harold F. Herron ---------------------------------------------------------------------- Harold F. Herron, Director Date: March 3, 200326, 2004 By: /s/ Don C. Anderson ---------------------------------------------------------------------- Don C. Anderson, Director Date: March 3, 200326, 2004 By: /s/ Nick Bebout ---------------------------------------------------------------------- Nick Bebout, Director Date: March 3, 200326, 2004 By: /s/ H. Russell Fraser ---------------------------------------------------------------------- H. Russell Fraser, Director Date: March 3, 200326, 2004 By: /s/ Michael T. Anderson --------------------------------------- Michael T. Anderson, Director Date: March 26, 2004 By: /s/ R. Scott Lorimer ---------------------------------------------------------------------- Robert Scott Lorimer, Principal Financial Officer/ Chief Accounting Officer 98-112- CERTIFICATION I, Robert Scott Lorimer, certify that: 1. I have reviewed this amended annual report on Form 10-K/A of U.S. Energy Corp.; 2. Based on my knowledge, this amended report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this amended report. 3. Based on my knowledge, the financial statements, and other financial information included in this amended report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this amended report. DATED this 3rd day of March 2003. /s/ Robert Scott Lorimer ------------------------------------ Robert Scott Lorimer Chief Financial Officer CERTIFICATION I, John L. Larsen, certify that: 1. I have reviewed this amended annual report on Form 10-K/A of U.S. Energy Corp.; 2. Based on my knowledge, this amended report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this amended report. 3. Based on my knowledge, the financial statements, and other financial information included in this amended report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this amended report. DATED this 3rd day of March 2003. /s/ John L. Larsen ------------------------------------ John L. Larsen, Chief Executive Officer 99