SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
Amendment No. 1
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 December 31, 2003 or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to
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Commission file number 0-8773
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CRESTED CORP.
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(Exact Name of Registrant as Specified in its Charter)
Colorado 84-0608126
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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
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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, $0.001 PAR VALUE
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(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] NO [ ]
Indicate by check mark whether the registrant is an accelerated filed (as
defined in Rule 12b-2 of the Act) YES [ ] NO [X].
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of June 30, 2003 computed by reference to the average of the
bid and asked prices for the Registrant's common stock as reported by National
Quotation Bureau on Pink Sheets for the week then ended, was approximately
$3,613,896.
Class Outstanding at March 26, 2004
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Common Stock, $0.001 par value 17,133,098 shares
Documents incorporated by reference: Portions of the documents listed below
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have been incorporated by reference into the indicated parts of this report as
- ---
specified in the responses to the item numbers involved:
Proxy Statement for the Meeting of Shareholders to be held 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. [ ]
1
DISCLOSURE REGARDING FORWARD 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; domestic market prices for
natural gas, uranium, gold, and molybdenum; 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 to reasonable proximity to our coalbed methane properties; and
whether and on what terms the capital necessary to develop our 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.
Crested Corp. is a Colorado corporation (formed in 1970) in the business of
acquiring, exploring, developing and/or selling or leasing mineral properties.
In this Annual Report, "we," "Company" or "Crested" refer to Crested Corp.
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, and the
last Annual Report was a transition report for the seven months ended December
31, 2002 (filed March 31, 2003)).
In 2003, most of our business activity was devoted to the coalbed methane
("CBM") business, which is conducted through Rocky Mountain Gas, Inc ("RMG"), a
non-consolidated affiliate 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, from Hi-Pro Production, LLC
("Hi-Pro"). These properties contain proven gas reserves. A portion of the
purchase price was paid with a loan 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 2004, RMG
raised $1.8 million in working capital from institutional investors. See
"Coalbed Methane - RMG Equity Financing."
2
RMG's properties are located in Wyoming and southeastern Montana. As of
the filing date of this Annual Report, RMG holds approximately 264,300 gross
(128,200 net) mineral acres of CBM properties under leases and options. A
limited amount of exploratory drilling and testing was conducted on some of the
non-producing properties in 2003, but in general, significant additional work is
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. See "Oil and Gas, and Other
Properties." Canyon Resources was acquired in the 1990s from a utility as part
of an acquisition of uranium properties and a uranium mill near Ticaboo, Utah.
The uranium properties and mill, presently inactive, have not been sold. See
"Inactive Mining Properties - Uranium."
Historically, gas prices for 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 2003
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, particularly if aggravated by the
negative price differential experienced by Powder River Basin producers, could
adversely impact not only the economics of current production but also the
economics of exploration projects as they move into production in the future.
Crested and U.S. Energy Corp.("USE") originally were independent companies,
with two common affiliates (John L. Larsen and Max T. Evans; Mr. Evans died in
February 2002). In 1980, Crested and USE 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), Crested subsequently paid 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, the Company
issued another 6,666,666 shares of its common stock to reduce its debt owed to
USE by $3.0 million, which increased USE's ownership of Crested to 71.5%. All
the operations of the Company are in the United States.
Principal executive offices of Crested are located in the Glen L. Larsen
building at 877 North 8th Street West, Riverton, Wyoming 82501, telephone
307-856-9271. RMG has a field office in Gillette, Wyoming.
Most of the Company's operations are conducted through subsidiaries, the
USECC Joint Venture with USE, and jointly-owned subsidiaries of Crested and USE.
b) NARRATIVE DESCRIPTION OF BUSINESS (INCLUDING ITEM 2 - 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. The
Company owns 39.8% of RMG as of December 31, 2003 (as of the date of this Annual
Report, 39.1% ).
3
In 2003, RMG transferred all of its interest in certain coalbed methane
properties, including a producing property, to Pinnacle Gas Resources, Inc.
("Pinnacle"). At the same time, Carrizo Oil & Gas, Inc.'s subsidiary CCBM, Inc.
(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 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 264,300 gross mineral acres of federal, state and private (fee)
land in the Powder River Basin ("PRB") of Wyoming and Montana and adjacent to
the Green River Basin of Wyoming, not including acreage held by Pinnacle.
As of the filing date of this Annual Report, there are 108 producing wells
on the properties 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 these properties.
From RMG's inception through December 31, 2003, 72 exploratory wells have
been drilled, almost all with funds provided by industry partner CCBM, Inc.
("CCBM") and former industry partner SENGAI (see below). 43 of the wells were on
properties transferred to Pinnacle Gas Resources, Inc. 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 were drilled.
The Castle Rock property in southeast Montana , and the Oyster Ridge
property adjacent to the Green River Basin (southwest Wyoming), are large
properties which will require the drilling of numerous exploratory wells and
extended dewatering for each group or "pod" of wells (possibly as much as 24
months after drilling and completion) before an assessment of reserves can be
made.
Among the uncertainties we face in 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
economics of Powder River Basin properties can be adversely affected more
readily by lower gas prices. The Hi-Pro properties, and all revenues therefrom,
are pledged to service $3,635,000 of debt. To continue exploration efforts,
additional capital (in addition to RMG's one-half of remaining balance under the
CCBM $5.0 million drilling commitment, which one half of remaining balance was
$305,100 at December 31, 2003) will be needed. Permitting issues for new wells
on undeveloped acreage may be delayed. An unfavorable confluence of these
uncertainties 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; in a
write-down of the carrying value of other properties which need more wells
drilled and dewatered to establish or improve the economics
4
of 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, Inc. ("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, develop, additional CBM
properties in Wyoming and Montana; and (2) RMG (through its ownership interest
in Pinnacle) 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
5
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.
Equity in Pinnacle
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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
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(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 workon 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.
- 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
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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 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 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.
8
- - 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.
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 valorm and production taxes on a pre-income tax basis, and is not intended to
represent the current market value of the 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
9
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 time 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, work-over costs, remedial costs
and abandonment obligations. 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.
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 work over program on a number
of existing wells, and upgrade the gas gathering
10
and pipeline facilities included in the purchase. The work over 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.
- 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
11
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 $78.50 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 warrantholders 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.
- - RMG EQUITY TRANSACTION
In the first quarter of 2004, 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' weighted
average closing price for the five days prior to closing, 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.
12
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.
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 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.
13
(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 December 31, 2003, RMG incurred
net acquisition (purchase price and holding costs) and exploration costs
(drilling and completion) on CBM properties of approximately $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 properties on the balance
sheet at December 31, 2003 reflect the reduction (by $5,143,000) to reflect the
reduction of the natural gas properties in accordance with the full cost method
of accounting as a result of principal payments made by 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 by RMG. Costs associated with the Hi-Pro acquisition after December
31, 2003 are not included.
Year Ended Seven Months Ended Year Ended
December 31, December 31, May 31,
------------ ------------ ------------
2003 2002 2002
------------ ------------ ------------
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 $265,400,
$1,033,400, and $280,000 represent 1.1%, 3.6%, and 1.0% of total assets at
December 31, 2003, December 31, 2002, and May 31, 2002, 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 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 estimated future
net pre-tax cash flows from proved gas reserves as established by reserve
reports, the excess costs will be charged to operations.
All acquisition and exploration costs for a property are capitalized until
such time as reserves can be established, or not, for the property. If no
reserves are established, those capitalized costs will be transferred to the
amortization base and be subject to an impairment test. To 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 future exploration work (in particular the larger
prospects) is 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.
14
COALBED METHANE PROPERTIES
As of the filing of this Annual Report, we hold leases and options to
develop approximately 264,300 gross mineral acres (including 69,895 acres under
options - 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 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.
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 executive 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, pending production permitting), and
dewatering the well sufficiently so production can start. The decision whether
to complete the well is made by the executive officers of RMG.
Table 1 reflects RMG's, Quaneco's and CCBM's acreage position as of the
filing of this Annual Report. Table 1 does not reflect the reduction in net
acreage held by RMG if Anadarko Petroleum, Inc. exercises its options to back-in
for a 25% working interest on 31,711 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, 69,895 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 agreements with Anadarko and Kerr McGee. See "Description of
Prospects - Oyster Ridge" below.
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
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
- --------------------------------------------------------------------------------
15
RMG owns 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
can purchase a 6.25% working interest in RMG's 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 consideration. The acreage data in
Table 1 reflects these transactions.
CCBM agreed to pay up to $5,000,000 for drilling and completing CBM wells
on the properties owned by RMG and CCBM. RMG has a carried working interest in
all of the wells drilled on properties owned in July 2001 (after the Pinnacle
transaction, those properties consist of the Castle Rock, Baggs, and the Oyster
Ridge property (not including the Kerr-McKee earn-in acreage)). To date, CCBM
has not indicated whether they will participate in the Kerr 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 the 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 a carried interest in wells on future
properties.
A total of 72 wells have been drilled on RMG acreage through December 31,
2003: Five in (former) fiscal year 2001; 53 in (former) fiscal 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 a option and
farm-in agreement. Eleven of those 19 wells were stratigraphic wells and have
been plugged by SENGAI; 8 of those 19 wells were completed and are owned by RMG
(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).
As of December 31, 2003, CCBM and RMG have spent approximately $2,194,900
of the $2,500,000 drilling 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 $305,100 balance to pay for
continued drilling and completion work on the Castle Rock and Oyster Ridge
properties, as to which RMG will have a carried working interest with no
financial obligation of RMG for drilling and completion costs until the drilling
fund is exhausted. For other properties we acquire in which CCBM elects to
participate, CCBM would bear 50% of drilling and completion costs for their 50%
working interest.
Future annual financial obligations for coalbed methane properties consist
of approximately $173,100 gross in rental fees to the lessors for 2004 ($81,800
net to RMG).
Table 2 lists the number of wells drilled, the total exploration costs and
the remaining number of wells currently permitted for drilling as of December
31, 2003. 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.
TABLE 2
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
Wells $ Wells $ Wells $ Wells $ Wells $ Permits
- ---------------------------------------------------------------------------------------------------------------------------
Castle
Rock 3* $283,900 19** $2,500,000 $ 4,300 0 0 22 $2,788,200 5
- ---------------------------------------------------------------------------------------------------------------------------
Oyster
Ridge 2 150,500 5 464,200 3,400 0 0 7*** 618,100 4
- ---------------------------------------------------------------------------------------------------------------------------
Hi-Pro n/a n/a n/a n/a n/a n/a n/a 0 n/a n/a 9
- ---------------------------------------------------------------------------------------------------------------------------
TOTAL 5 $434,400 24 $2,964,200 $ 7,700 0 0 29 $3,406,300 18
* one well has been plugged and abandoned
** drilled by SENGAI, 11 have been plugged and abandoned
*** includes 3 wells that have been plugged and abandoned
16
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 properties held in Montana and Wyoming, and to acquire and develop more
properties.
RMG assigned CCBM an undivided 50% interest in all of RMG's then 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. This note was reduced in connection with
CCBM's contribution of properties to Pinnacle (see "Transaction with Pinnacle
Gas Resources, Inc. - Continuing Operations of RMG, Continuing Agreement with
CCBM, and the AMI Agreement, after the Pinnacle Transaction"), and the balance
on the note is secured with a 50% undivided interest in the remaining properties
(Oyster Ridge and Baggs North but not Hi-Pro).
CCBM has the right to participate in other properties RMG may acquire under
an area of mutual interest ("AMI") agreement. This agreement has been modified
by the AMI 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 agreement, see "Carrizo - Purchase and Sale Agreement" in the
Annual Report (Form 10-K/A1) for the former fiscal year 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 was 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 its purchase price of the contributed properties. The
payment of $1.8 million was a reduction to the principal on the original $7.5
million note from CCBM. The $1.25 million that CCBM was to recover from 20% of
RMG's revenue interest on the contributed properties was netted against the
total purchase price on the contributed properties which yielded the $1.8
million cash payment. CCBM is not entitled to 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 88,409 net
acres of Bureau of Land Management ("BLM") land; 14,916 net acres of state land
(Montana), and 82,775 net acres of fee land. In fiscal 2000 and 2001, RMG paid
Quaneco the cash purchase price of $5,500,000 for the acreage 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, see "Quaneco Agreement" in the
Annual Report (Form 10-K/A1) for the (former) fiscal year ended May 31, 2002.
17
DESCRIPTION OF PROSPECTS
Leases of federal mineral rights are obtained from the United States Bureau
of Land Management ("BLM") 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 2004 to 2009 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 $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 2004 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 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
Net Net Net
Net Leased Leased Leased
Gross Net Leased from from from
Leased Leased from State of State of Private
Prospect Acres Acres BLM Wyoming Montana Owners
------- ------- -------- ------- ------- ------
Castle Rock 123,840 111,567 55,104 0 10,860 45,603
Oyster Ridge* 20,306 20,306 17,107 639 0 2,560
Baggs North 120 120 0 120 0 0
Hi-Pro (undeveloped) 40,120 40,120 0 112 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 11,078
------- ------- ------ ----- ------ ------
Total Acres 197,006 183,931 72,671 1,151 10,860 99,249
======= ======= ====== ===== ====== ======
*Does not include 29,151 acres under option from Anadarko Petroleum and
38,184 acres under option from Kerr McGee. See "Description of Properties -
Oyster Ridge."
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
18
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.
OYSTER RIDGE: The Oyster Ridge project consists of two 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; RMG and CCBM have a 100% working
interest (50% each) in 20,765 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-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: RMG 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 31,711 acres area. Wells drilled by our seller, and by RMG (with
CCBM), have earned 2,560 acres, which are included in the 20,306 acres leased
presently.
Another 29,151 gross acres in the Oyster 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 wells drilled to date on this
prospect. If Anadarko elects to participate in the future, working interest
ownership in affected wells would be 37.5% RMG, 37.5% CCBM, and 25% Anadarko.
(2) On February 27, 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 earn-in agreement is expected 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 wells (one to the Frontier coal seams and one to the Adaville
Cretaceous coal seams), to earn 60% of KM's working and net revenue interest in
the 640 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 costs) 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.
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.
19
If this commitment is made, RMG shall drill at least 10 wells per year on KM
lands beginning in 2006. Each well will earn for RMG a 60% working interest in
the 640 acre section surrounding the well, and each lease will be delivered to
RMG with a 82.5% net revenue interest. KM may elect to participate for a 40%
working interest in any development well. If KM elects not to participate in the
first well in the section, KM will be deemed to relinquish the 40% working (and
associated net revenue) interest in the well until RMG reaches payout. If KM
elects not to participate in the second well in any section previously earned by
RMG, then KM shall have relinquished all of its interest in the entire section.
RMG will be the operator for each stage of the KM project.
As of the filing date of this Annual Report, CCBM has not determined
whether to participate with RMG in the Kerr-McGee earn-in agreement. However,
our net acreage calculations assume that CCBM 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 holds a 50% working interest in this prospect. To date, RMG has
not conducted any significant exploration on the property.
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 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 mass), micropores, and cleats in the coal;
and 4) as absorbed gas within the molecular 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.
Methane production is a direct result of reducing the hydrostatic (water)
pressure in the coal formation. Three principal stages are involved:
x 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 is
conducive to the formation of CBM.
x Install gathering lines to hook up and put wells on pump to "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
20
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).
x 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.)
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")
21
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.
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.
22
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.
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.
x 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
23
completed in September 2001. It is believed that capacity could be
increased by another 200 Mmcfd by adding additional compression to
this line.
x 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 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 Grasslands pipeline. However,
one additional line that is well along in its planning stage, 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 byWBI, 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.
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). This larger
than normal negative spread resulted from a combination of (i) rapidly growing
CBM
24
and conventional gas production volumes in this region, (ii) the curtailment of
both of the primary lines taking gas south out of the PRB due to maintenance
and/or construction (Fort Union and Thunder Creek), (iii) large amounts of
current pipeline capacity controlled by the larger producers, and (iv) restraint
in new pipeline construction from both regulatory delays and hesitancy to
construct new lines by the pipeline companies.
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-bearing properties are
in areas which produced significant amounts of uranium in the 1970s and 1980s.
At some future date, we could sell, develop and/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. 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, the uranium
properties will remain shut down.
At the dates of the consolidated balance sheets in this Report, there are
no values carried on the balance sheets for uranium properties.
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. 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."
We have recorded reclamation liabilities for the SMP properties. All
historical costs in the SMP properties were offset against a monetary award
which was received from Nukem during fiscal 1999.
UTAH
Plateau Resources Limited ("Plateau") is a wholly-owned subsidiary of USE.
In 2003, reclamation work on uranium properties (the Tony M, Velvet, and Woods
Complex) in San Juan County, Utah was completed. Although Crested does not own
any of Plateau's common stock, it participates in all Plateau cash flows on a
50-50 basis with USE.
25
PLATEAU'S SHOOTARING CANYON MILL AND PROPERTIES
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.
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.
For information on the Shootaring mill facility and related real estate
property at Ticaboo, please see "Plateau's Shootaring Canyon Mill and
Properties" in the annual report (Form 10-K/A1) for the former fiscal year ended
May 31, 2002.
THE GREEN MOUNTAIN MINING VENTURE ("GMMV") PROJECT
For information on the GMMV agreement, see "Green Mountain Mining Venture"
in the annual report (Form 10-K/A1) for the (former) fiscal year ended May 31,
2002.
SHEEP MOUNTAIN PARTNERS ("SMP")
SMP PARTNERSHIP. In February 1988, Crested and 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. Crested, USE 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.
Permits to operate existing mines (now shut down) on the Crooks Gap
properties had been issued by the State of Wyoming, but amendments would be
needed to re-open them. A NPDES water discharge permit under the Clean Water Act
has been obtained; monitoring and treatment of water removed from the mines and
discharged in nearby Crooks Creek is generally required. However, for the last
three years, USECC has not
26
discharged wastewater into Crooks Creek, and the water instead is being
discharged into the USECC McIntosh Pit at the Sweetwater mill owned by Kennecott
(the Sweetwater mill had been part of the Green Mountain Mining venture).
INACTIVE MINING PROPERTIES - GOLD
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 an affiliate of Crested. Crested accounts for its 1.5% investment
in SGMC using the equity method.
This property has never been in production. Persistent low prices for gold
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 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. The conditional use permit is being kept current as
necessary to allow for possible mining activities on the properties in the
future.
In 1998 and 1999, SGMC 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 SGMC investment in
these properties. As a result of low market prices for gold at the time,
management of SGMC determined that they 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.
Management of SGMC has 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 shareholders, if necessary, 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 435 acres of surface and mineral
rights: (87 acres of surface rights (owned), 73 acres of surface rights
(leased), 146 acres of mineral rights (leased), and 289 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.
Surface and mineral rights holding costs, and property taxes, will be
approximately $130,000 and $9,900 for 2004.
27
The leases are for varying terms and require rental fees, 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 SGMC 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
$48,800 for 2003,
$49,200 for the seven months ended December 31, 2002, and $41,200 in (former)
fiscal year 2002. 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, Crested and USE
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, then 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 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 Crested and USE. 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. Crested recognized $60,300 of advance
royalty revenues in (former) fiscal 2001. Phelps Dodge ceased making payments
in July 2001.
Crested and USE also are entitled to receive $2,000,000 if the Mt. Emmons
properties are put into production and, in the event of a sale of Mt. Emmons
Mining Company (which owns the properties) or of its interest in the properties,
Crested and USE are entitled to receive 15% of the first $25,000,000 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.
Crested and USE are in litigation with Phelps Dodge concerning the
properties and related agreements, see "Item 3 - Legal Proceedings."
28
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.
WYOMING. The Company and USE 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 nonaffiliates and government agencies;
the second floor is occupied by the Company and USE. The property is mortgaged
to the WDEQ as security for future reclamation work on the Sheep Mountain Crooks
Gap uranium properties.
The Company and USE also own 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 to the public was shut down late in fiscal 2002.
The Company and USE own three mountain sites covering 16 acres in Fremont
County, Wyoming.
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.) 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
$2,940,581 balloon payment due in August 2008.
The sold properties are in Ticaboo, Utah, near Lake Powell, and included a
motel, restaurant and lounge, convenience store, recreational boat storage and
service facility, and improved residential and mobile home lots. Crested
receives credit for 50% of all cash received as a result of the sale of Ticaboo.
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"),
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.
29
As of December 31, 2003, we have estimated reclamation obligations of
$1,053,300. We anticipate paying for those reclamation efforts 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 J 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 had 34 full-time
employees, 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 Company 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.
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.
30
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 during the year ended
December 31, 2003 have been settled or otherwise finally resolved.
SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION
In 1991, disputes arose between Crested and USE 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
Crested and USE 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 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,
31
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 effect 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
Crested and USE, 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 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 Crested
and USE 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, Crested
and USE 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
32
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, 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, certain of its affiliates
(including Crested and USE) 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.
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.
33
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 approximately $49,300.
Negotiations to settle the lien and lawsuits are pending. Management believes
that the ultimate outcome of this matter will not have a material 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 and the only
issue considered was the re-election of the three directors: John L. Larsen,
Daniel P. Svilar and Michael D. Zwickl. These directors were reelected for a
term expiring at the next succeeding annual meeting and until their successors
are duly elected or appointed and qualified. With respect to the re-election of
the three directors, the votes cast were as follows:
Name of Director For Abstain
------------------ --- -------
John L. Larsen 15,584,751 19,550
Daniel P. Svilar 15,584,201 21,100
Michael D. Zwickl 15,587,301 17,000
34
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
(a) Market information.
-------------------
The principal trading market for the Registrant's Common Stock, $.001 par
value, is the over-the-counter market. Prices are reported by the National
Quotation Bureau on Pink Sheets. The range of high and low bid quotations for
the Common Stock is set forth below for each quarter in the two most recently
completed fiscal years. Retail markup or markdown, or commissions, are not
reflected.
High Low
---- ---
Calendar year ended December 31, 2003
- -----------------------------------------
Fourth quarter ended 12/21/03 0.31 0.19
Third quarter ended 09/30/03 0.87 0.27
Second quarter ended 06/30/03 0.84 0.50
First quarter ended 03/31/03 0.54 0.44
Transition period ended December 31, 2002
- -----------------------------------------
Month Ended 12/31/02 $0.65 $0.45
Second quarter ended 11/30/02 0.72 0.45
First quarter ended 8/31/02 0.71 0.26
Fiscal year ended May 31, 2002
- -----------------------------------------
Fourth quarter ended 5/31/02 $0.55 $0.37
Third quarter ended 2/29/02 0.60 0.33
Second quarter ended 11/30/01 0.50 0.20
First quarter ended 8/31/01 0.45 0.25
(b) Holders.
(b)(1) At March 23, 2004 there were 1,716 stockholders of record for
----------------
Crested common stock.
(b)(2) Not applicable.
(c) Crested has not paid any cash dividends with respect to its common
stock. There are no contractual restrictions on Crested's present or future
ability to pay cash dividends, however, Crested intends to retain any earnings
in the near future for operations.
(d) During the year ended December 31, 2003, Crested issued 18,822 shares of
its Common Stock to its outside directors for services rendered.
35
ITEM 6. SELECTED FINANCIAL DATA.
The following tables show certain selected historical financial data for
Crested for the year ended December 31, 2003, the seven months ended December
31, 2002 and December 31, 2001 and the four fiscal years ended May 31, 2002.
The selected financial data is derived from and should be read with the
financial statements for Crested.
December 31, May 31,
------------------------------------- ---------------------------------------------------
2003 2002 2001 2002 2001 2000 1999
----------- ----------- ----------- ----------- ----------- ------------ -----------
(unaudited)
Current assets $ 3,300 $ 3,300 $ 3,300 $ 3,300 $ 3,200 $ 3,000 $ 46,600
Current liabilities 9,408,300 8,553,900 6,397,400 7,560,700 5,740,200 10,230,200 7,015,200
Working capital deficit (9,405,000) (8,550,600) (6,394,100) (7,557,400) (5,737,000) (10,227,200) (6,968,600)
Total assets 4,387,100 5,889,900 5,763,200 6,054,100 6,221,100 6,495,800 4,742,200
Long-term obligations(1) 1,268,900 964,000 964,000 964,000 964,000 964,000 725,900
Shareholders' deficit (6,300,200) (3,638,100) (1,608,300) (2,480,700) (493,200) (4,742,300) (1,822,500)
<FN>
(1) Includes $1,053,300 of accrued reclamation costs on uranium properties at December 31, 2003; $748,400 at December 31,
2002, 2001 and May 31, 2002, 2001 and 2000, respectively; and $725,900 at May 31, 1999.
For the Year
Ended For the Seven Months Ended
December 31, December 31, For Years Ended May 31,
------------- ---------------------------- ------------------------------------------------------
2003 2002 2001 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------ ------------ ------------
(unaudited)
Revenues $ -- $ -- $ -- $ -- $ 3,891,500 $ 73,100 $ 86,800
Income (loss) before equity
In (loss) of affiliates and
and income taxes (263,300) (102,400) (117,000) (175,000) 3,702,400 (194,600) (786,100)
Equity in loss of
affiliates (2,114,600) (1,055,000) (998,200) (1,823,900) (2,496,700) (5,085,200) (1,165,600)
Cumulative effect of
Accounting change (293,800) -- -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------ ------------
Net income (loss) $(2,671,700) $(1,157,400) $(1,115,200) $(1,998,900) $ 1,205,700 $(5,279,800) $(1,951,700)
============ ============ ============ ============ ============ ============ ============
Net income (loss)
per share $ (0.16) $ (0.07) $ (0.07) $ (0.12) $ .12 $ (.51) $ (.19)
============ ============ ============ ============ ============ ============ ============
Cash dividends per share $ -0- $ -0- $ -0- $ -0- $ -0- $ -0- $ -0-
============ ============ ============ ============ ============ ============ ============
36
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
The Company historically has 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 properties. The Company participates in all these
ventures with U.S. Energy Corp. ("USE") which now owns approximately 71.5% of
the Company's common stock, through a non consolidated affiliate, USECC Joint
Venture ("USECC"). The Company and USE have entered into partnerships through
which they either joint venture or lease properties with non-related parties
for the development and production of certain of their 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
held in a care and maintenance status. See Item 3 above. 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 and USE formed Rocky Mountain Gas, Inc. ("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 39.8% 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 CBM
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
that 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 its CBM production 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 in 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
37
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 impact heating and cooling
requirements; 2) electrical generation needs and 3) the amount of gas being
produced by companies in the gas production business. May of the Company's
industry competitors are very large international companies that are well
funded. All of these factors are variable and cannot be accurately predicted.
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") assets. On August 1, 2003, the U.S.
District Court of Colorado entered a Judgment in favor of the Company and USE
against Nukem in the amount of $20,044,183. Nukem has appealed this Judgment to
the 10th Circuit Court of Appeals ("CCA"). The Company and USE have 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 and USE, the liquidity of the Company will be
significantly impacted as it is entitled to 50% of any award received. 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company has relied on its major shareholder USE, to fund its portion of
operations and working capital requirements for the periods covered by this
Report. As of December 31, 2003 the Company had a very nominal amount of cash
on hand, had incurred a shareholders' deficit of $6.3 million and had a working
capital deficit of $9.4 million. The principal component of this working
capital deficit was an account payable to USE of $9.4 million. During prior
periods, the Company has negotiated reductions of the amount due USE by issuing
shares of its common stock as payment. USE has agreed not to call the note
during the next 14 months. Should the Nukem litigation be resolved in favor of
the Company and USE, a significant portion of the Company's receipts would be
applied to the USE debt. The litigation may or may not be finally resolved in
2004.
CAPITAL RESOURCES
A major component of capital resources in the near future is the settlement
of the litigation with Nukem. Should the 10th CCA affirm the Judgment (without
modification) of the U.S. District Court of Colorado, the net award to the
Company would be approximately $10 million.
The Company holds interests in RMG and the investments that RMG has made.
Currently it is not management's position to sell these interests but should the
need arise to reduce debt or should other investments become available,
management may monetize the RMG investments and apply the proceeds to debt
reduction or alternate investments.
The Company, jointly with USE, has a $750,000 line of credit with a
commercial bank. The line of credit is secured by certain real estate holdings
and equipment jointly owned with USE. At December 31, 2003, the full line of
credit was available to the Company and USE. The line of credit could be used
for short term working capital needs associated with operations.
38
The capital resources at December 31, 2003, are not sufficient to satisfy
all the capital requirements of the Company. To provide the capital resources
needed for the next fiscal year, the Company will need to (1) continue to
successfully negotiate the terms of its debt with USE, (2) collect accounts
receivable which are held jointly with USE that are not consolidated but in
which the Company benefits when the cash is collected, (3) assist RMG in its
development of coalbed methane properties including the funding of that
development, and (4) successfully resolve the Nukem litigation.
CAPITAL REQUIREMENTS
The direct capital requirements of the Company during 2004 remain its
General and Administrative costs and expenses. The general and administrative
cash requirements during the year ended December 31, 2003 were $162,900. The
cash requirements for the seven months ended December 31, 2002 and the year
ended May 31, 2002 were $100,300 and $163,600, respectively. Management does
not anticipate entering into any business ventures which will increase the
general and administrative expenses until sufficient capital resources are
available.
The Company also is required to fund its portion of operations of USECC.
Due to reduced operations, these expenses have decreased during the past several
years. The amount of cash required for the Company's portion of USECC's capital
requirements during the year ended December 31, 2003, the seven months ended
December 31, 2002, and the fiscal years ended May 31, 2002 and 2001 was
$611,800, $892,900, $1,656,800 and $2,360,300, respectively. The capital
resources for the USECC operations continue to be provided by USE. It is
anticipated that the requirement during calendar 2004 will approximate the
amount spent in calendar 2003.
The Company's cash requirements for funding USE operations include general
and administrative costs and stand-by costs for mining properties. The Company
also participates in all cash flows generated by the Sheep Mountain uranium
Properties, the Plateau Resources uranium properties and the Sutter Gold
properties.
MAINTAINING URANIUM PROPERTIES
------------------------------
SMP URANIUM PROPERTIES
The care and maintenance costs associated with the Sheep Mountain uranium
mineral properties (of which the Company is responsible for 50%) decreased by
$11,500 during the year ended December 31, 2003 to approximately $16,500 per
month. 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 conducted during 2004.
PLATEAU RESOURCES URANIUM PROPERTIES
We are contractually obligated to fund 50% of the cash requirements of
Plateau and also share in 50% of any cash receipts of Plateau. USE is
responsible for the other 50%. Plateau owned the Ticaboo townsite, motel,
convenience store, boat storage, restaurant and lounge. During the year ended
December 31, 2003, the Company and USE sold their interests in the townsite
operations to a non-affiliated entity, The Cactus Group ("Cactus"). As a result
of the sale of the townsite, USE received 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 and the
Company will receive 50% of the benefit of the receipt of them. (See Note E)
39
Additionally, Plateau owns and maintains the Tony M uranium mine and
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. The Company received
the benefit of this release of cash.
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.
It is estimated that the Company and USE will incur approximately $500,000 in
reclamation related costs during calendar 2004. The Company is responsible for
one half of these expenditures. Although reclamation has been initiated on the
Plateau properties, management of the Company and USE continue to evaluate the
future of the properties as a result of the significant increases in the market
price for uranium to approximately $17 per pound U3O8 in March 2004 from
approximately $10.10 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 $50,000 to $75,000 per month during the year
ending December 31, 2004. The Company and USE share these costs equally.
SUTTER GOLD MINING COMPANY (SGMC)PROPERTIES
Because of the recent increase in the price of gold, management of Sutter
Gold has decided to place the properties controlled by it 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 the SGMC properties be self supporting and
thereby not requiring any capital resource commitment from the Company or USE.
Until such time as Sutter is able to raise its own capital, the Company and USE
will continue to fund SGMC on a one eighth - seven eighths basis. Management
projects that the total cash costs to be incurred in getting Sutter funded will
not exceed $120,000, one eighth of which will be the obligation of the Company.
(See Note J)
DEVELOPMENT OF COALBED METHANE PROPERTIES
---------------------------------------------
The majority of the costs during the year ended December 31, 2003 for the
development of RMG's coalbed methane 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 for the
benefit of RMG's portion only under this arrangement was $305,100. 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 RMG and CCBM contributed certain undeveloped and
producing coalbed methane properties to Pinnacle. RMG has the opportunity to
increase its ownership in Pinnacle by advancing cash to purchase common stock in
Pinnacle through the exercise of options, but that increase would be offset to
the extent other parties contribute additional capital to 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 E)
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
40
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. (See Part I "Acquisition of Producing
and Non-Producing Properties from Hi-Pro Production, LLC" and Note N to the
financial statements in this Annual Report).
Management of the Company believes that RMG's recent investment as well as
the development of its unproven properties will be financed through cash that
RMG has on hand as well as equity and industry partner financings. None of the
Company's capital resources should be needed therefore to fund operations or
development work of RMG during 2004.
All cash flows from gas production on the Hi-Pro properties are pledged to
pay the acquisition debt. See Note N to the financial statements in this Annual
Report and Part I, Acquisition of Producing and Non-Producing Properties from
Hi-Pro Production, LLC. The 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 for the debt.
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.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED MAY 31, 2002
- ---------------------------------------------------------------------------
The Company continued to have no revenues from operations as its mineral
properties are all on a care and maintenance status. The real estate properties
and other ventures that the Company participates in are not consolidated but are
reported as equity losses from affiliates.
Effective January 1, 2003, the Company adopted SFAS 143 "Accounting for
Asset Retirement Obligations." As a result of adopting SFAS 143, the Company
recorded $90,900 of accretion in relation to its reclamation liability on the
SMP uranium properties which was netted against the Company's cash expended on
SMP reclamation of $70,700 for a net expense of $11,200. The Company also
recognized a $293,800 cumulative effect as a result of the adoption of SFAS 143.
The Company did not have similar expenses or cumulative effects during the
fiscal year ended May 31, 2002.
The Company recognized equity losses of $2,114,600 from affiliates during
the year ended December 31, 2003. The reason for the increase of $290,700 over
the twelve months ended May 31, 2002 is the increased activities in RMG during
the year ended December 31, 2003. The equity loss recorded for the year ended
December 31, 2003 compared to the seven months ended December 31, 2002 and the
fiscal years ended May 31, 2002 and 2001 is as follows:
41
Year Ended Seven Months Ended
December 31, December 31, Year Ended May 31,
------------ ------------ --------------------------------
2003 2002 2002 2001
-------------- ------------ -------------- --------------
USECC $ (1,667,100) $ (897,300) $ (1,639,000) $ (2,210,600)
RMG (447,500) (157,700) (184,900) (286,100)
-------------- ------------ -------------- --------------
$ (2,114,600) $(1,055,000) $ (1,823,900) $ (2,496,700)
============== ============ ============== ==============
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 $293,800.
The Company recorded a net loss of $2,671,700 or $0.16 per share during
the year ended December 31, 2003 as compared to a loss of $1,998,900 or $0.12
per share during the fiscal year ended May 31, 2002
SEVEN MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THE SEVEN MONTHS ENDED DECEMBER
- --------------------------------------------------------------------------------
31, 2001
- ---------
The Company had no revenues during the seven month periods ended December
31, 2002 and 2001.
Costs and expenses during the seven month period ended December 31, 2002
decreased by $14,600 to $102,400 from the amount of costs and expenses incurred
during the seven month period ended December 31, 2001. This decrease was
primarily as a result of reductions in overhead relative to government filings
and the funding of the USE Employee Stock Option Plan for the employees that the
Company uses to conduct its business. These reductions in costs and expenses
were offset by a small increase in contract services.
During the seven months ended December 31, 2002 the Company recognized an
equity loss from affiliates of $1,055,000. This equity loss was realized from
USECC and RMG in the amounts of $897,300 and $157,700, respectively. The
increase during the seven months ended December 31, 2002 of $56,800 from the
equity loss recognized during the seven months ended December 31, 2001 was as a
result of an increase of the work performed in the natural gas business.
The Company recognized a loss of $1,157,400 for the seven months ended
December 31, 2002 as compared to the loss of $1,115,200 for the seven months
ended December 31, 2001 for the same reasons mentioned above.
FISCAL 2002 COMPARED TO FISCAL 2001
- ----------------------------------------
The Company had no revenues during the fiscal year ended May 31, 2002.
Mineral Revenues decreased $60,300 from revenues for the previous year. This
decrease was a result of Phelps Dodge suspending the payment of advance
royalties on the Mt. Emmons molybdenum property. The Company and USE are
involved in a legal action with Phelps Dodge to reinstate the advance royalty
payments. See Item 3 above.
During fiscal 2001, the Company recognized $3,566,400 in litigation
settlement revenues. These revenues came as a result of a settlement of
litigation with Kennecott Energy on the Green Mountain Mining Venture. Of this
amount, $2,000,000 was a non-cash recognition of a deferred purchase option for
cash received in a prior period. No litigation settlement revenues were
recognized during fiscal 2002.
42
Costs and expenses decreased by $14,100 during fiscal 2002 from fiscal
2001. This decrease was as a result of reductions in the workforce of the
Company and USE. The reduction in workforce reduced the Company's obligation to
fund retirement benefits. The Company recorded an equity loss from USECC and
RMG in the amounts of $1,823,900 and $2,496,700 for fiscal 2002 and 2001,
respectively.
Operations for fiscal 2002, resulted in a loss of $1,998,800 compared to
net earnings of $1,205,700 for fiscal 2001.
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 Company implemented the pronouncement effective
January 1, 2003.
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.
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 more 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 AND OIL. Our decisions to expand into the coalbed methane
industry were predicated on the projections for natural gas prices. We believe
that the energy demands of the United States of America will sustain higher
natural prices. The recent increase in price of oil will not materially affect
our operations for fiscal 2004.
URANIUM AND GOLD. Changes in the prices of uranium and gold will affect our
operational decisions the most. Currently, both gold and uranium have
experienced an increase in price. We continually evaluate market trends and data
and are seeking financing or a joint venture to place the Company's gold and
uranium properties in production. We are currently evaluating our gold and
uranium properties as market prices have increased to the level that these
properties could produce profitably. Management is evaluating how long this
trend will continue and at what level market prices for gold and uranium will
settle at for the long term.
MOLYBDENUM. Changes in prices of molybdenum are not expected to materially
affect our operations during fiscal 2004.
CONTRACTUAL OBLIGATIONS. The Company had two contractual obligations as of
December 31, 2003: Debt to USE of $9,408,300, which is due upon demand, and
asset retirement obligations of $1,053,300 which will be paid over a period of
five to seven years.
43
ITEM 8. FINANCIAL STATEMENTS
Financial statements meeting the requirements of Regulation S-X for the
Company follow immediately.
44
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
-------------------------------------------------------
Crested Corp. Board of Directors
We have audited the accompanying balance sheets of Crested Corp. as of December
31, 2003 and 2002 and May 31, 2002 and the related statements of operations,
shareholders' deficit 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 financial statements referred to above present fairly, in
all material respects, the financial position of Crested Corp. 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 A 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.
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. In
addition, the Company has a working capital deficit of $9,405,000 as of December
31, 2003, the substantial portion of which is owed to an affiliated entity.
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
45
CRESTED CORP.
BALANCE SHEET
ASSETS
December 31, May 31,
----------------------------- --------------
2003 2002 2002
-------------- ------------- -------------
CURRENT ASSETS:
Cash and cash equivalents $ 3,300 $ 3,300 $ 3,300
INVESTMENTS IN AFFILIATES 4,373,800 5,876,600 6,038,700
PROPERTIES AND EQUIPMENT
Library 10,000 10,000 10,000
Developed oil properties, full cost method 886,800 886,800 886,800
-------------- ------------- -------------
PROPERTIES AND EQUIPMENT 896,800 896,800 896,800
Less accumulated depreciation,
depletion and amortization (886,800) (886,800) (886,800)
-------------- ------------- -------------
10,000 10,000 10,000
OTHER ASSETS
Other assets -- -- 2,100
-------------- ------------- -------------
-- -- 2,100
-------------- ------------- -------------
$ 4,387,100 $ 5,889,900 $ 6,054,100
============== ============= =============
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Debt to affiliate $ 9,408,300 $ 8,553,900 $ 7,560,700
COMMITMENT TO FUND EQUITY INVESTEES 215,600 215,600 215,600
ASSET RETIREMENT OBLIGATION 1,053,300 748,400 748,400
COMMITMENTS AND CONTINGENCIES
FORFEITABLE COMMON STOCK, $.001 par value
15,000 shares issued, forfeitable until earned 10,100 10,100 10,100
SHAREHOLDERS' DEFICIT
Preferred stock, $.001 par value;
100,000 shares authorized
none issued or outstanding -- -- --
Common stock, $.001 par value; unlimited shares
authorized; 17,118,098, 17,099,276
and 17,099,276 respectively
shares issued and outstanding 17,200 17,200 17,200
Additional paid-in capital 11,804,800 11,795,200 11,795,200
Accumulated deficit (18,122,200) (15,450,500) (14,293,100)
-------------- ------------ ------------
TOTAL SHAREHOLDERS' DEFICIT (6,300,200) (3,638,100) (2,480,700)
-------------- ------------- -------------
$ 4,387,100 $ 5,889,900 $ 6,054,100
============== ============= =============
The accompanying notes are an integral part of these statements.
46
CRESTED CORP.
STATEMENTS OF OPERATIONS
Year Ended 7 mos Ended
December 31, December 31, Year Ended May 31,
------------ ------------ --------------------------
2003 2002 2002 2001
------------ ------------ ------------ ------------
REVENUES:
Mineral revenue $ -- $ -- $ -- $ 60,300
Interest -- -- -- 200
Litigation settlement -- -- -- 3,566,400
Other -- -- -- 264,600
------------ ------------ ------------ -----------
-- -- -- 3,891,500
COSTS AND EXPENSES:
Accreation of asset retirement obligation 90,900 -- -- --
General and administrative 172,400 102,400 175,000 189,100
------------ ------------ ------------ ------------
263,300 102,400 175,000 189,100
------------ ------------ ------------ ------------
(LOSS) INCOME BEFORE EQUITY LOSS, PROVISION
FOR INCOME TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE (263,300) (102,400) (175,000) 3,702,400
EQUITY IN LOSS OF AFFILIATES (2,114,600) (1,055,000) (1,823,900) (2,496,700)
------------ ------------ ------------ ------------
(LOSS) INCOME BEFORE PROVISION FOR INCOME
TAXES AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE (2,377,900) (1,157,400) (1,998,900) 1,205,700
PROVISION FOR INCOME TAXES -- -- -- --
------------ ------------ ------------ ------------
(LOSS) INCOME BEFORE CUMULATIVE EFFECT
OF ACCOUNING CHANGE (2,377,900) (1,157,400) (1,998,900) 1,205,700
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE (293,800) -- -- --
------------ ------------ ------------ ------------
NET (LOSS) INCOME $(2,671,700) $(1,157,400) $(1,998,900) $ 1,205,700
============ ============ ============ ============
PER SHARE DATA
NET (LOSS) INCOME PER SHARE, BASIC AND DILUTED
FROM CONTINUED OPERATIONS $ (0.14) $ (0.07) $ (0.12) $ 0.12
FROM EFFECT OF ACCOUNTING CHANGE (0.02) -- -- --
BASIC AND DILUTED $ (0.16) $ (0.07) $ (0.12) $ 0.12
============ ============ ============ ============
BASIC AND DILUTED WEIGHTED AVERAGE
SHARES OUTSTANDING 17,117,374 17,099,276 17,075,320 10,448,505
============ ============ ============ ============
The accompanying notes are an integral part of these statements.
47
CRESTED CORP.
STATEMENT OF SHAREHOLDERS' DEFICIT
Additional Total
Common Stock Paid-In Accumulated
-------------------
Shareholders'
Shares Amount Capital Deficit Deficit
---------- ------- ----------- ------------- ------------
Balance May 31, 2000 10,316,664 $10,400 $ 8,747,200 $(13,499,900) $(4,742,300)
Issuance of stock to directors 40,000 -- 9,600 -- 9,600
Release of forfeitable status 50,000 100 33,700 -- 33,800
Issuance of common stock
to retire debt 6,666,666 6,700 2,993,300 -- 3,000,000
Net income -- -- -- 1,205,700 1,205,700
---------- ------ ---------- ------------ -----------
Balance May 31, 2001 17,073,330 17,200 11,783,800 (12,294,200) (493,200)
Issuance of stock to directors 25,946 -- 11,400 -- 11,400
Net loss -- -- -- (1,998,900) (1,998,900)
---------- ------ ---------- ------------ -----------
Balance May 31, 2002 17,099,276 17,200 11,795,200 (14,293,100) (2,480,700)
Net loss -- -- -- (1,157,400) (1,157,400)
---------- ------ ---------- ------------ -----------
Balance December 31, 2002 17,099,276 17,200 11,795,200 (15,450,500) (3,638,100)
Issuance of stock to directors 18,822 -- 9,600 -- 9,600
Net loss -- -- -- (2,671,700) (2,671,700)
---------- ------ ---------- ------------ -----------
Balance December 31, 2003 17,118,098 $17,200 $11,804,800 $(18,122,200) $(6,300,200)
========== ======= =========== ============= ============
<FN>
Total Shareholders' Deficit at December 31, 2003, December 31, 2002 May 31, 2002
and May 31, 2001 does not include 15,000 shares currently issued but forfeitable
if certain conditions are not met by the recipients.
The accompanying notes are an integral part of this statement.
48
CRESTED CORP.
STATEMENTS OF CASH FLOWS
For the For the seven
year ended months ended For the year ended
December 31, December 31, May 31,
------------ ------------ --------------------------
2003 2002 2002 2001
------------ ------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $(2,671,700) $(1,157,400) $(1,998,900) $ 1,205,700
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Equity in loss of affiliates 2,114,600 1,055,000 1,823,900 2,496,700
Deferred GMMV purchase option -- -- -- (2,000,000)
Accretion of asset retirement obligation 90,900 -- -- --
Cumulative effect of accounting change 293,800 -- -- --
Noncash compensation 9,600 -- 11,400 9,600
Decrease in asset retirement obligation (79,800) -- -- --
Net changes in assets and liabilities -- 2,100 -- --
------------ ------------ ------------ ------------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES: (242,600) (100,300) (163,600) 1,712,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment -- -- -- 138,500
Investment in affiliates (611,800) (892,900) (1,656,800) (2,360,300)
------------ ------------ ------------ ------------
NET CASH USED IN INVESTING ACTIVITIES: (611,800) (892,900) (1,656,800) (2,221,800)
CASH FLOWS FROM FINANCING ACTIVITES:
Net activity on debt to affiliate 854,400 993,200 1,820,500 510,000
------------ ------------ ------------ ------------
NET (DECREASE) INCREASE IN
CASH AND CASH EQUIVALENTS -- -- 100 200
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 3,300 3,300 3,200 3,000
------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 3,300 $ 3,300 $ 3,300 $ 3,200
============ ============ ============ ============
SUPPLEMENTAL DISCLOSURES:
Interest paid $ - $ - $ - $ -
============ ============ ============ ============
Income tax paid $ -- $ -- $ -- $ --
============ ============ ============ ============
NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of stock to outside directors $ 9,600 $ -- $ 11,400 $ 9,600
============ ============ ============ ============
Issuance of stock for affiliate debt $ -- $ -- $ -- $ 3,000,000
============ ============ ============ ============
The accompanying notes are an integral part of these statements.
49
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
A. BUSINESS ORGANIZATION AND OPERATIONS:
Crested Corp. (the "Company" or "Crested") was incorporated in the State of
Colorado on September 18, 1970. It engages in the acquisition, exploration,
sale and/or development of mineral and coalbed methane gas properties, the
production of petroleum properties and marketing of minerals and/or methane gas
primarily through equity investees. Principal mineral interests are in coalbed
methane, uranium, gold and molybdenum. Only coalbed methane was producing
during the year ended December 31, 2003. The Company also holds various real
estate properties. These properties are managed through a non consolidated
joint venture discussed below and in Note B.
The Company and U.S. Energy Corp. ("USE"), an approximate 71.5% shareholder
of the Company, were engaged in the standby and maintenance of two uranium
properties, one a joint venture with Kennecott Uranium Company ("Kennecott")
known as the Green Mountain Mining Venture ("GMMV"), and the second known as
Sheep Mountain Partners ("SMP"). Both of these ventures have been involved in
significant litigation (see Note J). Sutter Gold Mining Company ("SGMC"), a
Wyoming corporation, manages the Company's and USE's interest in gold
properties. Rocky Mountain Gas, Inc. ("RMG"), was formed in fiscal 2000 to
consolidate all coalbed methane gas operations of the Company and USE. The
Company owns and controls approximately 39.8% of RMG as of December 31, 2003.
The Company changed its year end to December 31 from May 31 effective
December 31, 2002.
MANAGEMENTS PLAN
The Company has generated significant net losses prior to and including the
year ended December 31, 2003 resulting in an accumulated deficit of $18,122,200
at December 31, 2003. The Company also has a working capital deficit of
$9,405,000 at December 31, 2003 that includes $9,408,300 due to USE. The
Company experienced negative cash flows from operations of $242,600, $100,300
and $163,000 for the year ended December 31, 2003, the seven months ended
December 31, 2002 and the fiscal year ended May 31, 2002, respectively. The
Company had positive cash flows from operations during the fiscal year ended May
31, 2001 of $1,712,000. At December 31, 2003, the Company does not have
sufficient cash or cash flows from operations to meet its obligations. All of
these factors raise substantial doubt about the Company's ability to continue as
a going concern during the upcoming year.
The Company has historically relied on, and continues to rely on, advances
from USE to fund its current operating requirements. It is uncertain whether
this funding will continue. The Company has certain assets that are unencumbered
that could be sold to generate cash. However, there can be no assurances that
any funds generated from the sale of assets will be sufficient to meet the
Company's obligations.
In order to improve the liquidity of the Company, management intends to do
the following:
x Collect amounts due under the terms of certain notes receivable that it
shares the cash proceeds of with USE and their subsidiaries. These notes
receivable are as a result of the sale of certain coalbed methane interests
and real estate interests to non-affiliated entities.
50
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
x Assist RMG in obtaining financing for the development of its coalbed
methane properties and the acquisition of additional developed and
undeveloped coalbed methane properties.
x Raise equity funds through private placements of RMG common stock.
x Concluding the litigation with Nukem, Inc. ("Nukem") at December 31, 2003,
the Company and USE were awarded a $20 million plus judgment against Nukem
and its affiliates. Nukem has appealed this judgment to the Tenth Circuit
Court of Appeals.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
INVESTMENTS
Investments in joint ventures and 20% to 50% owned companies are accounted
for using the equity method. The Company accounts for its 3.7% investment in
USE using the equity method because the Company is controlled by USE. The
Company's investment in SGMC, RMG and USECC Joint Venture ("USECC") are
accounted for using the equity method (see Note E).
CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents.
PROPERTIES AND EQUIPMENT
The Company capitalizes all costs related to the acquisition, exploration
and development of mineral properties. Capitalized costs are charged to
operations when the properties are determined to have declined in value or have
been abandoned. The Company currently has no net capitalized costs associated
with mineral properties.
Oil and gas properties are accounted for using the full cost method.
Capitalized costs plus any future development costs are amortized by the
units-of-production method using proved reserves. Capitalized costs are subject
to an impairment test which limits capitalized costs less accumulated
amortization and related deferred income taxes to the present value of future
net revenues using current prices and operating costs discounted at 10%.
Depreciation of vehicles, machinery and equipment was provided by the
straight-line method over the estimated useful lives of the related assets. All
such vehicles, machinery and equipment have been fully depreciated.
LONG-LIVED ASSETS
The Company evaluates its long-lived assets 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 results of
operations. An uneconomic commodity market price, if sustained for an extended
period of time, or an inability to obtain
51
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
financing necessary to develop the mineral interests may result in asset
impairment. As of December 31, 2003, management believes no impairment of the
Company's long-lived assets exists.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash equivalents and other current assets
approximates fair value because of the short term nature of those instruments.
It is not practicable to determine fair value of debt to affiliate carried at
$9,408,300 and $8,553,900 respectively at December 31, 2003 and 2002.
REVENUE RECOGNITION
Advance royalties which are repayable only from future production or which
are non-refundable are recognized as revenue when received. Non-refundable
option deposits are recognized as revenue when the option expires.
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 carry forwards.
SFAS 109 requires recognition of deferred tax assets for the expected
future effects of all deductible temporary differences, loss carry-forwards and
tax credit carry-forwards. Deferred tax assets are then 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.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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.
52
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
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 in estimate 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.
The following is a reconciliation of the total liability for asset
retirement obligations
Balance December 31, 2002 $ 748,400
Impact of adoption of SFAS No. 143 293,800
Addition to Liability --
Liability Settled (79,800)
Accretion Expense 90,900
---------------
Balance December 31, 2003 $ 1,053,300
===============
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 $(2,377,900) $(1,157,400) $ (1,998,900) $1,205,700
Pro-Forma adjustments
net of tax -- (34,900) (57,100) (52,500)
------------ ------------ ------------ -----------
Pro-Forma net income (loss) $(2,377,900) $(1,192,300) $(2,056,000) $1,153,200
============ ============ ============ ===========
PER SHARE OF COMMON STOCK:
Reported net income (loss) basic
from continuing operations $ (0.14) $ (0.07) $ (0.12) $ 0.12
Pro-Forma adjustments
net of tax -- -- -- (0.01)
------------ ------------ ------------ -----------
Pro-Forma net income (loss) basis $ (0.14) $ (0.07) $ (0.12) $ 0.11
============ ============ ============ ===========
Reported net income (loss) diluted $ (0.14) $ (0.07) $ (0.12) $ 0.12
Pro-Forma adjustments -- -- -- (0.01)
------------ ------------ ------------ -----------
Pro-Forma net income (loss) diluted $ (0.14) $ (0.07) $ (0.12) $ 0.11
============ ============ ============ ===========
53
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
C. RELATED-PARTY TRANSACTIONS:
The Company does not have employees, but utilizes USE's employees and pays
for one-half of these costs under the USECC Joint Venture Agreement. 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's employees. As of December 31,
2003, December 31, 2002 and May 31, 2002 and 2001, the Board of Directors of USE
contributed 76,294, 43,867, 70,075 and 53,837shares of USE stock to the ESOP at
prices of $3.10, $3.08, $3.29 and $5.35 per share, respectively. The Company is
responsible for one-half of the value of these contributions or $118,300,
$67,600, $118,400 and $144,000 for the year ended December 31, 2003 and the
seven months ended December 31, 2002 and the years ended May 31, 2002 and 2001,
respectively, which was advanced through debt to affiliate. As of December 31,
2003, all shares of 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.
D. INVESTMENTS IN AFFILIATES:
The Company's investments in affiliates are as follows:
December 31, At May 31,
-------------------- ----------
Ownership 2003 2002 2002
--------- -------- --------- ----------
RMG 39.8% $ -- $ 447,500 $ 605,200
USECC 50.0% 4,367,100 5,422,400 5,426,800
SGMC 1.5% (85,500) (85,500) (85,500)
Yellow Stone Fuels Corp. ("YSFC") 13.2% (130,100) (130,100) (130,100)
USE 3.7% -- -- --
Others various 6,700 6,700 6,700
At December 31, 2003 and 2002 and May 31, 2002, investments of $4,373,800,
$5,876,600 and $6,038,700, respectively, are presented as investments in
affiliates in the accompanying balance sheets. A liability of $215,600 has been
presented as a commitment to fund equity investees as of December 31, 2003, 2002
and May 31, 2002 for these investments in affiliates that the Company must fund.
Equity (loss) gain from investments accounted for by the equity method is
as follows:
Year Ended Seven Months Ended
December 31, December 31, Year Ended May 31,
--------------- ------------- ----------------------------------
2003 2002 2002 2001
--------------- ------------- --------------- ---------------
USECC $ (1,667,100) $ (897,300) $ (1,639,000) $ (2,210,600)
SGMC -- -- -- -- --
YSFC -- -- -- -- --
RMG (447,500) (157,700) (184,900) (286,100)
USE -- -- -- -- --
--------------- ------------- --------------- ---------------
$ (2,114,600) $ (1,055,000) $ (1,823,900) $ (2,496,700)
=============== ============= =============== ===============
54
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
CONDENSED COMBINED BALANCE SHEETS:
EQUITY INVESTEES
Year Ended Seven Months Ended Year Ended
December 31, December 31, May 31,
------------- ------------ ------------
2003 2002 2002
------------- ------------ ------------
Current assets $ 17,871,200 $ 20,112,900 $ 18,601,900
Non-current assets 11,753,700 16,619,900 22,256,700
------------- ------------ ------------
$ 29,624,900 $ 36,732,800 $ 40,858,600
============= ============ ============
Current liabilities $ 3,641,600 $ 5,872,700 $ 4,787,300
Reclamation and other liabilities 12,120,700 12,404,700 11,897,800
Excess in assets 13,862,600 18,455,400 24,173,500
------------- ------------ ------------
$ 29,624,900 $ 36,732,800 $ 40,858,600
============= ============ ============
CONDENSED COMBINED STATEMENTS OF OPERATIONS:
EQUITY INVESTEES
Year Ended Seven Months Ended
December 31, December 31, Year Ended May 31,
------------ ------------- ------------- ------------
2003 2002 2002 2001
------------ ------------- ------------- ------------
Revenues $ 1,021,700 $ 563,500 $ 1,250,500 $ 8,249,900
Costs and expenses (8,881,600) (3,939,200) (8,565,500) (10,794,400)
Other income
and expenses (422,200) (309,600) 682,500 242,600
------------ ------------- ------------- ------------
Net loss $ (8,282,100) $ (3,685,300) $ (6,632,500) $(2,301,900)
============= ============= ============= ============
Condensed combined balance sheets and statements of operations of the
Company's equity investees include USECC, RMG, SGMC, YSFC and USE.
E. MINERAL TRANSACTIONS AND MINING PROPERTIES:
GMMV
During fiscal 1990, the Company and USE 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. (See Note J).
55
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
SMP
During fiscal 1989, Crested and USE, 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 J for the status of the related litigation/arbitration.
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 J).
PHELPS DODGE
During prior years, the Company and USE 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 1999. The properties have not
been placed into production as of December 31, 2003.
Amax and later Cyprus Amax paid the Company and USE an annual advance
royalty of 50,000 (25,000 lbs. each) pounds of molybdenum (or its cash
equivalent). During fiscal 2000, Phelps Dodge assumed this obligation and made
its first advance royalty payment to the Company and 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
fiscal 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 and
USE.
Per the contract with AMAX, the Company and USE are to receive 15% of the
first $25,000,000, or $3,750,000, if the properties are sold, which the Company
and USE believe occurred when Phelps Dodge purchased Cyprus Amax. Phelps Dodge
filed suit against the Company and USE on June 19, 2002 regarding these matters.
(See Note J).
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
taken an impairment on the associated assets.
During fiscal 2000, a visitor's center was developed and became
operational. SGMC 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 that management believes will allow SGMC to produce gold from
the property on
56
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
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 investors to obtain sufficient capital to complete the
development of the mine, construct a mill and place the property into
production. However, there can be no assurance that any funds will be obtained
and the development of the mine will occur. (See Note N).
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 the Plateau stock and agreed to
assume all environmental liabilities and reclamation bonding obligations. At
December 31, 2003, Plateau has a cash security in the amount of $6.8 million to
cover reclamation and annual licensing of the properties (see Note J). Although
the Company has no ownership in Plateau, Directors of the Company and USE have
agreed to divide equally a portion of certain reclamation obligations above a
defined amount, and will share equally in the cash flows derived from
operations.
The Company and USE are 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 and USE sold interests in the Ticaboo
Townsite in southern Utah 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.
Pursuant to the note agreement, the Company and USE are 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. The Company shares these cash flows on a
50-50 basis with USE.
57
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
ROCKY MOUNTAIN GAS, INC.
During fiscal 2000, the Company and USE 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 39.8% by the Company and 47.5% by USE.
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. 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 principal
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 due to a principal reduction of approximately $1.5 million. (See
Pinnacle below) The 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,
58
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
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 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 CFSB
contributed $5.0 million for 25% of the common stock of Pinnacle.
CSFB also contributed approximately $13.0 million of cash to Pinnacle in
return for the Redeemable Preferred Stock of Pinnacle ("Pinnacle Preferred
Stock"), 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 interests 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 note receivable
from CCBM to RMG. At December 31, 2003, the balance on the note
59
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
receivable for CCBM was $863,200. The principal reductions to the note
receivable from CCBM reduced the monthly principal payments to $53,000. The
receipt of payments from CCBM on the note receivable 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.
F. OIL AND GAS INFORMATION:
Costs related to the oil and gas activities of the Company were incurred as
follows:
For the For the seven For the
year ended months ended year ended
December 31, December 31, May 31,
-------------- -------------- ----------
2003 2002 2002
--------- --------- ---------
Company's share of equity method
investees' cost of property acquisition,
exploration and development $ 103,800 $ 288,400 $ 228,100
========= ========= =========
The Company had the following aggregate capitalized costs relating to the
Company's oil and gas activities as follows:
December 31, May 31,
------------------------ ----------
2003 2002 2002
--------- --------- ---------
Proved oil and gas properties $ 886,800 $ 886,800 $ 886,800
Less accumulated depreciation,
depletion and amortization 886,800 886,800 886,800
--------- ---------- ----------
$ -- $ -- $ --
========= ========== ==========
Company's share of equity method investees'
net capitalized costs $ 470,900 $1,961,600 $2,585,800
========= ========== ==========
No depreciation, depletion or amortization expense was recorded for the year
ended December 31, 2003, the seven months ended December 31, 2002 and the fiscal
years ended May 31, 2002 and 2001 respectively.
60
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
G. DEBT:
Obligations of the Company consist of advances payable to USE, which are
due upon demand. The obligation is due to U.S. Energy for funding a majority of
the operations of USECC, of which 50% is the responsibility of the Company. All
advances payable to USE are classified as current as of December 31, 2003,
December 31, 2002 and May 31, 2002 as a result of USE's unilateral ability to
modify the repayment terms.
December 31, May 31,
-------------------------- ------------
2003 2002 2002
------------ ------------ ------------
Advances payable - U.S. Energy
balance payable in full on
demand (see Note A) $ 9,408,300 $ 8,553,900 $ 7,560,700
============ ============ ============
<FN>
As of December 31, 2003, the Company and USE had a $ 750,000 line of credit
with a commercial bank. The line of credit bears interest at a variable rate
(5% 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, there was no
outstanding balance due under the line of credit. This line of credit is
secured by a share of the net proceeds of fees from production of oil wells and
certain assets of USECC.
H. INCOME TAXES:
The components of deferred taxes as of December 31, 2003 and 2002 and
May 31, 2002 are as follows:
December 31, May 31,
------------------------- ------------
2003 2002 2002
------------ ------------ ------------
Deferred tax assets:
Deferred compensation $ 3,400 $ 172,700 $ 131,200
Deferred gains 106,100 106,100 106,100
Non-deductible allowances 104,600 288,500 288,500
Net operating loss carry-forwards 5,085,900 4,306,400 3,636,200
Tax credits 15,000 15,000 15,000
Tax basis in excess of book basis -- -- 57,000
------------ ------------ ------------
Total deferred tax assets 5,315,000 4,888,700 4,234,000
Deferred tax liabilities:
Basis difference of investments (235,600) (131,800) --
Development and exploration costs (36,100) (36,100) (36,100)
------------ ------------ ------------
Total deferred tax liabilities (271,700) (167,900) (36,100)
------------ ------------ ------------
Net deferred tax assets
- all non-current 5,043,300 4,720,800 4,197,900
Valuation Allowance (5,043,300) (4,720,800) (4,197,900)
------------ ------------ ------------
Net deferred tax asset $ -- $ -- $ --
============ ============ ============
At December 31, 2003, the Company had available, for federal income tax
purposes, net operating loss carry-forwards of approximately $14,959,000 which
expire from 2006 through 2022. The Company has
61
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
established a valuation allowance for the full amount of the net deferred tax
assets due to the recurring losses of the Company and the uncertainty of the
Company's ability to generate future taxable income to utilize the NOL
carry-forwards. In addition, the use of the NOL carry-forwards may be limited by
Internal Revenue Service provisions governing significant change in company
ownership.
The valuation allowance increased $322,500 for the year ended December 31,
2003, increased $522,900 for the seven months ended December 31, 2002 and
increased (decreased) $255,900 and $(1,490,000) for the years ended May 31, 2002
and 2001, respectively.
The income tax provision 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:
Seven
Year Ended Months Ended
December 31, December 31, Year Ended May 31,
------------ ----------- -----------------------
2003 2002 2002 2001
------------ ----------- ---------- ------------
Expected federal income tax
expense (benefit) $ (808,500) $ (394,000) $(679,600) $ 410,000
Losses from subsidiaries not
consolidated for tax purposes,
utilization of net operating
losses and other 486,000 (128,900) 423,700 1,080,000
Valuation allowance 322,500 522,900 255,900 (1,490,000)
------------ ----------- ---------- ------------
Income taxes $ -- $ -- $ -- $ --
============ =========== ========== ============
<FN>
There were no taxes payable as of December 31, 2003, 2002 or, May 31, 2002
or 2001.
I. SHAREHOLDERS' EQUITY:
The Boards of Directors of the Company from time to time, issued stock
bonuses to certain directors, employees and third parties. These shares are
forfeitable to the Company until earned. The Company is responsible for the
compensation expense related to these issuances. For the year ended December
31, 2003, the seven months ended December 31, 2002 and the years ended May 31,
2002 and 2001, the Company did not recognize compensation expense resulting from
these issuances. A schedule of forfeitable shares for Crested is set forth in
the following table:
62
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
Issue Number Issue Total
Date of Shares Price Compensation
----- --------- ----- ------------
June 1990 25,000 $1.06 $ 26,562
December 1990 7,500 .50 3,750
January 1993 6,500 .22 1,430
January 1994 6,500 .28 1,828
January 1995 6,500 .19 1,230
January 1996 5,000 .3125 1,600
January 1997 8,000 .9375 7,500
Release of Earned Shares (50,000) (33,800)
-------- -----------
Balance at
December 31, 2003 15,000 $ 10,100
========= ============
J. 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 Crested and USE 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
Crested and USE 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 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."
63
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
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 extensions 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.
See "Business - Commercial Operations - Real Estate and Other Commercial
Operations - Colorado Properties" above.
PHELPS DODGE LITIGATION
Crested and USE, 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 in USECC's agreement
64
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
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 Crested
and USE 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, Crested
and USE 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
reversionary 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 reversionary 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, 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, certain of its affiliates
(including Crested and USE) and some 20 other defendants. The plaintiff is
seeking to
65
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
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 or
Crested 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.
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. 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 result of operations.
RECLAMATION AND ENVIRONMENTAL LIABILITIES
Most of the Company's and USE's exploration activities are subject to
federal and state regulations that require the Company and USE to protect the
environment. The Company and USE conduct their operations in accordance with
these regulations. The Company's and USE's current estimates of their
reclamation obligations and their current level of expenditures to perform
ongoing reclamation may change in the future. At the present time, however, the
Company and USE cannot predict the outcome of future regulation or impact on
costs. Nonetheless, the Company and USE have recorded their 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
66
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
Company's and USE's reclamation, environmental and decommissioning liabilities.
The Company and USE believe the recorded amounts are consistent with those
reviews and related bonding requirements. To the extent that production on their
properties is delayed, interrupted or discontinued because of regulation or the
economics of the properties, the future earnings of the Company and USE would be
adversely affected. The Company and USE believe they have 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 USE's environmental obligations relate to
former mining properties acquired by the Company and USE. Since the Company and
USE currently do not have properties in production, the Company's and USE'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 in the future. The Company and USE
also do 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 December 31, 2003, estimated reclamation obligations related to the
above mentioned mining properties total $7,264,700. Crested's portion of this
obligation is $1,053,300, which is reflected on the balance sheet of the
Company. The remaining balance of $6,211,400 is an obligation of USE and its
other affiliates, (excluding Crested). 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 USE currently have three 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:
SMP
---
The Company and USE are equally 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, USE and the regulatory authorities during the year
ended December 31, 2003 and the balance in the reclamation liability account at
December 31, 2003 of $2,106,600 (2 accrued by Crested) is believed by management
to be adequate. The Company and USE are 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 USE 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 USE completed the
required reclamation on the Ion Exchange Plant. A final reclamation report has
been submitted to the regulatory agencies. Although this report has not been
audited by the regulatory agency, no further reclamation cost is anticipated.
67
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
SUTTER GOLD MINING COMPANY
-----------------------------
SGMC's mineral properties are currently in a shut down status and have
never been in production. SGMC has recorded a reclamation liability as of
December 31, 2003 that is covered by a $27,400 reclamation cash bond.
PLATEAU RESOURCES, LIMITED
----------------------------
The environmental and reclamation obligations acquired with the acquisition
of Plateau include obligations relating to the Shootaring Mill. As of December
31, 2003, the reclamation liability on the Plateau properties was $5,364,000.
Plateau held a cash deposit for reclamation in the amount of $6,778,700.
EXECUTIVE COMPENSATION
The Company and USE are committed to pay the surviving 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 and USE. 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.
68
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
K. 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 $ -- $ --
Costs and expenses 102,400 117,000
------------ ------------
Loss before equity in affiliates (102,400) (117,000)
Equity in loss in affiliates (1,055,000) (998,200)
------------ ------------
Loss before income taxes (1,157,400) (1,115,200)
Provision for income taxes -- --
------------ ------------
Net loss $(1,157,400) $(1,115,200)
============ ============
PER SHARE DATA:
Revenues $ -- $ --
Costs and expenses 0.01 0.01
------------ ------------
Loss before equity loss (0.01) (0.01)
Equity in loss of affiliates (0.06) (0.06)
------------ ------------
Loss before income taxes (0.07) (0.07)
Provision for income taxes -- --
------------ ------------
Net loss basic and diluted $ (0.07) $ (0.07)
============ ============
Weighted average common shares outstanding
Basic and diluted 17,099,276 17,073,330
============ ============
69
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
M. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
------------------------------------------------------
March 31, June 30, September 30, December 31,
2003 2003 2003 2003
------------ ------------ ------------ ------------
Operating revenues $ -- $ -- $ -- $ --
Operating loss (59,200) (75,200) (64,200) (64,700)
Equity in loss from affiliate (373,500) (1,026,800) (371,200) (343,100)
------------ ------------ ------------ ------------
Net loss $ (726,500) $(1,102,000) $ (435,400) $ (407,800)
============ ============ ============ ============
Loss per share, basic and diluted $ (0.04) $ (0.06) $ (0.03) $ (0.02)
============ ============ ============ ============
Basic and diluted weighted average
shares outstanding 17,115,137 17,118,098 17,118,098 17,118,098
============ ============ ============ ============
Three Months Ended
------------------------------------------------------
May 31, February 28, November 30, August 31,
2002 2002 2001 2001
------------ ------------ ------------ ------------
Operating revenues $ -- $ -- $ -- $ --
Operating loss (37,300) (38,300) (51,400) (48,000)
Equity in loss from affiliate (505,800) (502,800) (237,100) (578,200)
------------ ------------ ------------ ------------
Net loss $ (543,100) $ (541,100) $ (288,500) $ (626,200)
============ ============ ============ ============
Loss per share, basic and diluted $ (0.03) $ (0.03) $ (0.02) $ (0.04)
============ ============ ============ ============
Basic and diluted weighted average
shares outstanding 17,073,330 17,073,330 17,073,330 17,073,330
============ ============ ============ ============
70
CRESTED CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002 AND MAY 31, 2002, 2001
(Continued)
N. 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 box 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 and USE through Sutter 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 takeover 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 produce initially, 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 agreement by the Directors and
Shareholders of both companies, and approval by Canadian regulatory authorities.
71
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
To Board of Directors U.S. Energy Corp. and Crested Corp.:
We have audited the accompanying balance sheets of USECB Joint Venture (a
Wyoming Joint Venture) as of December 31, 2003 and 2002 and May 31, 2002, and
the related statements of operations, partners' capital 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 Partnership's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (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 present fairly, in all material
respects, the financial position of USECB Joint Venture as of December 31, 2003
and 2002 and May 31, 2002, and the results of its operations and its 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.
The accompanying financial statements have been prepared assuming the
Partnership will continue as a going concern. As discussed in Note A to the
financial statements, the Partnership has experienced significant losses from
operations during three of the periods presented. These factors raise
substantial doubt about the ability of the partnership 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
June 20, 2004
72
USECB JOINT VENTURE
BALANCE SHEETS
ASSETS
DECEMBER 31, DECEMBER 31, MAY 31,
2003 2002 2002
-------------- -------------- ------------
CURRENT ASSETS:
Cash $ 176,200 $ 525,000 $ 536,800
Accounts receivable,
net of allowance of $27,800 9,900 -- 37,500
Inventory 21,800 9,700 23,900
Current portion of notes receivable 56,100 148,600 229,000
Prepaid insurance 98,500 137,400 57,500
-------------- -------------- ------------
TOTAL CURRENT ASSETS 362,500 820,700 884,700
PROPERTIES AND EQUIPMENT
Land and improvements 561,200 561,200 743,900
Buildings and improvements 4,498,200 4,498,300 4,706,200
Equipment 3,403,000 3,371,100 3,227,000
Other 35,900 35,900 35,900
-------------- -------------- ------------
8,498,300 8,466,500 8,713,000
Less accumulated depreciation (3,796,200) (3,513,200) (3,524,800)
-------------- -------------- ------------
4,702,100 4,953,300 5,188,200
OTHER ASSETS
Restricted cash 247,500 145,300 154,700
Notes receivable
Trade 8,500 17,300 36,800
Related parties 5,756,100 7,786,200 7,497,900
Deposits and other 355,400 351,100 348,300
-------------- -------------- ------------
6,367,500 8,299,900 8,037,700
-------------- -------------- ------------
$ 11,432,100 $ 14,073,900 $14,110,600
============== ============== ============
73
USECB JOINT VENTURE
BALANCE SHEETS
LIABILITIES AND CAPITAL
DECEMBER 31, DECEMBER 31, MAY 31,
2003 2002 2002
------------- ------------- -----------
CURRENT LIABILITIES:
Accounts payable $ 436,700 $ 317,200 $ 327,100
Accrued expenses 97,600 96,600 11,900
Current portion of long-term debt 136,800 202,100 295,400
Other current liabilities 5,000 5,000 5,000
------------- ------------- -----------
TOTAL CURRENT LIABILITIES 676,100 620,900 639,400
HEALTH INSURANCE OBLIGATIONS 247,500 176,700 149,100
LONG TERM DEBT, net of current portion 1,271,100 1,637,300 1,516,100
COMMITMENTS AND CONTINGENCIES (Note F)
CAPITAL
U. S. Energy 4,618,700 5,819,500 5,903,000
Crested Corp 4,618,700 5,819,500 5,903,000
------------- ------------- -----------
9,237,400 11,639,000 11,806,000
------------- ------------- -----------
$ 11,432,100 $ 14,073,900 $14,110,600
============= ============= ===========
74
USECB JOINT VENTURE
STATEMENTS OF OPERATIONS
SEVEN MONTHS
YEAR ENDED ENDED
DECEMBER 31, DECEMBER 31, YEAR ENDED MAY 31,
2003 2002 2002 2001
------------ ------------ ------------ ------------
OPERATING REVENUES:
Commercial operations $ 103,700 $ 94,000 $ 231,100 $ 98,600
Sale of uranium -- -- -- 334,300
Management fees 427,100 197,500 378,900 533,600
------------ ------------ ------------ ------------
530,800 291,500 610,000 966,500
OPERATING COSTS AND EXPENSES:
Commercial operations 237,900 146,500 230,600 294,200
Mine holding costs 1,500,500 596,600 1,465,300 2,495,300
General and Administrative 2,448,500 1,412,900 2,662,800 2,801,800
------------ ------------ ------------ ------------
4,186,900 2,156,000 4,358,700 5,591,300
------------ ------------ ------------ ------------
OPERATING LOSS (3,656,100) (1,864,500) (3,748,700) (4,624,800)
OTHER INCOME & EXPENSES
Sale of Assets 1,200 160,700 693,400 512,200
Interest Income 42,500 25,500 42,500 59,000
Other -- 27,800 13,400 89,300
Litigation settlement -- -- -- 7,132,800
Interest Expense (194,600) (83,100) (197,300) (219,300)
------------ ------------ ------------ ------------
(150,900) 130,900 552,000 7,574,000
------------ ------------ ------------ ------------
(LOSS) INCOME FROM
CONTINUING OPERATIONS (3,807,000) (1,733,600) (3,196,700) 2,949,200
DISCONTINUED OPERATIONS -- -- (81,300) (237,700)
------------ ------------ ------------ ------------
NET (LOSS) INCOME $(3,807,000) $(1,733,600) $(3,278,000) $ 2,711,500
============ ============ ============ ============
75
USECB JOINT VENTURE
STATEMENTS OF CASH FLOWS
SEVEN MONTH
YEAR ENDED PERIOD ENDED FISCAL YEAR ENDED
DECEMBER 31, DECEMBER 31, YEAR ENDED MAY 31,
------------ ------------ --------------------------
2003 2002 2002 2001
-------------- -------------------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (3,807,000) $ (1,733,600) $(3,278,000) $ 2,711,500
Adjustments to reconcile net (loss) income
to net cash used in operating activities:
Depreciation, depletion and amortization 303,000 172,300 357,800 630,300
Gain on sale of assets (1,200) (160,700) (693,400) (512,200)
Write off of properties -- 21,500 -- --
Change in other assets (4,300) (2,800) (17,700) (2,300)
Change in health insurance obligations 70,800 27,600 35,700 (97,000)
Net changes in components of working capital
Accounts receivable (9,900) 37,500 1,248,600 (262,000)
Inventory (12,100) 14,200 4,700 5,100
Current portion of notes receivable 92,500 80,400 -- --
Prepaid insurance 38,900 (79,900) (7,200) (33,900)
Accounts payable 119,500 (9,900) (485,800) (17,700)
Deferred income -- -- -- (4,000,000)
Accrued expenses 1,000 84,700 (12,700) (60,500)
-------------- -------------------- ------------ ------------
NET CASH USED IN
OPERATING ACTIVITIES (3,208,800) (1,548,700) (2,848,000) (1,638,700)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of property and equipment 32,800 557,200 1,073,700 1,948,600
Purchase of property and equipment (83,400) (355,400) (176,700) (1,645,400)
Net activity on restricted cash (102,200) 9,400 (77,100) 142,100
Net activity on notes receivable affiliates 2,030,100 (288,300) 128,600 (2,013,300)
Proceeds advanced on notes receivable -- -- (260,500) (16,300)
Payments from notes receivable 8,800 19,500 37,000 147,500
-------------- -------------------- ------------ ------------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES 1,886,100 (57,600) 725,000 (1,436,800)
CASH FLOWS FROM FINANCING ACTIVITIES:
Contributions from partners 1,405,400 1,566,600 3,313,600 1,572,800
Proceeds from third party debt 150,500 392,800 379,100 2,138,800
Repayments of debt (582,000) (364,900) (1,087,700) (581,300)
-------------- -------------------- ------------ ------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 973,900 1,594,500 2,605,000 3,130,300
-------------- -------------------- ------------ ------------
76
USECB JOINT VENTURE
STATEMENTS OF CASH FLOWS
(CONTINUED)
SEVEN MONTH
YEAR ENDED PERIOD ENDED FISCAL YEAR ENDED
DECEMBER 31, DECEMBER 31, YEAR ENDED MAY 31,
------------ ------------ --------------------------
2003 2002 2002 2001
-------------- -------------------- ------------ ------------
NET (DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS $ (348,800) $ (11,800) $ 482,000 $ 54,800
CASH AND CASH EQUIVALENTS
AT THE BEGINNING OF THE PERIOD 525,000 536,800 54,800 --
-------------- -------------------- ------------ ------------
CASH AND CASH EQUIVALENTS
AT THE END OF THE PERIOD $ 176,200 $ 525,000 $ 536,800 $ 54,800
============== ==================== ============ ============
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 194,600 $ 83,100 $ 197,300 $ 219,300
============== ==================== ============ ============
77
USECB JOINT VENTURE
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
FROM MAY 31, 2000 TO DECEMBER 31, 2003
U.S. Energy Crested Corp. Total
------------- --------------- ------------
Balance May 31, 2000 $ 3,743,050 $ 3,743,050 $ 7,486,100
Capital contributions 786,400 786,400 1,572,800
Net income 1,355,750 1,355,750 2,711,500
------------- --------------- ------------
Balance May 31, 2001 5,885,200 5,885,200 11,770,400
Capital contributions 1,656,800 1,656,800 3,313,600
Net loss (1,639,000) (1,639,000) (3,278,000)
------------- --------------- ------------
Balance May 31, 2002 5,903,000 5,903,000 11,806,000
Capital contributions 783,300 783,300 1,566,600
Net loss (866,800) (866,800) (1,733,600)
------------- --------------- ------------
Balance December 31, 2002 5,819,500 5,819,500 11,639,000
Capital contributions 702,700 702,700 1,405,400
Net loss (1,903,500) (1,903,500) (3,807,000)
------------- --------------- ------------
Balance December 31, 2003 $ 4,618,700 $ 4,618,700 $ 9,237,400
============= =============== ============
78
USECB JOINT VENTURE
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2003 AND 2002, MAY 31, 2002 AND MAY 31, 2001
A. BUSINESS ORGANIZATION AND OPERATIONS:
USECB Joint Venture was formed in the State of Wyoming on August 1, 1981.
USECB (the "Partnership" or "USECB") is equally owned by U. S. Energy Corp.
("USE") and its subsidiary Crested Corp. ("Crested"). As such it manages 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 held by USE
and Crested are in coalbed methane, uranium, gold and molybdenum. The uranium
and gold properties are currently all in a shut down status. USE and Crested
also hold various real and personal properties used in commercial activities.
The Partnership has generated significant net losses prior to and including
the year ended December 31, 2003. The Partnership also has a working capital
deficit of $313,600 at December 31, 2003. The Partnership experienced negative
cash flows from operations of $3,208,800, $1,545,700, $2,848,000 and $1,638,700
for the year ended December 31, 2003, the seven months ended December 31, 2002
and the fiscal year ended May 31, 2002 and 2001, respectively. At December 31,
2003, the Partnership does not have sufficient cash or cash flows from
operations to meet its obligations. All of these factors raise substantial doubt
about the Partnership's ability to continue as a going concern during the
upcoming year.
The Partnership has historically relied on, and continues to rely on,
contributions from USE and Crested to fund its current operating requirements.
It is uncertain whether this funding will continue. The Partnership has certain
assets that are unencumbered that could be sold to generate cash. However, there
can be no assurances that any funds generated from the sale of assets will be
sufficient to meet the Partnership's obligations.
The year end for USECB was changed to December 31 effective December 31,
2002.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
CASH EQUIVALENTS
The Partnership considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. The Partnership
maintains its cash and cash equivalents in bank deposit accounts which exceed
federally insured limits. At December 31, 2003, the Partnership had its cash and
cash equivalents with one financial institution. The Partnership 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 CASH
Under its health insurance plan for employees, the partnership deposits
cash in a restricted account to fund the payment of potential insurance claim
obligations.
ACCOUNTS RECEIVABLE
The majority of the Partnership's accounts receivable are due from
affiliates of USE and Crested. The Partnership determines any required allowance
by considering a number of factors including length of time
79
accounts receivable are past due and the Partnership's previous loss history.
The Partnership writes off accounts receivable when they become uncollectible,
and payments subsequently received on such receivables are credited to the
allowance for doubtful accounts.
INVENTORIES
Inventories consist of aviation fuel and gold and silver bullion.
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.
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 Headquarters' Building 45 years
LONG-LIVED ASSETS
The Partnership evaluates its long-lived assets 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, 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 Partnership's financial position and results
of operations.
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.
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 Partnership purchased
80
all uranium delivered under supply contracts from the open market as all of USE
and Crested's uranium operations are shut down.
Management fees are recorded as a percentage of actual costs for services
provided for affiliated entities for which the Partnership provides management
services. The Partnership 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
No provision for income taxes is recorded in the financial statements of
the Partnership due to the fact that it is a joint venture and, therefore, not
subject to income tax. The tax effects of the Partnership's operations accrue to
the members.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America 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 periods financial
statements in order to conform with the presentation for the 2003 year.
RECENT ACCOUNTING PRONOUNCEMENTS
The Partnership has reviewed 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 Partnership.
C. RELATED PARTY TRANSACTIONS:
The Partnership provides management and administrative services for
affiliates under the terms of various management agreements. The Partnership
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 for USE and Crested and their subsidiaries.
D. DEBT:
LINES OF CREDIT
- -----------------
The Partnership 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 and matured on June 1,
2004. Effective June 29, 2004, the line of credit had been extended through
December 31, 2004.
81
LONG-TERM DEBT-CONTINUED
- -------------------------
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
----------- ----------- -----------
Installment notes to financial institutions
collateralized by equipment; interest
at 5.0% to 9.0%, matures in 2004-2009 $1,407,900 $1,839,400 $1,611,600
Less current portion (136,800) (202,100) (295,400)
----------- ----------- -----------
$1,271,100 $1,637,300 $1,316,200
=========== =========== ===========
Principal requirements on long-term debt are $136,800, $104,200; $107,200;
$1,046,300; $11,700 and $1,700 for the years ended December 31, 2004 through
2008, and thereafter, respectively.
E. COMMITMENTS, CONTINGENCIES AND OTHER:
SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION
During fiscal 1989, USE and Crested, through the Partnership, entered into
an agreement to sell a 50% interest in their Sheep Mountain properties to a
subsidiary of Nukem Inc., CRIC. USE, Crested 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.
In 1991, disputes arose between USE and Crested 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,
USECB 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. USECB 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 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 USECB the
balance of the damage award. Nukem did so, but then moved for a satisfaction of
judgment without accounting for the
82
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. All required briefs have been filed by both
parties for consideration by the Tenth Circuit Court of Appeals. Management
believes that the ultimate outcome of this matter will not have an adverse
affect on the Partnership's financial condition or results of operations.
F. DISCONTINUED OPERATIONS.
During the third quarter of the fiscal year ended May 31, 2002, USECB made
the decision to discontinue its drilling/construction segment. The assets
associated with this business segment were sold and or converted for use
elsewhere by USECB. The financial statements for the fiscal year ended May 31,
2001 have been revised to present the effect of discontinued operations.
G. TRANSITION PERIOD COMPARATIVE DATA
Seven Months Ended
December 31,
--------------------------
2002 2001
------------ ------------
(Unaudited)
Revenues $ 291,500 $ 258,300
Cost and Expenses 2,156,000 2,782,800
------------ ------------
Operating Loss (1,864,500) (2,524,500)
Other Income and Expenses 130,900 411,100
------------ ------------
Loss before Discontinued Operations (1,733,600) (2,113,400)
Discontinued Operations, net of tax -- (99,600)
------------ ------------
Net Loss $(1,733,600) $(2,213,000)
============ ============
83
H. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
----------------------------------------------------------------------------
December 31, September 30, June 30, March 31,
2003 2003 2003 2003
-------------------- ---------------- ----------------- -----------------
Operating Revenues $ 107,400 $ 124,600 $ 163,500 $ 135,300
==================== ================ ================= =================
Operating (loss) $ (1,436,200) $ (1,244,000) $ (250,900) $ (725,000)
==================== ================ ================= =================
(Loss) income from operations $ (1,502,600) $ (1,276,200) $ (290,400) $ (737,800)
Discontinued operations $ -- $ -- $ -- $ --
-------------------- ---------------- ----------------- -----------------
Net loss $ (1,502,600) $ (1,276,200) $ (290,400) $ (737,800)
==================== ================ ================= =================
Month Ended Three Months Ended
-------------------- -----------------------------------
December 31, November 30, August 31,
2002 2002 2002
-------------------- ---------------- -----------------
Operating Revenues $ 65,900 $ 115,900 $ 109,700
==================== ================ =================
Operating (loss) $ (356,000) $ (848,900) $ (659,600)
==================== ================ =================
(Loss) income from operations $ (392,800) $ (671,700) $ (669,100)
Discontinued operations $ -- $ -- $ --
-------------------- ---------------- -----------------
Net (loss) $ (392,800) $ (671,700) $ (669,100)
==================== ================ =================
Three Months Ended
----------------------------------------------------------------------------
May 31, February 28, November 30, August 31,
2002 2002 2001 2001
-------------------- ---------------- ----------------- -----------------
Operating Revenues $ 114,800 $ 36,100 $ 328,400 $ 130,700
==================== ================ ================= =================
Operating (loss) $ (834,000) $ (977,100) $ (754,800) $ (1,182,800)
==================== ================ ================= =================
(Loss) income from operations $ (675,400) $ (1,015,500) $ (372,100) $ (1,133,700)
Discontinued operations $ 33,700 $ (19,500) $ (102,100) $ 6,600
-------------------- ---------------- ----------------- -----------------
Net (loss) income $ (641,700) $ (1,035,000) $ (474,200) $ (1,127,100)
==================== ================ ================= =================
84
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.
85
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
December 31, 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 is incorporated herein by reference to our Proxy Statement
for the 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, WY 82501.
INFORMATION CONCERNING EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS.
The following information is provided pursuant to Instruction 3, Item 401
of Reg. S-K, regarding certain of the executive officers of Crested who is not
also a director.
ROBERT SCOTT LORIMER, age 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 of these companies since May 25, 1991,
their Treasurer since December 15, 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,
he has not been involved in any Reg. S-K Item 401(f) listed proceeding.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by Item 11 is incorporated herein by reference to
the Proxy Statement for the Meeting of Shareholders to be held in June 2004,
under the caption "Director's Fees and Other Compensation."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by Item 12 is incorporated herein by reference to
the Proxy Statement for the Meeting of Shareholders to be held in June 2004,
under the caption "Principal Holders of Voting Securities."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by Item 13 is incorporated herein by reference to
the Proxy Statement for the Meeting of Shareholders to be held in June 2004,
under the caption "Certain Relationships and Related Transactions."
86
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 Ended December 31, 2002
Audit Fees(a) $ 27,600 $ 24,100
Audit-Related Fees(b) $ -- $ --
Tax Fees(c) $ 5,500 $ 2,800
All Other Fees(d): $ -- $ --
(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 83% (90%); Tax
Fees 17% (10%); and All Other Fees 0% (0%).
87
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES,
REPORTS AND FORM 8-K.
(a) The following financial statements are filed as a part of this Report as
Item 8:
Page No.
---------
(1) Financial Statements
Registrant and Affiliate
Report of Independent Public Accountants
Grant Thornton LLP . . . . . . . . . . . . . . . . . . . . . . . . .45
Balance Sheets - December 31, 2003 and 2002
May 31, 2002. . . . . . . . . . . . . . . . . . . . . . . . . . .46
Statements of Operations
for the Year ended December 31, 2003, the seven months ended
December 31, 2002 and the Years Ended May 31, 2002 and 2001. . . . . .47
Statements of Shareholders'
Deficit for the Year ended December 31, 2003, the seven months ended
December 31, 2002 and the Years Ended May 31, 2002 and 2001. . . . . .48
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 and 2001. . . . . .49
Notes to Financial Statements. . . . . . . . . . . . . . . . . .50-71
Report of Independent Public Accountants
Grant Thornton LLP . . . . . . . . . . . . . . . . . . . . . . . . 72
USECB Joint Venture Balance Sheets December 31, 2003 and 2002
May 31, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . .73-74
USECB Joint Venture Statements of Operations
for the Year ended December 31, 2003,
the seven months ended December 31, 2002
and the years Ended May 31, 2002 and 2001 . . . . . . . . . . . . . . 75
USECB Joint Venture 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 and 2001 . . . . . . . . .76-77
USECB Joint Venture Statements of Changes in Partners' Capital
from May 31, 2000 to December 31, 2003 . . . . . . . . . . . . . . . 78
USECB Joint Venture Notes to Financial Statements . . . . . . . . .79-84
(2) All other schedules have been omitted because the required information
is inapplicable or is shown in the notes to financial statements.
88
(3) Exhibits Required to be Filed.
Exhibit Sequential
No. Title of Exhibit Page No.
------ ------------------ ----------
3.1 Restated Articles of Incorporation. . . . . . . . . . . . . .[1]
3.1(a) Articles of Amendment to the Articles
of Incorporation of Rocky Mountain Gas, Inc.
(to establish Series A Preferred Stock in March 2004). . . . . .*
3.2-3.3 [intentionally left blank]
3.4 By-Laws. . . . . . . . . . . . . . . . . . . . . . . . . . . .[2]
4.1 USE 1998 Incentive Stock Option Plan
and Form of Stock Option Agreement. . . . . . . . . . . .[6]
4.2 Form of Stock Option Agreement and
Schedule, Options granted 1992. . . . . . . . . . . . . . .[4]
4.3 Form of Stock Option Agreement and
Schedule, Options granted 1/96. . . . . . . . . . . . . . .[4]
4.4 USE Restricted Stock Bonus Plan
as Amended through 2/94). . . . . . . . . . . . . . . . . .[4]
4.5 Amendment to USE 1998 Incentive Stock Option Plan
(To Include Family Transferability of Options
Under SEC Rule 16b)). . . . . . . . . . . . . . . . . . . .[9]
4.6 Form of Stock Option Agreement and
Schedule, Options granted January 10, 2001). . . . . . . .[9]
4.7 USE 1996 Stock Award Program (Plan)). . . . . . . . . . .[5]
4.8 USE Restated 1996 Stock Award Plan and Amendment
to USE 1990 Restricted Stock Bonus Plan). . . . . . . . .[5]
4.9 USE 2001 Stock Award Plan). . . . . . . . . . . . . . . .[10]
10.1 Promissory Note from Crested to USE (5/31/97)). . . . . .[5]
10.2 Management Agreement - USE - CC). . . . . . . . . . . . .[3]
10.3 Joint Venture Agreement - Registrant and USE). . . . . . .[2]
10.4-10.58 [intentionally left blank]
89
10.59 Closing Agreement - Addendum to Agreement
for Purchase and Sale of Assets (see Exhibit 10.60). . . . . .[9]
10.60 Agreement for Purchase and Sale of Assets
(Rocky Mountain Gas, Inc. and Quantum Energy LLC)). . . . . .[7]
10.61 Purchase and Sale Agreement
CCBM, Inc. (subsidiary of Carrizo Oil & Gas, Inc.)
and Rocky Mountain Gas, Inc.) . . . . . . . . . . . . . .[10]
10.62-10.66 [intentionally left blank]
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]
14.0 Code of Ethics. . . . . . . . . . . . . . . . . . . . . . . . .*
21 Subsidiaries of Registrant). . . . . . . . . . . . . . . . . [9]
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
By Reference
- -------------
[1] Incorporated by reference from the like-numbered exhibits to the
Registrant's Form 10-K for the year ended May 31, 1989.
[2] Incorporated by reference from the like-numbered exhibits to the
Registrant's Form 10-K for the year ended May 31, 1990.
[3] Incorporated by reference from the like-numbered exhibits to the
Registrant's Form 10-K for the year ended May 31, 1991.
[4] Incorporated by reference from the like-numbered exhibits of the
Registrant's Form 10-K for the year ended May 31, 1996.
90
[5] Incorporated by reference from the like-numbered exhibits of the
Registrant's Form 10-K for the year ended May 31, 1997.
[6] Incorporated by reference from the like-numbered exhibits of the
Registrant's Form 10-K for the year ended May 31, 1998.
[7] Incorporated by reference from the like-number exhibit of the
Registrant's Form 10-K for the year ended May 31, 2000.
[8] [intentionally left blank]
[9] Incorporated by reference from the like-number exhibit of the
Registrant's Form 10-K for the year ended May 31, 2001.
[10] Incorporated by reference from the like-number exhibit of the
Registrant's Form 10-K for the year ended May 31, 2002.
[11]-[21] [intentionally left blank]
[22] Incorporated by reference from the exhibit filed with the Registrant's
Form 8-K, filed July 22, 2003
[23] [intentionally left blank]
[24] Incorporated by reference from the exhibit filed with the Registrant's
Form 8-K, filed February 17, 2004.
(b) Reports filed on Form 8-K.
During the fourth quarter ended December 31, 2003, the Registrant
filed one report on Form 8-K dated December 24, 2003.
(c) Required exhibits follow the signature page and are listed above under
Item 15 (a)(3).
(d) Required financial statement of significant 50% or less owned investee
will be filed by an amendment.
91
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CRESTED CORP.
(Registrant)
Date: March 26, 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 26, 2004 By: /s/ John L. Larsen
---------------------------
JOHN L. LARSEN, Director
Date: March 26, 2004 By: /s/ Daniel P. Svilar
---------------------------
DANIEL P. SVILAR, Director
Date: March 26, 2004 By: /s/ Michael D. Zwickl
---------------------------
MICHAEL D. ZWICKL, Director
Date: March 26, 2004 By: /s/ Robert Scott Lorimer
---------------------------
ROBERT SCOTT LORIMER,
Principal Financial Officer
and Chief Accounting Officer
92