SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended May 31, 2002 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 0-6814
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U.S. ENERGY CORP.
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(Exact Name of Registrant as Specified in its Charter)
Wyoming 83-0205516
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
877 North 8th West
Riverton, WY 82501
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including area code: (307) 856-9271
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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, $0.01 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
The aggregate market value of the shares of voting stock held by
non-affiliates of the Registrant as of September 11, 2002, computed by reference
to the average of the bid and asked prices of the Registrant's common stock as
reported by the National Market System of NASDAQ on that date, was approximately
$39,855,194.92
Class Outstanding at September 11, 2002
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Common Stock, $0.01 par value 12,075,493 shares
Documents incorporated by reference: Portions of the documents listed below have
been incorporated by reference into the indicated parts of this report as
specified in the responses to the referenced sections of this filing.
Proxy Statement for the Annual Meeting to be held
December 2002, 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. [ ]
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.
U.S. Energy Corp. is a Wyoming corporation (formed in 1966) in the business
of acquiring, exploring, developing and/or selling or leasing mineral
properties. In this Annual Report, "we", "company" or "USE" refers to U.S.
Energy Corp. including subsidiaries unless otherwise specifically noted. Our
fiscal year ends May 31.
In fiscal 2002, most of our business activity was devoted to the coalbed
methane business, i.e., acquiring acreage, drilling exploratory wells, testing
the wells, and negotiating the purchase of a coalbed methane ("CBM") producing
field. The coalbed methane gas business is conducted through Rocky Mountain Gas,
Inc ("RMG"), a Wyoming corporation owned 51.2% by USE and 40.5% by Crested Corp.
("Crested") at May 31, 2002; Crested is a 70.5% majority-owned subsidiary of
USE, see below). Properties of RMG are held in Wyoming and southeastern Montana.
As of the filing date of this Annual Report, RMG holds approximately 280,486
gross mineral acres of coalbed methane properties.
We also hold commercial properties, most of which are located in Utah that
were acquired as part of a uranium property and mill acquisition. In fiscal
2002, only the commercial properties produced revenues. For financial statement
presentation purposes, the Company has two segments of business (minerals and
commercial operations), see note I to the financial statements. However,
presently the Company's business priority is focused mainly on CBM; mining
activities will be reactivated in the future as the commodity prices improve and
the capital markets for mining finance improve.
The Company owns mining assets, all of which now are in a "shut down"
status. The uranium properties are located on Sheep Mountain in Wyoming, and in
southeast Utah; we also hold a royalty interest in uranium claims on Green
Mountain, Wyoming, now held by Kennecott Uranium Company (see below). The gold
property is located in Sutter Creek, California, east of Sacramento. Interests
are held in other mineral properties (principally molybdenum), but are either
non-operating interests or undeveloped claims.
2
For detailed information about our coalbed methane properties and business
strategy, please see "Minerals - Coalbed Methane" below.
USE and Crested originally were independent companies, with two common
affiliates (John L. Larsen and Max T. Evans; Mr. Evans died in calendar 2002).
In 1980, USE and Crested formed a joint venture ("USECC") to do business
together (unless one or the other elected not to pursue an individual project).
As a result of USE funding certain of Crested's obligations from time to time
(due to Crested's lack of cash on hand), and Crested subsequently paying these
debts by issuing common stock to USE, Crested became a majority-owned subsidiary
of USE in fiscal 1993. In fiscal 2001, Crested issued another 6,666,666 shares
of its common stock to reduce Crested's debt owed to USE by $3.0 million, which
increased USE's ownership of Crested to 70.5%. All of USE's (and Crested's)
operations are in the United States. Principal executive offices are located in
the Glen L. Larsen building at 877 North 8th Street West, Riverton, Wyoming
82501, telephone 307.856.9271.
Most of the Company's (USE's) operations are conducted through
subsidiaries, the USECC Joint Venture with Crested, and jointly-owned
subsidiaries of USE and Crested.
The Company's subsidiaries are:
Percent Primary
Subsidiary Owned by USE* Business Conducted
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Crested Corp. 70.5% Uranium, gold and
molybdenum properties,
and coalbed methane
USECC Joint Venture 50.0%
Plateau Resources, Ltd. 100.0% Uranium (Utah)
Rocky Mountain Gas, Inc. 91.7% Coalbed methane
Sutter Gold Mining Company 66.3% Gold (California)
Yellowstone Fuels Corp. 35.9% Inactive
Northwest Gold, Inc. 96.0% Inactive
Energx, Ltd. 90.0% Inactive
Four Nines Gold, Inc. 50.9% Inactive
Ruby Mining Company 4.0% Marine salvage
(sunken treasure)
*Includes ownership of Crested Corp. in RMG and Sutter.
The competitive conditions in our business are as follows:
In coalbed methane (and mining), we compete against many companies, some of
which are much larger and better financed than the Company. The principal area
of competition in the coalbed methane business (our currently most active
business area), is encountered in the financial ability to acquire good acreage
positions and drill wells to explore coalbed methane potential, then, if
warranted, drill production wells and install production equipment (gathering
systems, compressors, etc.). For example, Williams Company, Marathon-Pennaco and
Evergreen Resources (all public companies) are active in the coalbed methane
business in Wyoming and Montana. They acquire and sell acreage, drill
exploratory wells, and produce and sell coalbed methane gas. Additional
competition is presented in acreage acquisition by a number of private
independent companies.
In fiscal 2001, we reported revenues from contract methane well drilling
and support services. We have sold off most of the equipment used in these
operations in fiscal 2002, retaining three drilling rigs for RMG operations as
needed, and construction activities are limited to a few small projects in
Riverton,
3
Wyoming. We contract out RMG's coalbed drilling and construction work to third
parties. Therefore, contract drilling/construction no longer is a segment of our
business.
In the gold sector, we compete against Rio Tinto plc, Barrick, AngloGold,
Newmont Mining, and other public companies with worldwide exploration and
production facilities. These companies have inventories of exploration,
development stage and producing properties, and inventories of refined gold.
Putting a gold property into production requires significant capital; these
companies, unlike U.S. Energy Corp., have in place the financial capital, and
the engineering personnel, necessary to mine the minerals and build the related
infrastructure and production facilities. There are a number of small private
independent gold exploration companies in the United States, but they do not
compete with us.
We own a royalty interest in a molybdenum property in Colorado; the
property is owned by Phelps Dodge Corporation, a worldwide integrated minerals
company with inventories of exploration, development stage, and producing
properties, involving numerous metals and other minerals. We are not actively
engaged in the molybdenum business at the present time.
In the uranium sector, public companies like Cameco, Rio Tinto and Cogema
are the dominant uranium producers. They own inventories of exploration,
development stage and producing properties, and inventories of uranium oxide.
Although we have a fully-equipped mill (in Utah), the mill is not operating and
presently we need additional capital to mine the minerals we own nearby and
process the material through the mill.
In the commercial operations area (significant in terms of fiscal 2002
revenues but not our primary business focus), we own and manage an office
building (where our headquarters are located), and small parcels of land, all in
Riverton, Wyoming, and a small amount of additional acreage elsewhere in Wyoming
and Colorado. We also own a townsite, a motel and convenience store, and other
commercial facilities in Utah. There is no significant competition in this area;
although parcels are sold from time to time, we are not in the land development
business.
(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
See Note I to the financial statements.
(C) NARRATIVE DESCRIPTION OF BUSINESS (INCLUDING ITEM 2 - PROPERTIES).
MINERALS
COALBED METHANE
GENERAL. Rocky Mountain Gas, Inc. ("RMG") was incorporated in Wyoming on
November 1, 1999 for business in the coalbed methane industry in Wyoming and
Montana. RMG is a subsidiary of the Company (owned 51.2% by the Company and
40.5% by Crested).
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 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
4
different. Conventional natural gas wells require a porous and permeable
reservoir, hydrocarbon migration and a natural structural or stratigraphic trap.
Coalbed methane gas is trapped (adsorbed) in the coal itself and in the water
contained in the pore space, until 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 is a common component of coal since methane is created as part of
the coalification process. Coals vary in their methane content as measured by
standard cubic feet per ton. Whether a coalbed will produce commercial
quantities of methane gas depends on the coal quality, its content of natural
gas per ton of coal, the thickness of the coalbeds, the reservoir pressure, the
existence of natural fractures, the permeability of the coal, and saturation
with water to help hold methane in the coal bed.
Methane production is a direct result of reducing the hydrostatic (water)
pressure in the coal formation. CBM field evaluation requires two principal
stages: First, drill a number of wells (typically eight or more in a 'pod') down
to the same coal formation, in contiguous 80 acre spacing per well, and test the
water contained in the formation and test coal samples taken from the formation.
The water testing determines if the geochemical environment of the coal seam was
conducive to the formation of CBM in the coal. Second, assuming initial drill
and test data confirms CBM is present in the formation, install gathering lines
to hook up the wells and put the wells on pump to 'dewater' the coal formation.
Usually, for coals in the Powder River Basin, hydrostatic pressure must be
reduced to about 50% of initial pressure before enough data is obtained (water
flow rates, CBM gas flows) to determine how much CBM the wells may produce. This
dewatering stage may take 6 to 12 months. Production starts with the third
stage: Installing (or have a transmission company install) a compressor and
transport line to carry the 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 the
hydrostatic pressure is reduced approximately 90% from initial levels. During
the initial production phase, then and only then can reserves be established.
Due to the shallow coal seams in the Powder River Basin, of Montana and
Wyoming, the drilling, discovery, development and production of coalbed methane
has significant economic advantages compared with conventional natural gas
targets. Over the past several years, coalbed methane has become an important
source of pipeline quality gas in the United States.
The principal coals in the Powder River Basin ("PRB") include the thick
coal seams of the Tongue River member of the Paleocene Fort Union Formation,
which are among the thickest in the world. Individual coalbeds range in
thickness from a few feet up to 250 feet. A typical well might penetrate
multiple coal zones in depths over a 200 to 1,200 foot range. Based on reports
filed by other companies with the State of Wyoming, reserves per coalbed methane
well in the PRB can vary considerably but a typical estimate can exceed 300
million cubic feet (MMcf) of gas per well. Given the expected low drilling and
completion costs, these levels of reserves make coalbed methane wells attractive
to gas companies.
OVERVIEW OF RMG. As of the filing of this report, we hold leases and
options to develop approximately 280,486 gross mineral acres (including 43,711
acres we have options on) under leases from the United States Bureau of Land
Management, the states of Wyoming and Montana, and private landowners. Table 1
shows the total gross and net lease acres held in each prospect, and the amount
of such acreage held by RMG and by companies with which RMG has agreements
(CCBM, Inc. and Quaneco, L.L.C.). These agreements are summarized under "Carrizo
- - Purchase and Sale Agreement" and "Quaneco - Agreement." Acreage data assumes
CCBM completes its obligations; CCBM will own its 50% working interest in wells
drilled under CCBM's drilling fund commitment, but if CCBM does not complete its
purchase obligations, CCBM would not be entitled to a working interest in the
remaining undrilled acreage.
5
CCBM currently has purchase rights to acquire a 6.25% working interest in
the Castle Rock prospect, and owns a 6.25% working interest in eight wells in
Castle Rock, which were drilled by Suncor Energy Natural Gas America, Inc.
("SENGAI"). RMG's and CCBM's interests in the Castle Rock prospect, as shown in
Table 1, reflect the completion of SENGAI's drilling program in late calendar
2001. SENGAI elected not to exercise its option under an Option and Farmin
Agreement on February 8, 2002. See the summary below, and "SENGAI - Option and
Farmin Agreement."
Prospects are evaluated for coal potential using available public and
industry data, taking into account proximity to other positions held by RMG and
existing or planned gas transmission lines, and whether drilling and production
permits can be obtained and the costs thereof. The final decision to acquire a
prospect is made by the president 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 zones encountered in the well should be completed
for production. Completion requires setting casing pipe down to the zone(s),
installing pumps, and installing and setting up the necessary surface equipment
(for example, water disposal lines and water holding tanks for evaluation wells
in Montana, pending production permitting approval and water holding ponds in
Wyoming). The decision whether to complete the well is made by RMG's president.
Table 1 reflects RMG's, Quaneco's and CCBM's acreage position as of the
filing of this report. Table 1 does not reflect the reduction in net acreage
held by RMG if Anadarko Petroleum, Inc. exercises its option to back in for a
25% working interest on 43,711 gross acres within the Oyster Ridge prospect.
Also, 43,711 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 agreement
with Anadarko. See "Description of Prospects - Oyster Ridge" below.
TABLE 1
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Project
and Date Gross Lease Net Lease RMG Net Quaneco Net CCBM Net
Acquired Acres Acres Acres Acres Acres
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Castle Rock 123,840 111,567 48,811 55,784 6,973
Jan. 2000
Kirby 80,254 74,512 18,628 37,256 18,628
Jan. 2000
Bobcat June 1,940 930 465 0 465
2002
Oyster Ridge 65,247 65,247 25,729 0 25,729
Dec. 1999
Clearmont 6,305 3,745 1,873 0 1,873
Jan. 2000
Sussex 640 640 320 0 320
Jan. 2000
Finley 160 160 80 0 80
Jan. 2000
Baggs North 120 120 60 0 60
Jan. 2000
Gillette North 80 80 40 0 40
Jan. 2000
Arvada 1,900 1,700 850 0 850
Jan. 2000
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TOTAL 280,486 258,701 96,856 93,040 55,018
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6
We own a 25% working interest (20% net revenue interest) on 80,254 gross
and 74,512 net acres in the Kirby prospect (southeast Montana) and a 50% working
interest (from 30% to 50% net revenue interest) on 72,622 net acres in other
prospects (all in Wyoming). We own a 43.75% working interest (35% net revenue
interest) in the Castle Rock prospect on 123,840 gross and 111,567 net acres in
southeast Montana. CCBM, Inc., a subsidiary of Carrizo Oil and Gas, Inc., can
purchase a 6.25% working interest in our acreage (6,973 net acres) of the Castle
Rock prospect if they meet certain payment obligations. In July 2001, we sold a
50% working interest in all our coalbed methane leases, except at Castle Rock,
to CCBM for $7,500,000, plus other considerations. The acreage data above
reflects this transaction.
CCBM will pay up to $5,000,000 for drilling and completing coalbed methane
wells on the properties owned by RMG and CCBM. Drilling started on the Clearmont
prospect in Wyoming in August 2001. This drilling program should be sufficient
to drill a total of approximately 60 coalbed methane wells to completion or
abandonment stage. We have a carried working interest in all of the wells
drilled in these programs.
As of August 15, 2002, we had set casing on 31 wells (80 acre spacing
units) at the Clearmont prospect and are now in the process of drilling
additional wells. No reserves have been established to date. Drilling permits
for 58 additional wells have been issued for the Clearmont prospect.
A total of 58 wells have been drilled on RMG acreage to through May 31,
2002: five in fiscal 2001 53 in fiscal 2002. Nineteen of the wells were drilled
by SENGAI in Castle Rock under the terms of the Suncor Option and Farmin
Agreement (see below). Eleven of those 19 wells were stratigraphic wells and
will be reclaimed by Suncor; 8 of those 19 wells were completed and are owned by
RMG (93.7% working interest) and CCBM (6.25% working interest), as Quaneco opted
out of maintaining a working interest in the 8 wells. Other than the Castle Rock
wells, RMG and CCBM both have a 50% working interest in all of these wells (see
Table 2 below). For information on the 19 wells drilled by SENGAI in Castle
Rock, see "SENGAI - Option and Farmin Agreement" below.
As of May 31, 2002, CCBM and RMG have spent approximately, $2,245,000 of
the $5,000,000 drilling fund. We are relying on the $2,755,000 balance to pay
for 100% of the drilling and completion costs on up to 33 more wells currently
permitted, for which work is scheduled to start September 2002: 16 wells on the
Clearmont prospect (estimated costs $1,255,000); 9 wells on the Bobcat prospect
(estimated costs $800,000); 6 wells on the Arvada prospect (estimated costs
$550,000); and 2 wells on the Oyster Ridge prospect (estimated cost $150,000).
Like previous wells drilled with the CCBM drilling fund, RMG will have a 50%
carried working interest with no financial obligation to RMG for drilling and
completion costs until after CCBM has spent $5,000,000. Work would be delayed if
CCBM were not able to fund these costs. Presently, we do not have the capital
resources to fund these costs, and would have to obtain the necessary capital
from other industry partners or from sale of equity in the Company.
Future annual financial obligations for our coalbed methane properties
consist of approximately $286,300 for fiscal 2003 in acreage rental fees to
lessors, which will be paid 50% by RMG and 50% by CCBM on all acreage except
Castle Rock, and 21,536 acres within Oyster Ridge which are not covered by the
option with Anadarko. Costs and fees for Castle Rock will be paid 43.75% by RMG,
6.25% by CCBM, and 50% by Quaneco, except for the eight wells owned by RMG and
CCBM, which will be paid 93.75% by RMG and 6.25% by CCBM.
Table 2 shows the wells drilled on RMG's prospects from June 1, 2000
through May 31, 2002. Under the agreement with Carrizo, RMG has a carried
working interest in all these wells (with the exception of a $156,634 payment
that was made by RMG to cover 50% of a non-consent cost for 12 wells; CCBM also
paid $156,634 to cover 50% of their cost in acquiring a non-consent working
interest in those 12 wells), as CCBM has paid for all drilling and completion
costs on the wells other than the 19 Castle Rock wells. RMG has a carried
working interest in the 8 Castle Rock wells which were completed (out of the 19
drilled in that
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prospect), as SENGAI paid for all drilling and completion costs on the 8 Castle
Rock wells under a drilling program completed in December 2001. RMG owns a
93.75% working interest and CCBM owns a 6.25% working interest in the 8 Castle
Rock wells (CCBM paid for its interest in these wells, see "SENGAI - Option and
Farmin Agreement"). With the exceptions noted above, all the wells on the Oyster
Ridge, Clearmont and Arvada prospects have been drilled at CCBM's sole expense
since its participation began on June 30, 2001. Table 2 lists the number of
wells drilled, the total costs and the remaining number of wells currently
permitted for drilling as of May 31, 2002.
TABLE 2
ROCKY MOUNTAIN GAS, INC.
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PROSPECT FY 2001 FY 2002 TOTAL Remaining
(6/1/00 - 5/31/01) (6/1/01 - 5/31/02) Permits
Wells $ Wells $ Wells $
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Castle Rock 3 $ 283,894 19* $ 2,500,000 22 $ 2,783,894 15
Kirby 0 $ -- 0 $ -- 0 $ -- 6
Oyster Ridge 2 $ 150,503 5 $ 464,177** 7 $ 614,680 0
Clearmont 0 $ -- 28 $ 1,470,351 28 $ 1,470,351 59
Arvada 0 $ -- 1 $ 64,790 1 $ 64,790 3
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TOTAL 5 $ 434,397 53 $ 4,499,318 58 $ 4,933,715 83
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* Drilled by SENGAI
** These costs include an additional $169,314 spent on the two wells
drilled during fiscal 2001.
BOBCAT PROPERTY. On April 12, 2002, the Company and RMG signed an agreement
to purchase working interests in approximately 1,940 gross acres of coalbed
methane properties in the Powder River Basin of Wyoming. The contract closed on
June 4, 2002. The Company paid the seller $500,000 cash and another $150,000 by
issuing 37,500 shares of its restricted common stock to the seller; CCBM paid
$500,000 cash to the seller and Carrizo Oil & Gas, Inc. issued its restricted
shares of common stock valued at $150,000. The properties are located
approximately 25 miles north of Gillette, Wyoming, in Campbell County. To date,
18 coalbed methane wells have been drilled; 13 wells are currently hooked up and
producing at a combined rate of approximately one million cubic feet of gas per
day (1,000 mcf) from the two primary coals on the property: the Cook coal (11
wells) at 650 feet, and the Canyon coal (2 wells) at 450 feet. Production began
in late December 2001. Currently, RMG is planning to add equipment to increase
the production rate.
For August, 2002, RMG received an average price of $1.33 per Mcf (1,000
cubic feet) for the 30,404 Mcf of gas sold from the Bobcat field, with prices
ranging from $0.83 to $1.79 per Mcf. See "Gathering and Transmission of CBM Gas"
below. The property is currently producing at uneconomic rates of production at
these prices. Prices usually improve in the colder months. In addition, RMG is
replacing and upgrading some equipment and adding a compressor, with the
expectation of improving production volumes through the remainder of 2002 and
thereafter. An independent evaluation of CBM reserves will be undertaken when
production has increased, and reserve information will be disclosed when
available. No independent reserve evaluation has been started to date, as RMG
needed to take over operations of the field and obtain data after the property
was purchased in June, 2002.
Permits have been issued for drilling 30 more wells on 80 acre spacing.
8
CCBM has exercised its right to participate in purchase of the Bobcat
property, for 50% of the interests in the property subject to the agreement. For
information on agreements with CCBM, please see "Carrizo - Purchase and Sale
Agreement" below. RMG will be the operator of the properties.
The seller keeps as an overriding royalty interest all net revenue interest
in the properties in excess of 80%. RMG and CCBM each hold an average of 31%
working interest and an average of 25% net revenue interest, in the drilled
wells.
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 development of
the acreage prospective for coalbed methane 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 has 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 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. These properties consisted of the Kirby,
Oyster Ridge, Clearmont, Sussex, Finley, Baggs North, and Gillette North
properties. The 50% undivided interest is pledged back to RMG to secure the
purchase price, and will be released 25% when 33.3% of the principal amount
($2,500,000) of the purchase price is paid, another 25% when total principal
payments reach 66.6% of the principal amount ($5,000,000) of the purchase price,
and the balance of the total 50% undivided interest when all of the principal
amount ($7,500,000) of the purchase price, has been paid.
CCBM has the right to participate in other properties RMG may acquire (like
the Bobcat property) under the area of mutual interest ("AMI"), see Agreement
for Purchase of the Bobcat Property" above, and information on the AMI below.
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 will be "carried" for its 50% interest in these wells,
and will not be required to pay any of such costs. After the initial $5,000,000
has been spent, RMG and CCBM each will pay for their 50% share of costs in
subsequent wells, and also will pay for their 50% share of operating costs for
the wells drilled and completed in this drilling program. Without CCBM's
consent, none of the drilling funds can be used for operations associated with
water disposal wells, gas compression beyond 100 PSIG, or for facilities
downstream of compression beyond 100 PSIG. CCBM will earn a 50% working interest
in each well location (80 acres) and gas production therefrom, regardless of the
status of payments on the promissory note.
Drilling under the CCBM agreement started in August 2001. As of May 31,
2002, CCBM has spent approximately $2,245,000 of the $5,000,000 work commitment
on the drilling of 22 wells at Clearmont, 4 wells at Oyster Ridge, 1 well at
Arvada, and has funded $225,000 of the drilling conducted by SENGAI in Montana
as part of the Quaneco agreement. Amounts remaining out of the $5,000,000 will
be used for drilling during the remainder of fiscal 2002 and on into fiscal year
2003, or applied to property acquisitions, as agreed upon by the parties. If
less than the entire $5,000,000 is spent within two years (subject to extensions
due to force majeure), CCBM shall pay RMG one-half the unspent portion of the
$5,000,000. However, this payment obligation back to RMG is subject to RMG
complying with all of the terms and provisions of the Purchase and Sale
Agreement, the joint operating agreement, and the procedures therein set forth
regarding authorizations for expenditures to drill $5,000,000 worth of
"reasonable wells." This means wells which meet these economic criteria: (1)
individual well cost (including hook-up to sales) must meet a projected internal
rate of return in excess of 15% at prevailing market prices; (2) the wells must
be on acreage
9
blocks that are touching and contain minimum sizes (Kirby prospect, at least
2,560 acres; Clearmont, at least 640 acres; and Arvada, at least 480 acres); and
(3) no more than 10 wells per calendar year at Oyster Ridge will qualify as
reasonable. The intent is for CCBM to spend $2,500,000 on behalf of RMG on
drilling and completing "reasonable wells." If CCBM fails to do this despite a
total of $5,000,000 of reasonable well proposals by RMG, then CCBM shall be
obligated to pay any remaining unspent portion of the $2,500,000 directly to
RMG.
In addition to its one-half share of revenues in proportion to its one-half
share of the working interest, CCBM will be 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.
RMG is the designated operator under a Joint Operating Agreement between
RMG and CCBM, which governs all operations on the properties subject to the
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"). The AMI four-year term ends June 30, 2005. It covers the entire state
of Wyoming, and the Powder River Basin of Montana, but will be reduced if CCBM
does not obtain at least $20 million for future property acquisitions (see
below).
A management committee oversees all operations subject to the Purchase and
Sale Agreement, with two members each from CCBM and RMG, however, RMG shall have
a tie-breaking vote until the $5,000,000 drilling commitment has been expended
and until the purchase price has been paid. Once the $5,000,000 drilling
commitment has been expended and the full purchase price is paid, RMG will
allocate (with Quaneco's consent) to CCBM one of RMG's managing member positions
with Powder River Gas LLC, which is the operative entity for the Montana acreage
RMG holds with Quaneco L.L.C.
With respect to the Castle Rock prospect in Montana, which was subject to
the agreement with SENGAI, RMG was entitled to have CCBM pay for $225,000 of
RMG's drilling obligations; for this funding (part of the $5,000,000 drilling
program with CCBM), CCBM received an undivided 6.25% working interest on each
well so drilled and the 80 acre spacing allocated to each such well, i.e.
one-half of our 12.5% working interest, during the SENGAI drilling program. CCBM
made the $225,000 payment to RMG on March 26, 2002, and RMG has subsequently
paid SENGAI that amount to fulfill its obligations to SENGAI and Quaneco. See
"Quaneco - Agreement" and "SENGAI - Option and Farmin Agreement."
Under the Purchase and Sale Agreement with CCBM, CCBM will use its best
efforts to obtain financing to raise no less than $20,000,000 to be used by RMG
to acquire more properties in the AMI. CCBM would have a 50% working interest in
properties so acquired. If CCBM's efforts were not successful by June 30, 2002,
the AMI was to be reduced to a 6-mile radius from all existing properties held
jointly by RMG and CCBM unless RMG agreed to an extension of this time frame.
RMG has extended the time frame for CCBM raising the funds, to June 30, 2003.
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 88,410 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.
A separate provision in the Quaneco agreement required RMG to spend
$2,500,000 to drill and complete 25 wells. Under the subsequent Option and
Farmin Agreement with SENGAI, SENGAI paid $2,000,000 in their first drilling
program on this prospect, and RMG paid $250,000. Of this amount,
10
$225,000 was paid to RMG by CCBM and subsequently paid over to SENGAI, leaving
RMG with a net obligation of $25,000, which was paid. RMG had previously
performed work and paid costs for a credit of approximately $250,000 on the
Castle Rock and Kirby prospects. All of RMG's drilling obligations to Quaneco
therefore have been fulfilled.
The Kirby prospect, owned originally by RMG and Quaneco, and now CCBM as
well, is operated through Powder River Gas, LLC, a Wyoming limited liability
company. Initial CBM well sites have been selected by the management committee
in which Quaneco and RMG currently have equal representation. USECC has the
right to provide drilling services on the first 25 wells drilled by Powder River
Gas, LLC based on competitive drilling rates in the area surrounding the wells
to be drilled. Thereafter, USECC will have the right to submit bids on a
competitive basis to Powder River Gas LLC for drilling contracts on additional
acreage. CCBM has recently acquired 50% of RMG's interest in the Kirby prospects
leaving ownership interest at 25% RMG, 25% CCBM, and 50% Quaneco.
SENGAI - OPTION AND FARMIN AGREEMENT. On February 8, 2001, RMG closed an
Option and Farmin Agreement with Suncor Energy Natural Gas America, Inc.
("SENGAI"). SENGAI had an option on two blocks of acreage covering 111,566 net
acres in southeast Montana; the option on the second block of acreage was
contingent upon SENGAI exercising its option on the first block of acreage. The
option on the first block of acreage expired on February 8, 2002 without
exercise.
Under the Option and Farmin Agreement, SENGAI committed to pay for all
costs up to $2,000,000 in a $2,250,000 drilling program on the first block of
acreage, starting in the fall of 2001. RMG had to pay the remaining $250,000 for
the drilling program (on its behalf and for Quaneco LLC, which completes RMG's
drilling commitment to Quaneco; see below). SENGAI had to complete the drilling
program regardless of whether it exercised the options. SENGAI completed this
program in the fall of 2001.
As the first option was not exercised, all of the work paid for under the
drilling program will benefit RMG (and now CCBM and Quaneco in their respective
working interests), and SENGAI has no rights in the Castle Rock prospect or in
any wells drilled on it.
The SENGAI drilling program neither established CBM reserves or condemned
the drilled acreage as unproductive. RMG believes that SENGAI declined to
exercise the option based on SENGAI's evaluation of incomplete data generated by
SENGAI's drilling program, which SENGAI designed and executed. When SENGAI
drilled the 19 exploratory wells under its option on the Castle Rock prospect,
SENGAI did not utilize the best available procedures to detect possible CBM
content. In addition, 6 of the wells were drilled in a pod configuration but 5
of the 6 were drilled into separate coal seams, even though efficient dewatering
requires multiple close-spaced wells into the same coal. Eleven of the other
SENGAI-drilled wells confirmed the presence of coal at the depths originally
estimated by RMG, but otherwise insufficient data was generated by the drilling
and testing of these 11 wells to determine if the coal might be productive of
CBM.
RMG, Quaneco and SENGAI have signed a Project Completion Agreement, whereby
Powder River Gas L.L.C. (an operating company owned equally by RMG and Quaneco)
will become the operator of record for the Castle Rock properties and SENGAI's
working interest will revert to 0% in the project. In addition, RMG has elected
to accept a 93.75% working interest in (and RMG will operate) 8 completed wells
in the Castle Rock area. CCBM has a 6.25% working interest in these 8 wells.
Although the data on the 8 wells to be retained by RMG is incomplete (which
wells were drilled by SENGAI), RMG will further evaluate the data. If the
results are favorable, RMG will start dewatering these wells and establish a pod
grid to drill and complete and start dewatering more wells around each existing
well to maximize dewatering efficiency. As with any CBM project, a substantial
amount of dewatering of pods of wells into the same coal is necessary before the
economics of the wells can be assessed. We have not
11
prepared a budget or timetable for this future work but expect to do so by March
31, 2003. This future work would start in spring 2003, subject to having the
necessary funds on hand.
DESCRIPTION OF PROSPECTS
Leases of federal mineral rights are obtained from the United States Bureau
of Land Management and expire from 2004 to 2009, unless RMG establishes
production on the lease, in which event the lease is held so long as coalbed
methane or other gas or oil is produced. A royalty interest of 12.5% on the
production is paid to the BLM. State leases expire from 2003 to 2004 in Wyoming
and Montana, unless RMG establishes production on the lease, in which event the
lease is held so long as coalbed methane or other gas or oil is produced. The
royalty paid to the State of Wyoming is from 12.5 % to 16.67%, and 12.5% to the
State of Montana. Annual renewal fees for non-producing Federal leases is $1.50
to $2.00 per acre, and $1.00 and $1.50 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 2003 to 2011, unless production is established, in
which event the lease is held so long as there is production. The landowner is
paid a royalty from production of 12.5% to 20.0% , depending on the lease terms.
Table 3
ROCKY MOUNTAIN GAS, INC.
- ----------------------------------------------------------------------------------------------------------------------
Gross Leased Net Leased Net Leased Net Leased Net Leased Net Leased
Prospect Acres Acres from BLM from State of from State of from Private
Wyoming Montana Owners
- ----------------------------------------------------------------------------------------------------------------------
Castle Rock 123,840 111,567 55,104 0 10,860 45,603
Kirby 80,254 74,512 33,305 0 4,056 37,151
Oyster Ridge* 21,536 21,536 17,107 1,229 0 3,200
Clearmont 6,305 3,745 0 640 0 3,105
Sussex 640 640 0 640 0 0
Finley 160 160 0 160 0 0
Baggs North 120 120 0 120 0 0
Gillette North 80 80 0 80 0 0
Arvada 1,900 1,700 1,200 0 0 500
- ----------------------------------------------------------------------------------------------------------------------
Bobcat 1,940 1,940 0 0 0 1,940
- ----------------------------------------------------------------------------------------------------------------------
*Does not include 43,711 acres under option from Anadarko Petroleum. See
"Description of Properties - Oyster Ridge."
CASTLE ROCK: The Castle Rock project consists of 123,840 gross and 111,567
net acres located in the northeastern portion of the Powder River Basin of
Montana, west of Broadus, Montana. Coals present are in the Tongue River member
of the Fort Union formation and appear comparable to coals currently being
12
developed by other operators south of the Castle Rock acreage near the
Montana/Wyoming border. Currently, there are no pipelines in this area. The
federal leases generally have 10-year terms and fee and state leases generally
have two to five year terms.
KIRBY: The Kirby project consists of 80,254 gross and 74,512 net acres
located in the northwestern portion of the Powder River Basin in Montana located
in Big Horn and Rosebud Counties, Montana, north of Sheridan, Wyoming. Coals are
in the lower portion of the tertiary Fort Union formation and are similar to
productive coals in the Wyoming portion of the Powder River Basin to the south.
Redstone (recently acquired by Montana Dakota Utilities) has established
significant coalbed methane production 12 miles south of Kirby at the CX field.
At least two other operators are currently planning to drill and develop nearby
acreage. CMS's Bighorn Gas Gathering recently extended a new 20" pipeline to
within 10 miles of the Kirby project. Three exploration wells are currently
scheduled to be drilled at Kirby during the summer of 2002.
OYSTER RIDGE: The Oyster Ridge project consists of 65,247 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
21,536 acres within Oyster Ridge.
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: we must
drill at least four wells each year, each on a new section (640 acres), to earn
a lease on each drilled section , and also to keep in force previously earned
leases in the 43,711 acres areas. Wells drilled by our seller, and by us (with
CCBM), have earned 3,200 acres, which are included in the 21,536 acres leased
presently. As of March 31, 2002, we have met our drilling obligations for the
year ended March 31, 2002. Under the terms of the agreement, we must drill 4
additional wells by March 31, 2003 to keep our agreement in force. RMG expects
to meet this drilling commitment.
Within this prospect, 43,711 gross acres are subject to an option held by
Anadarko Petroleum, Inc. to participate as a 25% working interest owner on all
wells drilled each year. Anadarko has not yet elected to participate, and has no
working interest in the seven wells drilled to date on this prospect. If
Anadarko elects to participate in the future, working interest ownership in
affected wells would be of 37.5% RMG, 37.5% CCBM, and 25% Anadarko.
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. Exploratory drilling
and completion operations on previously drilled wells resumed at Oyster Ridge in
June, 2001. To date, $621,128 has been spent on 7 exploratory wells.
CLEARMONT: The Clearmont project consists of approximately 6,305 gross and
3,745 net acres located in the western Powder River Basin of Wyoming. RMG (and
now CCBM jointly) owns working interests ranging from 25% to 100%. The area is
characterized by several shallow Fort Union coalbeds (most notable the Roland
and Anderson coals) as well as several deeper coals that hold significant
exploration potential. Substantial coalbed methane production and development is
ongoing in the immediate area including Federated's Box Elder Creek project 12
miles to the west and the Penneco/CMS Wild Horse Creek project 15 miles to the
east. The Clearmont project is located at the convergence of the WBI Bitter
Creek and the Bighorn Sheridan Lateral pipelines. An exploration and development
drilling program began at Clearmont in August 2001 and could be in production in
2002 or early 2003 depending on drilling results and gas prices. To date,
$2,247,000 has been spent on drilling and infrastructure at Clearmont.
13
Nineteen of the existing 31 wells at Clearmont have been on full-scale
dewatering since June 2002. These 19 wells are hooked up to a gas gathering
system but no gas will be sold until the compressor is set up (see below). The
remaining 12 wells will start dewatering and be hooked up to a gas gathering
system in 2003. In addition, another 16 wells will be drilled and completed and
put on dewater pumps; it is expected that this added 16 well project will be
started in September 2002. We expect to have sufficient data to evaluate the
economics of Clearmont in the second or third calendar quarter 2003.
During 2003, RMG expects to begin selling gas produced from the Clearmont
wells to CMS Field Services, Inc. pursuant to a gas purchase contract. However,
production could be delayed if dewatering hasn't progressed sufficiently to
allow production of commercial amounts of gas. In the third calendar quarter
2002, RMG will complete construction of a field gathering system (for delivery
and initial compression of the gas) to Bighorn Gas Gathering, LLC. Bighorn has
signed a gas gathering agreement with RMG to deliver gas collected from RMG's
system to CMS, and Bighorn expects to have its system built from Clearmont to a
gas transmission pipeline in the fourth calendar quarter 2002.
SUSSEX: RMG and CCBM hold 640 gross and net acres in this project area
located in Johnson County, Wyoming. This State lease lies 3 miles south of
Sussex, Wyoming. RMG has a 100% working interest. To date, RMG has not conducted
any significant development on the property.
FINLEY: RMG and CCBM hold 160 gross and net acres in this project area
located in Converse County, Wyoming. This prospect is a State lease 12 miles
east of Edgerton, Wyoming. Review for a two well test is underway. To date, RMG
has not conducted any significant development on the property.
BAGGS NORTH: This prospect contains 120 gross and net acres located in
Carbon County, Wyoming. This State lease is located 7 miles north of Baggs,
Wyoming. RMG and CCBM hold a 100% working interest in this prospect. To date,
RMG has not conducted any significant development on the property.
GILLETTE NORTH: RMG and CCBM holds a 100% working interest in 80 gross and
net acres in this project area located in Campbell County, Wyoming. This State
lease lies at the north end of the City of Gillette. Existing coalbed methane
wells lay in the section immediately north. Permitting of two wells has begun on
RMG's property. RMG intends to conduct test drilling and production techniques
in this area which lies in the heart of the current coalbed methane play in the
Gillette area. To date, RMG has not conducted any significant development on the
property.
ARVADA: This prospect contains 1,900 gross acres, 1,700 net acres, located
in Sheridan County, Wyoming. RMG and CCBM hold a 100% working interest, and a
62% to 81.5% net revenue interest. To date, RMG and CCBM have spent $64,428 on
the drilling of one 1,471' deep test well and are analyzing the drilling
results. Subject to good results from further exploratory drilling, RMG
anticipates constructing a field gathering system on the Arvada property in
mid-calendar 2003 and begin production sales in the third calendar quarter 2003.
Gas gathering and production sales are covered by agreements with Bighorn Gas
Gathering, LLC and CMS Field Services, Inc.
COALBED METHANE WELL PERMITTING. Drilling coalbed methane wells requires
obtaining permits from various governmental agencies. The ease of obtaining the
necessary permits depends on the type of mineral ownership and the state in
which the property is located. Intermittent delays in the permitting process can
reasonably be expected throughout the development of any play. For example,
there is currently a temporary moratorium for drilling coalbed methane wells on
fee and state lands in Montana. We may shift our exploration and development
strategy as needed to accommodate the permitting process. As with all
governmental permit processes, there is no assurance that permits will be issued
in a timely fashion or in a form consistent with our plan of operations.
14
The Northern Plains Resource Council, Inc. ("NPRC") settled its suit
against the Montana Board of Oil and Gas Conservation (Board) in which the NPRC
requested an order of the court compelling the defendant to prepare a Draft
Environmental Impact Statement ("EIS") and amendment of the Powder River and
Billings Resource Management Plans for coalbed methane development. The Board
agreed to limit issuance of CBM well permits to 200 (of which RMG received 79)
pending completion of the draft EIS, which was completed in the summer of 2002.
A record of decision is expected in December 2002 or early 2003.
The Wyoming Department of Environmental Quality Supplemental Environmental
Impact Statement (SEIS) for the Powder River Basin in Wyoming, issued in the
fall of 1999, allowed the permitting of 5,000 CBM wells to be drilled on Federal
lands in Wyoming. More CBM well applications have been submitted causing the BLM
to begin a second EIS for the Powder River Basin Area in Wyoming. The new draft
EIS was completed in the summer of 2002. Development on Federal lands in Wyoming
has been stopped with the balance of the Wyoming Department of Environmental
Quality EIS permitted wells (4,000) occurring on fee and state lands. The BLM
completed an environmental assessment ("EA") in March 2001, reviewing drainage
issues, which could allow an additional 1,500 new CBM well permits in the
Gillette region of the Powder River Basin. The EIS may impact RMG's operations,
as the Arvada prospect is within the affected area, and we expect to begin
applying for permits in these prospects in late 2002. A record of decision is
expected in December 2002 or early 2003.
In addition, the Wyoming and Montana Departments of Environmental Quality
have regulations applying to the surface disposal of water produced from CBM
drilling operations. CBM operators are currently seeking changes in permit
requirements and department policy that would allow operators more flexibility
to discharge water on the surface. If these changes are not made, it may be
necessary to install and operate treatment facilities or drill disposal wells to
reinject the produced water back into the underground rock formations adjacent
to the coal seams or lower sandstone horizons. If we cannot obtain the
appropriate permits or if applicable laws or regulations require water to be
disposed of in an alternative manner, the costs to dispose produced water will
likely increase. These costs could have a material effect on operations in this
area, including potentially rendering future production and development in the
affected areas uneconomic.
RMG has received an Environmental Assessment and Finding of No Significant
Impact to drill up to 56 shallow gas sand wells. These wells are located on
Federal land held with Quaneco and would be converted to production status upon
receiving approval from the Montana Board of Oil and Gas. These wells would
evaluate potential CBM production as well as conventional gas. Regarding other
acreage held with Quaneco in Montana, the State of Montana may lift its
moratorium for CBM wells on private and state ground in Montana, and start
issuing new permits on these lands in summer 2002 (a voluntary moratorium is
currently in place for wells on private and state ground in Montana). We have
not determined to what extent we will participate in this procedure, and are
evaluating how best to protect our position to have reasonable exploration for
CBM wells proceed on state and fee ground. We have permits in place in order to
conduct exploration in expectation that commercial production will be approved
on completion of the EIS.
In August 2001, Montana and Wyoming announced an agreement for water
quality officials in both states to coordinate monitoring of water flows in the
Powder River and Little Powder River drainages, to determine the impact of
coalbed methane well water production on river water. Although usually well
water is drinkable, it may contain high sodium absorption ratios, which can
impair use of the water for irrigation purposes in clay-based soils. The
respective agencies will propose regulations to establish thresholds for
potential pollutants and require strict monitoring by local water quality
officials. If test results indicate some well water flows adversely impact river
water quality, operators could be required to put the water flow into holding
ponds or take other steps to eliminate or reduce water flows or pollutants in
the water. Implementation of the agreement may benefit continued coalbed methane
development in these areas by opening up the water discharge permitting process
in the affected areas, as water testing is completed in phases
15
on prospects within the affected drainage areas. Currently, we don't have
acreage that would be impacted by these regulations but future acreage could be
acquired in the affected areas.
The following summarizes permits now in place.
Table 4
- --------------------------------------------------------------------------------
Expiration
Prospect Remaining Permits or Renewal Date
- --------------------------------------------------------------------------------
Castle Rock 15 04/17/2003 and 10/17/2002
- --------------------------------------------------------------------------------
Kirby 6 01/01/03
07/31/2002; 08/30/2002;
09/26/2002; 10/24/2002;
- --------------------------------------------------------------------------------
Clearmont 59 11/01/002; 11/02/2002;
02/04/2003, 03/15/2003;
07/31/03 and 08/30/03
- --------------------------------------------------------------------------------
Arvada 3 11/12/2002
- --------------------------------------------------------------------------------
Bobcat 30 12/02/02
- --------------------------------------------------------------------------------
Total 113
- --------------------------------------------------------------------------------
Drilling permits issued by the State of Wyoming allow one year for drilling
completion; permits issued by the State of Montana allow six months. Expired
permits for undrilled locations are usually renewed by the agencies without
difficulty.
Once drilled, all wells in the Clearmont and Arvada prospects remain (and
future wells in Wyoming will be) subject to a National Pollution Discharge
Elimination System ("NPDES") permit relating to water testing and discharge. All
wells in the Castle Rock and Kirby prospects remain subject to the Montana Board
of Oil and Gas Commission approval. Upon completion of drilling, wells are
subject to monthly reporting regarding status and production to the respective
state agencies in which they are located.
GATHERING AND TRANSMISSION OF CBM GAS
Companies involved in CBM production generally outsource their gas
gathering, compression and transmission. We intend to outsource compression and
gathering needs as well, possibly on a competitive basis with transmission
companies in the immediate area. Negotiations with various transmission
companies have been initiated in order to better manage future capital
investment. To date, we have a gas gathering agreement and a separate gas
purchase contract for the Clearmont and Arvada properties (see above).
Coalbed methane production growth in the Powder River Basin has
historically been impeded by a shortage of gathering system capacity and
transport capacity out of the Basin. However, two large diameter gathering
pipelines were completed in September 1999 and a third was ready for service in
early 2000. The two completed pipelines provide an additional 900 million cubic
feet (MMcf), of daily gas capacity as set forth below:
Fort Union Gas Gathering, LLC's 106-mile, 24" gathering pipeline, commenced
operations September 1, 1999, with an initial capacity of 450 MMcf per day; and
Thunder Creek Gas Services, LLC's 126-mile, 24" gathering pipeline,
commenced operations September 1, 1999, with an initial capacity of 450 MMcf per
day.
Additionally, CMS Energy's 110-mile, Big Horn Gas Gathering pipeline, that
connects to the northern terminus of the Fort Union pipeline, is continuing to
be expanded in length and has an initial capacity of 256
16
MMcf per day which can readily be upgraded to 500 MMcf per day with the addition
of booster compression. Further, on June 19, 2000, Big Horn Gas Gathering
announced the extension of its pipeline to serve producers in the Sheridan area.
This 50+ mile extension will place a 20" high pressure pipeline within 5 miles
of the Montana border and within close proximity to the development planned by
RMG, CCBM, and Quaneco on their Kirby Prospect area.
Wyoming Interstate Gas Company's 143-mile, 24" Medicine Bow Lateral
pipeline commenced operations in November 1999 with an initial capacity of 260
MMcf per day. This pipeline will transport natural gas from the Thunder Creek
and Fort Union pipelines at the south end of the Powder River Basin to
interconnect with multiple interstate pipelines accessing markets to the east
and along the front range of Colorado. This system is already being expanded as
demand for transportation space grows. Further transmission lines are being
planned by other companies in the area.
Wyoming operators have been realizing lower than expected prices for gas
produced in the Powder River Basin, due in part to seasonal/supply factors, but
more significantly due to a bottleneck in take away capacity. There is now ample
capacity to move gas from CBM fields within the PRB but limited interstate
movement capacity from the PRB to the major markets on the coasts and in the
midwest, which results in a negative price differential. The newly announced
Grasslands Pipeline (to be constructed to move gas to midwest and northern
markets) and the additional looping (now under construction) of the Kern River
Pipeline, will add 1,000 MMcf daily PRB take away capacity when completed by the
end of 2003, and should reduce the negative price differential.
For August, 2002, RMG received an average price of $1.33 per Mcf (1,000
cubic feet) of gas produced from the Bobcat field (its only producing field at
September 2002), with prices ranging from $0.83 to $1.79 per Mcf. This
represents a negative price differential of approximately 60% compared to the
average price of approximately $3.30 per Mcf received by producers nationwide.
While increased pipeline capacity planned or under construction is expected to
reduce this negative price differential by the end of 2003, there is no
guarantee that the increase will eliminate the negative price differential or
even significantly reduce it. Continued low prices would impair our ability to
raise capital for RMG and reduce revenues from production coming on line.
URANIUM
GENERAL. We have interests in several uranium-bearing properties in Wyoming
and Utah and in a uranium processing mill in southeastern Garfield County, Utah
(the "Shootaring Mill"). 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 develop and operate these properties (directly or through a
subsidiary company or a joint venture) to produce uranium concentrates ("U3O8")
for sale to public utilities that operate nuclear powered electricity generating
plants. However, until uranium oxide prices improve significantly, all of the
uranium properties are shut down, meaning work is performed to keep the mines
from flooding and permitting work is done as needed (monitoring and reporting)
to keep existing permits in effect.
Substantial work would be required to put the uranium properties into
production, including cleaning out drifts and other underground passages,
pumping water out of the mines, and sampling to ascertain whether a commercially
viable ore body exists on any of the properties. This work will require
significant capital expenditures.
SHEEP MOUNTAIN - WYOMING
Unpatented lode mining claims, underground and open pit uranium mines and
mining equipment in the Crooks Gap area are located on Sheep Mountain in Fremont
County, Wyoming and are adjacent to and
17
west of the GMMV mining claims. From December 21, 1988 to June 1, 1998, these
assets 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 disputes with Nukem, Inc. ("Nukem") and its
subsidiary Cycle Resource Investment Corp. ("CRIC"). The judgment against Nukem
impressing the CIS uranium supply contracts in constructive trust with SMP
remains unresolved. See "Legal Proceedings." The Sheep Mountain Mines 1 and 2
were first operated by Western Nuclear, Inc., a subsidiary of Phelps Dodge
Corporation, in the late 1970s.
THE GREEN MOUNTAIN MINING VENTURE ("GMMV") PROJECT
In fiscal 1991, we entered into an agreement to sell 50 percent of our
interests in the Green Mountain uranium claims, and certain other rights, to
Kennecott Uranium Company ("KUC" or "Kennecott"), a subsidiary of Kennecott
Energy and Coal Company of Gillette, WY, to develop these assets in the GMMV
with funding provided by Kennecott. For detailed explanation of the GMMV
agreement, please see U.S. Energy Corp.'s 1999 Form 10-K at pages 8-11.
The GMMV holds 521 unpatented lode mining claims (the "Green Mountain
Claims") on Green Mountain in Fremont County, Wyoming, including 105 claims on
which the Round Park (Jackpot) uranium deposit is located, and the Sweetwater
Mill, (approximately 23 miles south of the proposed Jackpot Mine)., are held by
the Green Mountain Mining Venture ("GMMV"), which until September 11, 2000 was
owned 50% by Kennecott and 50% by USE and Crested.
In September 2000, Kennecott filed a lawsuit to dissolve the GMMV and we
counterclaimed for damages. This lawsuit was settled on September 11, 2000.
Kennecott paid USECC $3,250,000 to acquire all of our (and Crested's and
USECC's) interest in the GMMV, its properties and the Sweetwater Uranium Mill
(with certain exceptions). Kennecott also assumed all reclamation and other
liabilities associated with the GMMV. We and Crested together have retained a 4%
net profits royalty in any future uranium oxide produced from the GMMV mining
claims through the Sweetwater Mill (currently shut down and not operational).
When Kennecott has completed necessary reclamation work on the Green
Mountain unpatented lode mining claims (including the Round Park uranium deposit
proposed to be mined through the Jackpot Mine) Kennecott will quit claim all
such mining claims to us and Crested, as well as certain equipment currently
being used at the mine (including a compressor and standby generator). Kennecott
plans to keep the Sweetwater Mill.
PLATEAU'S SHOOTARING CANYON MILL AND PROPERTIES
ACQUISITION OF PLATEAU RESOURCES LIMITED ("PLATEAU"). In August 1993, USE
purchased from Consumers Power Company ("CPC"), all of the outstanding stock of
Plateau which owns the Shootaring Canyon uranium processing mill and support
facilities in southeastern Utah (the "Shootaring Mill") for a nominal cash
consideration. The Shootaring Mill holds a source materials license from the
NRC. In the purchase of the stock from CPC, we agreed to various obligations, as
disclosed in USE's 1998 Form 10-K at pages 15 and 16.
SHOOTARING MILL AND FACILITIES. The Shootaring Mill is located in
southeastern Utah and occupies 19 acres of a 265 acre plant site. The mill was
designed to process 750 tpd, but only operated on a trial basis for two months
in mid-summer of 1982. In 1984, Plateau placed the mill on standby because CPC
had canceled the construction of an additional nuclear energy plant.
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Plateau also owns approximately 90,000 tons of uranium mineralized material
stockpiled at the mill site and approximately 172,000 tons of mineralized
material stockpiled at the Tony M Mine. Included with mill assets are tailings
cells, laboratory facilities, equipment shop and inventory. The NRC issued a
license to Plateau authorizing production of uranium concentrates, however,
since the mill was shut down, only maintenance and required safety and
environmental inspection activities were performed and the source materials
license with the NRC was for standby operations only. Plateau applied to the NRC
to convert the source materials license from standby to operational and upon
increasing the reclamation bond, the NRC issued the new license on May 2, 1997.
Plateau has a cash bond in favor of the NRC in the amount of $8,818,600 plus and
additional $1,082,300 in government securities for bonding future reclamation.
Plateau obtained approval of a water control permit for the tailings
cell from the Utah Water Control Division and is awaiting the NRC's review of
the operating license conditions so Plateau can continue with construction of
tailing facilities if it so desires.
The Shootaring Mill has remained shut down because of continued low uranium
prices. Substantial expense would be incurred to upgrade the mill to operating
status and fully activate the NRC permit, and substantial work would be needed
to put the Velvet and Woods Complex Mines into production for material to run
through this mill. This work would include cleaning out adits and drifts,
dewatering, and sampling to ascertain the location and grade of mineralized
material.
Plateau is the lessee of the Tony M Mine properties (with underground
uranium deposits in San Juan County, Utah, located partially on Utah State
lease) and has posted a bond securing Plateau's obligations to reclaim these
properties. The Tony M mine was originally developed by Plateau at the time
Plateau was owned by Consumers Power Company ("CPC"), a Michigan public utility.
Significant areas of uranium mineralization have been accessed and delineated by
the prior owner's underground workings.
Plateau also acquired the Velvet Mine and the nearby Woods Complex in the
Lisbon Valley area in southeastern Utah. The Velvet Mine was developed and
permitted by its prior owner and is located approximately 178 miles by road from
the Shootaring Mill. The prior owner drove several miles of access tunnels
(adits) and drifts (access tunnels) and mined material from the workings.
However, we cannot ascertain the amount or grade of material previously mined,
nor have we ascertained by our own drilling the location and grade of remaining
mineralized material in the mine. The Woods Complex was formerly an operating
uranium mine with a remaining undeveloped resource.
SHEEP MOUNTAIN PARTNERS ("SMP")
SMP PARTNERSHIP. In February 1988, USE acquired uranium mines, mining
equipment and mineralized properties (Sheep Mountain Mines) at Crooks Gap in
south-central Fremont County, Wyoming, from Western Nuclear, Inc. These Crooks
Gap mining properties are adjacent to the Green Mountain uranium properties.
USECC mined and milled uranium ore from one of the underground Sheep Mines
during fiscal 1988 and 1989. In December 1988, USECC sold 50 percent of the
interests in the Crooks Gap properties to Nukem's subsidiary Cycle Resource
Investment Corporation ("CRIC") for cash. The parties thereafter contributed the
properties to and formed Sheep Mountain Partners ("SMP"), in which USECC
received an undivided 50 percent interest. SMP is a Colorado general partnership
formed on December 21, 1988, between USECC and Nukem, Inc. then of Stamford, CT
("Nukem") through its wholly-owned subsidiary CRIC. Each group provided one-half
of $315,000 to purchase equipment from Western Nuclear, Inc.; USECC also
contributed its interests in three uranium supply contracts to SMP and agreed to
be responsible for property reclamation obligations. The SMP Partnership
agreement provided that each partner generally had a 50 percent interest in SMP
net profits, and an obligation to contribute 50 percent of funds needed for
partnership programs or discharge of liabilities. Capital needs were to have
been met by loans, credit lines and
19
contributions. Nukem is a uranium brokerage and trading concern. See Item 3,
Legal Proceedings, for information on litigation with Nukem and CRIC.
SMP PROPERTIES. USE , Crested and/or USECC own 98 unpatented lode mining
claims and a 644 acre Wyoming State Mineral Lease in the Crooks Gap area.
An ion exchange plant located on the properties (to remove natural
soluble uranium from mine water) was reclaimed and the plant disposed of at the
Sweetwater Mill impoundment facility in fiscal 2002.
Permits to operate existing mines (now shut down) on the Crooks Gap
properties have been issued by the State of Wyoming. Amendments are needed to
open new mines within the permit area. As a condition to issuance of the
permits, 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. During the past two
years, USECC did not discharge wastewater into Crooks Creek, and the mine water
is presently being discharged into the USECC McIntosh Pit.
URANIUM MARKET INFORMATION.
URANIUM SPOT MARKET. Uranium exchange value spot price as reported by
Tradetech was $9.85/lb. U3O8 on July 31, an increase from an unrestricted value
of $7.95/lb U3O8 and restricted value of $8.95/ U3O8 at July 31, 2001. During
the first half of 2002, total spot market volume was approximately 8.4 million
lbs. U3O8 which was 3.8 million lbs. for the first half of 2001, or an increase
of 4.5 million lbs. U3O8.
URANIUM LONG-TERM MARKET. The long-term market has been active in 2002 with
the long-term contracts reported by market analysts to have exceeded 10.9
million pounds of U3O8 during the first half of 2002. The uranium price
indicator published by Tradetech was at $10.75 per pound U3O8 at July 31, 2002,
up from the $10.00/lb. at July 31, 2001.
GOLD
SUTTER GOLD MINE (CALIFORNIA)
SUTTER GOLD MINING COMPANY. In fiscal 1991, USE acquired an interest in the
underground Sutter Gold Mine and related properties (the "SGM") located in the
Mother Lode Mining District of Amador County, California. The entire Lincoln
Project (which is the name we use for the properties) is owned by Sutter Gold
Mining Company, a Wyoming corporation ("SGMC"), and a majority-owned subsidiary
of USE.
SGMC is revising plans to put the SGM into production. However,
implementation of this plan will require substantial capital financing.
Persistent low prices for gold have made financing difficult, and in fiscal 1999
resulted in a substantial write down of the SGMC assets. See "Managements
Discussion and Analysis of Financial Condition and Results of Operations" for
fiscal 1999.
Due to the depressed gold prices in the past and lack of available funding,
SGMC has deferred the start of construction of a gold mill complex and
development of the underground mine. The tourist visitor's center has been
leased to a third party for $1,500 per month plus a 4% gross royalty on
revenues. There is one caretaker employee at the Sutter operation. Except for
limited infrastructure improvements in 2000, the assets are in a care and
maintenance mode and the exploration permits are being kept current as
necessary.
PROPERTIES. SGMC holds approximately 216 acres of surface and mineral
rights (owned), 54 acres of surface rights (owned), 55 acres of surface rights
(leased), 154 acres of mineral rights (leased), and 366
20
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 will be approximately $90,000 from
June 1, 2002 through May 31, 2003. Property taxes for fiscal 2003 are estimated
to be $20,000.
The leases are for varying terms, and require rental fees, advance
production royalties, real property taxes and insurance.
PERMITS. The Amador County Board of Supervisors has issued a Conditional
Use Permit ("CUP") allowing mining of the SGM and milling of production, subject
to conditions relating to land use, environmental and public safety issues, road
construction and improvement, and site reclamation.
MOLYBDENUM
As a holder of royalty, reversionary and certain other interests in
properties located at Mt. Emmons near Crested Butte, Colorado, USE and Crested
are entitled to receive annual advance royalties of 50,000 pounds of molybdenum,
or cash equivalent. AMAX Inc. (which was acquired by Cyprus Minerals Company and
was renamed Cyprus Amax Minerals Company in November 1993 and was 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 paid in equal quarterly installments until: (i)
commencement of production; (ii) failure to obtain certain licenses, permits,
etc., that are required for production; or (iii) AMAX's return of the properties
to USE and Crested. The advance royalty payments reduce the operating royalties
(6% of gross production proceeds) which would otherwise be due out of
production. There is no obligation to repay the advance royalties if the
property is not placed in production. USE recognized $108,500 and $132,600 of
revenues in fiscal 2001 and 2000 related to this royalty interest. Phelps Dodge
ceased making the quarterly installments in July 2001.
The Agreement with AMAX also provides that USE and Crested receive
$2,000,000 when the Mt. Emmons properties are put into production and, in the
event AMAX sells its subsidiary, Mt. Emmons Mining Company, or its interest in
the molybdenum properties, USE and Crested are to receive 15% of the first
$25,000,000 received by AMAX.
USE and Crested are in litigation with Phelps Dodge concerning the
Agreement and the properties, see "Item 3 - Legal Proceedings."
OIL AND GAS
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.
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COMMERCIAL OPERATIONS
MOTEL, REAL ESTATE AND OTHER OPERATIONS AND ASSETS. We own varying
interests, alone and with Crested, in affiliated companies engaged in real
estate, and other commercial businesses. Activities of these and other
subsidiaries include ownership and management of a commercial office building,
the townsite of Jeffrey City, Wyoming (which has been sold), and the townsite,
motel, convenience store and other commercial facilities in Ticaboo, Utah.
The Company and Crested own a 14-acre tract in Riverton, Wyoming, with a
two-story 30,400 square foot office building (including underground parking).
The first floor is rented to affiliates, nonaffiliates and government agencies;
the second floor is occupied by the Company and Crested. The property is
mortgaged to the WDEQ as security for future reclamation work on the Sheep
Mountain Crooks Gap uranium properties.
The Company and Crested also 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 operation for
services to the public was shut down late in fiscal 2002.
The Company and Crested also own 17 semi-developed lots on 26.8 acres and
63 acres of undeveloped land near the Riverton Regional Airport, and three
mountain sites covering 16 acres in Fremont County, Wyoming. Also in Riverton,
Wyoming, the Company owns four city lots and a 9-acre tract with improvements
including two smaller office buildings and two other buildings with 12,000
square feet of office facilities, and repair and maintenance shops containing
8,000 square feet.
USECC owns 182 acres of undeveloped land in and near Gunnison, Colorado.
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.
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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
USE has approximately 33 full-time employees, down from 55 in July 2001.
Crested uses approximately 50 percent of the time of USE employees, and
reimburses USE on a cost reimbursement basis.
MINING CLAIM HOLDINGS
TITLE. Nearly all the uranium mining properties held by the GMMV, USE,
USECC and Plateau 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.
RMG's properties and mineral leases of BLM, state and fee lands require
annual cash payments of approximately $286,300 during fiscal 2003. RMG is
obligated for $96,400 of this amount to keep the leases in effect.
PROPOSED FEDERAL LEGISLATION. The U.S. Congress has, in legislative
sessions in recent years, actively considered several proposals for major
revision of the General Mining Law, which governs mining claims and related
activities on federal public lands. If any of the recent proposals become law,
it could result in the imposition of a royalty upon production of minerals from
federal lands and new requirements for mined land reclamation and other
environmental control measures. It remains unclear whether the current Congress
will pass such legislation and, if passed, the extent such new legislation will
affect existing mining claims and operations. The effect of any revision of the
General Mining Law on operations cannot be determined conclusively until such
revision is enacted; however, such legislation could materially increase the
carrying costs of mineral properties which are located on federal unpatented
mining claims, and could increase both the capital and operating costs for such
projects and impair the ability to hold or develop such properties.
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ITEM 3. LEGAL PROCEEDINGS
Material pending proceedings are summarized below. Other proceedings which
were pending in fiscal 2002 have been settled or otherwise finally resolved.
SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION
In 1991, disputes arose between USE/Crested, and Nukem, Inc. and its
subsidiary Cycle Resource Investment Corp. ("CRIC"), concerning the formation
and operation of the Sheep Mountain Partners partnership for uranium mining and
marketing, and activities of the parties outside SMP. Arbitration proceedings
were initiated by CRIC in June 1991 and in July 1991, USECC filed a lawsuit
against Nukem, CRIC and others in the U.S. District Court (District of Colorado)
in Civil No. 91B1153. Later, USECC filed another suit for the standby costs at
the SMP mines against SMP in the Colorado State Court. The Federal Court stayed
both the arbitration proceedings and the State Court case. In February 1994, all
of the parties agreed to exclusive and binding arbitration of the disputes
before the American Arbitration Association ("AAA"), for which the legal claims
made by both sides included fraud and misrepresentation, breach of contract,
breach of duties owed to the SMP partnership, and other claims.
The AAA panel (the "Panel") entered an Order and Award (the "Order") in
April 1996 and clarified the Order on July 3, 1996, finding generally in favor
of USE and Crested on certain of their claims (including the claims for
reimbursement for standby maintenance expenses and profits denied SMP in Nukem's
trading of uranium), and in favor of Nukem/CRIC and against USE and Crested on
certain other claims, and imposing a constructive trust in favor of Sheep
Mountain Partners on uranium contracts Nukem entered into to purchase uranium
from CIS republics. USECC filed a petition for confirmation of the Order and on
June 30, 1997, and the U.S. District Court confirmed the Order in its Second
Amended Judgment (the "Judgment"). Thereafter, Nukem/CRIC appealed the Judgment
to the 10th Circuit Court of Appeals ("CCA").
A three judge panel of the 10th CCA issued an Order and Judgment on October
22, 1998, which unanimously affirmed the Federal District Court's Second Amended
Judgment without modification. The ruling affirmed (i) the imposition of a
constructive trust in favor of SMP on Nukem's rights to purchase CIS uranium,
the uranium acquired pursuant to those rights, and the profits therefrom; and
(ii) the damage award against Nukem/CRIC. As a result of the ruling of the 10th
CCA, USE and Crested received an additional $6,077,264 (including interest and
court costs) from Nukem in February 1999 for a total net monetary award of
$15,468,625 in the arbitration/litigation, and equitable relief in the form of
USE's and Crested's interest in SMP, which holds the constructive trust over the
CIS contracts. Nukem/CRIC filed two motions for entry of final satisfaction of
Judgment. The U.S. District Court denied both motions, Nukem again appealed to
the 10th CCA, which again affirmed the District Court's ruling, and held that
Nukem/CRIC had not demonstrated that the Judgment had been satisfied because
they had not provided USECC with an accounting of the partnerships assets.
In February 2001, the U.S. District Court appointed a Special Master to
determine the amounts, if any, owed by Nukem to SMP pursuant to the constructive
trust. The Special Master has ordered an accounting to identify all deliveries
of CIS uranium made directly or indirectly to Nukem and any Nukem affiliates; to
identify the ultimate disposition of all uranium purchased under the CIS
contracts; to identify the location, number of pounds, and associated cost of
uranium purchased under the CIS contracts at December 31, 2001, and to calculate
the profits realized from the sale of CIS uranium. At a status hearing held
before the U.S. District Court on August 23, 2002, the Court ordered the Special
Master to file his report on or before December 6, 2002 and a further hearing to
schedule arguments will be held on December 13, 2002.
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CONTOUR DEVELOPMENT LITIGATION
On July 28, 1998, USE filed a lawsuit in the United States District Court,
Denver, Colorado, Case No. 98WM1630, against Contour Development Company, L.L.C.
and entities and persons associated with Contour Development Company, L.L.C.
(together, "Contour") seeking compensatory and consequential damages of more
than $1.3 million from the defendants for dealings in real estate owned by USE
and Crested in Gunnison, Colorado. The Contour defendants asserted a
counterclaim asking for payment of attorneys fee and costs. The matter has been
settled, with USE receiving $25,000 cash and unencumbered title to two
commercial real estate lots covering seven acres in Gunnison, Colorado, and
unencumbered title to five development lots covering 175 acres north of
Gunnison, Colorado.
See "Business - Commercial Operations - Real Estate and Other Commercial
Operations - Colorado Properties" above.
PHELPS DODGE LITIGATION
U.S. Energy Corp. and its majority-owned subsidiary, Crested Corp., d/b/a
USECC, were served with a lawsuit on June 19, 2002, filed in the U.S. District
Court of Colorado (Case No. 02-B-0796(PAC)) by Phelps Dodge Corporation and its
subsidiary, Mt. Emmons Mining Company (MEMCO), over contractual obligations from
USECC's agreement with Phelps Dodge's predecessor companies, concerning a mining
property in Colorado.
The litigation stems from agreements that date back to 1974 when U.S.
Energy and Crested Corp. leased mining claims on Mt. Emmons near Crested Butte,
Colorado to AMAX Inc., Phelps Dodge's predecessor company. The claims cover one
of the world's largest and richest deposits of molybdenum. AMAX reportedly spent
over $200 million on the acquisition, exploration and mine planning activities
on the Mt. Emmons properties. In counter and cross-claims filed in the U.S.
District Court of Colorado, USECC contends that Phelps Dodge and its
subsidiaries committed several breaches of contracts related to the agreements,
including breach of fiduciary obligations and covenants of good faith and fair
dealing. USECC also contends Phelps Dodge is guilty of violating federal and
state antitrust laws when it purchased Cyprus Amax Minerals Company (Cyprus
Amax).
The complaint filed by Phelps Dodge and MEMCO seeks a determination that
Phelps Dodge's acquisition of Cyprus Amax was not a sale. Under a 1986 agreement
between USECC and AMAX, if AMAX sold MEMCO or its interest in the mining
properties, U.S. Energy and Crested would receive 15% (7.5% each) of the first
$25 million of the purchase price ($3.75 million). In 1991, Cyprus Minerals
Company acquired AMAX to form Cyprus Amax Minerals Co. USECC's counter and
cross-claims allege that in 1999, Phelps Dodge formed a wholly-owned subsidiary
CAV Corporation, for the purpose of purchasing the controlling interest of
Cyprus Amax and its subsidiaries (including MEMCO) at an estimated value in cash
and Phelps Dodge stock exceeding $1 billion and making Cyprus Amax a subsidiary
of Phelps Dodge. Therefore, USECC asserts the acquisition of Cyprus Amax by
Phelps Dodge was a sale of MEMCO and the properties that triggers the obligation
of Cyprus Amax to pay USECC the $3.75 million plus interest.
A second counterclaim by USECC rejects the claim by Phelps Dodge that it
and its predecessors, Cyprus Amax and AMAX Inc., had mistakenly paid royalties
to USECC since January 1991. In 1984, AMAX began paying the cash equivalent
(half each to U.S. Energy and Crested Corp.) of 700,000 pounds of molybdenum per
year as an advance royalty prior to the mine beginning production. In 1986,
USECC agreed to assist financially troubled AMAX and substantially reduced the
annual advance royalty to 50,000
25
pounds of molybdenum, so that AMAX could continue to hold the properties and
eventually bring them into production. AMAX, Cyprus Amax and Phelps Dodge
continued paying the annual advance royalties to U.S. Energy and Crested Corp.
until the payment due in July 2001, when Phelps Dodge unilaterally ceased making
the payments. Phelps Dodge and MEMCO seek a declaratory judgment that the
advance royalty payment obligation has terminated, and further, that USECC
should repay $948,109 of royalties paid to USECC from 1993 through 2000, because
those payments were made by mistake.
The third issue in the litigation is whether USECC must, under terms of a
1987 royalty deed, accept Phelps Dodge's and MEMCO's forth-coming conveyance of
the Mt. Emmons properties back to USECC, which properties now include a plant to
treat mine water, costing in excess of $1 million a year to operate in
compliance with State of Colorado regulations. Phelps Dodge's and MEMCO's
threatened reconveyance would require USECC to assume the operating costs of the
water treatment plant. USECC refuses to have the water treatment plant included
in the return of the properties because, the USECC counterclaim argues, the
properties must be in the same condition as when they were acquired by AMAX
before the water treatment plant was constructed by AMAX.
The properties are comprised of 10 unpatented lode mining claims (for which
patents are expected to be issued by the BLM in the near future), and 770
unpatented lode mining claims, for a total of 15,600 acres.
As added counterclaims, USECC seeks (i) damages for defendants' breach of
covenants of good faith and fair dealing; (ii) damages for defendants' failure
to develop the Mt. Emmons properties and not protecting USECC's rights as
revisionary owner of the mining rights to the properties, (iii) damages for
unjust enrichment of defendants; (iv) damages for breach of the defendants'
fiduciary duties owed to USECC as revisionary owner of the property, and for
neglecting to maintain the mining rights and interests in the properties; and
(v) damages relating to defendants' actions in violation of federal and Colorado
anti-trust and constraint of trade laws.
USECC also seeks a declaratory judgment of its rights and liabilities under
the agreements affecting the Mt. Emmons properties; an injunction against
defendants prohibiting the conveyance of the properties to USECC with the water
treatment plan; an injunction against further waste of the properties by the
defendants; an injunction requiring defendants to divest their molybdenum
holdings (including the Mt. Emmons properties); and an injunction requiring
defendants to assist USECC in mining molybdenum from the Mt. Emmons properties.
On August 2, 2002, Phelps Dodge ad MEMCO filed a reply to the counterclaims
of USECC and Cyprus Amax filed an answer to the counterclaims and third party
complaint of USECC, generally denying the allegations of USECC. CAV Corporation
filed a motion for summary judgment seeking dismissal of USECC's cross complaint
and is pending. An order has been entered by the Court setting the
Scheduling/Planning Conference in the case for September 12, 2002.
Except for the parties' claims regarding payment of the $3.75 million due
on the sale of MEMCO, payments of royalties, and responsibility going forward
for payment of the operating costs of the water treatment plan, the financial
impact to U.S. Energy Corp. and Crested Corp. of favorable or unfavorable
outcomes in the litigation presently is not determinable.
26
SUTTER GOLD LITIGATION
On or about March 13, 2002, the Company's subsidiary, Sutter Gold Mining
Company, was served with a complaint filed in the Superior Court of Amador
County, California, Case Number 02CU2051. The plaintiff is Edward A. Swift
individually and as a trustee and the other defendant is Meridian Minerals
Company (Meridian). The litigation involves a mining lease entered into in 1989
between Plaintiffs and Defendant Meridian on the rental of Plaintiffs' land.
Plaintiffs contend Defendants owe them $136,186 for past due rent and some
$12,000 in unpaid taxes and for fence repair. Defendant Sutter Gold, has filed
an answer generally denying the complaint and the case is pending. We have
negotiated the terms of a settlement but due to the death of one of the
essential parties in the matter, finalization of the settlement has been
delayed. We hope to finalize a settlement in calendar 2002.
ROCKY MOUNTAIN GAS LITIGATION
On or about April 1, 2002, the Company's subsidiary, Rocky Mountain Gas,
Inc. ("RMG") was served with a Second Amended Complaint wherein the Northern
Plains Resource Council had filed suit in the U.S. District Court of Montana,
Billings Division in Case No. CV-01-96-BLG-RWA, against the United States Bureau
of Land Management ("BLM"), RMG and certain of its affiliates (including U.S.
Energy Corp. and Crested Corp.), and joined some 20 other defendants. The
plaintiff is seeking to cancel oil and gas leases issued to RMG et al by the BLM
in the Powder River Basin of Montana and for other relief. RMG and its
affiliates have not yet answered or otherwise pled to the complaint.
The basis for the complaint appears to be that the BLM's regulations
require the BLM to respond to objections filed by persons owning land or lease
rights adjacent to the coalbed properties which the BLM is offering to lease to
the public. The argument of plaintiff appears to be that if objections are not
responded to by the BLM prior to issuing CBM leases, the leases are invalid.
Based on this argument, the plaintiff appears to have been successful in forcing
cancellation of some CBM leases granted to others in the Powder River Basin of
Montana, because the BLM did not respond to some objecting adjacent landowners.
However, all of the BLM leases in Montana held by RMG (none are held by U.S.
Energy Corp. or Crested Corp. in their own corporate names) are at least four
years old, and there is no record of any objections being made to the issue of
those leases.
Based on filings in the case to date, it appears that the BLM is taking the
initiative in responding to the plaintiff. We believe RMG's 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. However, RMG
holds BLM leases on 88,411 gross acres in Montana (in the Castle Rock and Kirby
prospects), which equals 31.5% of RMG's total coalbed methane leases. An adverse
court ruling to the effect that all or a substantial portion of the BLM leases
in Montana are invalid could materially and adversely impact RMG. No trial date
has been set.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
27
PART II
ITEM 5. MARKET FOR COMMON SHARES AND RELATED STOCKHOLDER MATTERS
(a) Market Information
Shares of USE common stock are traded on the over-the-counter market, and
prices are reported on a "last sale" basis by the National Market System ("NMS")
of the National Association of Securities Dealers Automated Quotation System
("Nasdaq"). The range by quarter of high and low sales prices is set forth below
for fiscal 2002 and 2001.
High Low
---- ---
Fiscal year ended May 31, 2002
------------------------------
First quarter ended 8/31/01 $6.05 $3.56
Second quarter ended 11/30/01 4.15 3.09
Third quarter ended 2/29/02 5.27 3.50
Fourth quarter ended 5/31/02 4.30 3.29
Fiscal year to ended May 31, 2001
---------------------------------
First quarter ended 8/31/00 $3.00 $1.75
Second quarter ended 11/30/00 3.38 1.75
Third quarter ended 2/28/01 4.00 2.00
Fourth quarter ended 5/31/01 6.25 3.56
(b) Holders
(1) At August 15, 2002, the closing market price was $3.05 per share and there
were approximately 714 shareholders of record. As of August 26, 2002, we have
12,075,493 shares of common stock issued and outstanding, including shares owned
by our subsidiaries and shares in officers' and directors' names that are
subject to forfeiture.
(2) Not applicable.
(c) We have not paid any cash dividends with respect to common stock. There are
no contractual restrictions on our present or future ability to pay cash
dividends, however, we intend to retain any earnings in the near future for
operations.
ITEM 6. SELECTED FINANCIAL DATA.
The following tables show certain selected historical financial data for
USE for the five years ended May 31, 2002. The selected financial data is
derived from and should be read with the financial statements for USE included
in this Report.
28
May 31,
---------------------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Current assets $ 4,897,600 $ 3,330,000 $ 3,456,800 $ 12,718,900 $ 14,301,000
Current liabilities 1,406,400 2,396,700 6,617,900 5,355,600 6,062,100
Working capital (deficit) 3,491,200 933,300 (3,161,100) 7,363,300 8,238,900
Total assets 30,537,900 30,465,200 30,876,100 33,391,000 45,019,100
Long-term obligations(1) 14,949,100 14,981,500 14,025,200 14,526,900 14,468,600
Shareholders' equity 10,597,200 7,320,600 4,683,800 10,180,300 17,453,500
(1)Includes $8,906,800, $8,906,800, $8,906,800, $8,860,900, and $8,778,800, of
accrued reclamation costs on mining properties at May 31, 2002, 2001, 2000, 1999
and 1998, respectively. See Note K of Notes to Consolidated Financial
Statements.
For Years Ended May 31,
----------------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Operating revenues $ 2,004,100 $ 3,263,000 $ 3,303,900 $ 3,788,600 $ 6,132,600
Loss from
continuing operations (7,454,200) (7,517,800) (11,356,100) (22,713,300) (4,984,900)
Other income & expenses 1,319,500 8,730,800 802,200 6,655,500 5,349,900
(Loss) income before minority
interests, equity in (loss)
income of affiliates,
discontinued operations,
and income taxes (6,134,700) 1,213,000 (10,553,900) (16,057,800) (365,000)
Minority interest in loss
(income) of consolidated
subsidiaries 39,500 220,100 509,300 4,468,400 (772,500)
Equity in loss of affiliates -- -- (2,900) (59,100) (575,700)
Income taxes -- -- -- -- --
Discontinued operations
net of tax (85,900) 488,100 (594,300) - -
Preferred stock dividends (86,500) (150,000) (20,800) -- --
------------ ------------- ------------- ------------- -----------
Net (loss) income
to common shareholders $ (6,267,600) $ 1,771,200 $ (10,662,600) $ (11,648,500) $ (983,200)
============ ============ ============= ============= ==============
29
For Years Ended May 31,
----------------------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Per share financial data
Operating revenues $ 0.22 $ 0.42 $ 0.43 $ 0.53 $ 0.92
Loss from
continuing operations (0.80) (0.96) (1.39) (3.18) (0.75)
Other income & expenses 0.14 1.11 0.01 0.93 0.80
(Loss) income before minority
interests, equity in income
(loss) of affiliates,
discontinued operations, and
income taxes (0.66) 0.15 $ (1.38) $ (2.25) $ 0.05
Minority interest in loss (income)
of consolidated subsidiaries 0.01 0.03 0.07 0.63 (0.12)
Equity in loss of affiliates -- -- -- (0.01) (0.08)
Discontinued operations (0.01) 0.06 (0.08) -- --
Income taxes -- -- -- -- --
Preferred stock dividends (0.01) (0.01) -- -- --
-------- -------- -------- -------- --------
Net income (loss)
per share, basic $ (0.67) $ 0.23 $ (1.39) $ (1.63) $ (0.15)
======== ======== ======== ======== ========
Net income (loss)
per share diluted $ (0.67) $ 0.21 $ (1.39) $ (1.63) $ (0.15)
======== ======== ======== ======== ========
Cash dividends per share $ -0- $ -0- $ -0- $ -0- $ -0-
======== ======== ======== ======== ========
30
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following is Management's Discussion and Analysis of significant
factors which have affected our liquidity, capital resources and results of
operations during the periods included in the accompanying financial statements.
The discussion contains forward-looking statements that involve risks and
uncertainties. Due to uncertainties in our business, actual results may differ
materially from the discussion below.
CRITICAL ACCOUNTING POLICIES
OIL AND GAS PRODUCING ACTIVITIES
We follow the full cost method of accounting for oil and gas properties.
Accordingly, all costs associated with acquisition, exploration, and development
of oil and gas reserves, including directly related overhead costs, are
capitalized.
Once we begin production, all capitalized costs of oil and gas properties
including the estimated future costs to develop proved reserves, will be
amortized on the unit-of-production method using estimates of proved reserves.
Investments in unproved properties and major development projects are not
amortized until proved reserves associated with the projects can be determined.
Unproved properties are assessed periodically to ascertain whether impairment
has occurred. Such assessments could cause the Company to reduce the carrying
values of the properties.
In addition, the capitalized costs are subject to a "ceiling test," which
basically limits such costs to the aggregate of the "estimated present
value,"discounted at a 10-percent interest rate of future net revenues from
proved reserves, based on current economic and operating conditions, plus the
lower of cost or fair market value of unproved properties.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonments of properties are accounted for as adjustments of capitalized costs
with no loss recognized.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 2002, our cash position increased by $1,878,800 over the
prior balance at May 31, 2001 to a cash balance of $2,564,300. This increase
came as a result of $1,822,300 and $3,391,300 being generated in investing
activities and financing activities, respectively. This increase in cash of
$5,213,600 was offset by a reduction of $3,334,800 which was consumed in
operations.
Operations for the fiscal year ended May 31, 2002, resulted in a net loss
of $6,267,600. The major noncash components of the net loss for the year were:
Depreciation of $541,500; impairment of goodwill of $1,622,700; services which
were paid for with our common stock $787,700; gain on the sale of assets of
$812,700; provision for bad debts of $171,200; noncash compensation of $535,200;
and the net change in assets and liabilities of $115,200.
During December 2001, we purchased equity in Rocky Mountain Gas, Inc.
("RMG") from certain minority shareholders under the terms of their initial
investment which allowed for a conversion to shares of our common stock if
certain conditions were not met. Subject to those conversion terms, we purchased
1,105,499 shares of RMG stock (adding to our original consolidated ownership an
additional 8.7% ownership interest in RMG), by issuing a total of 912,233 shares
of our common stock at $3.92 per share. An impairment of $1,622,700 was taken on
this investment in RMG during the third quarter of fiscal 2002 as
31
RMG had no production and to bring the total investment in RMG carried on our
books in line with the fair market value of RMG assets, the impairment was
taken.
During fiscal 2002, there were shares of our common stock and warrants
issued to our outside directors and consultants, which were valued at a total of
$787,700 in a noncash payment for services rendered. Our directors received
3,429 shares of our common stock valued at $14,400 for annual director's fees;
consultants received 45,000 shares of our common stock in exchange for $148,100
in consulting services and other consultants and investors received warrants
valued at $625,200. The $535,200 in noncash compensation was through the funding
of our ESOP with 70,075 shares of our common stock valued at $236,900 and the
amortization of various Company stock bonus plans in the amount of $298,300.
We sold our controlling interest in Ruby Mining Company ("Ruby") to
Admiralty Corporation ("Admiralty") of Atlanta, Georgia in fiscal 2001.
Admiralty has developed technology that differentiates ferrous from non-ferrous
metals in sea water. This technology is used to explore for and recover sunken
treasures. Admiralty paid us $100,000 and signed a promissory note for $225,000
for the purchase of Ruby. Admiralty defaulted on the payment of the promissory
note. As a result, we recorded a provision for doubtful accounts for the balance
due under the Admiralty note of $171,200.
Investing activities provided $1,822,300 during fiscal 2002. The primary
components of this source of cash was the sale of an interest in RMG's coalbed
methane properties to CCBM, Inc. ("CCBM") of Houston, Texas for $1,125,000;
proceeds of $752,000 from the sale of various surplus equipment, and a net
change of $406,500 in the investment we have in affiliated companies. Uses of
cash in Investing Activities were the expenses incurred in the development of
RMG's coalbed methane properties of $142,100; increased value of restricted
investments of $236,800 through the reinvestment of interest earned on those
investments, and the purchase of $82,300 of equipment.
RMG assigned CCBM an undivided 50% interest in all of RMG's existing
coalbed methane properties (with the exception of Castle Rock of which only a
6.25% working interest was assigned) for the purchase price of $7,500,000 by a
promissory note payable in principal amounts of $125,000 per month plus interest
at 8% per annum over 41 months (starting on July 31, 2001) with a balloon
payment due on the forty-second month. The note is secured by a pledge of CCBM's
interest in the properties of RMG being purchased by CCBM. All payments on the
promissory note principal, $1,125,000 were taken against our full cost pool of
coalbed methane gas properties. CCBM has made all payments due under the terms
of the promissory note. CCBM also agreed to pay $5,000,000 to drill and complete
coalbed methane wells on RMG's properties. One half of this amount, $2,500,000
will be credited against any drilling or property development costs that are the
obligation of RMG. As of May 31, 2002, the total amount expended by CCBM towards
this work commitment was $2,245,000 leaving a balance under the work commitment
of $2,755,000 approximately half of which will be spent to cover RMG's
commitments in the development of the joint properties.
RMG did expend $142,100 in the development of coalbed methane properties
during fiscal 2002, which were outside the work commitment of CCBM. We maintain
cash investments in the amount of $10,015,500, that are dedicated to reclamation
liabilities and cannot be used for operations of the Company. These investments
earn interest annually which is used to pay licensing fees on our uranium mill
in southern Utah. Any unused earned interest proceeds are reinvested into the
restricted investments. During fiscal 2002, restricted investments increased by
$236,800.
Financing activities during fiscal 2002 provided $3,391,300. These proceeds
were generated from the sale of common stock of the Company and its subsidiary
RMG in the amount of $3,957,400 and proceeds from long term debt, $1,000,000.
These cash proceeds from financing activities were partially offset by
repayments of the Company's line of credit and other long term debt in the
amounts of $650,000 and $547,800, respectively.
32
The Company sold 871,592 shares of it common stock in private placements
for a total of $2,350,500. Employees of the Company also exercised options to
purchase 253,337 shares of the Company's common stock for $602,500. RMG sold
333,333 shares of its common stock in a private placement to outside investors
for $1,000,000. These shares of RMG stock were converted to common shares of the
Company's common stock as discussed above.
On May 30, 2002, the Company entered into a debt financing agreement with
an independent company. The Company secured $1,000,000 in debt through this
transaction which bears interest of 8% per annum and is due quarterly commencing
on September 1, 2002. Collateral for the loan is a junior security interest in
the assets of the Company. The entire debt is due on or before May 30, 2004. At
the option of the lending company, all or any portion of the debt may be repaid
with the common stock of the Company or RMG, at the rate of $3.00 per share for
Company shares, or $1.50 per share for RMG shares. In addition, the lending
company received detached warrants to purchase 120,000 shares of the Company and
120,000 shares of RMG's common stock at $3.00 and $1.50 per share, respectively
and a beneficial conversion provision. The Company therefore recognized a
discount on the $1,000,000 loan in the total amount of $670,100.
The balance of the increase in long term debt was for the financing of
prepaid insurance and the financing of miscellaneous assets.
Working capital increased by $2,557,900 from $933,300 at May 31, 2001 to
working capital of $3,491,200 at May 31, 2002. This increase in working capital
was primarily as a result of the increased cash receipts discussed above.
CAPITAL RESOURCES
The primary sources of our capital resources are cash on hand; collection
of receivables; receipt of monthly payments from CCBM for the purchase of an
interest in RMG's coalbed methane properties; CCBM funding of drilling and
development programs; projected production from RMG's coalbed methane
properties; sale of excess mine, construction and drilling equipment; sale of
real estate properties which are no longer needed in the core business of the
Company; sale of partial ownership interest in mineral properties; proceeds
under the line of credit; equity financing of the Company's subsidiaries; and
the final determination of the Sheep Mountain Partners ("SMP")
arbitration/litigation. We will also continue to receive revenues from our
commercial operations in southern Utah.
Drilling and development capital requirements will be satisfied for the
majority of fiscal 2003 from the CCBM work commitment of which there is
$2,755,000 remaining as of May 31, 2002. Approximately one-half of this amount
will be paid by CCBM on behalf of RMG for its obligations for drilling and
property development of coalbed methane properties. There is also a balance of
$6,375,000 due from CCBM under its purchase agreement. Under the terms of the
promissory note, this amount will continue to be paid at the rate of $125,000
per month plus interest until November 2004 at which time a balloon payment of
$2,375,000 is due. CCBM's interest in RMG's coalbed methane properties is
pledged as security for the note to RMG. After CCBM has paid $2,500,000 (33%) of
the principal amount of the promissory note, RMG will release 25% of the
undivided interest in the coalbed methane properties purchased by CCBM; another
25% when $5,000,000 (66.6%) of the principal is paid, and the balance of the
total 50% undivided interest when all of the principal amount of $7,500,000 of
the purchase price has been paid.
Under the agreement with CCBM, CCBM also agreed to use its best efforts to
obtain financing to raise no less than $20 million to be used by RMG to acquire
more coalbed methane properties. CCBM has not been successful in raising these
funds within the terms of the agreement due to market conditions for coalbed
methane gas. RMG has extended the time for CCBM to raise the funds to June 30,
2003. If CCBM is unsuccessful in raising the funds to purchase additional
coalbed methane properties or for any reason
33
determines to discontinue participation in the development of RMG's coalbed
methane properties, RMG will continue to seek equity or industry funding to
develop its properties.
The Company has shut down it mines and has discontinued its mining and
construction operations. It therefore has surplus equipment and buildings from
these operations. During fiscal 2001 and 2002, the Company sold the majority of
its surplus equipment. In addition, the Company owns various raw land which is
held as investment property or were intended to be used in mining operations.
These properties are no longer needed for the core business of the Company and
will be sold. The Company currently has an offer to sell a piece of property in
California which was previously held for the development of a mill tailings site
for its subsidiary Sutter Gold Mining Company, ("SGMC"). This property was never
developed for a tailings site so has no reclamation liability.
The Company continues to market home and mobile home lots in southern Utah.
These fully developed properties are not important to the operations of the
Company. The lots were a portion of the assets that the Company acquired when it
purchased the Shootaring uranium mill and Ticaboo Townsite. The Company has also
listed the commercial operations at Ticaboo for sale. It is the intention of
management of the Company to sell this commercial property. The Company also has
determined to sell the Shootaring uranium mill. It is the goal of the Company's
management to sell the mill as a unit but proposals to sell the mill parts have
also been considered. No firm proposal is currently being considered on the
mill.
To assist in financing the holding costs of the Sutter gold properties
(which are shut down), the Company developed a mine tour business. After
operating the mine tour business for approximately one year, it was determined
to lease out the tour business. Proceeds under the lease agreement partially
defray the holding costs of the mine property. The Company is currently
discussing the potential of either a sale of the property to an industry partner
or a possible joint venture agreement to operate the property. Equity financing
will be required to develop the mine and mill complex. A decision to further
develop the property at Sutter is contingent on the price of gold.
We currently have a $750,000 line of credit with a commercial bank. As of
May 31, 2002, this line of credit has been drawn down by $200,000. The line of
credit will be renewed in September of 2002. Due to the sale of mining
equipment, which was held as collateral for the line of credit, the limit of the
line of credit may be reduced. We also have a $500,000 line of credit through
our affiliate Plateau Resources. This line of credit is for the development of
the Ticaboo Townsite in southern Utah. Plateau has drawn down $300,000 of this
financing facility which is repayable over 10 years. All payments on these lines
of credit are current as of the filing date of this report.
We have been involved in litigation with Nukem, Inc. involving SMP for the
past eleven years. The U.S. District Court of Colorado has appointed a Special
Master to determine the value of the purchase rights, the pounds of uranium and
the profits under certain contracts Nukem entered into with 3 CIS Republics,
which contracts have been placed in a constructive trust. The Special Master is
currently performing the accounting. The Federal Court has ordered that the
accounting be completed and filed with the Court by December 6, 2002 with a
further status hearing to be held on December 13, 2002. The ultimate outcome of
this litigation cannot be determined but management of the Company believes that
it will be beneficial to the Company.
We believe that these cash resources will be sufficient to sustain
operations during fiscal 2003.
34
CAPITAL REQUIREMENTS
The primary capital requirements during fiscal 2003 are expected to be
development of coalbed methane properties; the cost of maintaining our uranium
properties that are shut down; the SGMC gold properties holding costs; and
general and administrative costs. Estimated capital requirements for fiscal 2003
are: $873,500 for the development and holding costs of coalbed methane
properties; costs to maintain uranium properties and associated real estate
assets in the amount of $600,000; gold properties holding costs of $230,000, and
general and administrative costs of $3,885,000. These allocations and estimates
may vary depending on the level of acquisition and drilling RMG participates in
during the year.
DEVELOPMENT OF COALBED METHANE PROPERTIES
-----------------------------------------
The majority of the fiscal 2003 development costs associated with the
coalbed methane properties of RMG has been funded through the CCBM agreement.
Under the CCBM purchase and sale agreement, if properties are drilled that are
owned 50% by RMG, we may be required to fund the drilling costs for the interest
ownership of the remaining non-participating parties. Should we be required to
fund any non- participating entities portion of the development programs, there
is a back-in provision on each property which gives RMG a disproportionate
amount of the production revenues until our cost and additional amounts are
recovered before the non-participating parties begin to receive production
funds.
MAINTAINING MINERAL PROPERTIES
------------------------------
SMP URANIUM PROPERTIES
The care and maintenance costs associated with the uranium mineral
properties formerly owned by Sheep Mountain Partners ("SMP"), are approximately
$28,000 per month. We continue to implement cost cutting measures to reduce the
holding cost while at the same time preserving the assets. We have begun the
process of reclamation on certain of these mine properties and will continue to
do work during fiscal 2003. It is estimated that $50,000 in reclamation work
will be completed on the SMP mine properties during fiscal 2003. The Company is
seeking final approval from the regulatory agencies of the reclamation work
completed on the GMIX water treatment plant during fiscal 2002.
PLATEAU RESOURCES URANIUM PROPERTIES
Plateau owns the Ticaboo Townsite, which includes a motel, convenience
store, boat storage, restaurant and lounge. Prior to fiscal 2002, we operated
all of these entities. A decision was made to lease out all but the motel
operations during fiscal 2002. This decision relieved us of the obligation and
expense of employees, inventory and risk of loss from the business operations.
Additionally, Plateau owns and maintains the Tony M uranium mine and
Shootaring Canyon uranium mill. We are pursuing alternative uses for these
properties including the potential sale of the uranium mill. There are no major
reclamation projects anticipated on the mill or mine properties during fiscal
2003.
SUTTER GOLD MINING COMPANY GOLD PROPERTIES
Due to the depressed market price of gold, the development of the gold
properties has been deferred until the price of gold improves. In the meantime,
SGMC developed a tourism business to cover the holding costs of the properties.
A decision was made to lease out the tourism business to a third party. The
revenues received from the lease cover a majority of our holding costs
associated with the mine, shop and mineral leases. We have one employee at the
SGMC properties to preserve the core assets and properties. SGMC is in the
process of evaluating the potential of selling certain of the nom-essential land
positions that it has
35
acquired in developing a mine plan. SGMC is also considering other alternatives
such as equity financing or obtain industry partners to develop the property in
the event that market prices reach to the level to warrant placing the
properties into production.
Carrying values for the SGMC properties, as of May 31, 2002, are lower than
the fair market value of the properties. These assets consist primarily of raw
land that was purchased for a mill tailings cell but is no longer needed under
the new mine development plan. The land is in the path of a proposed highway
development project by the State of California.
DEBT PAYMENTS
-------------
Debt to non-related parties at May 31, 2002 was $2,559,000 as compared with
$2,294,500 at May 31, 2001. The increase in debt to non-related parties of
$264,500 consists of debt incurred to finance annual insurance premiums of
$250,500; purchase of equipment of $180,600; and the convertible debt in the
amount of $1,000,000 from an independent company which was discounted by
$670,100 for detached warrants and a beneficial conversion provision, which will
be amortized over the life of the debt. During fiscal 2002 the Company made
payments on outstanding debt in the amount of $496,500. Payment requirements on
this debt during fiscal 2003 is $80,000 of interest on the convertible debt and
$205,700 in principal payments on the balance of the debt. Principal
requirements of long term debt are $205,700, $540,200, $182,200, $199,000,
$1,036,600 and $394,000 for fiscal 2003 through 2008, respectively. At May 31,
2002, the Company borrowed $200,000 under its $750,000 line of credit with a
commercial bank. The line of credit is to be renewed in September of 2002.
FEDERAL INCOME TAX ISSUES
-------------------------
During fiscal 2002, the Internal Revenue Service ("IRS") audited our books
and records for the fiscal years ended May 31, 1999 and 2000. The audits have
been completed and all issues agreed to. There were no changes in the amount of
taxes due as a result of these audits. All issues through May 31, 2000 are now
settled and the years through then are closed.
RECLAMATION COSTS
-----------------
The reclamation obligations are long term and are either bonded through the
use of cash bonds or the pledge of assets. It is anticipated that only $50,000
of reclamation work will be performed during fiscal 2003. The reserves to pay
the reclamation obligations are either real estate holdings of the Company that
are pledged or restricted cash investments.
The reclamation liability on the Plateau uranium mining and milling
properties in Utah is $7,382,100 which is reflected on the Balance Sheet as a
reclamation liability. This liability is fully funded by cash investments that
are recorded as long term restricted assets.
The reclamation costs of the Sheep Mountain uranium properties in Wyoming
are $1,496,800 and are covered by a reclamation bond which is secured by a
pledge of certain of our real estate assets.
The reclamation requirements for the SGMC gold properties is approximately
$27,900. This reclamation obligation is bonded with a cash bond.
36
RESULTS OF OPERATIONS
---------------------
FISCAL 2002 COMPARED TO FISCAL 2001
- -----------------------------------
Revenues:
- --------
Revenues from operations decreased by $1,258,900 to $2,004,100 during
fiscal 2002 from the $3,263,000 recognized during fiscal 2001. Components of
this decrease are reductions of $426,500 in motel, real estate and airport
operations; mineral sales of $334,300; mineral royalties of $108,500; and
management fees of $389,600. Mineral sales during fiscal 2001 resulted from
purchase of uranium oxide on the open market to fill uranium sales contracts and
the sale of a uranium contract to a third party. We did not supply any of the
uranium sold under the contracts from production out of our mines. We have not
produced any minerals from mines for several years. The uranium contracts
expired and no molybdenum advance royalties have been received since 2001.
The reduction of motel, real estate and airport operations of $426,500 was
primarily as a result of reduced revenues at our Ticaboo motel in southern Utah.
The reduction in revenues in the tourism business is attributed to the general
decline in the economy as well as the negative effect that the terrorist attacks
have had on people's desire to travel.
There were no mineral sales during fiscal 2002 while there was one delivery
under a uranium contract as well as the sale of one of the Company's uranium
contracts to a third party during fiscal 2001. Currently the Company does not
have any delivery contracts for uranium or any other mineral. Depending on the
outcome of the SMP litigation, the Company may well have CIS pounds of uranium
for which it will need to obtain delivery contracts.
The Company holds a 6% royalty on the Mt. Emmons molybdenum deposit near
Crested Butte, CO. Under the provisions of the royalty agreement, the Company
and Crested are to receive 50,000 pounds of molybdenum or its cash equivalent
annually as an advance royalty. The royalty agreement was originally made with
AMAX, Inc., which was purchased by Cyprus Minerals Company in 1993 and changed
its name to Cyprus Amax Minerals Company ("Cyprus Amax"). In 1999, Cyprus Amax
was purchased by Phelps Dodge Corporation. AMAX and Cyprus had made the advance
royalty payments to USECC on a timely basis. Phelps Dodge made one advance
royalty payment and ceased making payments in fiscal 2001. Phelps Dodge has
suspended payments under the advance royalty agreement and has sued the Company.
The Company has filed counter claims against Phelps Dodge requesting that the
advance royalty and other issues be reinstated. It is not known what the outcome
of this litigation will be.
Management fees were reduced by $389,600 in fiscal 2002 from the prior
period due to reduced activity in the entities from which management fees are
collected.
Costs and Expenses:
- ------------------
During fiscal 2002, costs and expenses were reduced by $1,322,500. This
reduction was as a result of reduced activity in our commercial operations in
southern Utah because some of the operations were leased to third parties, and
the general economy turned down as a result of terrorist attacks. This reduced
both revenues as discussed above and costs and expenses of $1,307,300. The
holding costs of mineral properties were reduced by $1,661,500 as a result of
the Company reducing costs associated with mineral properties that are shut
down. The general and administrative costs were reduced by $104,700. In addition
to these reductions in costs and expenses, the Company recognized an expense of
$123,800 in abandonment of mining equipment during fiscal 2001. There was no
abandonment expense in fiscal 2002.
37
These reductions in costs and expenses were offset by increases in
impairment of goodwill of $1,622,700; provision for doubtful accounts of
$171,200 and other expenses of $80,900. The impairment of goodwill came as a
result of the Company purchasing an additional 8.7% of RMG equity or 1,105,499
shares of RMG stock by issuing 912,233 shares of the Company's common stock. The
shares of the Company's common stock were valued at $3.92 per share. An
impairment of $1,622,700 was taken on this investment in RMG as RMG had no gas
production and the impairment brought the total investment in RMG in line with
the fair market value of the RMG assets.
A provision for doubtful accounts was provided on the balance of a note
receivable that the Company held for the sale of Ruby Mining Company to
Admiralty Corporation. The note was in the original amount of $225,000 and had
been reduced to $171,200. The note went in default during fiscal 2002 at which
time the Company began negotiations with Admiralty to resolve the issue of the
outstanding balance. Terms were reached which required Admiralty to pay interest
on the note, plus accrued interest, through August 2003, at which time the
entire note balance would come due. Due to the financial condition of Admiralty,
it is not known if that company will be able to pay off the balance of the note.
The entire amount of the note was therefore reserved.
Other Income and Expenses:
- -------------------------
Gain on sale of assets income decreased by $350,900 during fiscal 2002 to
$812,700. This decrease was as a result of the sale of a majority of the surplus
mining equipment that the Company had for sale during the prior year. During
fiscal 2002, there was no income from litigation settlements while during fiscal
2001 there was $7,132,800 in litigation settlement as a result of the Company
settling all issues appertaining to the Kennecott litigation. Interest income
increased by $152,400 during fiscal 2002 over fiscal 2001 as did interest
expense which increased by $80,000 for the same period. These increases were as
a result of larger amounts invested in interest bearing accounts and increased
debt.
Operations for the twelve months ended May 31, 2002 resulted in a net loss
of $6,267,600 or $0.67 per share as compared to net income of $1,771,200 or
$0.23 per share for the previous year.
FISCAL 2001 COMPARED TO FISCAL 2000
- -----------------------------------
Revenues:
- --------
Operating revenues during fiscal 2001 decreased $40,900 from revenues for
the previous year to $3,263,000. This decrease was primarily as a result of a
decrease in revenues from motel, real estate and airport operations. This
decrease was offset by increases in mineral sales and management fees.
During fiscal 2001, we recorded $334,300 in revenues from mineral sales
compared with no mineral sales revenue during the previous year. The increase
was the result of the sale of a uranium delivery contract to a non-affiliated
company, and a delivery of uranium made under that market related contract
before the sale of the contract. There were no similar sales of uranium during
the same period of the prior year. The Company purchased the uranium necessary
to deliver to its contract. The Company has not produced uranium for several
years.
Revenues from motel, real estate and airport operations decreased from
$2,734,800 at May 31, 2000 to $2,222,400 at May 31, 2001. This decrease is as
result of the mine tour at SGMC and the boat storage, restaurant and convenience
store operations being leased to third parties by Plateau during fiscal 2001.
Management fees increased $161,300 to $597,800 during fiscal 2001. This
increase was due to RMG operations on which we receive a management fee.
38
Costs and Expenses:
- ------------------
Costs and expenses decreased by $3,879,200 during fiscal 2001 to
$10,780,800 from $14,660,000 during the previous year. This reduction in costs
and expenses came as a result of reduced motel, real estate and airport
operations expense of $151,100, and general and administrative costs and
expenses of $3,805,900. These reductions in costs and expenses were offset by
increases in mineral holding costs and expenses of $662,600; and abandonment of
mining equipment of $123,800.
General and administrative costs during fiscal 2000 were significantly
higher than those experienced during fiscal 2001 due to a noncash charge to
operations of $3,139,100 as a result of the issuance of common shares of RMG
stock below the market. Other reductions in general and administrative costs and
expenses during fiscal 2001 were related to a reduction of staff.
Other Income and Expenses:
- -------------------------
As a result of the settlement of the Kennecott litigation, $7,132,800 was
recorded as revenue during fiscal 2001. This revenue has two components: (1)
Noncash revenues as a result of the recognition of $4,000,000 of a deferred GMMV
purchase option payment that was received in 1997 and (2) the receipt of cash
from Kennecott as a result of the settlement, $3,132,800 - net of accounts
receivable from GMMV.
During the fiscal 2001, we recognized a gain of $1,163,600 from the sale of
equipment that was determined to be surplus. One component of this amount was
the sale of certain GMMV assets that were distributed to the Company from the
GMMV upon the resolution of the Kennecott litigation. The other main components
of this increase are the final royalty payment received from the sale of The
Brunton Company of $233,000, and the sale of a real estate property in Colorado
of $264,600.
Operations for the fiscal year ended May 31, 2001, resulted in earnings of
$1,771,200 or $0.21 per share fully diluted as compared to a loss of $10,621,000
or $1.33 per share fully diluted for the fiscal year ended May 31, 2000.
FUTURE OPERATIONS
-----------------
We have generated operating losses in each of the last three years as a
result of costs associated with shut down mineral properties. We have maintained
some of our investments in gold and uranium properties that have not generated
operating revenues. These properties require expenditures for items such as
permitting, care and maintenance, holding fees, corporate overhead and
administrative expenses. Success in the minerals industry is dependent on the
price that a producer can receive for its minerals. We cannot predict what the
long term price for gold and uranium will be and therefore cannot predict when,
or if, we will generate net income from these operations.
At May 31, 2002 we are committed to be in the coalbed methane business well
into the future. Uranium prices and market projections are being evaluated.
Decisions to liquidate part or all of the Company's uranium holdings are being
considered. We are also evaluating its commitment to the gold business depending
on the price for gold recovering.
39
EFFECTS OF CHANGES IN PRICES
----------------------------
Mineral operations are significantly affected by changes in commodity
prices. As prices for a particular mineral increase, prices for prospects for
that mineral also increase, making acquisitions of such properties costly, and
sales advantageous. Conversely, a price decline facilitates acquisitions of
properties containing that mineral, but makes sales of such properties more
difficult. Operational impacts of changes in mineral commodity prices are common
in the mining industry.
NATURAL GAS. Our decision to expand into the coalbed methane gas industry
were predicated on the projections for natural gas demand and prices.
URANIUM AND GOLD. Changes in the prices of uranium and gold will affect our
operational decisions in the future. Currently, both gold and uranium are at low
prices. We continually evaluate market trends and data. We do not plan to go
forward with any work on our uranium and gold properties until the market price
for these metals increase and remain at profitable levels.
MOLYBDENUM AND OIL. Changes in prices of molybdenum and petroleum are not
expected to materially affect our operations during fiscal 2003.
ITEM 8. FINANCIAL STATEMENTS
Financial statements meeting the requirements of Regulation S-X for the
Company follow immediately. Please note that the financial information contained
in these financial statements for the year ended May 31, 2000 was audited by
Arthur Andersen LLP who has ceased operations. A copy of Arthur Andersen's
previously issued audit report, dated September 11, 2000 is included in this
filing. This report has not been revised. This report refers to financial
information for the two years ended May 31, 2000. However, only the information
for the year ended May 31, 2000 is included in the financial statements filed
with this report.
40
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
--------------------------------------------------
To U.S. Energy Corp.:
We have audited the accompanying consolidated balance sheets of U.S. ENERGY
CORP. (a Wyoming corporation) AND SUBSIDIARIES as of May 31, 2002 and May 31,
2001, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the two years in the period ended May 31,
2002. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. The financial statements of U.S. ENERGY CORP.
AND SUBSIDIARIES as of and for the year ended May 31, 2000, were audited by
other auditors who have ceased operations. Those auditors expressed an
unqualified opinion on those financial statements before the reclassifications
described in Notes B and L in their report dated September 11, 2000.
As described in Notes B and L, the financial statements include certain
reclassifications. We have audited the reclassifications that were applied to
the 2000 financial statements. In our opinion, such reclassification adjustments
are appropriate and have been properly applied. However, we were not engaged to
audit, review, or apply any procedures to the 2000 financial statements of the
Company other than with respect to such reclassification adjustments and
accordingly, we do not express an opinion or any form of assurance on the 2000
financial statements taken as a whole.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the 2002 and 2001 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of U.S.
Energy Corp. and subsidiaries as of May 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the two years ended May 31,
2002, in conformity with accounting principles generally accepted in the United
States of America.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note A to the financial
statements, the Company has experienced recurring losses from operations and has
a substantial accumulated deficit. These factors raise substantial doubt about
the ability of the Company to continue as a going concern. Management's plans in
regards to these matters are also described in Note A. The financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
GRANT THORNTON LLP
Denver, Colorado,
July 18, 2002
41
The report that appears below is a copy of the report issued by the
Company's previous independent auditor, Arthur Andersen, LLP. That firm has
discontinued performing auditing and accounting services.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To U.S. Energy Corp.:
We have audited the accompanying balance sheet of U.S. Energy Corp. (a Wyoming
corporation) as of May 31, 2000, and the related consolidated statements of
operations, shareholders' equity and cash flows for the year ended May 31, 2000.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of U.S. Energy Corp. as of May 31,
2000, and the results of operations and cash flows for the year ended May 31,
2000, in conformity with accounting principles generally accepted in the United
States.
ARTHUR ANDERSEN LLP
Denver, Colorado
September 11, 2000
42
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
May 31,
-------------------------------
2002 2001
------------ -------------
CURRENT ASSETS:
Cash and cash equivalents $ 2,564,300 $ 685,500
Accounts receivable:
Trade, net of allowance of $27,800 768,800 1,319,300
Affiliates 132,800 74,200
Current portion of long-term notes 229,000 225,000
Assets held for resale and other 1,111,100 983,800
Inventory 86,600 42,200
------------ ------------
Total current assets 4,897,600 3,330,000
INVESTMENTS AND ADVANCES:
Affiliates -- 16,200
Restricted investments 10,015,500 9,778,700
------------ ------------
Total investments and advances 10,015,500 9,794,900
PROPERTIES AND EQUIPMENT:
Land 1,764,100 1,771,800
Buildings and improvements 8,501,300 8,425,400
Machinery and equipment 5,107,700 5,536,900
Proved oil and gas properties, full cost method 1,773,600 1,773,600
Unproved coalbed methane properties,
excluded from amortization 4,995,600 5,881,700
------------ ------------
Total property and equipment 22,142,300 23,389,400
Less-accumulated depreciation,
depletion and amortization (7,584,200) (7,285,100)
------------ ------------
Net property and equipment 14,558,100 16,104,300
OTHER ASSETS:
Accounts and notes receivable:
Real estate and equipment sales 36,800 42,400
Employees 65,000 180,300
Deposits and other 969,900 1,013,300
------------ ------------
Total other assets 1,071,700 1,236,000
------------ ------------
Total assets $ 30,537,900 $ 30,465,200
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these statements.
43
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND SHAREHOLDERS' EQUITY
May 31,
------------------------------
2002 2001
------------ ------------
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 758,600 $ 1,404,300
Prepaid drilling costs 242,100 --
Current portion of long-term debt 205,700 142,400
Line of credit 200,000 850,000
------------ ------------
Total current liabilities 1,406,400 2,396,700
LONG-TERM DEBT 2,353,300 2,152,100
RECLAMATION LIABILITY 8,906,800 8,906,800
OTHER ACCRUED LIABILITIES 2,544,200 2,777,800
DEFERRED TAX LIABILITY 1,144,800 1,144,800
MINORITY INTERESTS 575,300 1,177,800
COMMITMENTS AND CONTINGENCIES
FORFEITABLE COMMON STOCK,
$.01 par value; 500,788 and 433,788
shares issued, forfeitable until earned 3,009,900 2,748,600
PREFERRED STOCK,
$.01 par value; 1,000 shares authorized,
0 and 200 shares issued and outstanding respectively -- 1,840,000
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value; unlimited shares
authorized; 11,720,818 and 8,989,047 and
shares issued, respectively 117,200 90,000
Additional paid-in capital 48,278,500 38,681,600
Accumulated deficit (34,567,600) (28,300,000)
Treasury stock at cost, 959,725 and 949,725
shares, respectively (2,740,400) (2,660,500)
Unallocated ESOP contribution (490,500) (490,500)
------------ ------------
Total shareholders' equity 10,597,200 7,320,600
------------ ------------
Total liabilities and shareholders' equity $ 30,537,900 $ 30,465,200
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these statements.
44
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended May 31,
------------------------------------------------
2002 2001 2000
------------ ------------ ------------
OPERATING REVENUES:
Motel, real estate and airport operations $ 1,795,900 $ 2,222,400 $ 2,734,800
Mineral sales -- 334,300 --
Mineral royalties -- 108,500 132,600
Management fees 208,200 597,800 436,500
------------ ------------ ------------
2,004,100 3,263,000 3,303,900
OPERATING COSTS AND EXPENSES:
Motel, real estate and airport operations 1,928,900 3,236,200 3,387,300
Mineral holding costs 1,707,800 3,369,300 2,706,700
General and administrative 3,946,800 4,051,500 7,857,400
Abandonment of mining equipment -- 123,800 --
Provision for doubtful accounts 171,200 -- 708,600
Other 80,900 -- --
Impairment of goodwill 1,622,700 -- --
------------ ------------ ------------
9,458,300 10,780,800 14,660,000
------------ ------------ ------------
OPERATING LOSS (7,454,200) (7,517,800) (11,356,100)
OTHER INCOME & EXPENSES
Gain on sales of assets 812,700 1,163,600 71,400
Litigation settlements, net -- 7,132,800 --
Interest income 852,100 699,700 813,600
Interest expense (345,300) (265,300) (82,800)
------------ ------------ ------------
1,319,500 8,730,800 802,200
------------ ------------ ------------
(LOSS) INCOME BEFORE MINORITY INTEREST
AND EQUITY IN LOSS OF AFFILIATES (6,134,700) 1,213,000 (10,553,900)
MINORITY INTEREST IN LOSS
OF CONSOLIDATED SUBSIDIARIES 39,500 220,100 509,300
EQUITY IN LOSS OF AFFILIATES -- -- (2,900)
------------ ------------ ------------
(Continued)
The accompanying notes to consolidated financial statements
are an integral part of these statements.
45
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(CONTINUED)
Year Ended May 31,
-------------------------------------------------
2002 2001 2000
------------ ------------- -------------
(LOSS) INCOME BEFORE
INCOME TAXES (6,095,200) 1,433,100 (10,047,500)
PROVISION FOR INCOME TAXES -- -- --
------------ ------------ ------------
NET (LOSS) INCOME FROM
CONTINUING OPERATIONS (6,095,200) 1,433,100 (10,047,500)
DISCONTINUED OPERATIONS, NET OF TAX (85,900) 488,100 (594,300)
------------ ------------ ------------
NET (LOSS) INCOME (6,181,100) 1,921,200 (10,641,800)
------------ ------------ ------------
PREFERRED STOCK DIVIDENDS (86,500) (150,000) (20,800)
------------ ------------ ------------
NET (LOSS) INCOME TO
COMMON SHAREHOLDERS $ (6,267,600) $ 1,771,200 $(10,662,600)
============ ============ ============
NET (LOSS) INCOME PER SHARE BASIC
FROM CONTINUED OPERATIONS $ (0.66) $ 0.17 $ (1.31)
FROM DISCONTINUED OPERATIONS (0.01) 0.06 (0.08)
------------ ------------ ------------
$ (0.67) $ 0.23 $ (1.39)
============ ============ ============
NET (LOSS) INCOME
PER SHARE DILUTED
FROM CONTINUED OPERATIONS $ (0.66) $ 0.15 $ (1.31)
FROM DISCONTINUED OPERATIONS (0.01) .06 (0.08)
------------ ------------ ------------
$ (0.67) $ 0.21 $ (1.39)
============ ============ ============
BASIC WEIGHTED AVERAGE
SHARES OUTSTANDING 9,299,359 7,826,001 7,673,475
============ ============ ============
DILUTED WEIGHTED AVERAGE
SHARES OUTSTANDING 9,299,359 8,487,680 7,673,475
============ ============ ============
The accompanying notes to consolidated financial statements
are an integral part of these statements.
46
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Additional
-------------------------- Paid-In Accumulated
Shares Amount Capital Deficit
------ ------ ------------ -------------
Balance May 31, 1999 8,550,624 $ 85,600 $ 33,014,900 $(19,408,600)
Funding of ESOP 123,802 1,200 370,200 --
Issuance of common stock
to outside directors 6,020 100 21,000 --
Issuance of common stock for
purchase of subsidiary stock 73,109 700 259,900 --
Forfeitable shares earned 9,600 100 88,000 --
Treasury stock from consolidation
of subsidiaries Ruby Mining Co.
and Northwest Gold, Inc. -- -- -- --
Unrealized gain on sale of
subsidiary stock -- -- 1,053,700 --
Noncash compensation
paid by subsidiary -- -- 2,990,000 --
Writedown of unallocated
ESOP contribution -- -- -- --
Net Loss -- -- -- (10,662,600)
--------- ------------ ------------ ------------
Balance May 31, 2000 8,763,155 $ 87,700 $ 37,797,700 $(30,071,200)
========= ============ ============ ============
47a
Treasury Stock Unallocated Total
------------------------- ESOP Shareholders'
Shares Amount Contribution Equity
------ ------ ------------- -------------
Balance May 31, 1999 930,532 $ (2,584,600) $ (927,000) $ 10,180,300
Funding of ESOP -- -- -- 371,400
Issuance of common stock
to outside directors -- -- -- 21,100
Issuance of common stock for
purchase of subsidiary stock -- -- -- 260,600
Forfeitable shares earned -- -- -- 88,100
Treasury stock from consolidation
of subsidiaries Ruby Mining Co.
and Northwest Gold, Inc. 14,193 (55,300) -- (55,300)
Unrealized gain on sale of
subsidiary stock -- -- -- 1,053,700
Noncash compensation
paid by subsidiary -- -- -- 2,990,000
Writedown of unallocated
ESOP contribution -- -- 436,500 436,500
Net Loss -- -- -- (10,662,600)
------- ------------ ------------ ------------
Balance May 31, 2000 944,725 $ (2,639,900) $ (490,500) $ 4,683,800
======= ============ ============ ============
Total Shareholders' Equity at May 31, 2000 does not include 396,608 shares
currently issued but forfeitable if certain conditions are not met by the
recipients. "Basic and Diluted Weighted Average Shares Outstanding" also
includes the 827,108 shares of U.S. Energy common stock held by majority-owned
subsidiaries, which, in consolidation, are treated as treasury shares.
The accompanying notes to consolidated financial statements
are an integral part of these statements.
47b
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(CONTINUED)
Common Stock Additional
-------------------------- Paid-In Accumulated
Shares Amount Capital Deficit
------ ------ ------------ --------------
Balance May 31, 2000 8,763,155 $ 87,700 $ 37,797,700 $(30,071,200)
Funding of ESOP 53,837 500 287,500 --
Issuance of common stock
to outside directors 8,532 100 19,100 --
Forfeitable shares earned 29,820 300 193,900 --
Issuance of common stock
for services rendered 15,000 200 70,400 --
Treasury stock from payment
on balance of note receivable -- -- -- --
Sale of Ruby Mining -- -- 25,800 --
Issuance of common stock
for exercised options 118,703 1,200 287,200 --
Net income -- -- -- 1,771,200
--------- ------------ ------------ ------------
Balance May 31, 2001 8,989,047 $ 90,000 $ 38,681,600 $(28,300,000)
========= ============ ============ ============
48a
Treasury Stock Unallocated Total
------------------------- ESOP Shareholders'
Shares Amount Contribution Equity
------ ------ ------------- -------------
Balance May 31, 2000 944,725 $ (2,639,900) $ (490,500) $ 4,683,800
Funding of ESOP -- -- -- 288,000
Issuance of common stock
to outside directors -- -- -- 19,200
Forfeitable shares earned -- -- -- 194,200
Issuance of common stock
for services rendered -- -- -- 70,600
Treasury stock from payment
on balance of note receivable 5,000 (20,600) -- (20,600)
Sale of Ruby Mining -- -- -- 25,800
Issuance of common stock
for exercised options -- -- -- 288,400
Net income -- -- -- 1,771,200
--------- ------------ ------------ ------------
Balance May 31, 2001 949,725 $ (2,660,500) $ (490,500) $ 7,320,600
========= ============ ============ ============
Total Shareholders' Equity at May 31, 2001 does not include 433,788 shares
currently issued but forfeitable if certain conditions are not met by the
recipients. "Basic and Diluted Weighted Average Shares Outstanding" also
includes 814,496 shares of common stock held by majority-owned subsidiaries,
which, in consolidation, are treated as treasury shares.
The accompanying notes to consolidated financial statements
are an integral part of these statements.
48b
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(CONTINUED)
Common Stock Additional
-------------------------- Paid-In Accumulated
Shares Amount Capital Deficit
------ ------ ------------ --------------
Balance May 31, 2001 8,989,047 $ 90,000 $ 38,681,600 $(28,300,000)
Funding of ESOP 70,075 700 236,200 --
Issuance of common stock
to outside directors 3,429 -- 14,400 --
Issuance of common stock
for services rendered 45,000 500 147,600 --
Issuance of common stock warrants
for services rendered -- -- 592,900 --
Treasury stock from payment
on balance of note receivable -- -- -- --
Issuance of common stock
in exchange for preferred stock 513,140 5,100 1,846,400 --
Issuance of common stock
in exchange for subsidiary stock 912,233 9,100 3,566,900 --
Issuance of common stock
to purchase property 61,760 600 246,200 --
Issuance of common stock
through private placement 871,592 8,700 2,341,800 --
Issuance of common stock
for exercised stock warrants 1,205 -- 4,500 --
Issuance of common stock
for exercised options 253,337 2,500 600,000 --
Net loss -- -- -- (6,267,600)
---------- ------------ ------------ ------------
Balance May 31, 2002 11,720,818 $ 117,200 $ 48,278,500 $(34,567,600)
========== ============ ============ ============
49a
Treasury Stock Unallocated Total
-------------------------- ESOP Shareholders'
Shares Amount Contribution Equity
------ ------ ------------- -------------
Balance May 31, 2001 949,725 $ (2,660,500) $ (490,500) $ 7,320,600
Funding of ESOP -- -- -- 236,900
Issuance of common stock
to outside directors -- -- -- 14,400
Issuance of common stock
for services rendered -- -- -- 148,100
Issuance of common stock warrants
for services rendered -- -- -- 592,900
Treasury stock from payment
on balance of note receivable 10,000 (79,900) -- (79,900)
Issuance of common stock
in exchange for preferred stock -- -- -- 1,851,500
Issuance of common stock
in exchange for subsidiary stock -- -- -- 3,576,000
Issuance of common stock
to purchase property -- -- -- 246,800
Issuance of common stock
through private placement -- -- -- 2,350,500
Issuance of common stock
for exercised stock warrants -- -- -- 4,500
Issuance of common stock
for exercised options -- -- -- 602,500
Net loss -- -- -- (6,267,600)
------- ------------ ------------ ------------
Balance May 31, 2002 959,725 $ (2,740,400) $ (490,500) $ 10,597,200
======= ============ ============ ============
Total Shareholders' Equity at May 31, 2002 does not include 500,788 shares
currently issued but forfeitable if certain conditions are not met by the
recipients. "Basic and Diluted Weighted Average Shares Outstanding" also
includes 814,496 shares of common stock held by majority-owned subsidiaries,
which, in consolidation, are treated as treasury shares.
The accompanying notes to consolidated financial statements
are an integral part of these statements.
49b
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended May 31,
-------------------------------------------------
2002 2001 2000
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (6,267,600) $ 1,771,200 $(10,662,600)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Minority interest in loss of
consolidated subsidiaries (39,500) (220,100) (509,300)
Depreciation and amortization 541,500 1,254,000 1,273,000
Impairment of goodwill 1,622,700 -- --
Impairment of mineral interests -- 123,800 --
Noncash services 787,700 19,100 21,100
Noncash dividend 11,500 -- --
Equity in loss from affiliates -- -- 2,900
Gain on sale of assets (812,700) (1,163,600) (71,400)
Provision for doubtful accounts 171,200 -- 708,600
Noncash compensation 535,200 501,700 3,361,400
Deferred income -- (4,000,000) --
Net changes in assets and liabilities:
Accounts and notes receivable 799,900 1,241,000 (536,500)
Other assets (47,500) (112,700) 92,200
Prepaid drilling costs 242,100 -- --
Accounts payable and accrued expenses (879,300) (887,300) (217,200)
Reclamation and other -- -- 82,100
------------ ------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (3,334,800) (1,472,900) (6,491,900)
CASH FLOWS FROM INVESTING ACTIVITIES:
Development of coalbed methane gas properties (142,100) (1,187,800) (4,727,200)
Development of mining properties -- (4,400) (22,200)
Proceeds from sale of property and equipment 752,000 2,608,000 78,300
Proceeds from sale of gas interests 1,125,000 -- --
Increase in restricted investments (236,800) (417,700) (200,600)
Purchase of property and equipment (82,300) (307,000) (2,217,800)
Net change in investments in affiliates 406,500 292,400 (12,500)
------------ ------------ ------------
NET CASH PROVIDED BY (USED IN)
INVESTING ACTIVITIES 1,822,300 983,500 (7,102,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 2,957,400 288,400 --
Proceeds from issuance of preferred stock -- -- 1,840,000
Proceeds from sale of stock by subsidiary 1,000,000 -- 2,160,000
Proceeds from long-term debt 631,700 619,100 886,400
Net activity from lines of credit (650,000) 200,000 650,000
Purchase of treasury stock -- (20,600) --
Repayments of long-term debt (547,800) (828,400) (1,246,300)
Cash acquired in purchase of subsidiary -- -- 47,200
------------ ------------ ------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES $ 3,391,300 $ 258,500 $ 4,337,300
------------ ------------ ------------
The accompanying notes to consolidated financial statements
are an integral part of these statements.
50
U.S. ENERGY CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Year Ended May 31,
-----------------------------------------------
2002 2001 2000
------------ ------------- -------------
NET INCREASE (DECREASE) IN
CASH AND CASH EQUIVALENTS $ 1,878,800 $ (230,900) $ (9,256,600)
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 685,500 916,400 10,173,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 2,564,300 $ 685,500 $ 916,400
============ ============ ============
SUPPLEMENTAL DISCLOSURE
Income tax paid $ -- $ -- $ --
============ ============ ============
Interest paid $ 345,300 $ 265,300 $ 35,800
============ ============ ============
NONCASH INVESTING AND
FINANCING ACTIVITIES:
Issuance of stock to invest in subsidiary $ 3,568,500 $ -- $ --
============ ============ ============
Issuance of stock to retire preferred stock $ 1,840,000 $ -- $ --
============ ============ ============
Sale of assets through notes and
accounts receivable $ 442,200 $ 1,164,500 $ --
============ ------------ ============
Issuance of stock as deferred compensation $ 261,300 $ 358,400 $ 201,000
============ ============ ============
Acquisition of assets through issuance of debt $ 180,600 $ 1,631,700 $ 506,000
============ ============ ============
Acquisition of assets through issuance of stock $ 96,800 $ -- $ --
============ ============ ============
Satisfaction of receivable - employee
with stock in company $ 79,900 $ -- $ --
============ ============ ============
Issuance of stock for services $ 14,400 $ 70,500 $ --
============ ============ ============
Issuance of stock for retired employees $ -- $ 194,400 $ 88,100
============ ============ ============
Satisfaction of receivable - affiliate
with stock in affiliate $ -- $ 3,000,000 $ 196,700
============ ============ ============
Issuance of stock warrants in conjunction
with notes payable $ 592,900 $ -- $ --
============ ============ ============
The accompanying notes to consolidated financial statements
are an integral part of these statements.
51
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
A. BUSINESS ORGANIZATION AND OPERATIONS:
U.S. Energy Corp. and subsidiaries (the "Company" or "USE") was
incorporated in the State of Wyoming on January 26, 1966. The Company engages in
the acquisition, exploration, holding, sale and/or development of mineral and
coalbed methane gas properties, the production of petroleum properties and
marketing of minerals and methane gas. Principal mineral interests are in
uranium, gold, molybdenum and the Company's mineral properties are currently in
a shut down status. The Company holds various real and personal properties used
in commercial activities. Most of these activities are conducted through the
joint venture discussed below and in Note D.
The Company was engaged in the maintenance of two uranium properties, one
in southern Utah, and the second known as Sheep Mountain Partners ("SMP"). Both
of these ventures have been involved in significant litigation (see Note K).
Sutter Gold Mining Company ("SGMC"), a Wyoming corporation owned 66.3% by the
Company at May 31, 2002, manages the Company's interest in gold properties. The
Company also owns 100% of the outstanding stock of Plateau Resources Limited
("Plateau"), which owns a nonoperating uranium mill and support facilities in
southeastern Utah. Currently, the mill is nonoperating but has been granted a
license to operate subject to certain conditions. Rocky Mountain Gas, Inc.
("RMG") was formed in fiscal 2000 to consolidate all methane gas operations of
the Company. The Company owns and controls 91.7% of RMG as of May 31, 2002.
MANAGEMENT'S PLAN
-----------------
The Company has generated significant net losses during two of the past
three fiscal years ending May 31, 2002 and has an accumulated deficit of
approximately $34,567,600 at May 31, 2002. The Company has working capital of
approximately $3,491,200 at May 31, 2002 and its cash balance has increased from
$685,500 at the prior year end to $2,564,300 at May 31, 2002. Although the cash
position of the Company improved during the year ended May 31, 2002, the Company
has experienced negative cash flows during fiscal 2001 and 2000 in the amounts
of $230,900 and $9,256,600, respectively.
After the CCBM work commitment has been fully funded, the Company does not
have current funds available to fund its portion of the anticipated development
activities on its coalbed methane properties. Additionally, the Company's known
cash flows through May 31, 2003 for current operations and associated overhead
are negative based on current projections. In order to improve liquidity of the
Company, management intends to do the following:
o Increase production from the Bobcat coalbed methane property which was
purchased during fiscal 2003. Management believes that production can
be increased as the coals are de- watered and more gas wells are
placed on production. The Company is also working to assist in
reducing the price differential that affects Wyoming gas production.
These two factors along with anticipated higher production demand
pushing methane gas prices higher should have a significant impact on
the Company's cash flows.
52
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
o Continue to reduce its mining and construction activities resulting in
surplus equipment and buildings. The Company sold a portion of this
equipment during fiscal 2002 and 2001 and plans to continue selling
the balance of the surplus equipment and buildings during fiscal 2003.
This reduction in equipment and buildings will improve cash flow of
the Company.
o Sell home and mobile home lots at its commercial operations in
southern Utah. These lots are no longer needed for current operations
and will provide cash flows to the Company.
o Sell the Ticaboo Townsite in southern Utah. Included in the townsite
is a motel, C store, restaurant/lounge, boat storage and repair
facility and undeveloped land. The sale of this property would
increase cash position of the Company significantly and would allow
the employees of the Company to concentrate on the Company's core
business of coalbed methane.
o Sell raw land in Riverton, Wyoming and Sutter Creek, California.
Management intends to sell this land at its fair market value. The
land is not needed for the operations of the Company now or into the
future. The land in California was originally purchased to be used as
a mill tailings cell site. Although the property was permitted for
that purpose, no actual construction of the tailings cell has
occurred. The State of California has plans to build a highway through
the property and has made an offer to purchase the property. The
Company has other property for a proposed tailings site.
o Seek equity funding or a joint venture partner to place the Sutter
Gold Mining Company property into production or sell the entire
property to an industry partner. Currently, the Company has several
third party companies who are looking at options.
o Raise additional capital through a private placement and a public
offering on its subsidiary Rocky Mountain Gas, Inc. The timing of such
a public offering will depend on the market prices for methane gas.
o Reduce overhead expenses and concentrate on its primary business -
coalbed methane.
Additionally, management of the Company believes that funds will be
received as a result of the accounting that is currently being conducted by the
Special Master under the direction of the U.S. District Court, District of
Colorado in the litigation with Nukem, Inc. The Court ordered that the final
accounting be delivered to the Court no later than December 6, 2002. Management
cannot predict the ultimate outcome of the litigation, however, management of
the Company believes it will be beneficial to the Company.
As a result of these plans, management believes that they will generate
sufficient cash flows to meet its current obligations in fiscal 2003.
53
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of USE and subsidiaries include the
accounts of the Company, the accounts of its majority-owned or controlled
subsidiaries Plateau (100%), Energx, Ltd ("Energx") (90%), Four Nines Gold, Inc.
("FNG") (50.9%), SGMC (66.3%), Crested Corp. ("Crested") (70.5%), Yellowstone
Fuels Corp. ("YSFC") (35.9%) Rocky Mountain Gas ("RMG") (91.7%), Northwest Gold,
Inc. ("NWG") (96%) and the USECC Joint Venture ("USECC"), a consolidated joint
venture which is equally owned by U.S. Energy Corp. and Crested, through which
the bulk of their operations are conducted.
Prior to fiscal 2001, Ruby Mining Company ("Ruby") which was 91% owned by
the Company, was also consolidated. During 2001, Ruby was sold to a third party
and therefore is no longer consolidated.
With the exception of YSFC, investments in joint ventures and all 20% to
50% owned companies are accounted for using the equity method (see Note E). YSFC
was an equity investee through February 1999, at which time the Company
purchased the majority of the shares of common stock of YSFC owned by outside
shareholders by issuing 677,167 shares of Company's common stock. As a result of
the common directors and control of YSFC by USE and its employees, YSFC was
consolidated as of March 1, 1999. Investments of less than 20% are accounted for
by the cost method. All material intercompany profits, transactions and balances
have been eliminated.
CASH EQUIVALENTS
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents.
RESTRICTED INVESTMENTS
Based on the provisions of Statement of Financial Accounting Standards No.
115 ("SFAS 115"), the Company accounts for its restricted investment in certain
securities as held-to-maturity. Held-to-maturity securities are measured at
amortized cost. If a decline in fair value of such investments is determined to
be other than temporary, the investment is written down to fair value.
INVENTORIES
Inventories consist primarily of retail inventory of aviation and
automobile fuel and associated aircraft parts for motel and airport operations,
mining supplies and gold stockpiles. Retail inventories are stated at lower of
cost or market using the average cost method. Mine supplies and gold stockpile
inventories are stated at the lower of cost or market.
54
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
PROPERTIES AND EQUIPMENT
Land, buildings, improvements, machinery and equipment are carried at cost.
Depreciation of buildings, improvements, machinery and equipment is provided
principally by the straight-line method over estimated useful lives ranging from
3 to 45 years. Following is a breakdown of the lives over which assets are
depreciated.
Office Equipment 3 to 5 years
Field Tools and Hand Equipment 5 to 7 years
Vehicles and Trucks 3 to 7 years
Heavy Equipment 7 to 10 years
Service Buildings 20 years
Corporate Headquarter's Building 45 years
OIL AND GAS ASSETS
The Company follows the full cost method of accounting for oil and gas
properties. Accordingly, all costs associated with acquisition, exploration, and
development of oil and gas reserves, including directly related overhead costs,
are capitalized.
All capitalized costs of oil and gas properties including the estimated
future costs to develop proved reserves, are amortized on the unit-of-production
method using estimates of proved reserves. Investments in unproved properties
and major development projects are not amortized until proved reserves
associated with the projects can be determined or until impairment occurs. If
the results of an assessment indicate that the properties are impaired, the
amount of the impairment is added to the capitalized costs to be amortized.
In addition, the capitalized costs are subject to a "ceiling test," which
basically limits such costs to the aggregate of the "estimated present value,"
discounted at a 10-percent interest rate of future net revenues from proved
reserves, based on current economic and operating conditions, plus the lower of
cost or fair market value of unproved properties.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves of oil and gas, in which case the gain or loss is recognized in income.
Abandonments of properties are accounted for as adjustments of capitalized costs
with no loss recognized.
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
55
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
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 financing necessary to develop mineral
interests, may result in asset impairment. During fiscal 2002, the Company
recorded an impairment on goodwill that arose from the purchase of additional
stock of RMG of $1,622,700. During fiscal 2001, the Company recorded an
impairment on its mineral assets of $123,800 in YSFC. As of May 31, 2002,
management believes no further impairment is necessary and that the fair market
of remaining assets exceeds the carrying value. See Note F for further
discussion.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash equivalents, receivables, other current assets,
accounts payable and accrued expenses approximates fair value because of the
short-term nature of those instruments. The recorded amounts for short-term and
long-term debt, approximate fair market value due to the variable nature of the
interest rates on the short term debt, and the fact that interest rates remain
general unchanged from issuance of the long term debt.
REVENUE RECOGNITION
Advance royalties which are non-refundable are recognized as revenue when
received (see Note F). Non-refundable option deposits are recognized as revenue
when the option expires.
Revenues from gold and uranium sales are recognized upon delivery. Revenues
are recognized from the rental of certain assets ratably over the related lease
terms. Revenues from motel, real estate and airport operations, which represent
primarily real estate activity and an airport fixed base operation, are
recognized as goods and services are delivered. Oil and gas revenue is
recognized at the time of product delivery.
INCOME TAXES
The Company accounts for income taxes under the provisions of Statement of
Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income
Taxes". This statement requires recognition of deferred income tax assets and
liabilities for the expected future income tax consequences, based on enacted
tax laws, of temporary differences between the financial reporting and tax bases
of assets, liabilities and carryforwards.
SFAS 109 requires recognition of deferred tax assets for the expected
future effects of all deductible temporary differences, loss carryforwards and
tax credit carryforwards. Deferred tax assets are reduced, if deemed necessary,
by a valuation allowance for any tax benefits which, based on current
circumstances, are not expected to be realized.
56
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
NET (LOSS) INCOME PER SHARE
The Company reports net (loss) income per share pursuant to Statement of
Financial Accounting Standards No. 128 ("SFAS 128"). SFAS 128 specifies the
computation, presentation and disclosure requirements for earnings per share.
Basic earnings per share is computed based on the weighted average number of
common shares outstanding. Diluted earnings per share is computed based on the
weighted average number of common shares outstanding adjusted for the
incremental shares attributed to outstanding options to purchase common stock,
if dilutive. Potential common shares relating to options and warrants are
excluded from the computation of diluted earnings (loss) per share, because they
were antidilutive, totaled 466,000, 661,679 and 335,420 for the years ended May
31, 2002, 2001 and 2000, respectively.
COMPREHENSIVE INCOME
There are no components of comprehensive income which have been excluded
from net income and, therefore, no separate statement of comprehensive income
has been presented.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." The statement requires entities
to record the fair value of a liability for legal obligations associated with
the retirement of obligations of tangible long-lived assets in the period in
which it is incurred. When the liability is initially recorded, the entity
increases the carrying amount of the related long-lived asset. Accretion of the
liability is recognized each period, and the capitalized cost is depreciated
over the useful life of the related asset. Upon settlement of the liability, an
entity either settles the obligation for its recorded amount or incurs a gain or
loss upon settlement. The standard is effective for fiscal years beginning after
June 15, 2002, with earlier application encouraged. The Company is currently
evaluating the effect of adopting SFAS No. 143 on its financial statements and
has not determined the timing of adoption. The Company has reviewed other
current outstanding statements from the Financial Accounting Standards Board and
does not believe that any of those statements will have a material adverse
affect on the financials statements of the Company when adopted.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
RECLASSIFICATIONS
Certain reclassifications have been made in the prior years financial
statements in order to conform with the presentation for the current year.
57
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
C. RELATED-PARTY TRANSACTIONS:
The Company provides management and administrative services for affiliates
under the terms of various management agreements. Revenues from services by the
Company to unconsolidated affiliates were $78,800, $132,500, and $39,900 and in
fiscal 2002, 2001, and 2000, respectively. The Company has $132,800 of
receivables from unconsolidated subsidiaries as of May 31, 2002.
As of May 31, 2002, the Company had notes receivable due from certain
directors and employees of the Company totaling $65,000 due December 31, 2002.
This indebtedness is secured by 144,000 shares of the Company's common stock.
During fiscal 2002, this debt was reduced by $115,300.
D. USECC JOINT VENTURE:
The Company operates the Glen L. Larsen office complex; an aircraft hangar
with a fixed base operation, office space and certain aircraft; holds interests
in various mineral operations; conducts oil and gas operations; and transacts
all operating and payroll expenses through a joint venture with Crested, the
USECC joint venture.
E. INVESTMENTS IN AND ADVANCES TO AFFILIATES:
The Company's restricted investments secure various decommissioning,
reclamation and holding costs. Investments are comprised of debt securities
issued by the U.S. Treasury that mature at varying times from three months to
one year from the original purchase date. As of May 31, 2002 and 2001, the cost
of debt securities was a reasonable approximation of fair market value. These
investments are classified as held-to- maturity under SFAS 115 and are measured
at amortized cost.
The Company's investment in and advances to affiliates are as follows:
Carrying Value at May 31,
Consolidated --------------------------------
Ownership 2002 2001
------------ ----------- -----------
Powder River Gas LLC -- $ -- $ 16,200
Equity loss from investments accounted for by the equity method are as
follows:
Year Ended May 31,
-----------------------------------------------------
2002 2001 2000
------------ ----------- -------------
Ruby Mining Company** $ -- $ -- $ (2,900)**
** Consolidated beginning December 1, 1999. This represents the equity loss
through November 30, 1999. Ruby was sold during fiscal 2001 and is no longer
consolidated.
Condensed combined balance sheets and statements of operations of the
Company's equity investees for fiscal 2000 include Ruby Mining Company.
58
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
F. MINERAL CLAIMS TRANSACTIONS:
GMMV
- ----
During fiscal 1990, the Company entered into an agreement with Kennecott, a
wholly-owned, indirect subsidiary of The RTZ Corporation plc, for Kennecott to
acquire a 50% interest in certain uranium mineral properties in Wyoming known as
the Green Mountain Properties. During the life of the venture, the parties
entered into various amendments to the GMMV agreement.
As a result of sustained depressed uranium prices, the GMMV properties were
maintained on a shut down basis. During fiscal 2000, certain disputes arose in
the GMMV venture and Kennecott sued the Company. On September 11, 2000, the
parties settled all disputes by Kennecott paying the Company $3.25 million and
Kennecott assuming all reclamation liabilities of the GMMV Properties.
SMP
- ---
During fiscal 1989, the Company, through USECC, entered into an agreement
to sell a 50% interest in their Sheep Mountain properties to Nukem's subsidiary
CRIC. USECC and CRIC immediately contributed their 50% interests in the
properties to a newly-formed partnership, Sheep Mountain Partners ("SMP"). SMP
was established to further explore uranium mineralization on the claims on Sheep
Mountain, acquire uranium supply contracts and market uranium. Certain disputes
arose among USECC, CRIC and its parent Nukem, Inc. over the operation of SMP.
These disputes have been in litigation/arbitration for the past ten years. See
Note K for a description of the investment and a discussion of the related
litigation/arbitration.
Due to the litigation and arbitration proceedings involving SMP for the
past ten years, the Company has expensed all of its costs related to SMP and has
no carrying value of its investment in SMP as proceeds from litigation and
arbitration proceedings were accounted for under the cost recovery method of
accounting as discussed in Note K. The Company's direct loss generated from its
investment in SMP, which represents mine holding costs incurred directly by the
Company, was $508,600, $399,300, and $711,300 for the years ended May 31, 2002,
2001 and 2000, respectively.
As part of a partial settlement agreement dated June 1, 1998, the Company
was awarded the return of its Sheep Mountain uranium mines and certain other
properties. Accordingly, all mine holding costs were expensed by the Company
during fiscal 2002, 2001 and 2000.
PHELPS DODGE
- ------------
During prior years, the Company conveyed interests in mining claims to AMAX
Inc. ("AMAX") in exchange for cash, royalties, and other consideration. AMAX
merged with Cyprus Minerals ("Cyprus Amax") which was purchased by Phelps Dodge
Mining Company ("Phelps Dodge") in December of 1999. The properties have not
been placed into production as of May 31, 2002.
59
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
AMAX and later Cyprus Amax, paid the Company an annual advance in royalty
of 50,000 pounds of molybdenum (or its cash equivalent). During fiscal 2000,
Phelps Dodge assumed this obligation and made payments to the Company during
fiscal 2001. Phelps Dodge is entitled to a partial credit against future
royalties for any advance royalty payments made, but such royalties are not
refundable if the properties are not placed into production. The Company
recognized $0, $108,500, and $132,600 of revenue from the advance royalty
payments in fiscal 2002, 2001, and 2000, respectively. Phelps Dodge did not make
the payment of the advance royalty during 2002. The Company considers this a
breach of Phelps Dodge's contractual obligations and has filed suit against
Phelps Dodge. See Note K for further discussion.
Phelps Dodge may elect to return the properties to the Company, which would
cancel future obligations under the advance royalty obligation. If Phelps Dodge
formally decides to place the properties into production, it is obligated to pay
$2,000,000 to the Company. Also, per the contract with AMAX, the Company is to
receive 15% of the first $25,000,000, or $3,750,000, if the molybdenum
properties are sold, which the Company believes has occurred.
SUTTER GOLD MINE COMPANY
- ------------------------
SGMC was established in 1990 to conduct operations on mining leases and to
produce gold from the Lincoln Project in California. Additional development work
is required prior to the commencement of commercial production. SGMC has not
generated any significant revenue and has no assurance of future revenue. All
acquisition and mine development costs since inception were initially
capitalized. Due to the decline in the spot price for gold and the lack of
adequate financing, SGMC has the mine on a shut down status and written down the
associated assets. Management believes that the fair market value of the
remaining assets exceeds the carrying value. The remaining SGMC assets include
raw land which is no longer needed in the mining operations, buildings and
equipment.
YELLOW STONE FUELS CORP.
- ------------------------
In fiscal 1998, the Company became contractually obligated to exchange its
common stock for common stock of YSFC, plus interest, because certain conditions
were not met (See Note J). As a result of depressed market prices for uranium,
YSFC was not successful in the public offering of its common stock. As a result,
the terms of the exchange agreement became effective between the Company and
YSFC shareholders. The Company therefore issued 677,167 shares of its common
stock. The exchange offer for YSFC remained effective until September 13, 1999.
Due to continued low uranium market prices and the inability to raise
financing to place the YSFC properties into production, the Company recorded an
impairment of $123,800 in fiscal 2001 and $2,506,100 in 1999 related to YSFC's
mineral assets, which is classified as impairment of mineral assets in the
accompanying Consolidated Statements of Operations. The impairment was
specifically related to the YSFC mining equipment in fiscal 2001.
60
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
PLATEAU RESOURCES LIMITED
- -------------------------
During fiscal 1994, the Company entered into an agreement with Consumers
Power Company to acquire all the issued and outstanding common stock of Plateau,
a Utah corporation. Plateau owns a uranium processing mill and support
facilities and certain other real estate assets through its wholly-owned
subsidiary Canyon Homesteads, Inc. in southeastern Utah. The Company paid
nominal cash consideration for the Plateau stock and agreed to assume all
environmental liabilities and reclamation bonding obligations. At May 31, 2002,
Plateau had a cash security in the amount of $9,900,900 to cover reclamation of
the properties (see Note K).
The Company is currently evaluating the best utilization of Plateau's
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 the current depressed uranium market. Commercial revenues
are being generated from the townsite assets which include a motel, C-store,
lounge, restaurant, boat storage facility and housing.
The convenience store, lounge and restaurant, and boat storage facility are
leased to third party companies. The Company receives rent on these facilities
and a percentage of the revenues of each operation. The Company is also
considering the possibility of selling the mill facility.
The Company's Balance Sheet reflects $569,400 of Plateau Resources assets
in land and buildings and improvements. These costs reflect what the Company
believes is a minimum recoverable investment of the value of surface equipment
and improvements, and the value of surface land, without regard to the results
of future mining activities, given current market conditions. Both the
properties are on standby due to depressed market prices of uranium. The Company
plans on maintaining the properties until the market prices of uranium recover
to better economic values and they are placed into production or until such time
as the properties are sold to a third party.
RUBY MINING COMPANY
- -------------------
During fiscal 2001, the Company sold its controlling interest in Ruby
Mining Company to Admiralty Company. The Company retained 900,000 shares of Ruby
Mining common stock; received $100,000 upon closing, and a promissory note in
the amount of $225,000. Because the promissory note is currently in default, the
Company has written off the note and will account for any future collection on a
cash basis.
ROCKY MOUNTAIN GAS, INC.
- ------------------------
During fiscal 2000, the Company organized RMG to enter into the coalbed
methane gas business. RMG is engaged in the acquisition of coalbed methane gas
leases and the exploration, development and production of methane gas from those
properties. The Company owns and controls 91.7% of RMG. RMG sold 333,333, 53,000
and 1,203,333 shares, respectively, of its common stock in private placements
during fiscal 2002, 2001 and 2000, respectively, for total proceeds of
approximately $4,669,000.
61
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
RMG entered into an agreement with Quantum Energy, L.L.C. (Quantum has
since changed its name to ("Quaneco")) on January 3, 2000 to purchase a 50%
working interest and 40% net revenue interest in approximately 185,000 acres of
unproven leasehold interests in the Powder River Basin of southeastern Montana.
The terms of the Quantum agreement were payments of $3,200,000 on closing,
$1,000,000 on or before May 1, 2000 and $1,300,000 on or before December 31,
2000. RMG also had a $2,500,000 work commitment to drill approximately 25 wells
on the Quantum properties by November 30, 2000.
During fiscal 2001, RMG and Quaneco entered into an Option and Farmin
Agreement with Suncor (Natural Gas) America, Inc. ("SENGAI") on 112,000 acres in
southeast Montana. SENGAI paid $1,705,000 for the right to exercise the option,
of which $1,278,800 was due to RMG. These funds were applied to the final
payment due under the Quaneco agreement. All amounts due to Quaneco had been
paid as of May 31, 2002.
SENGAI also committed to assume $2,000,000 of the remaining $2,250,000
drilling commitment that RMG had under its drilling commitment to Quaneco.
SENGAI made the decision not to exercises its option on the acreage. RMG also
acquired a 100% working interest (82% revenue interest) in 63,000 net mineral
acres in southwest Wyoming.
On July 10, 2001, RMG closed a Purchase and Sale Agreement with CCBM, Inc.
("CCBM"), a wholly-owned subsidiary of Carrizo Oil & Gas, Inc. of Houston,
Texas. CCBM purchased an undivided 50% interest in all of RMG's existing coalbed
properties. CCBM signed a $7,500,000 Promissory Note payable in principal
amounts of $125,000 per month plus interest at annual rate of 8% over 41 months
(starting July 31, 2001) with a balloon payment due on the forty-second month.
The 50% undivided interest is pledged back to RMG to secure the purchase price,
and will be released 25% when 33.3% of the principal amount of the purchase
price is paid, another 25% when the total principal payments reach 66% of the
principal amount of the purchase price and the balance when the total principal
amount is paid.
CCBM has also agreed to fund $5,000,000 for an initial drilling program. If
CCBM fails to expend $5,000,000 in the drilling program or $2,500,000 for RMG's
benefit, CCBM will be obligated to pay any remaining unspent portions of the
$2,500,000 directly to RMG. If CCBM defaults on its purchase obligation CCBM
will still earn a 50% working interest in each well location (80 acres) and
production therefrom. CCBM's ownership will be earned on these wells regardless
of the status of the payments on the promissory note.
CCBM will be entitled to a credit (applied as a prepayments of the purchase
price for the production of the undivided 50% interest in RMG's acreage), equal
to 20% of RMG's net revenue interest from wells drilled with the $5,000,000
until CCBM equals $1,250,000 from production proceeds.
62
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
OIL AND GAS PROPERTIES AND EQUIPMENT INCLUDED THE FOLLOWING:
- -----------------------------------------------------------
May 31,
---------------------------------------------
2002 2001 2000
----------- ----------- ------------
Oil and gas properties:
Subject to amortization $ 1,773,600 $ 1,773,600 $ 1,773,600
Not subject to amortization:
Acquired in fiscal 2002 363,900 -- --
Acquired in fiscal 2001 1,154,500 1,154,500 --
Acquired in fiscal 2000 4,727,200 4,727,200 4,727,200
----------- ----------- -----------
8,019,200 7,655,300 6,500,800
Sale of gas interests (1,250,000) -- --
----------- ----------- -----------
6,769,200 7,655,300 6,500,800
Accumulated depreciation, depletion
and amortization (1,773,600) (1,773,600) (1,773,600)
----------- ----------- -----------
Net oil and gas properties $ 4,995,600 $ 5,881,700 $ 4,727,200
=========== =========== ===========
The Company began drilling of its coalbed methane properties during 2001.
At such time as production begins on these properties the cost associated with
the development of such production will be added to the amortization base.
Production is projected to begin in fiscal 2003.
G. DEBT:
LINES OF CREDIT
The Company has a $750,000 line of credit from a commercial bank. The line
of credit has a variable interest rate (5.75% as of May 31, 2002). The weighted
average interest rate for 2002 was 6.5%. As of May 31, 2002, $200,000 was
outstanding on this line of credit. The line of credit is collateralized by
certain real property and a share of the net proceeds of fees from production
from certain oil wells.
63
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
LONG-TERM DEBT
The components of long-term debt as of May 31, 2002 and 2001 are as
follows:
May 31,
----------------------------
2002 2001
----------- -----------
USECB installment notes - collateralized by equipment;
interest at 8.1% to 11.0%, matures in 2002-2015 $ 1,611,600 $ 1,670,200
SGMC installment notes - secured by
certain properties, interest at
7.5% to 8.0%, maturity from 2002 - 2007 579,500 624,300
USE convertible note - net of discount of $670,100
collateralized by equipment and real estate,
interest at 8.0%; matures in fiscal 2004 329,900 --
PLATEAU installment note - collateralized by
PLATEAU equipment, interest at 8.0%;
matures in fiscal 2004 38,000 --
----------- -----------
2,559,000 2,294,500
Less current portion (205,700) (142,400)
----------- -----------
$ 2,353,300 $ 2,152,100
=========== ===========
Principal requirements on long-term debt are $205,700, $540,200; $183,200;
$199,000; $1,036,600; $394,300 for the years 2003 through 2008, respectively.
H. INCOME TAXES:
The components of deferred taxes as of May 31, 2002 and 2001 are as
follows:
May 31,
------------------------------
2002 2001
------------ ------------
Deferred tax assets:
Deferred compensation $ 273,400 $ 279,000
Net operating loss carryforwards 9,028,600 8,180,000
Tax Credits -- 15,000
Non-deductible reserves and other 622,800 840,000
Tax basis in excess of book basis 250,000 2,850,400
------------ ------------
Total deferred tax assets 10,174,800 12,164,400
------------ ------------
Deferred tax liabilities:
Development and exploration costs 2,753,800 2,157,200
------------ ------------
Total deferred tax liabilities 2,753,800 2,157,200
------------ ------------
7,421,000 10,007,200
Valuation allowance (8,565,800) (11,152,000)
------------ ------------
Net deferred tax liability $ (1,444,800) $ (1,144,800)
============ ============
64
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
A valuation allowance for deferred tax assets is required when it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of this deferred tax asset depends on the
Company's ability to generate sufficient taxable income in the future.
Management believes it is more likely than not that the net deferred tax asset
will not be realized by future operating results.
The Company has established a valuation allowance of $8,565,800 and
11,152,000 against deferred tax assets due to the losses incurred by the Company
in past fiscal years. The Company's ability to generate future taxable income to
utilize the NOL carryforwards is uncertain.
The income tax provision (benefit) is different from the amounts computed
by applying the statutory federal income tax rate to income before taxes. The
reasons for these differences are as follows:
Year Ended May 31,
----------------------------------------------
2002 2001 2000
------------ ------------ ------------
Expected federal income tax $(2,131,000) $ 602,200 $(3,618,200)
Net operating losses not previously
benefitted and other 4,717,200 2,213,300 (10,600)
Valuation allowance (2,586,200) (2,815,500) 3,628,800
----------- ----------- -----------
Income tax provision $ -- $ -- $ --
=========== =========== ===========
There were no taxes currently payable as of May 31, 2002, 2001 or 2000
related to continuing operations.
At May 31, 2002, the Company and its subsidiaries had available, for
federal income tax purposes, net operating loss carryforwards of approximately
$22,500,000 which will expire from 2006 to 2022. The Internal Revenue Code
contains provisions which limit the NOL carryforwards available which can be
used in a given year when significant changes in company ownership interests
occur. In addition, the NOL amounts are subject to examination by the tax
authorities.
The Internal Revenue Service has audited the Company's and subsidiaries tax
returns through the year ended May 31, 2000. The Company's income tax
liabilities are settled through fiscal 2000.
65
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
I. SEGMENTS AND MAJOR CUSTOMERS:
The Company's primary business activity is the sale of minerals and the
acquisition, exploration, holding, development and sale of mineral bearing
properties, although the Company has no producing mines. The other reportable
industry segment is commercial activities through motel, real estate and airport
operations. The Company discontinued its drilling/construction segment in the
third quarter of fiscal 2002. The following is information related to these
industry segments:
Year Ended May 31, 2002
------------------------------------------------------------
Commercial
Minerals Operations Consolidated
-------- ---------- ------------
Revenues $ -- $ 1,795,900 $ 1,795,900
============= ===========
Other revenues 208,200
-------------
Total revenues $ 2,004,100
=============
Operating loss $ (1,707,800) $ (133,000) $ (1,840,800)
============= ===========
Other revenue 208,200
General corporate and other expenses (5,821,600)
Other income and expenses 1,319,500
Discontinued operations, net of tax (85,900)
Equity in loss of affiliates and
minority interest in subsidiaries 39,500
-------------
Loss before income taxes $ (6,181,100)
=============
Identifiable net assets at
May 31, 2002 $ 18,138,500 $ 4,351,600 $ 22,490,100
============= ===========
Investments in affiliates --
Corporate assets 8,047,800
-------------
Total assets at May 31, 2002 $ 30,537,900
=============
Capital expenditures $ 151,300 $ 101,500
============= ===========
Depreciation, depletion and
amortization $ 167,600 $ 254,300
============= ===========
66
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Year Ended May 31, 2001
-------------------------------------------------------------------
Drilling/
Commercial Construction
Minerals Operations Operations Consolidated
-------- ---------- ---------- ------------
Revenues $ 442,800 $ 2,222,400 $ 2,238,600 $ 4,903,800
============= ============= ============
Other revenues 597,800
-------------
Total revenues $ 5,501,600
=============
Operating (loss) profit $ (2,866,400) $ (1,013,800) $ 488,100 $ (3,392,100)
============= ============= ============
Other revenue, income and expenses 9,328,600
General corporate and other expenses (4,235,400)
Equity in loss of affiliates and
minority interest in subsidiaries 220,100
-------------
Income before income taxes $ 1,921,200
=============
Identifiable net assets at May 31, 2001 $ 18,424,900 $ 5,616,400 $ 1,050,500 $ 25,091,800
============= ============= ============
Investments in affiliates 16,200
Corporate assets 5,357,200
-------------
Total assets at May 31, 2001 $ 30,465,200
=============
Capital expenditures $ 1,280,200 $ 1,326,800 $ 256,000
============= ============= ============
Depreciation, depletion and
amortization $ 129,700 $ 271,100 $ 324,700
============= ============= ============
67
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Year Ended May 31, 2000
------------------------------------------------------------------
Drilling/
Commercial Construction
Minerals Operations Operations Consolidated
-------- ---------- ---------- ------------
Revenues $ 132,600 $ 2,734,800 $ 3,584,900 $ 6,452,300
============= ============= ============
Other revenues 436,500
--------------
Total revenues $ 6,888,800
==============
Operating (loss) profit $ (2,518,600) $ (652,500) $ (594,300) $ (3,765,400)
============= ============= ============
Other revenue, income and expenses 530,100
General corporate and other expenses (7,912,900)
Equity in loss of affiliates and
minority interest in subsidiaries 506,400
--------------
Loss before income taxes $ (10,641,800)
==============
Identifiable net assets at May 31, 2000 $ 17,543,700 $ 4,880,900 $ 2,163,300 $ 24,587,900
============= ============= ============
Investments in affiliates 9,600
Corporate assets 6,278,600
--------------
Total assets at May 31, 2000 $ 30,876,100
==============
Capital expenditures $ 4,749,300 $ 944,600 $ 1,551,800
============= ============= ============
Depreciation, depletion and
amortization $ 72,600 $ 148,100 $ 155,400
============= ============= ============
68
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
J. SHAREHOLDERS' EQUITY:
STOCK OPTION PLANS
The Board of Directors adopted the U.S. Energy Corp. 1989 Stock Option Plan
for the benefit of USE's key employees. The Option Plan, as amended and renamed
the 1998 Incentive Stock Option Plan ("1998 ISOP"), reserved 2,750,000 shares of
the Company's $.01 par value common stock for issuance under the 1998 ISOP.
Options which expired without exercise were available for reissue. During fiscal
1992, the Company issued 371,200 non-qualified options to certain of its
executive officers, Board members and others at prices ranging from $2.75 to
$2.90 per share. Unexercised options expired on April 14, 2002 and April 30,
2002. During fiscal 1996, the Company issued options to purchase 360,000 common
shares at $4.00 per share. Unexercised options expired on December 31, 2000.
During fiscal 1999, the Company issued 837,500 options under the 1998 ISOP,
including 299,462 non-qualified and 538,038 qualified options. The non-
qualified options were issued at a price below fair market value, resulting in
the recognition of $262,000 in compensation expense at the time of issuance.
During fiscal 2001, the Company issued 1,499,000 options under the 1998 ISOP,
including 918,763 non-qualified and 580,237 qualified options. Various employees
exercised 118,703 of the outstanding options raising $288,400 of capital. During
fiscal 2002, various employees exercised 253,337 of the outstanding options
raising $602,500 of capital.
In December 2001, the Board of Directors adopted (and the shareholders
approved) the U.S. Energy Corp. 2001 Incentive Stock Option Plan (the "2001
ISOP") for the benefit of USE's key employees. The 2001 ISOP reserves 3,000,000
shares of the Company's $.01 par value common stock for issuance for a period of
10 years. During fiscal 2002, the Company issued 1,030,000 options to certain of
its employees, executive officers, and board members at $3.90 per share. These
options will expire in December, 2011.
The 2001 ISOP replaces the 1998 ISOP, however, options granted under the
1998 ISOP remain exercisable until their expiration date under the terms of that
Plan.
EMPLOYEE STOCK OWNERSHIP PLAN
The Board of Directors of USE adopted the U.S. Energy Corp. 1989 Employee
Stock Ownership Plan ("ESOP") in 1989, for the benefit of USE employees. During
fiscal 2002, 2001 and 2000, the Board of Directors of USE contributed 70,075,
53,837, and 123,802 shares to the ESOP at prices of $3.29, $5.35, and $3.00 per
share, respectively. The Company has expensed $236,900, $288,000, and $371,400
in fiscal 2002, 2001, and 2000, respectively related to these contributions. USE
has loaned the ESOP $1,014,300 to purchase 125,000 shares from the Company and
38,550 shares on the open market. These loans, which are secured by pledges of
the stock purchased, bear interest at the rate of 10% per annum. The loans are
reflected as unallocated ESOP contribution in the equity section of the
accompanying Consolidated Balance Sheets.
EXECUTIVE OFFICER COMPENSATION
In May 1996, the Board of Directors of USE approved an annual incentive
compensation arrangement ("1996 Stock Award Program") for its CEO and four other
officers of the Company payable in shares of the
69
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Company's common stock. The 1996 Stock Award Program was subsequently modified
to reflect the intent of the directors which was to provide incentive to the
officers of the Company to remain with USE. The shares are to be issued annually
pursuant to the recommendation of the Compensation Committee on or before
January 15 of each year, beginning January 15, 1997, as long as each officer is
employed by the Company. The officers will receive up to an aggregate total of
67,000 shares per year for the years 1997 through 2002. The shares under the
plan are forfeitable until retirement, death or disability of the officer. The
shares are held in trust by the Company's treasurer and are voted by the
Company's non-employee directors. As of May 31, 2002, 349,158 total shares have
been issued to the five officers of the Company under the 1996 Stock Award Plan.
In December 2001, the Board of Directors adopted (and the shareholders
approved) the 2001 Stock Award Plan to compensate five of its executive officers
and the president of RMG. Under the Plan, an aggregate of 60,000 shares may be
issued each year from 2002 through 2006. No shares were issued under this Plan
is fiscal 2002.
OPTIONS AND WARRANTS TO OTHERS
During fiscal 1998, the Company and YSFC entered into an Exchange Rights
Agreement (the "Agreement"). Under the Agreement the YSFC private placement
shareholders and related broker agent had the right, but not the obligation, to
exchange their shares in YSFC for USE common stock if YSFC's common shares were
not listed and available for quotation on the NASDAQ marketing system by March
1998. The Company exchanged 677,167 shares of its common stock during fiscal
1999, at a fair value of $2,591,500, for 1,131,500 shares of YSFC common stock
or 9% of the outstanding shares of YSFC. During fiscal 2000, the Company issued
an additional 57,752 shares of its common stock valued at $206,900 for an
additional 96,250 shares of YSFC common stock or an additional 1% of the
outstanding shares of YSFC common stock. The exchange rate for USE shares was
the price paid for the YSFC's common shares plus 10% per annum return to the
investor from the date of purchase. The number of USE shares exchanged was based
on the exchange rate for a share of USE common stock for the five business days
prior to the date of notice given by the YSFC shareholder to exchange their
shares.
In January 1998, the Company entered into a warrant purchase agreement with
another investment advisory firm to purchase 200,000 shares of the Company's
common stock at an exercise price of $7.50/share expiring January 20, 2000. The
warrants were issued in exchange for services to be provided during the period
from January 1998 to January 1999. The Company determined the fair value
associated with these warrants to be $264,000, which was recognized ratably over
the term of the related advisory agreement. Accordingly, $27,000 was recognized
as an expense in fiscal 2000 and $176,000 in fiscal 1999.
In February of 1999, the Company entered into a warrant purchase agreement
with a consulting firm to purchase 20,000 shares of the Company's common stock
at an exercise price of $2.62 expiring January 31, 2002 (extended to October 15,
2002). The warrants were issued in exchange for services to be provided during
the period from February 1999 to February 2000. The Company determined the fair
value associated with these warrants to be $36,000, which is recognized ratably
over the term of the consulting agreement. Accordingly, $9,000 was recognized as
an expense in fiscal 1999 and $27,000 in fiscal 2000.
70
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Also, during fiscal 1999, the Company issued warrants in exchange for
outstanding YSFC warrants, which were originally issued for services provided by
outside consultants in connection with the agreement discussed above. The
Company issued 67,025 warrants at an exercise price of $3.64 expiring September
19, 2002. The Company determined the fair value associated with these warrants
to be $167,000, which was recorded as an additional investment in YSFC during
fiscal 1999. During fiscal 2002, a warrant for 6,703 shares was canceled and
20,000 shares were issued to its holder in exchange for services provided during
fiscal 2002.
In February 1999, the Company entered into a consulting agreement with an
individual to provide consulting and other services for a period of 24 months,
commencing on February 8, 1999 and ending on January 31, 2001. As consideration
for services to be performed, the Company granted the individual 25,000 shares
of the Company's common stock at a grant price of $2.75 per share and entered
into a 5 year warrant purchase agreement to purchase up to 75,000 shares of the
Company's common stock at an exercise price of $2.25 per share, expiring
February 8, 2004. The Company determined the fair value associated with the
stock grant to be $68,750 and the warrants to be $140,000, which were recognized
ratably over the term of the consulting agreement. Accordingly, $69,550;
$104,400; and $34,800 were recognized as an expense in fiscal 2001, 2000 and
1999, respectively related to this agreement.
During fiscal 2000, the Company issued 200 shares of its $.01 par value
mandatorily convertible preferred stock for $2,000,000. A commission of $160,000
was paid to an independent broker on this transaction. This preferred stock was
mandatorily convertible into either 677,667 shares of common stock of RMG or
into shares of common stock of the Company at the market price of the Company's
common stock on the date of conversion. The preferred shares were convertible at
the earlier of the date RMG completed an initial public offering of its common
stock or April 11, 2002. During December 2001, the Company converted this
preferred stock to common stock by issuing 513,140 shares of its common stock to
the holder of the preferred stock. Dividends of $80,500, $150,000 and $20,800
were paid on the preferred stock in 2002, 2001 and 2000, respectively.
During fiscal 2001, the Company entered into a consulting agreement with a
company to provide consulting services for a period of two years, commencing on
April 11, 2001. In addition to a monthly cash payment of $2,000, the Company
issued the consultant an option to purchase up to 20,000 shares of the Company's
common stock at $3.98 per share. The option expires on April 10, 2006. The fair
value of the grant was $65,180.
Also during fiscal 2001, the Company entered into a consulting agreement
with a company to provide consulting and other services for a period of 18
months, commencing on May 14, 2001 and ending on November 14, 2002. As
consideration for services to be performed, the Company issued the consultant
15,000 shares of the Company's common stock at a grant price of $4.70 per share
and entered into two stock option agreements to purchase up to 30,000 shares of
the Company's common stock at an exercise price of $4.70, expiring May 14, 2003.
The first option for 10,000 shares, is exercisable upon the condition that the
Company's common stock market price closes at or above $6.50 per share for
ninety (90) consecutive days prior to the expiration date of May 14, 2003. The
exercise price of this option equaled or exceeded market price of the stock at
the date of grant. The second option for 20,000 shares is exercisable if and
when the
71
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Company's common stock market price closes at or above $10.00 per share for
ninety (90) consecutive days prior to its expiration date on May 14, 2003.
During fiscal 2002, the Company raised $2,350,500 by issuing 871,592 shares
of common stock with 437,511 detached warrants in two separate private
placements.
In May 2002, the Company issued warrants to purchase 120,000 shares of the
Company's common stock at $3.00 per share, and warrants to purchase 120,000
shares of the Company's subsidiary, RMG at $1.50 per share in connection with a
$1 million convertible debt issue. The warrants expire on May 30, 2005. The fair
value of the warrants was $271,700 which has been recorded as a discount on the
debt which will be amortized over the term of the convertible debt.
Additionally, a discount of $398,400 has been recorded against the convertible
debt resulting from allocation of proceeds to the beneficial conversion feature
of the debt instrument. The fair value of the warrants was estimated on the date
of the grant using the Black-Scholes Options Pricing Model with the following
weighted average assumptions: No expected dividends; expected volatility 51.3%;
risk factor interest rate of 5% and expected life of three years.
FORFEITABLE SHARES
Certain of the shares issued to officers, directors, employees and third
parties are forfeitable if certain conditions are not met. Therefore, these
shares have been reflected outside of the Shareholders' Equity section in the
accompanying Consolidated Balance Sheets until earned. During fiscal 1993, the
Company's Board of Directors amended the stock bonus plan. As a result, the
earn-out dates of certain individuals were extended until retirement. For the
years ended May 31, 2001, 2000 and 1999, the Company had compensation expense of
$298,300; $201,000; and $173,300, respectively, resulting from these issuances.
A schedule of total forfeitable shares for the Company is set forth in the
following table:
72
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Issue Number Issue Total
Date of Shares Price Compensation
------------- --------- ----- ------------
May 1990 40,300 $ 9.75 $ 392,900
June 1990 66,300 11.00 729,300
November 1992 10,660 N/A N/A
May 1993 20,000 3.375 67,500
November 1993 18,520 3.00 55,600
January 1994 18,520 4.00 74,100
January 1995 13,520 3.75 50,700
February 1996 7,700 15.125 116,500
December 1996 28,380 10.875 308,600
December 1996 8,452 11.50 97,200
August 1997 7,320 10.875 79,600
August 1997 5,706 10.875 62,100
May 1998 67,000 6.56 439,500
------- ------------
Balance at
May 31, 1998 312,378 2,473,600
May 1999 67,000 $ 4.00 268,000
Shares earned (40,170) -- (269,900)
------- ------------
Balance at
May 31, 1999 339,208 2,471,700
May 2000 67,000 $ 3.00 201,000
Shares earned (9,600) -- (88,100)
------- ------------
Balance at
May 31, 2000 396,608 2,584,600
May 2001 67,000 $ 5.35 358,400
Shares earned (29,820) -- (194,400)
------- ------------
Balance at
May 31, 2001 433,788 2,748,600
May 2002 67,000 $ 3.90 261,300
------- ------------
Balance at
May 31, 2002 500,788 $ 3,009,900
======== ============
During 2002, 2001, and 2000; 0, 29,820, and 9,600 shares were earned,
respectively.
Statement of Financial Accounting Standards No. 123 ("SFAS 123")
SFAS 123, "Accounting for Stock-Based Compensation," defines a fair value
based method of accounting for employee stock options or similar equity
instruments. However, SFAS 123 allows the continued measurement of compensation
cost for such plans using the intrinsic value based method prescribed by APB
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), provided
that pro forma
73
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
disclosures are made of net income or loss and net income or loss per share,
assuming the fair value based method of SFAS 123 had been applied. The Company
has elected to account for its stock-based compensation plans under APB 25;
accordingly, for purposes of the pro forma disclosures presented below, the
Company has computed the fair values of all options granted using the
Black-Scholes pricing model and the following weighted average assumptions (no
options were granted during 2000):
2002 2001 2000
---- ---- ----
Risk-free interest rate 5.6% 4.29% --
Expected lives 10 years 10 years --
Expected volatility 62.65 73.1% --
Expected dividend yield -- -- --
To estimate expected lives of options for this valuation, it was assumed
options will be exercised upon expiration at the end of the ten years. All
options are initially assumed to vest. Cumulative compensation cost recognized
in pro forma net income or loss with respect to options that are forfeited prior
to vesting is adjusted as a reduction of pro forma compensation expense in the
period of forfeiture. Pro forma stock-based compensation, net of the effect of
forfeitures, was $3,079,700, $2,746,600 and $0 for 2002, 2001 and 2000,
respectively.
If the Company had accounted for its stock-based compensation plans in
accordance with SFAS 123, the Company's net loss and pro forma net loss per
common share would have been reported as follows:
Year Ended May 31,
-----------------------------------------------
2002 2001 2000
------------- ------------ --------------
Net loss to common shareholders
As reported $ (6,267,600) $ 1,771,200 $ (10,662,600)
Pro forma $ (9,347,300) $ (975,400) $ (10,662,600)
Net loss per common share
As reported, Basic $ (.67) $ .23 $ (1.39)
As reported, Diluted $ (.67) $ .21 $ (1.39)
Pro forma, Basic $ (1.01) $ (.12) $ (1.39)
Pro forma, Diluted $ (1.01) $ (.12) $ (1.39)
Weighted average shares used to calculate pro forma net loss per share were
determined as described in Note B, except in applying the treasury stock method
to outstanding options, net proceeds assumed received upon exercise were
increased by the amount of compensation cost attributable to future service
periods and not yet recognized as pro forma expense.
74
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
A summary of the Employee Stock Option Plan activity for the years ended
May 31, 2002 and 2001 is as follows:
Year Ended May 31,
-----------------------------------------------------------------------------
2002 2001 2000
------------------------ ------------------------ -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----
Outstanding at beginning
of year 2,449,000 $2.49 1,300,200 $2.79 1,300,200 $2.79
Granted 1,030,000 3.90 1,499,000 2.69 -- --
Forfeited (75,000) 2.49 (82,500) 2.88 -- --
Expired (253,833) 2.89 (149,000) -- -- --
Exercised (253,337) 2.48 (118,700) -- -- --
---------- -------- ---------
Outstanding at end of year 2,896,830 2.96 2,449,000 2.49 1,300,200 2.79
========== ========= =========
Exercisable at end of year 2,896.830 2.96 2,449,000 2.49 1,300,200 2.79
========== ========= =========
Weighted average fair
value of options
granted during the year $2.99 $1.83 --
The following table summarized information about employee stock options
outstanding and exercisable at May 31, 2002:
Weighted
Weighted Number of Average Number
Average Options Remaining of Options
Exercise Outstanding at Contractual Exercisable at
Price May 31, 2002 Life in years May 31, 2002
-------- -------------- ------------- --------------
$2.00 278,808 6.33 278,808
2.40 1,201,548 8.60 1,201,548
2.88 386,474 6.33 386,474
3.90 1,030,000 8.52 1,030,000
2,896,830 2,896,830
========= =========
75
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
K. COMMITMENTS, CONTINGENCIES AND OTHER:
LEGAL PROCEEDINGS
Material pending proceedings are summarized below. Certain of the Company's
affiliates are involved in ordinary routine litigation incidental to their
business. Other proceedings which were pending in fiscal 2001 have been settled
or otherwise finally resolved.
SHEEP MOUNTAIN PARTNERS ARBITRATION/LITIGATION
In 1991, disputes arose between the Company, Crested, Nukem, Inc. and its
subsidiary Cycle Resource Investment Corp. ("CRIC"), concerning the formation
and operation of the Sheep Mountain Partners partnership. Arbitration
proceedings were initiated by CRIC in June 1991 and in July 1991, USECC filed a
lawsuit against Nukem, CRIC and others in the U.S. District Court (District of
Colorado) in Civil No. 91B1153. Later, USECC filed another suit for the standby
costs at the SMP mines against SMP in the Colorado State Court. The Federal
Court stayed both the arbitration proceedings and the State Court case. In
February 1994, all of the parties agreed to consensual and binding arbitration
of the disputes before the American Arbitration Association ("AAA"), for which
the legal claims made by both sides included fraud and misrepresentation, breach
of contract, breach of duties owed to the SMP partnership, and other claims.
The AAA panel (the "Panel") entered an Order and Award (the "Order") in
April 1996 and clarified the Order on July 3, 1996, finding generally in favor
of USE and Crested on certain of their claims (including the claims for
reimbursement for standby maintenance expenses and profits denied SMP in Nukem's
trading of uranium), and in favor of Nukem/CRIC and against USE and Crested on
certain other claims, and imposing a constructive trust in favor of Sheep
Mountain Partners on uranium contracts Nukem entered into to purchase uranium
from CIS republics. USECC filed a petition for confirmation of the Order and on
June 30, 1997, and the U.S. District Court confirmed the Order in its Second
Amended Judgment (the "Judgment"). Thereafter, Nukem/CRIC appealed the Judgment
to the 10th Circuit Court of Appeals ("CCA").
A three judge panel of the 10th CCA issued an Order and Judgment on October
22, 1998, which unanimously affirmed the Federal District Court's Second Amended
Judgment without modification. The ruling affirmed (i) the imposition of a
constructive trust in favor of SMP on Nukem's rights to purchase CIS uranium,
the uranium acquired pursuant to those rights, and the profits therefrom; and
(ii) the damage award against Nukem/CRIC. As a result of the ruling of the 10th
CCA, USE and Crested received an additional $6,077,264 (including interest and
court costs) from Nukem in February 1999 for a total net monetary award of
$15,468,625 in the arbitration/litigation, and equitable relief in the form of
USE's and Crested's interest in SMP, which holds the constructive trust over the
CIS contracts. Nukem/CRIC filed two motions for entry of final satisfaction of
Judgment. The U.S. District Court denied both motions, Nukem again appealed to
the 10th CCA, which again affirmed the District Court's ruling, and held that
Nukem/CRIC had not demonstrated that the Judgment had been satisfied because
they had not provided USECC with an accounting of the partnerships assets.
76
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
In February 2001, the U.S. District Court appointed a Special Master to
determine the amounts, if any, owed by Nukem to SMP pursuant to the constructive
trust. The Special Master has ordered an accounting to identify all deliveries
of CIS uranium made directly or indirectly to Nukem and any Nukem affiliates; to
identify the ultimate disposition of all uranium purchased under the CIS
contracts; to identify the location, number of pounds, and associated cost of
uranium purchased under the CIS contracts at December 31, 2001, and to calculate
the profits realized from the sale of CIS uranium. At a status hearing held
before the U.S. District Court on August 23, 2002, the Court ordered the Special
Master to file his report on or before December 6, 2002 and a further hearing to
schedule arguments will be held before the Court on December 13, 2002.
CONTOUR DEVELOPMENT LITIGATION
On July 28, 1998, USE filed a lawsuit in the United States District Court,
Denver, Colorado, Case No. 98WM1630, against Contour Development Company, L.L.C.
and entities and persons associated with Contour Development Company, L.L.C.
(together, "Contour") seeking compensatory and consequential damages of more
than $1.3 million from the defendants for dealings in real estate owned by USE
and Crested in Gunnison, Colorado. The Contour defendants asserted a
counterclaim asking for payment of attorneys fee and costs. The matter has been
settled, with USE receiving $25,000 cash and unencumbered title to two
commercial real estate lots covering seven acres in Gunnison, Colorado, and
unencumbered title to five development lots covering 175 acres north of
Gunnison, Colorado.
See "Business - Commercial Operations - Real Estate and Other Commercial
Operations - Colorado Properties" above.
PHELPS DODGE LITIGATION
U.S. Energy Corp. and its majority-owned subsidiary, Crested Corp., d/b/a
USECC, were served with a lawsuit on June 19, 2002, filed in the U.S. District
Court of Colorado (Case No. 02-B-0796(PAC)) by Phelps Dodge Corporation and its
subsidiary, Mt. Emmons Mining Company (MEMCO), over contractual obligations from
USECC's agreement with Phelps Dodge's predecessor companies, concerning a mining
property in Colorado.
The litigation stems from agreements that date back to 1974 when U.S.
Energy and Crested Corp. leased mining claims on Mt. Emmons near Crested Butte,
Colorado to AMAX Inc., Phelps Dodge's predecessor company. The claims cover one
of the world's largest and richest deposits of molybdenum. AMAX reportedly spent
over $200 million on the acquisition, exploration and mine planning activities
on the Mt. Emmons properties. In counter and cross-claims filed in the U.S.
District Court of Colorado, USECC contends that Phelps Dodge and its
subsidiaries committed several breaches of contracts related to the agreements,
including breach of fiduciary obligations and covenants of good faith and fair
dealing. USECC also contends Phelps Dodge is guilty of violating federal and
state antitrust laws when it purchased Cyprus Amax Minerals Company (Cyprus
Amax).
77
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
The complaint filed by Phelps Dodge and MEMCO seeks a determination that
Phelps Dodge's acquisition of Cyprus Amax was not a sale. Under a 1986 agreement
between USECC and AMAX, if AMAX sold MEMCO or its interest in the mining
properties, U.S. Energy and Crested would receive 15% (7.5% each) of the first
$25 million of the purchase price ($3.75 million). In 1991, Cyprus Minerals
Company acquired AMAX to form Cyprus Amax Minerals Co. USECC's counter and
cross-claims allege that in 1999, Phelps Dodge formed a wholly-owned subsidiary
CAV Corporation, for the purpose of purchasing the controlling interest of
Cyprus Amax and its subsidiaries (including MEMCO) at an estimated value in cash
and Phelps Dodge stock exceeding $1 billion and making Cyprus Amax a subsidiary
of Phelps Dodge. Therefore, USECC asserts the acquisition of Cyprus Amax by
Phelps Dodge was a sale of MEMCO and the properties that triggers the obligation
of Cyprus Amax to pay USECC the $3.75 million plus interest.
A second counterclaim by USECC rejects the claim by Phelps Dodge that it
and its predecessors, Cyprus Amax and AMAX Inc., had mistakenly paid royalties
to USECC since January 1991. In 1984, AMAX began paying the cash equivalent
(half each to U.S. Energy and Crested Corp.) of 700,000 pounds of molybdenum per
year as an advance royalty prior to the mine beginning production. In 1986,
USECC agreed to assist financially troubled AMAX and substantially reduced the
annual advance royalty to 50,000 pounds of molybdenum, so that AMAX could
continue to hold the properties and eventually bring them into production. AMAX,
Cyprus Amax and Phelps Dodge continued paying the annual advance royalties to
U.S. Energy and Crested Corp. until the payment due in July 2001, when Phelps
Dodge unilaterally ceased making the payments. Phelps Dodge and MEMCO seek a
declaratory judgment that the advance royalty payment obligation has terminated,
and further, that USECC should repay $948,109 of royalties paid to USECC from
1993 through 2000, because those payments were made by mistake.
The third issue in the litigation is whether USECC must, under terms of a
1987 royalty deed, accept Phelps Dodge's and MEMCO's forth-coming conveyance of
the Mt. Emmons properties back to USECC, which properties now include a plant to
treat mine water, costing in excess of $1 million a year to operate in
compliance with State of Colorado regulations. Phelps Dodge's and MEMCO's
threatened reconveyance would require USECC to assume the operating costs of the
water treatment plant. USECC refuses to have the water treatment plant included
in the return of the properties because, the USECC counterclaim argues, the
properties must be in the same condition as when they were acquired by AMAX
before the water treatment plant was constructed by AMAX.
The properties are comprised of 10 unpatented lode mining claims (for which
patents are expected to be issued by the BLM in the near future), and 770
unpatented lode mining claims, for a total of 15,600 acres.
As added counterclaims, USECC seeks (i) damages for defendants' breach of
covenants of good faith and fair dealing; (ii) damages for defendants' failure
to develop the Mt. Emmons properties and not protecting USECC's rights as
revisionary owner of the mining rights to the properties, (iii) damages for
unjust enrichment of defendants; (iv) damages for breach of the defendants'
fiduciary duties owed to USECC as revisionary owner of the property, and for
neglecting to maintain the mining rights and interests in the properties; and
(v) damages relating to defendants' actions in violation of federal and Colorado
anti-trust and constraint of trade laws.
78
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
USECC also seeks a declaratory judgment of its rights and liabilities under
the agreements affecting the Mt. Emmons properties; an injunction against
defendants prohibiting the conveyance of the properties to USECC with the water
treatment plan; an injunction against further waste of the properties by the
defendants; an injunction requiring defendants to divest their molybdenum
holdings (including the Mt. Emmons properties); and an injunction requiring
defendants to assist USECC in mining molybdenum from the Mt. Emmons properties.
On August 2, 2002, Phelps Dodge and MEMCO filed a reply to the
counterclaims of USECC and Cyprus Amax filed an answer to the counterclaims and
third party complaint of USECC, generally denying the allegations of USECC. CAV
Corporation filed a motion for summary judgment seeking dismissal of USECC's
cross complaint and is pending. An order has been entered by the Court setting
the Scheduling/Planning Conference in the case for September 12, 2002.
Except for the parties' claims regarding payment of the $3.75 million due
on the sale of MEMCO, payments of royalties, and responsibility going forward
for payment of the operating costs of the water treatment plan, the financial
impact to U.S. Energy Corp. and Crested Corp. of favorable or unfavorable
outcomes in the litigation presently is not determinable.
LITIGATION INVOLVING LEASES ON COALBED METHANE PROPERTIES IN MONTANA
On or about April 1, 2001, the Company's subsidiary, Rocky Mountain Gas,
Inc. (RMG) was served with a Second Amended Complaint wherein the Northern
Plains Resource Council had filed suit in the U.S. District Court of Montana,
Billings Division in Case No. CV-01-96-BLG-RWA against the United States Bureau
of Land Management ("BLM"), RMG, certain of its affiliates (including U.S.
Energy Corp. and Crested Corp.) 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.
79
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
RECLAMATION AND ENVIRONMENTAL LIABILITIES
Most of the Company's and Crested's mine development, exploration and
operating activities are subject to federal and state regulations that require
the Company and Crested to protect the environment. The Company and Crested
conduct their mining operations in accordance with these regulations. The
Company's and Crested'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 Crested cannot predict
the outcome of future regulation or impact on costs. Nonetheless, the Company
and Crested 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 Company's and Crested's
reclamation, environmental and decommissioning liabilities, and the Company and
Crested believe the recorded amounts are consistent with those reviews and
related bonding requirements. To the extent that planned 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 Crested
would be adversely affected. The Company and Crested 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 Crested's environmental obligations
relate to former mining properties acquired by the Company and Crested. Since
the Company and Crested currently do not have properties in production, the
Company's and Crested's policy of providing for future reclamation and mine
closure costs on a unit-of-production basis has not resulted in any significant
annual expenditures or costs. For the obligations recorded on acquired
properties, including site-restoration, closure and monitoring costs, actual
expenditures for reclamation will occur over several years, and since these
properties are all considered future production properties, those expenditures,
particularly the closure costs, may not be incurred for many years. The Company
and Crested also 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 May 31, 2002, estimated reclamation obligations related to the above
mentioned mining properties total $8,906,800. Crested's portion of this
obligation is $748,400, which is reflected on the balance sheet of the Company.
The remaining balance of $7,614,700 is an obligation of USE and its other
affiliates, (excluding Crested). The Company is obligated for 50% of any
reclamation costs in excess of current estimated reclamation obligations. The
Company, however, does not expect that estimated reclamation costs will be
exceeded.
The Company and Crested currently have three mineral properties or
investments that account for most of their environmental obligations, SMP,
Plateau and SGMC. The environmental obligations and the nature and extent of
cost sharing arrangements with other potentially responsible parties, as well as
any uncertainties with respect to joint and several liability of each are
discussed in the following paragraphs:
80
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
SMP
---
The Company and Crested 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, Crested and the regulatory authorities during fiscal
2002 and the balance in the reclamation liability account at May 31, 2002 of
$1,496,800 (1/2 accrued by USE) is believed by management to be adequate. The
Company and Crested 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 Crested acquired mineral properties on
Green Mountain known as the Big Eagle Property. The GMMV also acquired a uranium
mill known as the Sweetwater Mill. As part of the settlement of the GMMV
litigation with Kennecott in September 2000, the Company was released from any
and all reclamation and environmental obligations related to the GMMV except the
Ion Exchange Plant. During fiscal 2002, the Company and Crested completed the
required reclamation on the Ion Exchange Plant. The work is completed, but the
regulatory agencies have not terminated monitoring the site. Additional
reclamation work may be required although none is anticipated.
SUTTER GOLD MINING COMPANY
--------------------------
SGMC's mineral properties are currently on shut down status and have never
been in production. Reclamation obligations are covered by a $27,800 reclamation
cash bond which SGMC has recorded as a reclamation liability as of May 31, 2002.
PLATEAU RESOURCES, LIMITED
--------------------------
The environmental and reclamation obligations acquired with the acquisition
of Plateau include obligations relating to the Shootaring Mill. Based on the
bonding requirements, Plateau transferred $2,500,000 to a trust account as
financial surety to pay future costs of mill decommissioning, site reclamation
and long-term site surveillance. In fiscal 1997, Plateau increased the NRC
surety to a cash bond of $6,784,000 in order to have its standby license changed
by the NRC to operational. As of May 31, 2002, Plateau held a cash deposit for
reclamation in the amount of $8,818,600 which management believes will satisfy
the obligation of reclamation.
81
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
EXECUTIVE COMPENSATION
- ----------------------
The Company is committed to pay the estates 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.
L. DISCONTINUED OPERATIONS.
In February 1996, the Company completed the sale of 100% of the 8,267,450
outstanding shares of common stock of Brunton to a third party for $4,300,000 in
accordance with a Stock Purchase Agreement dated January 30, 1996 (the "Purchase
Agreement"). The Company received $300,000 at execution of the Purchase
Agreement and approximately $3,000,000 at closing. The Company has also since
been paid in full on the $1,000,000 balance. In addition, the Company was
entitled to receive 45% of the profits before taxes as defined in the Purchase
Agreement related to Brunton products existing at the time the Purchase
Agreement was executed for a period of 4 years and three months, beginning
February 1, 1996. The Company received payments of $297,100 and $52,000 for
profits in 2001 and 2000, respectively.
During the third quarter of fiscal 2002, the Company made the decision to
discontinue its drilling/construction segment. The assets associated with this
business segment are being sold and or converted for use elsewhere in the
Company. The financial statements for 2001 and 2000 have been revised to present
the effect of discontinued operations. There is no material income or loss from
discontinued operations from the measurement date to May 31, 2002.
M. SUBSEQUENT EVENT
Subsequent to May 31, 2002, the Company's subsidiary RMG purchased an
average 25% net revenue interest and an average 31% working interest in 18
coalbed methane wells drilled on 930 net acres in the Powder River Basin.
Thirteen of the 18 drilled wells are currently hooked up and produce at a
combined rate of one million cubic feet of gas per day (1,000 mcf) from the two
primary coals on the property: the Cook coal (11 wells) at 650 feet, and the
Canyon Coal (2 wells) at 450 feet. One of the 18 wells is used as a water
injection well.
82
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
N. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
-------------------------------------------------------------------
May 31, February 28, November 30, August 31,
2002 2002 2001 2001
------------- ------------- ------------- -------------
Operating Revenues $ 408,800 $ 238,700 $ 724,200 $ 632,400
Operating (loss) $ (1,588,300) $ (3,066,700) $ (1,197,600) $ (1,601,600)
Loss from continuing operations $ (1,109,700) $ (3,172,000) $ (550,900) $ (1,349,100)
Discontinued operations, net of tax $ (22,200) $ (9,600) $ (37,300) $ (16,800)
Net loss $ (1,131,900) $ (3,181,600) $ (588,200) $ (1,365,900)
Loss per Share, basic
Continuing operations $ (0.10) $ (0.32) $ (0.07) $ (0.17)
Discontinued operations $ (0.01) $ -- $ -- $ --
------------ ------------ ------------ ------------
$ (0.11) $ (0.32) $ (0.07) $ (0.17)
============ ============ ============ ============
Basic weighted average
shares outstanding 10,579,828 9,837,494 8,580,904 8,192,316
Loss per share, diluted
Continued operations $ (0.11) $ (0.32) $ (0.07) $ (0.17)
Discontinued operations $ (0.01) $ -- $ -- $ --
------------ ------------ ------------ ------------
$ (0.11) $ (0.32) $ (0.07) $ (0.17)
============ ============ ============ ============
Diluted weighted average
shares outstanding 10,579,828 9,837,494 8,580,904 8,192,316
83
U.S. ENERGY CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAY 31, 2002
(CONTINUED)
Three Months Ended
---------------------------------------------------------------
May 31, February 28, November 30, August 31,
2001 2001 2000 2000
------------ ------------ ------------ ------------
Operating Revenues $ 72,000 $ 656,900 $ 900,800 $ 1,633,300
Operating (loss) $(2,760,500) $(1,679,800) $(1,772,300) $(1,305,200)
(Loss) earnings from continuing
operations $(2,163,400) $(1,513,500) $ 6,093,000 $(1,133,000)
Discontinued operations, net of tax $ 821,600 $ (344,300) $ (416,800) $ 427,600
Net earnings (loss) $(1,341,800) $(1,857,800) $ 5,676,200 $ (705,400)
Earnings (loss) per share, basic
Continuing operations $ (0.28) $ (0.19) $ 0.78 $ (0.14)
Discontinued operations $ 0.11 $ (0.04) $ (0.05) $ 0.05
----------- ----------- ----------- -----------
$ 0.17) $ (0.23) $ 0.73) $ (0.09)
=========== =========== =========== ===========
Basic weighted average
shares outstanding 7,847,680 7,819,446 7,818,430 7,818,430
Earning (loss) per share, diluted
Continuing operations $ (0.28) $ (0.19) $ 0.78 $ (0.14)
Discontinued operations $ 0.11 $ (0.04) $ (0.05) $ 0.05
----------- ----------- ----------- -----------
$ (0.17) $ (.023) $ 0.73 $ (0.09)
=========== =========== =========== ===========
Diluted weighted average
shares outstanding 7,847,680 7,819,446 8,215,038 7,818,430
84
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS ON SCHEDULE
To U.S. Energy Corp:
In connection with our audit of the consolidated financial statements of U.S.
ENERGY CORP. (a Wyoming Corporation) AND SUBSIDIARIES referred to in our report
dated July 18, 2002, which is included in the Company's annual report on Form
10-K, we have also audited Schedule II for each of the years in the period ended
May 31, 2002. In our opinion, this schedule presents fairly, in all material
respects, the information to be set forth therein.
GRANT THORNTON LLP
Denver, Colorado
July 18, 2002
85
U.S. ENERGY CORP.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Balance Additions
beginning charged to Balance end
of period expenses Deductions of period
----------- ------------ ------------ -----------
May 31, 2000 $ 27,800 $ 708,600 $ 708,600 $ 27,800
===========
May 31, 2001 $ 27,800 -- -- $ 27,800
===========
May 31, 2002 $ 27,800 171,200 171,200 $ 27,800
===========
86
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
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 May
31, 2002, 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 in incorporated herein by reference to our Proxy Statement
for the 2002 Annual Meeting of Shareholders, under the caption "Proposal 1:
Election of Directors." The information regarding the remaining executive
officers follows:
INFORMATION CONCERNING EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS.
The following are the two executive officers of USE as of the date of this
Form 10-K; these persons devote their full time to the Company's business.
ROBERT SCOTT LORIMER, age 51, has been the Chief Accounting Officer for
both USE and Crested for more than the past five years. Mr. Lorimer also has
been Chief Financial Officer for both these companies since May 25, 1991, their
Treasurer since December 14, 1990, and Vice President Finance since April 1998.
He serves at the will of each board of directors. There are no understandings
between Mr. Lorimer and any other person, pursuant to which he was named as an
officer, and he has no family relationship with any of the other executive
officers or directors of USE or Crested. During the past five years, Mr. Lorimer
has not been involved in any Reg. S-K Item 401(f) listed proceeding.
DANIEL P. SVILAR, age 73, has been General Counsel for USE and Crested for
more than the past five years. He also has served as Secretary and a director of
Crested, and Assistant Secretary of USE. On March 25, 2002, Mr. Svilar was
appointed Secretary of USE. His positions of General Counsel to, and as officers
of the companies, are at the will of each board of directors. There are no
understandings between Mr. Svilar and any other person pursuant to which he was
named as officer or General Counsel. He has no family relationships with any of
the other executive officers or directors of USE or Crested, except his nephew
Nick Bebout is a USE director. During the past five years, Mr. Svilar has not
been involved in any Reg. S-K Item 401(f) proceeding.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by Item 11 is incorporated herein by reference to
the Proxy Statement for the 2002 Annual Meeting of Shareholders, 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 2002 Annual Meeting of Shareholders, under the
caption "Principal Holders of Voting Securities."
87
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by Item 13 is incorporated herein by reference to
the Proxy Statement for the 2002 Annual Meeting of Shareholders, under the
caption "Certain Relationships and Related Transactions."
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, REPORTS AND FORMS 8-K.
(1) The following financial statements are filed as a part of the
Report in Item 8:
Consolidated Financial Statements Page No.
--------
U.S. Energy Corp. and Subsidiaries
Report of Independent Public Accountants
Grant Thornton LLP..................................................41
Report of Independent Public Accountants
Arthur Andersen LLP.................................................42
Consolidated Balance Sheets - May 31, 2002 and 2001..............43-44
Consolidated Statements of Operations
for the Years Ended May 31, 2002, 2001 and 2000..................45-46
Consolidated Statements of Shareholders'
Equity for the Years Ended May 31, 2002, 2001 and 2000...........47-49
Consolidated Statements of Cash Flows
for the Years Ended May 31, 2002, 2001 and 2000..................50-51
Notes to Consolidated Financial Statements.......................52-84
Report of Independent Certified
Public Accountants on Schedule......................................85
Schedule II - Valuation and Qualifying Accounts.....................86
(2) Not applicable.
(3) Exhibits Required to be Filed. Each individual exhibit filed herewith
is sequentially paginated corresponding to the pagination of the entire
Form 10-K. As a result of this pagination, the page numbers of
documents filed herewith containing a table of contents will not be the
same as the page number contained in the original hard copy.
88
Exhibit Sequential
No. Title of Exhibit Page No.
- --------- ------------------------------------------------- ----------
3.1 USE Restated Articles of Incorporation.........................[2]
3.1(a) USE Articles of Amendment to
Restated Articles of Incorporation.............................[4]
3.1(b) USE Articles of Amendment (Second) to
Restated Articles of Incorporation
(Establishing Series A Convertible Preferred Stock.............[9]
3.1(c) Articles of Amendment (Third) to
Restated Articles of Incorporation
(Increasing number of authorized shares)......................[14]
3.2 USE Bylaws, as amended through April 22, 1992..................[4]
4.1 Amendment to USE 1998 Incentive
Stock Option Plan (To include Family
Transferability of Options Under SEC Rule 16b)................[11]
4.2 USE 1998 Incentive Stock Option Plan
and Form of Stock Option Agreement 1/99........................[8]
4.3 USE Restricted Stock Bonus Plan,
as amended through 2/94........................................[5]
4.4 Form of Stock Option Agreement, and Schedule
Options Granted January 1, 1996................................[6]
4.5 Form of Stock Option Agreement and Schedule,
Options Granted January 10, 2001..............................[11]
4.6 [intentionally left blank]
4.7 USE 1996 Officers' Stock Award Program (Plan)..................[7]
4.8 USE Restated 1996 Officers' Stock Award Plan and
Amendment to USE 1990 Restricted Stock Bonus Plan..............[7]
4.9 Warrant held by Caydal LLC....................................[13]
4.10 Warrant held by Kevin P. Daly................................[13]
89
4.11 Rights Agreement, dated as of September 19, 2001
between U.S. Energy Corp. and Computershare
Trust Company, Inc. as Rights Agent. The Articles of
Amendment to Articles of Incorporation creating the
Series P Preferred Stock is included herewith as an
exhibit to the Rights Agreement.
Form of Right Certificate (as an exhibit to the
Rights Agreement).
Summary of Rights, which will be sent to
all holders of record of the outstanding
shares of Common Stock of the registrant,
also included as an exhibit to the
Rights Agreement..............................................[12]
4.12 Form of Advisor Warrant dated October 18, 2001
and List of Holders ..........................................[14]
4.13 Form of Advisor Warrant dated November 2, 2001
and List of Holders...........................................[14]
4.14 Form of Investor Warrant dated October 18, 2001
and List of Holders...........................................[14]
4.15 Stock Option held by R. Jerry Falkner
dated April 11, 2001..........................................[14]
4.16 Warrant held by Riches In Resources
dated May 14, 2001............................................[14]
4.17 Stock Option held by R. Jerry Falkner dated
October 11, 1999 and First Amendment thereto..................[15]
4.18 Amendment dated April 25, 2002 to
October 11, 1999 Stock Option
Agreement held by R. Jerry Falkner...........................[16]
4.19 USE 2001 Incentive Stock Option Plan
with Form of Option Agreement....................................*
4.20 USE Schedule of Options
Issued - 12/7/01 and 5/20/02.....................................*
4.21 USE 2001 Officers' Stock Compensation Plan.......................*
10.1 USECC Joint Venture Agreement - Amended as of 1/20/89..........[1]
10.2 Management Agreement with USECC................................[3]
10.3 Contract - R. J. Falkner & Company
dated April 11, 2001..........................................[11]
90
10.4 Consulting Agreement - Riches In Resources
dated May 14, 2001............................................[11]
10.5 Agreement for Strategic Services
VentureRound Group LLC........................................[14]
10.6-10.60 [intentionally left blank]
10.61 Closing Agreement - Addendum to Agreement
for Purchase and Sale of Assets (see Exhibit 10.62)...........[11]
10.62 Agreement for Purchase and Sale of Assets
(Rocky Mountain Gas, Inc. and Quantum Energy LLC)..............[9]
10.63 Purchase and Sale Agreement
CCBM, Inc. (subsidiary of Carrizo Oil & Gas, Inc.)
and Rocky Mountain Gas, Inc...................................[16]
10.64 Purchase and Sale Agreement
Bobcat Property...............................................[16]
10.65 Convertible Promissory Note and
Security Agreement dated May 30, 2002.........................[17]
21.1 Subsidiaries of Registrant....................................[11]
99.1 Certification Pursuant to Section 1350 of Chapter 63
of Title 18 of the United States Code............................*
* Filed herewith.
- -------------
Unless otherwise indicated, the SEC File Number for each of the following
documents incorporated by reference is 000-6814.
[1] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1989, filed August 29, 1989.
[2] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1990, filed September 14, 1990.
[3] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1991, filed September 13, 1991.
[4] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1992, filed September 14, 1991.
[5] Incorporated by reference from the like-numbered exhibit to the
Registrant's Form S-1 registration statement, initial filing
(SEC File No. 333-1689) filed June 18, 1996).
91
[6] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1996, filed September 13, 1996.
[7] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1997, filed September 15, 1997.
[8] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
1998, filed September 14, 1998.
[9] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K for the year ended May 31,
2000, filed September 13, 2000.
[10] Incorporated by reference from the like-numbered exhibit to the
Registrant's Form 8-K, filed February 5, 2001.
[11] Incorporated by reference from the like-numbered exhibit to the
Registrant's Annual Report on Form 10-K, filed August 29, 2001.
[12] Incorporated by reference to exhibit number 4.1 to the Registrant's
Form 8-A12G filed, September 20, 2001.
[13] Incorporated by reference from the like-numbered exhibit to the
Registrant's Form S-3 registration statement (SEC File No. 333-73546),
filed November 16, 2001.
[14] Incorporated by reference from the like-numbered exhibit to the
Registrant's Form S-3 registration statement (SEC File No. 333-75864),
filed December 21, 2001.
[15] Incorporated by reference from the like-numbered exhibit to the
Registrant' Form S-3 registration statement (SEC File No. 333-83040),
filed February 19, 2002.
[16] Incorporated by reference from the like-numbered exhibit to the
Registrant's Form S-3 registration statement, amendment no. 1 (SEC
File No. 333-83040), filed May 17, 2002.
[17] Incorporated by reference from the like-numbered exhibit filed to the
Registrant's Form 8-K, filed June 6, 2002.
(b) Reports filed on Form 8-K.
During the fourth quarter of the fiscal year ended on May 31, 2002, the
Registrant filed one Form 8-K Report on April 23, 2002, reporting the
non-exercise of the Suncor Option and the purchase of the Bobcat
property.
(c) Required exhibits are attached hereto and listed above under
Item 14 (a)(3).
(d) Required financial statement schedules are listed and attached hereto
in Item 14(a)(2).
92
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amended report to be
signed on its behalf by the undersigned, thereunto duly authorized.
U.S. ENERGY CORP. (Registrant)
Date: September 12, 2002 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: September 12, 2002 By: /s/ John L. Larsen
-------------------------------
John L. Larsen, Director
Date: September 12, 2002 By: Keith G. Larsen
-------------------------------
Keith G. Larsen, Director
Date: September 12, 2002 By: Harold F. Herron
-------------------------------
Harold F. Herron, Director
Date: September 12, 2002 By:
-------------------------------
Don C. Anderson, Director
Date: September 12, 2002 By: Nick Bebout
-------------------------------
Nick Bebout, Director
Date: September 12, 2002 By:
-------------------------------
H. Russell Fraser, Director
Date: September 12, 2002 By: /s/ Robert Scott Lorimer
-------------------------------
Robert Scott Lorimer,
Principal Financial Officer/
Chief Accounting Officer
93