Form 10-Q for CRESTED CORP
14-Aug-2006
Quarterly Report
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following is Management's Discussion and Analysis ("MD&A") 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. For a detailed explanation of the Company's Business Overview, it is suggested that Management's Discussion and Analysis of Financial Condition and Results of Operations for the six months ended June 30, 2006 be read in conjunction with the Company's Form 10-K for the year ended December 31, 2005. The discussion contains forward-looking statements that involve risks and uncertainties. Due to uncertainties in our business, actual results may differ materially from the discussion below.
General Overview
Crested Corp. ("Crested" or 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, and oil and gas. The Company also has been engaged to a limited extent in commercial real estate, primarily in connection with acquiring mineral properties which included commercial real estate.
The Company manages its operations through a non-consolidated joint venture, USECC Joint Venture ("USECC"), with its parent company, U.S. Energy Corp. ("USE"). USE owns 71% of the Company's common stock. The Company has entered into partnerships through which it either joint ventured or leased properties with non-related parties for the development and production of certain of its mineral properties. The Company had no production from any of its mineral properties during the six months ended June 30, 2006.
Until the calendar year ended December 31, 2005, the Company's uranium and gold properties were shut down due to depressed metals prices. During 2005 and 2006, the market prices for gold, uranium and molybdenum increased to levels which may allow the Company to place these properties into production or sell part or all of them to industry participants. Exploration work was resumed on the uranium properties in 2005 and new uranium properties have been acquired.
Uranium - The price of uranium concentrate has increased from a five year low of $7.25 per pound in January 2001 to a five year high of $46.50 per pound on June 30, 2006. (Ux Weekly)
Gold - The five year low for gold was $265 per ounce in July of 2001. The market price for gold has risen since that time to a five year high of $719.88 per ounce on May 11, 2006. The price for gold on June 30, 2006 was $613.50 per ounce. (Metal Prices.com).
Molybdenum - Annual Metal Week Dealer Oxide mean prices for molybdic oxide averaged $24.73 per pound during the six months ended June 30, 2006, compared with annual averages of: $32.94 per pound in 2005, $16.41 per pound in 2004, $5.32 per pound in 2003 and $3.77 per pound in 2002. The mean price for Dealer Oxide on June 30, 2006 was $25.75 per pound. (Metal Prices.com). Continued strong demand, which has outpaced supply over the past several years (deficit market conditions), has reduced inventory levels throughout the industry.
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The Company holds mineral and related properties in uranium and gold and, with USE, received the Mt. Emmons project which is now known as the Lucky Jack project, a significant molybdenum property from Phelps Dodge Corporation ("PD") on February 28, 2006. The rebound in uranium, gold and molybdenum therefore presents an opportunity for the Company to either develop or sell all or a portion of these properties to a third party.
Management's strategy to generate a return on shareholder equity is first, to demonstrate prospective value in the mineral properties sufficient to support substantial investments by large industry partners and second, to structure these investments to bring capital and long term development expertise to move the properties into production.
The principal uncertainties in the successful implementation of our strategy are:
· Whether a feasibility study will show volumes and grades of mineralization and manageable costs of mining, transportation and processing, which are sufficient to make a profit and to bring industry partners to the point of investment; and
· Whether USECC can negotiate terms with industry partners which will return a substantial profit to the Company for its retained interest and the project's development costs to that point in time.
To some extent, the economic feasibility of a particular property can be changed with modifications to the mining, transportation, milling and/or processing plans. However, the overall principal drivers to attainment of the business strategy are the quality and volume of the minerals in the ground, cost of production, and commodity prices.
Please see the risk factor disclosures of this Report for more information on the risks and uncertainties in the business.
Forward Looking Statements
This Report on Form 10-Q for the six months ended June 30, 2006 and Form 10-K for the year ended December 31, 2005 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. In addition, whenever words like "expect", "anticipate", or "believe" are used, the Company is making forward looking statements. Actual results may vary materially from the forward-looking statements and there is no assurance that the assumptions used will be realized in fact.
Critical Accounting Policies
Asset Impairments - We assess the impairment of property and equipment whenever events or circumstances indicate that the carrying value may not be recoverable.
Asset Retirement Obligations - The Company's policy is to accrue the liability for future reclamation costs of its mineral properties based on the current estimate of the future reclamation costs as determined by internal and external experts.
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Use of Accounting Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
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.
Marketable Securities - The Company accounts for its marketable securities under Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity Securities, which requires certain securities to be categorized as either: trading, available-for-sale or held-to-maturity. Based on the Company's intent to sell the securities its equity securities are carried at market value with net gains or (losses) recorded in the Statement of Operations at each reporting period depending on the market value at close of accounting period.
Recent Accounting Pronouncements
SFAS 123(R) In December 2004, the FASB issued its final standard on accounting for employee stock options, FAS No. 123 (Revised 2004), "Share-Based Payment" ("FAS123(R)"). FAS 123(R) replaces FAS No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"), and supersedes Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". FAS 123(R) requires companies to measure compensation costs for all share-based payments, including grants of employee stock options, based on the fair value of the awards on the grant date and to recognize such expense over the period during which an employee is required to provide services in exchange for the award. The pro forma disclosures previously permitted under FAS 123 will no longer be an alternative to financial statement recognition. FAS 123 (R) is effective for all awards granted, modified, repurchased or cancelled after, and to unvested portions of previously issued and outstanding awards vesting after, interim or annual periods, beginning after June 15, 2005, which for us was the first quarter of fiscal 2006. No stock-based employee compensation cost is reflected in net income for the six months and quarter ended June 30, 2006, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant and they were issued and vested prior to June 15, 2005. All future issuances of options under the plan will be evaluated using the Black Scholes model and expensed over the term of the option.
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.
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Liquidity and Capital Resources
As of June 30, 2006 the Company had sold 100,000 units of its Enterra trading securities. The Company received $1,295,500 from the sales of this stock and therefore had $1,418,900 in cash as of June 30, 2006. The Company also has 145,759 units of Enterra which are recorded as trading securities with a market value of $1,966,400 at June 30, 2006.
Additionally, at June 30, 2006, the Company had a working capital deficit of approximately $9,050,600 and a shareholders' deficit of approximately $17,572,200. The principal component of the working capital deficit is a debt payable to USE in the amount of approximately $12,329,600, which USE has agreed not to demand payment of during the next 14 months. The debt to USE increased $919,600 during the quarter ended June 30, 2006 and $1,507,800 during the six months then ended.
During the six months ended June 30, 2006 the Company consumed $1,331,000 investing activities while operations and financing activities generated $1,241,200 and $1,413,600 respectfully. Although the Company recorded a net loss of $2,223,900 during the six months ended June 30, 2006 the majority of the loss were non-cash expenditures relating to an equity loss from USECC in the amount of $344,300, the exchange of the Enterra Acquisitions shares of stock to Enterra Energy Trust units of $1,354,200, the change in valuation of the derivative associated with the conversion feature of the Enterra Acquisition units of $223,600, the loss on the sale of Enterra units $53,500, noncash compensation of $94,200 and the accretion of reclamation liabilities of $99,800.
As a result of the decision of the U.S. Federal District Court of Colorado, and the Company's decision to appeal that decision, the Company and USE must bond $7,538,340 as an award granted by the Court to Phelps Dodge Corporation ("PD") in relation to ongoing litigation regarding the Lucky Jack molybdenum project in Colorado. The Company will also have to continue to pay interest at the rate of
5 ½% on the judgment until such time as the judgment is either overturned or ultimately paid. The Company has reviewed FAS 5, "Accounting for Contingencies", and has determined that the likelihood of prevailing in the appeal is reasonably possible. Although a completely accurate prediction can not be made of the ultimate outcome or timing of an appeal, the Company's legal expert in the matter believes that the Company will ultimately prevail in overturning the U.S. District Court's award of attorney fees and costs. The proceeds from the sale of the Enterra units are expected to be sufficient to fund the bonding requirements of the appeal.
The Company received $1,295,500 from the sale of Enterra stock during the six months ended June 30, 2006. These funds were invested into USECC in the amount of $1,331,000, which resulted in the consumption of $35,300 in Investing Activities. Financing activities during the six months ended June 30, 2006 consisted of borrowings from USE in the amount of $1,413,600.
The Company believes that the current market prices for gold, uranium and molybdenum are at levels that warrant the exploration and development of the Company's mineral properties. Management of the Company anticipates these metals prices will remain at levels which will allow the properties to be produced economically. Management of the Company therefore believes that sufficient capital will be available to develop its mineral properties from strategic industry partners, debt financing, and the sale of equity or a combination of the three. The successful development and production of these properties could greatly enhance the liquidity and financial position of the Company.
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Capital Resources
Enterra Energy Trust
The Company received 245,759 units of Enterra Energy Trust ("Enterra") in June of 2006 as an automatic conversion from Enterra Acquisition shares which it received when it sold its interest in Rocky Mountain Gas, Inc. ("RMG") during calendar 2005. During the month of June, 2006 the Company sold 100,000 of the Enterra units. It received $1,295,500 for the sale of these units. Management of the Company plans on selling the balance of the Enterra units, 145,759 units, during the third and fourth quarters of calendar 2006. At June 30, 2006 the market price for the Enterra units was $13.49 per share. The price for the Enterra units has decreased since that time and at July 28, 2006 it was $11.97 per share. Part of the decrease in the price of Enterra units is attributed to Enterra announcing that it was reducing its monthly dividend from $0.18 per share to $0.12 per share. In the event that the Company can obtain the current market price for the Enterra units it owns it would receive approximately $1.7 million.
Pinnacle Gas Resources, Inc.
USECC owns a minority interest in Pinnacle Gas Resources, Inc. ("Pinnacle"). Enterra is entitled to be paid an amount of up to (but not more than) $2,000,000, if proceeds from a future disposition by USECC to a third party of their minority equity interest in Pinnacle exceeds $10,000,000. On May 10, 2006, Pinnacle filed a registration statement with the Securities and Exchange Commission relating to sales of its common stock by the selling stockholders named therein. Information about Pinnacle can be obtained from its registration statement, on file with the SEC at www.sec.gov. This registration statement has not yet become effective. USECC owns 9.8% of the outstanding common stock of Pinnacle and is participating in the public offering. Once this registration statement becomes effective, management of the Company and USE may sell some or all of their equity in Pinnacle.
Uranium Power Corp.
On December 8, 2004 Uranium Power Corp. ("UPC") signed a Purchase and Sales Agreement with USECC to purchase an undivided 50% interest in the Sheep Mountain properties. The agreement was amended on January 13, 2006.
UPC paid USECC $850,000 in calendar 2005, and issued 1,000,000 UPC shares to USECC (1/2 each to USE and Crested) in 2004 and 2005. As a result of the amendment, UPC has paid an additional $1,975,000 and issued 1.5 million more shares for a total of 2.5 million shares, against the purchase price. USECC sold 203,500 of these shares as of June 30, 2006 which generated $78,000 in net cash. These funds are used to pay operating costs of USECC.
An additional $4.1 million and 1.5 million shares are required to pay the full purchase price: $1.5 million on April 29, 2007 and $1.25 million on October 29, 2007 (provided UPC is required to pay 50% of all money it raises after January 13, 2006 until the two $1.5 million payments are made); and two additional payments each of $800,000 cash and 750,000 UPC shares (total $1,600,000 cash and 1,500,000 UPC shares) on June 29, 2007 and December 29, 2007.
USECC and UPC will each be responsible for paying 50% of (i) current and future Sheep Mountain reclamation costs in excess of $1,600,000, and (ii) all costs to maintain and hold the properties. UPC will contribute up to $10,000,000 to the joint venture (at $500,000 for each of 20 exploration projects). USECC and UPC each will be responsible for 50% of costs on each jointly approved project in excess of $500,000. As of June 30, 2006, UPC had funded $613,600 of the costs related to the properties in the venture. Of that amount the venture had expended $568,500.
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Closing of the agreement is required on or before December 29, 2007. UPC may terminate the agreement before closing, in which event UPC (i) would forfeit all payments made up to the termination date; (ii) lose all of its interest in the properties to be contributed by USECC under the agreement; (iii) lose all rights to additional properties acquired in the joint venture as well as forfeit all cash contributions to the joint venture, and (iv) be relieved of its share of reclamation liabilities existing at December 8, 2004.
Sutter Gold
On April 11, 2006, SGMI announced that it closed a non-brokered $759,100 private placement of 4,250,000 shares of its common stock at $0.18 per share. Each share also had an attached transferable warrant exercisable for two years at $0.27. Proceeds from this private placement will be used to fund additional exploratory/development core drilling on its Lincoln Gold Project.
On May 31, 2006, SGMI announced successfully closing a $2,818,900. The private placement consisted of 12,062,000 units at $0.225 per unit. Each unit comprises one common share and one 24-month warrant. Each warrant can be exercised to purchase one common share at a price of $0.315 per share. Proceeds from this private placement will fund a combined underground and surface diamond drill program and, if warranted, a feasibility study on its Sutter Gold Mine which is an advanced stage gold project in the historic Mother Lode located about 50 miles southeast of Sacramento, California.
Line of Credit
The Company, jointly with USE, has a $500,000 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 June 30, 2006, the full line of credit was available to the Company and USE. This line credit is used for short term working capital needs associated with operations.
Other
On May 15, 2006, the Arbitration Panel ("Panel") in the Nukem and Sheep Mountain Partners ("SMP") case issued a Clarification of the Arbitration Award as a result of the remand to the Panel by the United States District Court for the District of Colorado pursuant to the Order of the 10th Circuit Court of Appeals. In its Clarification of the Arbitration Award, the Panel held that the Constructive Trust was intended to secure the payment of the original damage award of $15 million and it was extinguished upon Nukem's payment of that damage award to USECC. The Company therefore will not receive its portion of the previously disclosed $20 million judgment from Nukem.
The Company's capital resources at June 30, 2006, are not sufficient to satisfy all the capital requirements of the Company. To provide the capital resources needed for the next calendar year, the Company will need to (1) continue to successfully negotiate the terms of its debt with USE and (2) sell its Enterra units and/or equity.
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Capital Requirements
The direct capital requirements of the Company during 2006 remain its general and administrative costs; expenses and funding of exploration drilling; the holding costs of the Sheep Mountain uranium properties in Wyoming and a uranium mill and uranium properties in southern Utah, Colorado and Arizona and the maintenance of jointly owned real estate. During the six months ended June 30, 2006, the Company and USE reacquired the Mt. Emmons molybdenum property, now known as the Lucky Jack Project ("Lucky Jack"), from PD. In addition to receiving the Lucky Jack property the Company and USE became the owners of a water treatment plant which is attached to the property and thereby responsible for the operation of the plant.
Maintaining Mineral Properties
Uranium Properties
The agreement with UPC calls for UPC to fund 50% of the expenses associated with maintaining the Sheep Mountain uranium properties in central Wyoming and five other uranium projects and performing exploration drilling on them. A budget of $2.3 million for the year ending December 31, 2006 has been approved, relating to reclamation work at the uranium properties, exploration drilling, geological and engineering work and other costs. UPC has also agreed to fund the first $500,000 of all approved projects up to a total of $10,000,000 and has advanced $613,600 against the 2006 approved budget. In the first half of 2006, a total of $568,500 was expended under these approved projects. The average care and maintenance costs associated with the Sheep Mountain uranium mineral properties in Wyoming is approximately $200,000 per year of which UPC is required to pay 50% annually.
Plateau Resources Limited, Inc., Uranium Properties
The Company is contractually obligated to fund 50% of the cash requirements of Plateau Resources Limited, Inc. ("Plateau") and will share in 50% of any cash receipts of Plateau. USE is responsible for the other 50%. Although the Company participates in 50% of the cash flow from Plateau; 100% of the common stock of Plateau is owned by USE. Plateau owns and maintains the Shootaring Canyon Uranium Mill (the "Shootaring Mill"). In March 2005, Plateau filed an application with the State of Utah to restart the Shootaring Mill. If management's projections of placing the Shootaring Mill into production hold, reclamation on the property is not anticipated to commence until some time in 2033.
It is anticipated that $31 million will be required to modify the Shootaring Mill's tailings facility to the State of Utah standards and complete other mill upgrades before production can begin. Additionally, a circuit to process vanadium, which is contained in almost all of the mineralized material found in nearby properties, may be added to the Shootaring Mill. In order to fund the refurbishment of the Shootaring Mill and acquire additional uranium properties from which to produce uranium bearing ores, USECC is seeking joint venture partners or equity participants. Once the State of Utah grants Plateau an operating license for the Shootaring Mill the bonding requirement will be increased.
On February 27, 2006, Plateau re-acquired, by Foreclosure Sale, the Ticaboo townsite operations ("Ticaboo") located in southern Utah near Lake Powell. The Ticaboo property includes a motel, restaurant and lounge, convenience store, recreational boat storage and service facility, and improved residential and mobile home lots. On April 12, 2006 Plateau signed a contract with ARAMARK Sports and Entertainment Services, Inc. for the management and operation of Ticaboo. Initially, the Company will be responsible for capital up-grades to the Ticaboo properties which are currently estimated to be approximately $250,000.
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Agreement with Uranium Power Corp.
USECC and Uranium Power Corp. ("UPC") signed an option agreement on May 11, 2006 to add two new projects; the Green River North and the Green River South projects, located in Emery County, Utah. USECC and UPC will hold equal interests in UPC's rights to earn 70% under the Initial Option, and another 10% under the Additional Option, in the Green River South project. For the Initial Option, UPC will provide the first $500,000, and USECC will provide the second $500,000. The cash payment and the exploration and development commitment for the Additional Option will be equally funded by UPC and USECC. For the UPC stock component on both the Initial Option and the Additional Option, USECC will pay UPC (in cash, UPC stock, or the Company and USE stock) 50% of the lesser of (i) UPC's stock price at the time the stock is issued by UPC , and (ii) Cdn$1.00 per share.
The Green River South project, previously known as the Sahara Property, was optioned by UPC from the Uranium Group ("UG") pursuant to an Amended and Restated Option and Joint Venture Agreement. Under this agreement, UPC has an option to earn a 70% interest (the "Initial Option") by making payments to UG of $585,000 and 200,000 shares of UPC stock and paying $1,365,000 for exploration and development activities, all over the four years ending December 31, 2009. Until the Initial Option is exercised, UPC will be solely responsible for paying property maintenance costs. At any time after UPC has paid the full price for the Initial Option (whether with the last installment on December 31, 2009, or earlier), UPC can earn a further 15% interest (the "Additional Option") by paying UG an additional $300,000, issuing to UG 400,000 more UPC shares, and spending an additional $700,000 (over the year following exercise of the Additional Option) on exploration and development work.
If the long term price of uranium oxide is below $20.00 per pound for four consecutive weeks in any calendar year, the payments for that year will be reduced by 50% and the balance deferred to the next year. If the uranium oxide price continues below $20.00, (or recovers but then falls below $20.00 in one or more subsequent years) the balance will be deferred to the next year or years after 2010.
After exercise of the Initial Option (and the Additional Option, if exercised), UG and UPC will fund programs and budgets in proportion to their interests in the property. A party's interest will be reduced in proportion to its non-funding of costs. If a party's interest is reduced to 10% or less, its interest will be converted to either a 10% net profits interest or a 2% gross income royalty.
At such time as the Initial Option is exercised, UPC is required to make available to UG a three year $1 million revolving loan (8% simple interest on outstanding balance) for purposes of UG funding its obligations on the project.
UPC (or its designee) is the manager of the project, and will be entitled to compensation (for reasonable management costs, not for profit) of not more than 10% of direct costs associated with exploration activities, plus not more than 2% of direct costs associated with contract work related to development and mining and the purchase of capital equipment. These percentages are subject to adjustment by the parties.
UPC will own a 50% interest in the Green River North project through its . . .
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U.S. Energy Corp. is a diversified natural resource company. Through its subsidiaries, Crested Corp., Sutter Gold Mining Inc., Plateau Resources Limited, U.S. Moly Corp. and U.S. Uranium Ltd., it owns interests or properties prospective for gold, uranium, vanadium and molybdenum. The Company also owns an equity interest in Pinnacle Gas Resources, Inc., a private coalbed methane company.
U. S. Energy Corp.'s objective is to capitalize on the tremendous opportunities in the minerals markets today. U.S. Energy Corp. is listed on the Nasdaq Capital Market under the symbol USEG.
Website
http://www.usnrg.com/default.php
Corporate Profile
U.S. Energy Corp. is a diversified natural resource company. Through its subsidiaries, Crested Corp., Sutter Gold Mining Inc., Plateau Resources Limited, U.S. Moly Corp. and U.S. Uranium Ltd., it owns interests or properties prospective for gold, uranium, vanadium and molybdenum. The Company also owns an equity interest in Pinnacle Gas Resources, Inc., a private coalbed methane company.
U. S. Energy Corp.'s objective is to capitalize on the tremendous opportunities in the minerals markets today. U.S. Energy Corp. is listed on the Nasdaq Capital Market under the symbol USEG.
Corporate Objectives
* Increase shareholder value by monetizing mineral assets over the next 2 years
* Capitalize on significant recent increases in commodity prices
* Acquire additional mineral assets
* Resolve outstanding litigation with Nukem
Management Team
CEO - Keith G. Larsen is the Chief Executive Officer and Chairman of the Board of the Company. He is also a director and Co-Chairman of Crested Corp., director for U.S. Uranium Ltd. and U.S. Moly Corp. and former CEO and director of Rocky Mountain Gas, Inc. Mr. Larsen also serves on the Board of Directors of Pinnacle Gas Resources, a private natural gas company.
President & COO - Mark J. Larsen is the President and Chief Operating Officer of the Company. He is the former President/Director of Rocky Mountain Gas, Inc. until its sale on June 1, 2005. Mr. Larsen was appointed President and Chief Operating Officer of the Company in October 2005 and is also the President of U.S. Moly Corp. Mr. Larsen also serves on the Board of Directors of Pinnacle Gas Resources, a private natural gas company. He received a B.S. degree in Business Administration from the University of Wyoming.
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