Sunday, November 26, 2006 6:33:16 PM
Form 10-Q for CRESTED CORP
14-Nov-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 nine months ended September 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 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 nine months ended September 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. Continued strong demand, which has outpaced supply over the past several years (deficit market conditions), has reduced inventory levels throughout the industry.
Exploration work was resumed on the uranium properties in 2005 and new uranium properties have been acquired during 2006. The Company and USE re-acquired the Lucky Jack ("Lucky Jack") molybdenum property near Crested Butte, Colorado during the nine months ended September 30, 2006. The Company and USE's interest in gold is being developed at Sutter Creek, California through exploration and development drilling which is being paid for by funds raised in an offering of Sutter Gold Mining, Inc. ("Sutter") common stock.
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 $60.00 per pound on October 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 October 31, 2006 was $604.10 per ounce (Metal Prices.com).
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Molybdenum - The five year low for molybdic oxide was $3.77 per pound in 2002. The five year high of molybdic oxide was $39.50 per pound on June 2, 2005. The price for molybdic oxide was $25.50 per pound on October 27, 2006. (Metal Prices.com).
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 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 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; and
· 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 or other investors to the point of further investment.
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 nine months ended September 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. 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.
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.
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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 nine months and quarter ended September 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.
Liquidity and Capital Resources
As of September 30, 2006 the Company had sold all of its Enterra Energy Trust ("Enterra") units, 245,759 units, that were converted from the Enterra Acquisitions Class D ("Acquisitions") shares on June 8, 2006. The Company received $2,991,000 in net cash proceeds. The Company also sold its minority interest in Pinnacle Gas Resources, Inc. ("Pinnacle") for $4,830,000.
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Although the Company received these cash proceeds during the quarter ended September 30, 2006 it continued to have a working capital deficit of $10,592,300 and a shareholders' deficit of $20,069,900. The principal component of the working capital deficit is a debt payable to USE in the amount of $14,335,400. The debt to USE increased $2,005,800 during the quarter ended September 30, 2006 and $3,513,600 during the nine months then ended.
During the nine months ended September 30, 2006 the Company consumed $3,641,000 in operations while investing and financing activities generated $4,749,700 and $3,317,800 respectively. The Company recorded a net loss of $4,758,700 during the nine months ended September 30, 2006. The major component of the loss was a negotiated settlement payment to Phelps Dodge Corporation ("PD") in the amount of $3.5 million. The settlement was as a result of an order from the Federal District Court of Colorado in favor of PD wherein the Company and USE were ordered to pay PD $7,538,300 plus interest at 5.5% per annum. Rather than appeal the award, the parties agreed on a settlement $7.0 million, of which the Company was obligated to pay one half. The Company had sufficient working capital to pay the settlement amount.
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.
Capital Resources
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 $2,100,000 and issued 1.5 million more shares for a total of 2.5 million shares, against the purchase price. USECC had sold 1,000,000 of these shares as of September 30, 2006 which generated $398,100 in net cash to USECC which is not a consolidated entity in the Company's financial statements. 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: $1.0 million on April 29, 2007 and $1.5 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.
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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 exploration drilling, geological and engineering work, reclamation and other costs associated with the uranium properties. UPC has also agreed to fund the first $500,000 in expenditures for up to 20 projects up to a total of $10,000,000. The Company, USE and UPC each will be responsible for 50% of costs on each jointly approved project in excess of $500,000. As of September 30, 2006, UPC has funded a total of $1,696,500. 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.
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.
sxr Uranium One Agreement
On July 10, 2006, the Company and USE signed an Exclusivity Agreement with sxr Uranium One Inc. ("Uranium One" or "SXR"), which is headquartered in Toronto, Canada with offices in South Africa and Australia (TSE and JSE "SXR"). Upon signing the Exclusivity Agreement, the Term Sheet (signed by Uranium One and by the Company and USE on June 22, 2006) became effective. The Term Sheet sets forth the terms of a proposed sale of the majority of the Company and USE uranium assets to Uranium One.
Under the terms of the Exclusivity Agreement, Uranium One paid USECC, which is not consolidated by the Company, $750,000 cash (nonrefundable, except for material breach of the Exclusivity Agreement) for the exclusive right to purchase the Company and USE uranium assets, including the Shootaring Canyon uranium mill in southeast Utah (and all geological libraries and other intellectual property related to the acquired assets and the mill), for a period of up to 270 days (an initial six month period, plus an optional three month extension). During this time, the parties will prepare definitive acquisition agreements. Subject to satisfactory results on Uranium One's due diligence review and obtaining all required approvals associated with the sale and purchase of the assets, the definitive agreements would be signed and the sale closed as soon as possible.
The Company and USE have continued exploratory and other work on some of the assets subject to the Exclusivity Agreement during the quarter ended September 30, 2006. The Exclusivity Agreement provides that when the assets acquisition is closed, Uranium One will reimburse the Company and USE for those expenses which have been pre-approved by Uranium One.
Under the Term Sheet, Uranium One has the right to purchase the assets under the following terms:
· $49,250,000 in Uranium One common stock at a set price at closing (the set price is the volume weighted average price of Uranium One stock for the 10 days prior to signing the Exclusivity Agreement, which is $7.45 U.S. or $8.32 Cdn per share). This represents the $50 million portion, less the cash paid for the Exclusivity Agreement.
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· $20 million in cash upon the start of commercial operation of the Shootaring Canyon uranium mill.
· $7.5 million in cash upon the first delivery of mineralized material to a commercial uranium mill from any of the purchased properties that are subject to the Agreement.
· A cash royalty equivalent to 5% of the revenues derived from the sales value of any commodity produced from the Shootaring Canyon uranium mill, to a maximum royalty payment of $12.5 million.
The Company and USE also hold a 4% net profits interest on Rio Tinto's Jackpot uranium property located on Green Mountain in Wyoming. This interest will not be included in the agreement to sell uranium assets to Uranium One. Uranium One has announced that it may acquire the Sweetwater mill and the Green Mountain properties from Rio Tinto, separate from the proposed transaction with the Company and USE.
If the Uranium One transaction closes, the Company and USE will own an equity interest in Uranium One. Capital and operating funds will not be required to maintain and modify the Shootaring Canyon Uranium Mill or any other uranium properties being sold to Uranium One.
Sutter Gold
During the second quarter of 2006, SGMI raised $3,173,700 of net proceeds from two private placements. Proceeds from these private placements will be used to fund additional exploratory/development core drilling on its Lincoln Gold Project.
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 September 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.
Cash on Hand
As discussed above the Company has monetized certain of its assets which have provided cash which will continue to be used to fund general and administrative expenses, limited exploration, development and required remedial work on its mineral properties and the maintenance of those properties and associated facilities such as the water treatment plant at the Lucky Jack property until such time as an industry partner is secured to develop the properties or they are sold.
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. On February 28, 2006, the Company and USE re-acquired the Lucky Jack molybdenum property 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.
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Maintaining Mineral Properties
Uranium Properties
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. There are also costs associated with the exploration and maintenance of the uranium properties in Utah, Colorado and Arizona. The majority of these costs are covered as a result of the agreements with UPC and SXR detailed above in Capital Resources. In the event that the sale of the properties to SXR is concluded all the costs of maintaining, exploring and developing and reclaiming these properties will be paid for by SXR and UPC.
Sutter Gold Mining Inc. (SGMI) Properties
Sutter initiated an 18,000 foot underground and surface drilling program during the second quarter 2006, to further delineate and define potential resources at the property. The 2006 drill program includes both underground and surface holes. As of September 30, 2006, 15 out of the 24 planned underground step-out and infill drill holes have been completed, which represents approximately 3,000 feet of the overall 18,000 foot surface and underground drill program. On September 14, 2006, Sutter announced that it intersected three new mineralized zones plus significant extensions to four shoots hosting previously reported mineral resources. The 9 to 12 hole surface drill program is to grid test an area containing what may be another significant mineralized zone in the K5 Vein, historically mined on Sutter's property at the South Spring Hill Mine.
The estimated cost of these projects is $897,500 also during the balance of calendar 2006. Capital to fund these projects was obtained from private placements of Sutter's common stock. See Capital Resources above.
Lucky Jack Molybdenum Property
The Company and USE re-acquired the Lucky Jack molybdenum property, from PD on February 28, 2006. The property was returned to the Company and USE by PD in accordance with a 1987 Amended Royalty Deed and Agreement between the Company and USE and Amax Inc. PD became the successor owner of the property in 1999.
Conveyance of the property by PD to the Company and USE also included the transfer of ownership and operational responsibility of the mine water treatment plant located on the properties. Operating costs for the water treatment plant are expected to approximate $1 million annually. In an effort to assure continued compliance, the Company and USE has retained the technical expert and contractor hired by PD on January 2, 2006 to operate the water treatment plant.
On September 26, 2006, the Company and USE paid PD $7,000,000 as the final settlement of the July 26, 2006 Judgment of $7,538,300 awarded by the U.S. Federal District Court of Colorado to PD. The Company paid one half of this amount or $3.5 million.
On October 6, 2006 the Company and USE entered into an agreement with Kobex Resources Ltd. ("KBX") (a British Columbia company traded on the TSX Venture Exchange under the symbol "KBX") to potentially pay these costs. See Subsequent Events below. Until such time as the Company and USE are able to find an industry partner to participate in the Lucky Jack property they will each be responsible for one half of the costs of holding the property which will be significant.
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Other
The employees of the Company are not given raises on a regular basis. In consideration of this and in appreciation of their work, the board of directors from time to time has accepted the recommendation of the Compensation Committee to grant a bonus to employees and directors.
Results of Operations
Quarter and Nine Months Ended September 30, 2006 compared with the Quarter and Nine Months Ended September 30, 2005
During the nine and three months ended September 30, 2006 the Company did not have any revenues from operations. Operating costs and expenses consisted of non cash accretion of asset retirement obligations of $149,100 for the nine months ended September 30, 2006 and $49,300 for the three months ended then. The increase in accretion expenses during the nine and three months ended September 30, 2006 as compared to those recorded at September 30, 2005 of $81,000 and $26,600 respectively was as a result of a re-estimation of the actual reclamation cost associated with the Sheep Mountain uranium properties and the addition of reclamation costs associated with the Lucky Jack project.
General and administrative expenses increased from $161,500 as of September 30, 2005 to $348,200 at September 30, 2006 for an increase during the nine months of $186,700. A similar increase of $148,100 was experienced during the quarter ended September 30, 2006 from that recorded during the quarter ended September 30, 2005. This increase is directly related to the re-valuation of the Executive Retirement Plan of the Company and USE for two of its executive officers, one of whom passed away during the quarter ended September 30, 2006 and the other whom determined that he would retire during the first quarter of 2007. The acceleration of their use of the retirement policy is within the requirements of the policy but was not anticipated so quickly. The change caused an acceleration of the accrual of the benefits due under the policy.
During the three and nine months ended September 30, 2006 the Company recorded a loss from the exchange of the Enterra Acquisition shares of $1,354,200 and a loss of $324,300 from the sale of Enterra units. The Company received exchangeable shares of Enterra Acquisitions when it sold RMG to Enterra in June of 2005. These shares were convertible to units of Enterra Energy Trust after a one year holding period. Prior to the actual conversion the conversion feature of the Enterra Acquisition shares was accounted for as an imbedded derivative. At the time the actual conversion took place the market price of Enterra Energy Trust units had significantly decreased. The Company sold all of the units of Enterra and recorded a loss on the sale of $324,300 while it recorded a net increase in cash of $2,991,000 from the sales.
During the nine months ended September 30, 2006 the Company recorded a net loss of $223,600 from the value of the derivative discussed above on the Enterra Acquisition shares. During the nine months ended September 30, 2005 the Company recognized revenue of $1,486,800 from the valuation of the derivative. Additionally, the Company recorded a net gain on the sale of RMG of $5,816,700 during the nine months ended September 30, 2005.
During the nine months and quarter ended September 30, 2006 the Company sold its equity ownership interest in Pinnacle to a third party. As a result of this sale the Company received $4,830,000 in cash proceeds and recognized a net gain on the sale of $3,794,800. The Company also settled its portion of the PD award ordered by the U.S. District Court of Colorado by paying $3.5 million to PD. There were no similar sales or litigation settlement transactions during the nine and three months ended September 30, 2005.
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Equity losses from USECC increased by $1,753,500 from $902,700 during the nine months ended September 30, 2005 to $2,656,200 during the nine months ended . . .(September 30, 2006)
14-Nov-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 nine months ended September 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 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 nine months ended September 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. Continued strong demand, which has outpaced supply over the past several years (deficit market conditions), has reduced inventory levels throughout the industry.
Exploration work was resumed on the uranium properties in 2005 and new uranium properties have been acquired during 2006. The Company and USE re-acquired the Lucky Jack ("Lucky Jack") molybdenum property near Crested Butte, Colorado during the nine months ended September 30, 2006. The Company and USE's interest in gold is being developed at Sutter Creek, California through exploration and development drilling which is being paid for by funds raised in an offering of Sutter Gold Mining, Inc. ("Sutter") common stock.
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 $60.00 per pound on October 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 October 31, 2006 was $604.10 per ounce (Metal Prices.com).
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Molybdenum - The five year low for molybdic oxide was $3.77 per pound in 2002. The five year high of molybdic oxide was $39.50 per pound on June 2, 2005. The price for molybdic oxide was $25.50 per pound on October 27, 2006. (Metal Prices.com).
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 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 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; and
· 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 or other investors to the point of further investment.
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 nine months ended September 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. 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.
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.
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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 nine months and quarter ended September 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.
Liquidity and Capital Resources
As of September 30, 2006 the Company had sold all of its Enterra Energy Trust ("Enterra") units, 245,759 units, that were converted from the Enterra Acquisitions Class D ("Acquisitions") shares on June 8, 2006. The Company received $2,991,000 in net cash proceeds. The Company also sold its minority interest in Pinnacle Gas Resources, Inc. ("Pinnacle") for $4,830,000.
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Although the Company received these cash proceeds during the quarter ended September 30, 2006 it continued to have a working capital deficit of $10,592,300 and a shareholders' deficit of $20,069,900. The principal component of the working capital deficit is a debt payable to USE in the amount of $14,335,400. The debt to USE increased $2,005,800 during the quarter ended September 30, 2006 and $3,513,600 during the nine months then ended.
During the nine months ended September 30, 2006 the Company consumed $3,641,000 in operations while investing and financing activities generated $4,749,700 and $3,317,800 respectively. The Company recorded a net loss of $4,758,700 during the nine months ended September 30, 2006. The major component of the loss was a negotiated settlement payment to Phelps Dodge Corporation ("PD") in the amount of $3.5 million. The settlement was as a result of an order from the Federal District Court of Colorado in favor of PD wherein the Company and USE were ordered to pay PD $7,538,300 plus interest at 5.5% per annum. Rather than appeal the award, the parties agreed on a settlement $7.0 million, of which the Company was obligated to pay one half. The Company had sufficient working capital to pay the settlement amount.
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.
Capital Resources
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 $2,100,000 and issued 1.5 million more shares for a total of 2.5 million shares, against the purchase price. USECC had sold 1,000,000 of these shares as of September 30, 2006 which generated $398,100 in net cash to USECC which is not a consolidated entity in the Company's financial statements. 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: $1.0 million on April 29, 2007 and $1.5 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.
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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 exploration drilling, geological and engineering work, reclamation and other costs associated with the uranium properties. UPC has also agreed to fund the first $500,000 in expenditures for up to 20 projects up to a total of $10,000,000. The Company, USE and UPC each will be responsible for 50% of costs on each jointly approved project in excess of $500,000. As of September 30, 2006, UPC has funded a total of $1,696,500. 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.
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.
sxr Uranium One Agreement
On July 10, 2006, the Company and USE signed an Exclusivity Agreement with sxr Uranium One Inc. ("Uranium One" or "SXR"), which is headquartered in Toronto, Canada with offices in South Africa and Australia (TSE and JSE "SXR"). Upon signing the Exclusivity Agreement, the Term Sheet (signed by Uranium One and by the Company and USE on June 22, 2006) became effective. The Term Sheet sets forth the terms of a proposed sale of the majority of the Company and USE uranium assets to Uranium One.
Under the terms of the Exclusivity Agreement, Uranium One paid USECC, which is not consolidated by the Company, $750,000 cash (nonrefundable, except for material breach of the Exclusivity Agreement) for the exclusive right to purchase the Company and USE uranium assets, including the Shootaring Canyon uranium mill in southeast Utah (and all geological libraries and other intellectual property related to the acquired assets and the mill), for a period of up to 270 days (an initial six month period, plus an optional three month extension). During this time, the parties will prepare definitive acquisition agreements. Subject to satisfactory results on Uranium One's due diligence review and obtaining all required approvals associated with the sale and purchase of the assets, the definitive agreements would be signed and the sale closed as soon as possible.
The Company and USE have continued exploratory and other work on some of the assets subject to the Exclusivity Agreement during the quarter ended September 30, 2006. The Exclusivity Agreement provides that when the assets acquisition is closed, Uranium One will reimburse the Company and USE for those expenses which have been pre-approved by Uranium One.
Under the Term Sheet, Uranium One has the right to purchase the assets under the following terms:
· $49,250,000 in Uranium One common stock at a set price at closing (the set price is the volume weighted average price of Uranium One stock for the 10 days prior to signing the Exclusivity Agreement, which is $7.45 U.S. or $8.32 Cdn per share). This represents the $50 million portion, less the cash paid for the Exclusivity Agreement.
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· $20 million in cash upon the start of commercial operation of the Shootaring Canyon uranium mill.
· $7.5 million in cash upon the first delivery of mineralized material to a commercial uranium mill from any of the purchased properties that are subject to the Agreement.
· A cash royalty equivalent to 5% of the revenues derived from the sales value of any commodity produced from the Shootaring Canyon uranium mill, to a maximum royalty payment of $12.5 million.
The Company and USE also hold a 4% net profits interest on Rio Tinto's Jackpot uranium property located on Green Mountain in Wyoming. This interest will not be included in the agreement to sell uranium assets to Uranium One. Uranium One has announced that it may acquire the Sweetwater mill and the Green Mountain properties from Rio Tinto, separate from the proposed transaction with the Company and USE.
If the Uranium One transaction closes, the Company and USE will own an equity interest in Uranium One. Capital and operating funds will not be required to maintain and modify the Shootaring Canyon Uranium Mill or any other uranium properties being sold to Uranium One.
Sutter Gold
During the second quarter of 2006, SGMI raised $3,173,700 of net proceeds from two private placements. Proceeds from these private placements will be used to fund additional exploratory/development core drilling on its Lincoln Gold Project.
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 September 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.
Cash on Hand
As discussed above the Company has monetized certain of its assets which have provided cash which will continue to be used to fund general and administrative expenses, limited exploration, development and required remedial work on its mineral properties and the maintenance of those properties and associated facilities such as the water treatment plant at the Lucky Jack property until such time as an industry partner is secured to develop the properties or they are sold.
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. On February 28, 2006, the Company and USE re-acquired the Lucky Jack molybdenum property 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.
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Maintaining Mineral Properties
Uranium Properties
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. There are also costs associated with the exploration and maintenance of the uranium properties in Utah, Colorado and Arizona. The majority of these costs are covered as a result of the agreements with UPC and SXR detailed above in Capital Resources. In the event that the sale of the properties to SXR is concluded all the costs of maintaining, exploring and developing and reclaiming these properties will be paid for by SXR and UPC.
Sutter Gold Mining Inc. (SGMI) Properties
Sutter initiated an 18,000 foot underground and surface drilling program during the second quarter 2006, to further delineate and define potential resources at the property. The 2006 drill program includes both underground and surface holes. As of September 30, 2006, 15 out of the 24 planned underground step-out and infill drill holes have been completed, which represents approximately 3,000 feet of the overall 18,000 foot surface and underground drill program. On September 14, 2006, Sutter announced that it intersected three new mineralized zones plus significant extensions to four shoots hosting previously reported mineral resources. The 9 to 12 hole surface drill program is to grid test an area containing what may be another significant mineralized zone in the K5 Vein, historically mined on Sutter's property at the South Spring Hill Mine.
The estimated cost of these projects is $897,500 also during the balance of calendar 2006. Capital to fund these projects was obtained from private placements of Sutter's common stock. See Capital Resources above.
Lucky Jack Molybdenum Property
The Company and USE re-acquired the Lucky Jack molybdenum property, from PD on February 28, 2006. The property was returned to the Company and USE by PD in accordance with a 1987 Amended Royalty Deed and Agreement between the Company and USE and Amax Inc. PD became the successor owner of the property in 1999.
Conveyance of the property by PD to the Company and USE also included the transfer of ownership and operational responsibility of the mine water treatment plant located on the properties. Operating costs for the water treatment plant are expected to approximate $1 million annually. In an effort to assure continued compliance, the Company and USE has retained the technical expert and contractor hired by PD on January 2, 2006 to operate the water treatment plant.
On September 26, 2006, the Company and USE paid PD $7,000,000 as the final settlement of the July 26, 2006 Judgment of $7,538,300 awarded by the U.S. Federal District Court of Colorado to PD. The Company paid one half of this amount or $3.5 million.
On October 6, 2006 the Company and USE entered into an agreement with Kobex Resources Ltd. ("KBX") (a British Columbia company traded on the TSX Venture Exchange under the symbol "KBX") to potentially pay these costs. See Subsequent Events below. Until such time as the Company and USE are able to find an industry partner to participate in the Lucky Jack property they will each be responsible for one half of the costs of holding the property which will be significant.
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Other
The employees of the Company are not given raises on a regular basis. In consideration of this and in appreciation of their work, the board of directors from time to time has accepted the recommendation of the Compensation Committee to grant a bonus to employees and directors.
Results of Operations
Quarter and Nine Months Ended September 30, 2006 compared with the Quarter and Nine Months Ended September 30, 2005
During the nine and three months ended September 30, 2006 the Company did not have any revenues from operations. Operating costs and expenses consisted of non cash accretion of asset retirement obligations of $149,100 for the nine months ended September 30, 2006 and $49,300 for the three months ended then. The increase in accretion expenses during the nine and three months ended September 30, 2006 as compared to those recorded at September 30, 2005 of $81,000 and $26,600 respectively was as a result of a re-estimation of the actual reclamation cost associated with the Sheep Mountain uranium properties and the addition of reclamation costs associated with the Lucky Jack project.
General and administrative expenses increased from $161,500 as of September 30, 2005 to $348,200 at September 30, 2006 for an increase during the nine months of $186,700. A similar increase of $148,100 was experienced during the quarter ended September 30, 2006 from that recorded during the quarter ended September 30, 2005. This increase is directly related to the re-valuation of the Executive Retirement Plan of the Company and USE for two of its executive officers, one of whom passed away during the quarter ended September 30, 2006 and the other whom determined that he would retire during the first quarter of 2007. The acceleration of their use of the retirement policy is within the requirements of the policy but was not anticipated so quickly. The change caused an acceleration of the accrual of the benefits due under the policy.
During the three and nine months ended September 30, 2006 the Company recorded a loss from the exchange of the Enterra Acquisition shares of $1,354,200 and a loss of $324,300 from the sale of Enterra units. The Company received exchangeable shares of Enterra Acquisitions when it sold RMG to Enterra in June of 2005. These shares were convertible to units of Enterra Energy Trust after a one year holding period. Prior to the actual conversion the conversion feature of the Enterra Acquisition shares was accounted for as an imbedded derivative. At the time the actual conversion took place the market price of Enterra Energy Trust units had significantly decreased. The Company sold all of the units of Enterra and recorded a loss on the sale of $324,300 while it recorded a net increase in cash of $2,991,000 from the sales.
During the nine months ended September 30, 2006 the Company recorded a net loss of $223,600 from the value of the derivative discussed above on the Enterra Acquisition shares. During the nine months ended September 30, 2005 the Company recognized revenue of $1,486,800 from the valuation of the derivative. Additionally, the Company recorded a net gain on the sale of RMG of $5,816,700 during the nine months ended September 30, 2005.
During the nine months and quarter ended September 30, 2006 the Company sold its equity ownership interest in Pinnacle to a third party. As a result of this sale the Company received $4,830,000 in cash proceeds and recognized a net gain on the sale of $3,794,800. The Company also settled its portion of the PD award ordered by the U.S. District Court of Colorado by paying $3.5 million to PD. There were no similar sales or litigation settlement transactions during the nine and three months ended September 30, 2005.
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Equity losses from USECC increased by $1,753,500 from $902,700 during the nine months ended September 30, 2005 to $2,656,200 during the nine months ended . . .(September 30, 2006)
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