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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 [Fee Required] for the fiscal year ended May 31, 1998 or
[ ] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934
[No Fee Required] for the transition period from ______ to ______
Commission file number 0-8773
CRESTED CORP.
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(Exact Name of Registrant as Specified in its Charter)
Colorado 84-0608126
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
877 North 8th West
Riverton, WY 82501
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including area code: (307) 856-9271
-----------------------------
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $0.001 PAR VALUE
(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of September 5, 1998 computed by reference to the average of
the bid and asked prices for the Registrant's common stock as reported by
National Quotation Bureau on Pink Sheets for the week then ended, was
approximately $600,000.
Class Outstanding at September 4, 1998
- --------------------------------------- -----------------------------------
Common Stock, $0.001 par value 10,302,694 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 item numbers involved:
1998 Annual Meeting Proxy Statement for the fiscal year ended May 31,
1998, into Items 10-13 of 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, including without limitation the statements under
Management's Discussion and Analysis of Financial Condition and Results of
Operations, the disclosures about the Green Mountain Mining Venture development
schedule for the Wyoming properties, the projected operating status of Plateau
Resources Limited's Shootaring Canyon uranium mill in Utah, future market prices
for uranium oxide, possible utility contracts for uranium oxide, and the plan of
operations for Yellow Stone Fuels Corp. and Sutter Gold Mining Company
(subsidiaries of Crested), are forward-looking statements. In addition, when
words like "expect," "anticipate" or "believe" are used, Crested is making
forward-looking statements.
Although Crested believes that the expectations reflected in such
forward-looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct. Important factors that could cause
actual results to differ materially from such expectations are disclosed in this
Annual Report. The forward-looking statements should be carefully considered in
the context of all the information set forth in this Annual Report.
PART I
ITEM 1 AND ITEM 2. BUSINESS AND PROPERTIES
(A) GENERAL.
Crested Corp. ("Crested" or the "Registrant") is in the business of
acquiring, exploring, developing and/or selling or leasing mineral properties,
and the mining and marketing of minerals. USE is now engaged in two principal
mineral sectors: uranium and gold, both of which are in the development stage.
The most significant uranium properties are located on Green Mountain and Sheep
Mountain in Wyoming, and in southeast Utah. USE's gold operations are conducted
through Sutter Gold Mining Company ("SGMC"), a 59% USE owned subsidiary.
Interests are held in other mineral properties (principally molybdenum), but are
either non-operating interests or undeveloped claims. Crested and its parent
U.S. Energy Corp. ("USE") also carry on small oil and gas operations in Montana
and Wyoming. Other Crested business segments are commercial operations (real
estate and general aviation). Crested has a May 31 fiscal year.
Crested was incorporated in Wyoming in 1970. All of its 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 Crested's operations are conducted through a joint venture with
USE, which owns a majority of Crested's Common Stock, and various jointly owned
subsidiaries of USE and Crested. The joint venture with USE is referred to in
this Report as "USECC". Construction operations are carried on primarily through
USE's subsidiary Four Nines Gold, Inc. ("FNG"). Oil and gas operations are
carried out through Energx, Ltd., a subsidiary of USE and Crested. USE and
Crested originally were independent companies, with two common affiliates (John
L. Larsen and Max T. Evans). In 1980, USE and Crested formed a joint venture 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 later payment of
the debts by Crested issuing common stock to USE, Crested became a majority
owned subsidiary of USE in fiscal 1993. See Part III of this Report.
2
In fiscal 1998, USE and USECC signed an agreement with Kennecott Uranium
Company ("Kennecott"), for the purchase of Kennecott's interest in the Green
Mountain Mining Venture ("GMMV") (the "Acquisition Agreement"). Please see
"Minerals-Uranium-The Green Mountain Mining Project-June 23, 1997 Acquisition
Agreement with Kennecott Uranium Company" below.
In fiscal 1998, USE and Crested continued the development of the GMMV
uranium mines and the upgrade of the GMMV's Sweetwater uranium mill and the
Shootaring Canyon uranium mill in southeast Utah (owned by Plateau Resources
Ltd., a wholly-owned USE subsidiary) In addition, USE intends to implement plans
for it and Crested to consolidate their uranium assets into a single subsidiary
and finance the startup of its mines and mill operations, subject to obtaining
the necessary debt or equity funding. There is no assurance such financing can
be obtained.
For fiscal 1999, USE and Crested intend to seek the financing necessary
to continue development work at the Jackpot Mine. In late July 1998, USE,
Crested and Kennecott made a business decision to temporarily cease development
work at the jackpot Mine because of the expected negative impact on uranium
prices due to the amount of uranium inventory which USEC Inc. announced was held
in its inventory and could be sold into the market. However, other factors are
affecting the uranium market (reductions in current and planned production),
such that the resumption of development work and putting the Utah uranium
properties into production in the near-term may be warranted. See "Uranium
Market Information." USE and Crested are in discussions with various sources of
capital for this purpose, however, no funding agreements have been reached as of
the date of this Report and there is no assurance any such funding would be
received. Such funding would also finance USE's and Crested's purchase of
Kennecott's interest in the GMMV. See "June 23, 1997 Acquisition Agreement with
Kennecott Uranium Company" below.
USE also will be refining the mine and mill plan for the Lincoln Project
in California (held by Sutter Gold Mining Company, a majority-owned subsidiary
of USE and a minority owned subsidiary of Crested), with the objective of
continuing mine development, building a gold mill and producing gold in late
fiscal 1999 or early fiscal 2000. Capital and operating costs for the Lincoln
Project may be funded internally by Sutter Gold Mining Company, as supplemented
by additional funding from USE and/or third parties. However, there are no
outside funding agreements as of the date of this Report and there is no
assurance needed funding will be received. See "Gold" below.
(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.
The Registrant operates in two business segments: (i) minerals and (ii)
commercial operations. The Registrant engages in other miscellaneous activities
such as oil and gas exploration, development and production. The principal
products of the operating units within each of the reportable industry segments
are:
INDUSTRY SEGMENTS PRINCIPAL PRODUCTS
----------------- ------------------
Minerals Sales and leases of mineral-bearing
properties and, from time to time, the
production and/or marketing of uranium,
gold and molybdenum.
Commercial Operations Operation of a motel and
rental of real estate, operation of an
aircraft fixed base operation (aircraft
fuel sales, flight instruction and
aircraft maintenance), and provision of
various contract services, including
managerial services for subsidiary
companies.
3
Percentage of Net Revenue contributions by the two segments in the last three
fiscal years were:
Percentage of Net Revenues During the Year Ended
------------------------------------------------
May 31, May 31, May 31,
1998 1997 1996
-------- -------- ------
Minerals 11% 6% 62%
Commercial Operations 19% 29% 16%
Crested received $429,300 in revenues from the sale of uranium in fiscal
1998. During fiscal 1996, mineral revenues were generated from sales of uranium
under certain of the utility supply contracts held by Sheep Mountain Partners
("SMP"), a Colorado general partnership. During fiscal 1997, there were no
revenues from mineral sales (except for molybdenum royalty interest) in part due
to the arbitration proceedings involving SMP (see Item 3, "Legal Proceedings -
Sheep Mountain Partners Arbitration/Litigation"). Additional mineral revenue was
generated by Crested's molybdenum interest.
(C) NARRATIVE DESCRIPTION OF BUSINESS BY INDUSTRY SEGMENT
(INCLUDING ITEM 2 - PROPERTIES DISCLOSURE).
MINERALS
URANIUM
GENERAL
Crested has interests in several uranium-bearing properties in Wyoming
and Utah and in uranium processing mills in Sweetwater County, Wyoming (the
"Sweetwater Mill") and 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. Crested and USE plan to
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. In
addition, other uranium-bearing properties in New Mexico and Wyoming are held by
Yellow Stone Fuels Corp. (a minority joint subsidiary of USE and Crested).
The property interests of Crested in Wyoming are:
-------------------------------------------------
Green Mountain
--------------
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). These assets are
held by the Green Mountain Mining Venture ("GMMV"), owned 50 percent by USE and
USECC (the "USE Parties"), and 50 percent by Kennecott Uranium Company ("KUC" or
"Kennecott"), a subsidiary of Kennecott Energy and Coal Company of Gillette, WY.
Kennecott Energy and Coal Company and Kennecott Corporation of Salt Lake City,
UT are subsidiaries of Rio Tinto plc, formerly RTZ PLC of London. Rio Tinto plc
is one of the world's leading natural resource companies and owns 69% of Rossing
Uranium Corp.'s operations in Namibia in southwest Africa. Rossing currently
produces about 6,000,000 lbs. of U3O8 out of its 10,000,000 lb. annual capacity.
Rio Tinto has delayed indefinitely the construction of its 4,000,000 lb. U3O8
per year Kintyre uranium project in Western Australia. Kennecott Corporation
owns and operates several mines including the Bingham Canyon, Utah open pit
copper mine which opened in 1906.
4
All of the GMMV mining claims are accessible by county, private and/or
United States Bureau of Land Management ("BLM") access roads. Exploration and
delineation of the principal uranium resources in the proposed Jackpot Mine have
been substantially completed. The BLM has signed a Record of Decision approving
the Jackpot Mine Plan of Operations following preparation of a final
Environmental Impact Statement ("EIS") for the proposed mine, and on June 25,
1996, the Wyoming Department of Environmental Quality ("WDEQ") issued Mine
Permit No. 660 that is required for GMMV to develop the underground Jackpot Mine
and mine the uranium deposits. The proposed mine has had no previous operators,
and will be a new mine when opened. The Big Eagle Mine and related claim groups
(which are near the proposed Jackpot Mine and are part of the Green Mountain
Claims held by the GMMV), are accessible by county and private roads. The Big
Eagle Mine was first operated by Pathfinder Mines Corporation ("PMC") starting
in the late 1970s.
Sheep Mountain
--------------
Unpatented lode mining claims, underground and open pit uranium mines
and mining equipment in the Crooks Gap area are located on Sheep Mountain in
Fremont County, Wyoming and are adjacent to and west of the GMMV mining claims.
From 1988 to June 1, 1998, these assets were held by SMP. On June 1, 1998, USECC
received back from SMP all of the Sheep Mountain mineral properties and
equipment, in partial settlement of disputes with Nukem and CRIC. The
disposition of SMP cash and the CIS uranium supply contracts, remain in dispute.
See Item 3, "Legal Proceedings." The Sheep Mountain Mines 1 and 2 are accessible
by county and private roads and were first operated by Western Nuclear, Inc., a
subsidiary of Phelps Dodge Corporation, in the late 1970s.
Yellow Stone Fuels Corp.
------------------------
Approximately 10,825 acres of properties are held by 437 unpatented lode
mining claims which have been staked by, plus four leases (including three state
leases) held by Yellow Stone Fuels Corp. (an Ontario, Canada corporation, or by
its wholly-owned subsidiary Yellow Stone Fuels, Inc., a Wyoming corporation,
hereafter collectively or individually referred to as "YSFC"). The properties
are located in Wyoming and New Mexico, and are believed to be prospective of
uranium and suitable for in-situ leaching. USE and Crested each own 12.7% of
YSFC.
The property interests of USE and Crested in Utah through
Plateau Resources Ltd. are:
----------------------------------------------------------
The Tony M Mine and the Frank M properties, underground uranium deposits
in San Juan County, Utah located partially on Utah State mining leases. These
properties are accessible by county roads.
Plateau is the lessee of the Tony M Mine and portions of the Frank M
properties 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. When the Tony M Mine was in production
(while Plateau was owned by CPC), it produced ore containing from three to eight
pounds of uranium concentrates per ton. Some of this ore was processed at the
Shootaring Mill. In addition, low grade uranium ore was stockpiled at the Tony M
Mine and at the Shootaring Mill.
Plateau also acquired the Velvet Mine and the nearby Woods Complex in
the Lisbon Valley area in southeastern Utah. The Velvet Mine was fully developed
and permitted by its prior owner and is located approximately 178 miles by road
from the Shootaring Mill. The Woods Complex was formerly an operating uranium
mine with a remaining undeveloped resource. Access to this resource would be by
extending a drift approximately 2,500 feet from the former Wood Mine. The Wood
Mine property is not permitted, but USE
5
and Crested do not expect difficulty in obtaining a new permit because the
surface facilities would occupy the site that has been disturbed from previous
operations.
Plateau Resources Ltd. is a wholly-owned subsidiary of USE, however,
Crested owns an interest in Plateau. See "Plateau Shootaring Canyon Mill" below.
THE GREEN MOUNTAIN MINING VENTURE ("GMMV") PROJECT
GMMV. In fiscal 1998, USE and USECC signed the Acquisition Agreement to
acquire Kennecott Uranium Company's interest in the GMMV. The following is a
description of the formation of GMMV and certain of its terms, which have been
modified as a result of the Acquisition Agreement and related transactions, as
set forth under the "June 23, 1997 Acquisition Agreement with Kennecott Uranium
Company" below.
In fiscal 1991, USE and USECC entered into an agreement to sell 50
percent of their interests in the Green Mountain uranium claims, and certain
other rights, to Kennecott for $15,000,000 (USE's share of the proceeds was
$12,600,000, and the balance was Crested's) and a commitment by Kennecott to
fund the first $50,000,000 of GMMV expenditures pursuant to Management Committee
budgets. At the same time, USE and USECC ("USE Parties") and Kennecott formed
the GMMV to develop, mine and mill uranium ore from the Green Mountain Claims,
and market U3O8.
After the first $50,000,000 of GMMV expenditures advanced by Kennecott
is spent (which has been completed as of the date of this 10-K Report (see
"Properties and Mine Plan" below)), the GMMV expenses are to be shared by the
parties generally in accordance with their participating interests (50 percent
Kennecott, 50 percent USE Parties). The agreement also provides that Kennecott
will pay a disproportionate share (up to an additional $45,000,000) of GMMV
operating expenses, but only out of cash operating margins from sales of
processed uranium at more than $24.00/lb (for $30,000,000 of such operating
expenses), and from sales of processed uranium at more than $27.00/lb (for the
next $15,000,000 of such operating expenses).
Pursuant to the GMMV joint venture agreement, each party's participation
interest in the GMMV is subject to reduction for voluntary or involuntary
failure to pay its share of expenses as required in approved budgets (including
Kennecott's commitment to fund the initial $50,000,000 of the GMMV
expenditures), so that in effect, the interest held by each party collateralizes
its performance. However, a defaulting party would remain liable for third party
liabilities incurred during the GMMV operations, proportionate to its interest
before reduction.
Assuming Kennecott's interest is not acquired by the USE Parties (see
below), the GMMV cash flows will be shared between Kennecott and the USE Parties
according to their participation interests. However, 105 of the Green Mountain
Claims, which cover the Round Park (Jackpot) uranium deposit, currently believed
to be the most significant mineralized resource on Green Mountain, were formerly
owned solely by USE. Pursuant to an agreement between USE and Crested, cash flow
from production of uranium out of these 105 Green Mountain Claims will be
distributed only to USE and Kennecott, and GMMV expenditures on such properties
will be shared 50 percent by USE and 50 percent by Kennecott. This sharing ratio
will change if Kennecott's interest is acquired by USE and Crested. See "June
23, 1997 Acquisition Agreement with Kennecott Uranium Company." Milling costs
will be paid by the GMMV as operating costs and shared among the participants
according to their ownership interests in the ore being milled.
The USE Parties' share of GMMV cash flow resulting from the balance of
the properties (outside the 105 claims), which were previously owned by USE and
Crested together, will be shared equally by USE and Crested. GMMV expenditures
from such properties will be shared 25 percent each by USE and Crested, and 50
percent by Kennecott. Such latter properties are expected to be developed after
the Round Park (Jackpot)
6
deposit is placed into production and the uranium deposits on these properties
may be accessed through the proposed tunnels at the Jackpot Mine. Development
work at the Jackpot Mine was temporarily halted in late July 1998, see "USEC
Inc." below.
The GMMV Management Committee has three Kennecott representatives and
two USECC representatives, acts by majority vote, and appoints and supervises
the project manager. In fiscal 1993, Kennecott became the GMMV project manager
and has continued as project manager through May 31, 1998. USECC has continued
work on a contract basis at Kennecott's request through May 31, 1998.
Activities on the GMMV properties have included environmental and mining
equipment studies, mine permitting and planning work, property maintenance,
setting up a uranium marketing program, acquisition and monitoring of the
Sweetwater Mill and preparation of an application to the U. S. Nuclear
Regulatory Commission ("NRC") to convert the Sweetwater Mill license from
standby to an operating license. USE and Crested have completed the construction
of additional mining support facilities at the Jackpot Mine in fiscal 1998,
including; the installation of natural gas lines and phone services;
construction of a new shop building containing offices, a dry-change room,
emergency generators, air compressors and mechanical repair base; upgrading the
ore haul road; and installation of a conveyor and stacker and other incidental
mine activities, while maintaining all permits and licenses at the Jackpot Mine
and Sweetwater Mill. For underground mine development work, as of the date of
this 10-K Report, the GMMV has driven twin decline tunnels 18 feet wide and 12
feet high on a -17 percent grade approximately 2,000 feet each into Green
Mountain with 1,000 feet of cross cuts between the declines. All of these
development costs in fiscal 1998 and to date in fiscal 1999 have been funded
through the $16,000,000 loan in connection with Kennecott's $50,000,000 work
commitment (for its 50 percent interest).
JUNE 23, 1997 ACQUISITION AGREEMENT WITH KENNECOTT URANIUM COMPANY
On June 23, 1997, USE and USECC signed an Acquisition Agreement with
Kennecott, for the right to acquire Kennecott's interest in the GMMV for
$15,000,000 and other consideration. Kennecott paid USE and USECC $4,000,000 as
a signing payment, and committed to provide the GMMV up to $16,000,000 for
payment of reimbursable costs incurred by USECC in developing the proposed
underground Jackpot Uranium Mine for production and in changing the status of
the Sweetwater Mill from standby to operational. The work to develop the
proposed Jackpot Mine and ready the Sweetwater Mill for operations was performed
by USECC as lessee of all the GMMV mineral properties under a Mineral Lease
Agreement between the GMMV and USECC (the "Mineral Lease"), and as an
independent contractor under a Contract Services Agreement (the "Mill Contract")
between Kennecott (as manager of the GMMV) and USECC. Both the Mineral Lease and
the Mill Contract, as well as a Fourth Amendment to the GMMV Mining Venture
Agreement among Kennecott, USE and USECC (the "Fourth Amendment to the GMMV
Agreement"), were executed simultaneously with the Acquisition Agreement.
The $16,000,000 provided by Kennecott to the GMMV was advanced to
Kennecott by an affiliate, Kennecott Energy Company ("KEC") under a secured
recourse Promissory Note (the "Note") bearing interest at 10.5% per annum
starting in April 1999 until paid in full. As of the date of this Report
approximately $14,000,000 of the $16,000,000 loan has been spent. If the
Acquisition Agreement closes, the Note converts to become a debt of the GMMV or
its successors, and would be payable quarterly out of 20% of cash flow from the
GMMV properties, but not more than 50% of the earnings for such quarter from the
GMMV operations, before interest, income tax, depreciation and amortization.
However, the Note is payable by GMMV or its successors (i) in full on June 23,
2010 regardless of cash flow and earnings of the GMMV, or (ii) sooner (on
December 31, 2005) if an economically viable uranium mine has not been placed
into production by such date. The Note is secured by a first mortgage lien
against Kennecott's 50% interest in the GMMV pursuant to a Mortgage, Security
Agreement, Financing Statement and Assignment of Proceeds, Rents and Leases
granted by Kennecott to KEC (the "Mortgage"). At closing of the Acquisition
Agreement, USE,
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USECC and their assignee (if such is assigned) will assume the Note, and the
assets of the GMMV will be subject to the Mortgage.
Pursuant to the Mineral Lease and the Mill Contract included in the
Acquisition Agreement, USECC is to expend funds to develop the proposed Jackpot
Mine and nearby Big Eagle Mine, and work with Kennecott in preparing the
Sweetwater Mill for renewed operations. Such work was funded from the
$16,000,000 loan provided to the GMMV by Kennecott. Under the Fourth Amendment
to the GMMV Agreement, Kennecott is entitled to a credit against Kennecott's
original $50,000,000 commitment to fund the GMMV, in the amount of two dollars
of credit for each one dollar of such funds out of the $16,000,000 provided by
Kennecott to the GMMV, plus the $4,000,000 paid to USE and USECC on signing of
the Acquisition Agreement. These credits satisfied the balance of Kennecott's
initial funding commitment to acquire a 50% interest in the GMMV.
Pursuant to the Fourth Amendment to the GMMV Agreement, USECC submits
detailed invoices for reimbursable costs, defined in the Mineral Lease and Mill
Contract to include USECC's labor and equipment costs (maintenance and rental),
environmental compliance costs, direct general and administrative costs of USECC
staff incurred in monitoring and invoicing project costs and expenditures and
associated engineering costs and expenditures, and an additional amount equal to
10% of all the preceding costs and expenditures as an administrative charge (the
same 10% as previously allowed in the GMMV Agreement). USECC also charges the
GMMV rental expense for equipment owned or leased by USECC. The reimbursable
cost allocations for each phase of the development of the Jackpot Mine and
upgrade of the Sweetwater Mill to operating status are made by the GMMV against
budgets under the Mineral Lease and Mill Contract. Also included in reimbursable
costs will be the amounts required to cover all reclamation activities that will
result from operations conducted on the mining properties pursuant to the Mill
Contract and the Mineral Lease (USE and USECC will be required to put such
reclamation cost amounts aside in a sinking fund to pay for the reclamation work
when production commences).
Kennecott provided funds to the GMMV each month in an amount adequate to
reimburse USECC for invoiced costs and restore the USECC working account balance
to $1,000,000. Payment by GMMV of the monthly invoiced costs is subject to
Kennecott's confirmation that such costs conform to the Mineral Lease and Mill
Contract budgets. Subject to and at the closing of the Acquisition Agreement,
Kennecott will advance to the GMMV cash equal to any difference between (i) the
$16,000,000 commitment and (ii) amounts advanced to pay reimbursable costs and
maintain the working capital account up until the closing date.
Also pursuant to the Mineral Lease, USECC pays the GMMV a monthly lease
fee of $3,363. Separately and pursuant to the Mineral Lease, USE and USECC are
required to pay all rental, leasehold, property and other payments relating to
the mining properties, and all utility and other payments, taxes and assessments
that may be assessed against such properties during the term of the Mineral
Lease.
Closing of the Acquisition Agreement is subject to USE and USECC
satisfying several conditions, including: (i) the acquiring entity (which may be
USE, USECC, or an entity formed by USE and USECC to acquire Kennecott's interest
in the GMMV) must have a market capitalization of at least $200,000,000 (this
condition has not yet been met and may not be met by the deadline); (ii) the
parties to the Acquisition Agreement must have received all authorizations,
consents, permits and approvals of government agencies required to transfer
Kennecott's interest in the GMMV to the acquiring entity; (iii) USE and USECC
shall have replaced, or caused the replacement of, approximately $25,000,000 of
reclamation bonds, in addition to other guarantees, indemnification and
suretyship agreements posted by Kennecott on behalf of the GMMV; and (iv) USE
and USECC, or the acquiring entity, must pay $15,000,000 in cash to Kennecott at
closing and assume all obligations and liabilities of Kennecott with respect to
the GMMV (including repayment of the $16,000,000 Note and the Mortgage) from and
after the closing. Under very limited circumstances, the closing date for the
Acquisition Agreement may be postponed not later than October 30, 1998 (see
"USEC
8
Inc. " below). The parties to the Acquisition Agreement also executed a mutual
General Release with respect to any and all claims that they may have with
respect to any prior disputes concerning the GMMV, which General Release would
be delivered to all such parties at closing of the Acquisition Agreement. Upon
closing of the Acquisition Agreement, the Mineral Lease and the Mill Contract
will be terminated and USE, USECC or the acquiring entity will own Kennecott's
50% of the GMMV, although its properties will remain subject to the Mortgage
until the Note is paid in full. If the Acquisition Agreement is closed, USE and
Crested would each own 50% of the GMMV, and Crested will thereby own the right
to 25% of the revenues from the Round Park (Jackpot Mine) deposit, because
Crested will have acquired one-half of Kennecott's 50% interest in the GMMV
(which includes the Round Park deposit).
Crested estimates that at least $40,000,000 will be needed to close the
Acquisition Agreement transactions ($15,000,000 closing cash purchase price to
Kennecott, plus $25,000,000 to assume or cause the replacement of reclamation
bonds, guarantees, indemnification agreements and suretyship agreements related
to the GMMV properties and the Sweetwater Mill). USE and Crested presently are
negotiating with investment banking firms to raise up to $100 million in debt or
a combination of debt and equity financing to close the Acquisition Agreement
and put the uranium assets into production. Such negotiations have not been
finalized as of the date of this Report. There is no assurance this financing
can be obtained by October 30, 1998 in light of current prices in the uranium
oxide market.
If the Acquisition Agreement is not closed, USE, USECC and Kennecott,
shall retain their respective 50% interests in the GMMV, and Kennecott's
obligation to repay the $16,000,000 loaned by KEC shall remain Kennecott's
obligation, without any adverse effect on the 50% interest in the GMMV held by
USE and USECC. However, the Jackpot Mine development work and Sweetwater Mill
upgrade work funded by the $16,000,000 loan will have benefitted all parties to
the GMMV. Further, if the Acquisition Agreement is not closed, the GMMV parties
will remain in the GMMV, and the development, mining and milling costs will be
paid for by such parties. If one of the parties does not pay its share, its
percentage in the GMMV is reduced if the other party pays instead. In the event
the Acquisition Agreement is not closed, Kennecott may not wish to participate
further in the project. If USE and USECC have the funding to pay for all costs
to continue the development of the Jackpot Mine and the upgrade work at the
Sweetwater Mill (but no the funds to purchase Kennecott's interest directly),
and USE and USECC make the decision to continue the project, then Kennecott's
interest would be reduced. Thus, it is possible that USE and Crested could
indirectly purchase Kennecott's interest through funding the project through the
GMMV.
USEC INC. In 1992, Congress enacted the "Energy Policy Act of 1992"
creating the U.S. Enrichment Corporation ("USEC") to operate the U.S. Department
of Energy's ("DOE") uranium enrichment program. Congress later enacted the "USEC
Privatization Act of 1996" to privatize USEC and allowed the DOE to transfer
various forms of uranium to USEC. The DOE has transferred approximately 75
million pounds of uranium and uranium equivalents to USEC. On July 22, 1998,
USEC Inc. became a publicly traded company. Because of the anticipated negative
impact of USEC Inc.'s sales of new uranium inventory in the market (see
"Marketing - U.S. Enrichment Corporation," below) on uranium oxide prices, on
July 31, 1998, Kennecott and USE and Crested made a business decision to
temporarily place the Jackpot Mine on standby, which resulted in the lay off of
approximately 45 employees. Resumption of development work with funding from
GMMV provided by Kennecott will depend on resolution of the USEC Inc. uranium
inventory sales issue (see "U.S. Enrichment Corporation" below and Item 13,
"Legal Proceedings") and improved uranium prices. However, it is possible that
third party financing will be obtained, in which event the development work
would resume and the Acquisition Agreement would be closed. The anticipated
negative impact of the USEC Inc. inventory on the uranium market may be
mitigated by other factors. Crested believes the GMMV's decision to place the
development of the Jackpot Mine on standby, should be viewed as an interim
event, because anticipated improved uranium prices based on supply and demand
projections, or even continued level prices, could lead to a decision to resume
development work on the Jackpot Mine. See "Uranium Market Information" below.
9
As a result of the current uncertainty surrounding the uranium market,
and the July 31, 1998 suspension of development work on the Jackpot Mine, USE
and Crested anticipate that certain provisions of the Acquisition Agreement will
be modified after discussions with Kennecott. Such changes may include an
extension of the deadline for purchase of Kennecott's interest in the GMMV; the
$200 million market capitalization requirement; provisions for funding GMMV's
standby maintenance costs; and other items. However, as of the date of this
Report, no such modifications had been finalized with Kennecott.
PROPERTIES AND MINE PLAN.
The GMMV owns a total of 521 claims on Green Mountain, including the 105
claims on which the Round Park (Jackpot) uranium deposit is located. Surface
rights are owned by the United States Government under management by the BLM. In
addition, other uranium mineralization has been delineated in the Phase 2 and
Whiskey Peak deposits on these claims, which formerly belonged to USE and
Crested. These deposits are undeveloped. Roads and utilities have been put in
place, which are satisfactory to support mine development.
The GMMV also owns the Big Eagle Properties on Green Mountain, which
contain substantial uranium mineralization, and are adjacent to the other GMMV
mining claims. The Big Eagle Properties contain two open-pit mines, as well as
related roads, utilities, buildings, structures, equipment and a stockpile of
500,000 tons of uranium material with a grade of approximately .05% U3O8. The
assets include two buildings (38,000 square feet and 8,000 square feet) formerly
used by Pathfinder Mines Corporation ("PMC") in mining operations. Also included
are three ore-hauling vehicles, each having a 100-ton capacity. Permits
transferred to the GMMV for the properties include: a permit to mine, an air
quality permit, and water discharge and water quality permits. The GMMV owns the
mineral rights to the underlying unpatented lode mining claims.
The Round Park (Jackpot) mining claims contain deposits of uranium which
have been estimated to contain 52,000,000 pounds of U3O8; the grade averages 4.6
pounds of U3O8 per ton of mineralized material. The GMMV plans to mine this
mineralize material from two decline tunnels (-17 percent slope) in the Jackpot
Mine, which are being driven underground from the south side of Green Mountain.
The first of several mineralized horizons is about 2,300 feet vertically down
from the top of Green Mountain.
The declines will ultimately extend up to 12,300 feet in length to
access the different zones of the deposit; one decline will be used for
ventilation and transportation of personnel, and the other will convey ore, rock
and waste out of the mine. The mine plan estimates that the Jackpot Mine will
produce about 3,000 tons of uranium ore per day and will have an expected mine
life of 13 to 22 years. The Big Eagle Mine facilities located about three miles
west of the Jackpot Mine site will be utilized. As many as 250 workers will be
required during mining full operations. To the date of this Report, USE has run
approximately 2,000 feet of tunnel in each decline.
The USE Parties expect the Jackpot Mine development costs will not
exceed an additional $10,000,000 to reach the "B" zone to continue the
development in the ore at the Round Park deposit. However, cost estimates may
change as the development progresses. Pursuant to the GMMV agreement, Kennecott
agreed to fund the initial $50,000,000 in development costs including
reclamation costs. To April 30, 1997, such expenditures totaled approximately
$20,355,142. In fiscal 1998, approximately $10,160,896 of additional GMMV costs
had been funded by the $16,000,000 loan. With the 2 for 1 credit provision in
the Acquisition Agreement which also applied to the $4,000,000 signing bonus,
Kennecott had completed its $50,000,000 commitment. Since June 1997, Kennecott
has advanced approximately $14,000,000 of the $16,000,000 to the GMMV, leaving a
balance of $2,000,000. Whether this $2,000,000 will be made available by
Kennecott for the GMMV to keep the Jackpot Mine on standby status has not been
determined as of the date of this Report.
10
SWEETWATER MILL. In fiscal 1993, GMMV acquired the Sweetwater uranium
processing mill and associated properties located in Sweetwater County, Wyoming,
approximately 23 miles south of the proposed Jackpot Mine, from a subsidiary of
Union Oil Company of California ("UNOCAL"), primarily in consideration of
Kennecott and the GMMV assuming environmental liabilities, and decommissioning
and reclamation obligations.
Kennecott is manager and operator of the Sweetwater Mill and, as such,
will be compensated by GMMV out of production. Payments for pre-operating
management will be based on a sliding scale percentage of mill cash operating
costs prior to mill operation; payments for operating management will be based
on 13 percent of mill cash operating costs when processing ore. Mill holding
costs have been paid by the GMMV and funded by Kennecott as part of its
$50,000,000 funding commitment.
The Sweetwater Mill includes buildings, milling and related equipment,
real estate improvements, mining and mill site claims and other real property
interests, personal property and intangible property (including government
permits relating to operation of those properties). The major assets are the
mill buildings and equipment located on approximately 92 acres.
The mill was designed as a 3,000 ton per day ("tpd") facility. UNOCAL's
subsidiary, Minerals Exploration Company, reportedly processed in excess of
4,200 tpd for sustained periods. The mill is one of the newest uranium milling
facilities in the United States, and has been maintained in good condition.
UNOCAL has reported that the mill buildings and equipment have historical costs
of $10,500,000 and $26,900,000, respectively.
As consideration for the Sweetwater Mill, GMMV agreed to indemnify
UNOCAL against certain reclamation and environmental liabilities, which
indemnification obligations are guaranteed by Kennecott Corporation (parent of
Kennecott Uranium Company). GMMV has agreed to be responsible for compliance
with mill decommissioning and land reclamation laws, for which the environmental
and reclamation bonding requirements are approximately $24,330,000, which
includes a $4,560,000 bond required by the NRC. None of the GMMV future
reclamation and closure costs are reflected in the Consolidated Financial
Statements (see "Notes F and K to the Consolidated Financial Statements for
fiscal year ended May 31, 1998").
The reclamation and environmental liabilities assumed by the GMMV
consist of two categories: (1) cleanup of the inactive open pit mine site near
the mill (the source of ore feedstock for the mill when operating under UNOCAL),
including water (heavy metals and other contaminants) and tailings (heavy metals
dust and other contaminants requiring abatement and erosion control) associated
with the pit; and (2) decontamination and cleanup and disposal of the mill
building, equipment and tailings cells after mill decommissioning. On June 18,
1996, Kennecott established an irrevocable Letter of Credit through Morgan
Guaranty Trust Company of New York City in the amount of $19,767,079 in favor of
the Wyoming Department of Environmental Quality ("WDEQ") for reclamation
requirements of the GMMV. The Letter of Credit was increased by $10,000 on
August 26, 1996 to cover off-permit wetland enhancement. The WDEQ exercises
delegated jurisdiction from the United States Environmental Protection Agency
("EPA") to administer the Clean Water Act and the Clean Air Act, and directly
administers Wyoming statutes on mined land reclamation. The Sweetwater Mill is
also regulated by the NRC for tailings cells and mill decontamination and
cleanup. The EPA has continuing jurisdiction under the Resource Conservation and
Recovery Act, pertaining to any hazardous materials which may be on site when
cleanup work is started.
Although the GMMV is liable for all reclamation and environmental
compliance costs associated with mill and site maintenance, as well as mill
decontamination and cleanup and site reclamation and cleanup after the mill is
decommissioned, USECC believes it is unlikely USECC would have to pay for such
costs directly. First, based on current estimates of cleanup and reclamation
costs (reviewed annually by the oversight agencies), such costs covered by the
letters of credit or other surety appear to be within the $24,330,000 of
11
reclamation bonds posted by Kennecott for GMMV. These costs are not expected to
increase materially if the mill is not put into operation. Second, UNOCAL has
agreed that if the GMMV incurs expenditures for environmental liabilities prior
to the earlier of commercial production by GMMV or February 1, 2001, (which
liabilities are not due solely to the operations of GMMV), then UNOCAL will loan
the GMMV the first $8,000,000 (escalated according to the Consumer Price Index
to current dollars, from 1993) of such expenditures. Any reimbursement for the
loan may only be recovered by UNOCAL from 20% of future cash flows from sale of
uranium concentrates processed through the Sweetwater Mill. Third, payment of
reclamation and environmental liabilities related to the Mill is guaranteed by
Kennecott. Last, the GMMV will set aside a portion of operating revenues to fund
reclamation and environmental liabilities when mining and milling operations are
finally shut down.
Kennecott will be entitled to contribution from the USE Parties in
proportion to their participating interests in the GMMV, if Kennecott is
required to pay mill cleanup costs directly pursuant to its guarantee. Such
contributions would be required only if the liabilities cannot be satisfied by
Kennecott within the balance of any development commitment as provided by the
Acquisition Agreement, after the credits provided by the Fourth Amendment to the
GMMV (see the "June 23, 1997 Acquisition Agreement with Kennecott" above). In
addition, if and to the extent such liabilities resulted from UNOCAL's mill
operations, and payment of the liabilities was required before February 1, 2001
and before mill production resumes, then up to $8,000,000 (escalated) of that
amount would be paid by UNOCAL, before Kennecott would be required to pay on its
guarantee. However, notwithstanding the preceding, the extent of any ultimate
USECC liability for contribution to mill cleanup costs cannot be predicted.
PERMITTING AND ACTIVITIES. The WDEQ issued a mine permit for the Jackpot
Mine on June 26, 1996. This Permit allows the GMMV to proceed with construction
of mine surface facilities, further underground mine development and eventual
mining of the Round Park (Jackpot) Deposit.
The Jackpot Mine Plan of Operations and a combination of the
alternatives analyzed in the EIS will allow for the disposal of mine waste rock
in the Big Eagle Mine pits some three miles from the Jackpot declines, the
upgrading of existing roads, and the construction of new haul road segments to
transport ore to the Sweetwater Mill. These roads will be subject to
modification in alignment necessary to minimize or avoid adverse impacts to
riparian and cultural resources.
Kennecott has initiated discussions and made filings with the NRC
regarding amendments to the Source Material License to resume ore processing at
the Sweetwater Mill. The NRC has advised that the Operating Permit should be
issued in September 1998.
Crested believes all of the uranium operations in which it owns an
interest are in compliance with these rules. There ultimately will be an effect
on the earnings of USE and Crested from environmental compliance expenditures by
the GMMV, since the GMMV operations will be accounted for by the equity method
if the acquisition of Kennecott's interest in the GMMV pursuant to the
Acquisition Agreement does not close. GMMV's expenses for compliance with
environmental laws (as well as other matters) are not expected to materially
affect the cash flow of USE and Crested during the next two years.
12
PLATEAU'S SHOOTARING CANYON MILL
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. USE agreed:
(a) to perform all studies, remedial or other response actions or other
activities necessary from time to time for Plateau to comply with environmental
monitoring and other provisions of (i) federal and state environmental laws
relating to hazardous or toxic substances, and (ii) the Uranium Mill Tailings
Radiation Control Act, the Atomic Energy Act of 1954, and administrative orders
and licenses relating to nuclear or radioactive substances or materials on the
property of, or produced or released by, Plateau; and
(b) to indemnify CPC from all liabilities and costs related to the
presence of hazardous substances or radioactive materials on Plateau property,
and to any future violation of laws and administrative orders and licenses
relating to the environment or to nuclear or radioactive substances.
Plateau transferred $2,500,000 cash to fund the "NRC Surety Trust
Agreement" with a commercial bank as trustee. The trustee is to pay future
decommissioning costs of Shootaring Mill as directed by the NRC. The amount
transferred to the trust is the minimum amount now required by the NRC as
financial assurance reclamation of the Shootaring Mill.
Plateau transferred $4,800,000 cash to fund the "Agency Agreement" with
a commercial bank. These funds will be available to indemnify CPC against
possible claims related to environmental or nuclear matters as described above,
and against third-party claims related to an agreement between Plateau and the
third-party (see Note K to the USE Consolidated Financial Statements for fiscal
year ended May 31, 1998).
There are no present claims against funds held under either the Trust
Agreement or Agency Agreement. Funds (including accrued interest) not disbursed
under the Trust and Agency Agreements will be paid over to Plateau upon
termination of such Agreements with NRC concurrence.
Subsequent to closing, USE and Crested agreed that after Plateau's
unencumbered cash had been depleted, USE and Crested each would assume one-half
of Plateau's obligations, and share equally in Plateau's operating cash flows,
pursuant to the USECC Joint Venture.
SHOOTARING MILL AND FACILITIES. The Shootaring Mill is located in
south-eastern 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 1982. In 1984, Plateau put the mill on standby because of the
depressed U3O8 market.
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 to $6,700,000, the NRC issued the new license on
May 2, 1997. Plateau has an additional $1,600,000 of government securities
available for further bonding needs.
13
In fiscal 1998, in anticipation of resuming milling operations, Plateau
has significantly performed a reactivation and rehabilitation program at the
Mill. Plateau is awaiting approval of the water control permit for the tailings
facility from the State of Utah Water Control Division.
TICABOO TOWNSITE
Plateau owns all of the outstanding stock of Canyon Homesteads, Inc.
("Canyon"), a Utah corporation, which developed the Ticaboo, Utah townsite 3.5
miles south of the Shootaring Mill. The Ticaboo site includes a motel,
restaurant, lounge, convenience store and single family, mobile home and
recreational vehicle sites (all with utility access). The townsite is located on
a State of Utah lease near Lake Powell and is being operated as a commercial
enterprise. An amendment was entered into on April 1, 1997 on the Utah State
lease covering the Ticaboo townsite whereby the State deeded portions of the
Townsite to Canyon on a sliding scale basis. USE and Crested may develop the
townsite to sell home and mobile home sites as the nearby Shootaring Canyon
uranium mill commences operations.
YELLOW STONE FUELS CORP.
Yellow Stone Fuels Corp., was organized on February 17, 1997 in Ontario,
Canada. As of February 17, 1997, YSFC acquired all the outstanding shares of
Common Stock of Yellow Stone Fuels, Inc. (a Wyoming corporation which was
organized on June 3,1996), in exchange for YSFC issuing the same number of
shares of YSFC Stock to the former shareholders of Yellow Stone Fuels, Inc.
("YFI"). YSFC and its wholly-owned subsidiary Yellow Stone Fuels, Inc. are
herein collectively referred to as YSFC.
In order to concentrate the efforts of USECC on conventional uranium
mining using the Shootaring and Sweetwater Mills, USECC decided to take a
minority position in Yellow Stone Fuels, Inc. and not be directly involved in
properties believed suitable for the production of uranium through the in-situ
leach ("ISL") mining process. USECC will have the right of first refusal with
respect to any uranium ore bodies YSFC discovers which are amenable to
conventional mining and milling and YSFC will have the right of first refusal
with respect to ore bodies discovered by USECC amenable to the ISL process. In
the ISL process, groundwater fortified with oxidizing agents is pumped in the
ore body, causing the uranium contained into the ore to dissolve. The resulting
solution is pumped to the surface where it is further processed to a dried form
of uranium which is shipped to conversion facilities for eventual sale.
Generally, the ISL process is more cost effective and environmentally benign
compared to conventional underground mining techniques. In addition, less time
may be required to bring an ISL mine into operation than to permit and build a
conventional mine.
In Wyoming, YSFC has staked and/or holds 356 unpatented mining claims
and has entered into four State leases covering a total of 9,040 acres located
in the Powder River Basin and Red Desert uranium districts. Three State leases
have a 10 year term expiring October 1, 2006; one State lease has a 10 year term
expiring October 1, 2008; each require annual rental of $1.00 per acre for five
years, then $2.00 for the second five years, or sooner upon the discovery of
commercial quantities of minerals; plus a 5% gross royalty of the value of
uranium bearing ore mined from the leased properties is payable to the State of
Wyoming.
Also in Wyoming, YSFC owns or leases a total of 113 unpatented mining
claims in the Powder River Uranium District. One group of 63 claims is located
approximately 20 miles northwest of the producing Rio Algom's Smith Ranch Mine.
These claims may be similar in geology and hydrology to the Smith Ranch and
Cameco's Highland ISL operations.
In New Mexico, YSFC has staked and holds 39 unpatented mining claims and
has leased 8 patented mining claims (approximately 945 acres) in the Grants
uranium region of New Mexico. The 8 unpatented mining claims (covering 165
acres) are held by a 5 year renewable lease ($500 monthly rental, and a 5% gross
14
royalty on revenues from uranium sold from the property). Other claims in the
immediate area were mined for up to 600,000 pounds U3O8 at a grade of 0.24% by
other companies in the 1970s. The extent of further mineral resources on the
properties is presently unknown.
In fiscal 1997, USE, USECC and the GMMV have entered into several
agreements with YSFC, including a Milling Agreement through Plateau Resources.
The Shootaring Canyon mill facilities will be available to YSFC to transport
uranium concentrate slurry and loaded resin to the mill and process it into
uranium concentrate ("yellowcake"), for which Plateau will be paid its direct
costs plus 10%. Other agreements include a Drill Rig Lease Agreement for YSFC to
access USE drilling rigs at the prevailing market rates; an Outsourcing and
Lease Agreement for assistance from USECC accounting and technical personnel on
a cost plus 10% basis and a sublease for 1,000 square feet of office space and
use of various office equipment for $3,000 per month; and a Ratification of
Understanding by which USECC will offer to YSFC (with a reserved royalty in
amounts to be agreed on later) any uranium properties amenable to in-situ
production which USECC acquires or has the right to acquire. In return, YSFC
will offer to USECC ( with a reserve royalty in amounts to be agreed on later)
uranium properties amenable to conventional mining methods which YSFC acquires
or has the right to acquire. USECC also will make its library of geological
information and related materials available to YSFC. YSFC also has a Storage
Agreement with GMMV by which YSFC stores used low-level contaminated mining
equipment at the Sweetwater Mill.
YSFC has 11,764,000 shares of Common Stock issued and outstanding,
including 3,000,000 shares 25.4%) issued to USE and Crested. Most of the funds
used by YSFC have been provided by USECC under a $400,000 loan facility. As part
consideration for the loan, USE and Crested entered into a Voting Trust
Agreement having an initial term of 24 months with two principal shareholders of
YSFC, whereby USE and Crested will have voting control of more than 50% of the
outstanding shares of YSFC. See Part III of this Report.
SHEEP MOUNTAIN PARTNERS ("SMP")
PARTNERSHIP. In February 1988, USE and Crested 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. SMP mined and sold uranium ore from one of the underground Sheep
Mines during fiscal 1988 and 1989. Production ceased in fiscal 1989, because
uranium could be purchased from the spot market at prices below the mining and
milling costs of SMP. In December 1988, USE and Crested sold 50 percent of their
interests in the Crooks Gap properties to Nukem's subsidiary 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. of Stamford, CT ("Nukem") through its wholly-owned subsidiary Cycle
Resource Investment Corporation ("CRIC"). Each group provided one-half of
$315,000 to purchase equipment from Western Nuclear, Inc.; USE and Crested also
contributed their 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 contributions. Nukem is a uranium brokerage
and trading concern.
SMP was directed by a management committee, with three members appointed
by USECC, and three members appointed by Nukem/CRIC. The committee has not met
since 1991 as a result of the SMP arbitration/litigation. During fiscal 1991,
certain disputes arose between the partners of SMP. These disputes resulted in
arbitration/litigation and subsequent consensual arbitration from which an Order
and Award was issued on April 18, 1996. USE and Crested filed petitions for
confirmation of the Order and Award with the
15
U.S. District Court of Colorado and the Court has entered a Second Amended
Judgment confirming the monetary and equitable provisions of the Order and
Award. Some of the claims have been resolved and the rest are to be determined
by the 10th Circuit Court of Appeals ("CCA"), which is expected to occur in
fiscal 1999 (see "Legal Proceedings - Sheep Mountain Partners
Arbitration/Litigation").
PROPERTIES. Until June 1, 1998, SMP owned 80 unpatented lode mining
claims on the Crooks Gap properties, including two open-pit and five underground
uranium mines and an inventory of uranium ore. In connection with a partial
settlement of litigation/arbitration between USE/Crested and Nukem/CRIC, SMP
conveyed these mineral properties and equipment to USECC. See "Item 3."
Production from the properties is subject to sliding-scale royalties payable to
Western Nuclear, with rates ranging from one to four percent on recovered
uranium concentrates.
Various structures and equipment are located on the properties including
three operating and three non-operating mine headframes with hoists, maintenance
shops, offices, and other buildings, equipment and supplies. An ion-exchange
plant is located on the properties.
Of the claims, which contain a previously-mined open-pit uranium mine
and three underground mines, Pathfinder Mines Corporation ("PMC") has the right
to mine a portion (the Congo area), by open-pit or in-situ techniques to certain
depths, without royalty or other obligations to USECC. PMC has the
responsibility for reclamation work needed thereon as a result of its
activities. If PMC mines any portion of the properties outside the Congo area, a
3% royalty is owed to USECC. Conversely, USECC has the right to mine portions of
the claims and leases outside the Congo area (and specified surrounding zones)
by underground mining techniques, subject to a 3% royalty to PMC. PMC had
conducted an exploration program on a portion of these properties, and has
advised the Company that it does not intend any further development. PMC has
decommissioned and dismantled its two uranium mills in the vicinity.
The ion exchange plant on the properties was used to remove natural
soluble uranium from mine water. USE, on behalf of USECC, has submitted a plan
to the NRC to decommission this facility and obtained a three year extension for
timeliness of decommissioning. Management is reviewing the economics of
relicensing this facility as part of a potential in-situ leach uranium mining
operation.
PROPERTY MAINTENANCE. As operating manager for SMP, USECC was
responsible for exploration, mining, and care and maintenance of the SMP mineral
properties. USECC was to have been reimbursed by SMP for certain expenditures on
the properties. During the SMP arbitration/litigation, Nukem/CRIC refused to
allow SMP to pay USECC for care and maintenance and other work performed on the
properties since the spring of 1991. As part of the Order and Award made on
April 18, 1996, the Arbitration Panel awarded USECC $2,065,989 for Nukem/CRIC's
50% share of care and maintenance expenses for the SMP properties plus interest
of $446,834 to March 31, 1996 and per diem cost of $616 thereafter. See Item 3,
"Legal Proceedings - Sheep Mountain Partners Arbitration/Litigation - Stipulated
Arbitration." Currently, USECC has a maintenance staff on site to care for and
maintain the mines and pump mine water to prevent flooding of the mines, which
could destroy equipment and the concrete lined vertical shafts accessing the
various levels of uranium mineralization.
SMP MARKETING. Nukem, Inc. was engaged by SMP to provide SMP with
financial expertise and marketing services. SMP entered into a marketing
agreement with CRIC, which was concurrently assigned to and assumed by Nukem.
Nukem was to provide marketing and trading services for SMP, which included
acquiring uranium for SMP by purchasing or borrowing. Nukem was to be reimbursed
at its direct costs for acquiring such uranium for SMP. USECC, SMP and Nukem had
seven long-term contracts plus an additional long-term contract with a domestic
utility that was awarded to SMP by the Arbitration Panel (three of these
contracts remained in SMP until the partial settlement on June 1, 1998). The
contracts all were for sales of
16
uranium originally to eight domestic utilities. SMP's uranium supply contracts
were either base-price escalated or market-related (referring to how price is
determined for uranium to be delivered at a future date). Base- price escalated
contracts set a floor price which is escalated over the term of the contract to
reflect changes in the GNP price deflator. Two of the base priced contracts have
been fulfilled and the third base-price escalated contract of SMP required a
delivery of 130,000 pounds of uranium concentrates on May 15, 1997 which was
made, completing that contract. The fourth contract of SMP (which has been
transferred to USECC) is a market-related contract, and calls for delivery of
unspecified quantities of U3O8 totaling approximately 1,000,000 lbs. U3O8
(depending on the number of reactors this utility is operating and their
consumption levels). This contract may be completed in calendar 2000.
Under the market-related contracts, the purchaser's cost depends on
quoted market prices based on estimated prices at which a willing seller would
sell its U3O8 during specified periods before delivery.
Through fiscal 1997 and for prior years, USECC and its affiliates have
satisfied most of these contracts with uranium concentrates previously produced
by SMP, borrowed from others, or purchased on the open market. In fiscal 1998,
$429,300 in revenues was received representing Crested's portion of revenues for
a delivery made in late fiscal 1997 by Nukem. See "Legal Proceedings - Sheep
Mountain Partners Arbitration/Litigation."
PERMITS. Permits to operate existing mines 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, SMP did not discharge
wastewater into Crooks Creek, and the mine water is presently being discharged
into the McIntosh Pit.
URANIUM MARKET INFORMATION.
There are currently nine producers of uranium in the United States,
which collectively produced 5,800,000 pounds of U3O8 during calendar 1997 and
produced approximately 6,300,000 pounds in calendar 1996. Production in the U.S.
for 1998 is estimated at 5,000,000 pounds. In addition, there are several major
producers in Canada (Cameco, Cogema Canada, Ltd., Rio Algom and Uranerz);
Australia (Energy Resources of Australia and Pancontinental Mining, Ltd.);
Africa (Cogema and Rio Tinto's Rossing unit), and Europe, which collectively
produced about 78,000,000 pounds of U3O8 during calendar year 1997 and are
expected to produce approximately the same amount in calendar 1998. Several
members of the Commonwealth of Independent States ("CIS") also export uranium
into the western markets although the amount of such exports to the United
States and European markets are currently limited.
Uranium is primarily used in nuclear reactors to heat water which drive
turbines to generate electricity. According to the Uranium Institute based in
London, England, nuclear plants generated approximately 17% of the world's
electricity in 1996, up from less than 2% in 1970. According to the Uranium
Institute, through the year 2000, nuclear generating capacity is expected to
grow at 1 % per annum primarily as a result of new reactor construction outside
the United States and increased efficiencies of existing reactors.
In 1997, 437 nuclear power plants were operating and 28 were under
construction worldwide, according to the Uranium Institute. Uranium consumption
by world commercial reactors has increased from about 60,000,000 pounds in 1981
to approximately 165,000,000 pounds in 1997.
17
SUPPLY AND DEMAND
From the early 1970s through 1980, the Western World uranium industry
was characterized by increasing uranium production fueled by overly optimistic
projections of nuclear power growth. From 1970 to 1985, production exceeded
consumption by approximately 500,000,000 pounds U3O8. By the end of 1985, enough
inventory had been amassed to fuel Western World reactor needs for over five
years. In response, sales of excess inventory followed and prices plummeted from
highs above $40 per pound in 1979 to below $8 per pound U3O8 in 1992. As prices
fell, Western World production declined dramatically from a high of 115,000,000
pounds in 1980 to a low of 57,000,000 pounds by 1994. Since 1985, uranium demand
in the Western World has exceeded Western World production by over 400,000,000
pounds. In 1995, uranium demand in the Western World was 129,000,000 pounds,
nearly double the production of 66,000,000 pounds by Western World producers. In
1997, total world demand rose to an estimated 165,000,000 pounds, while world
mine supply increased only to an estimated 93,000,000 pounds (including the
78,000,000 pounds produced in North America, Australia, Africa and Europe, see
above). Accordingly, by the end of 1997, excess inventory levels in the Western
World (inventory in excess of preferred levels) had been reduced to less than
1.5 years of forward reactor requirements, and the excess inventories in the
U.S. had been reduced to less than one year of projected forward requirements.
This trend is expected to continue in calendar 1998.
Countering the drawdown of Western World inventories and contributing
directly to the downturn of market prices was the importation of uranium from
the CIS republics, and to a lesser extent, from Eastern Europe and mainland
China starting in 1989. As the result of an anti-dumping suit filed in the U.S.
("CIS Anti-dumping Suit") in 1991 against republics of the CIS, suspension
agreements were signed by six CIS republics (Russia, Ukraine, Kazakhstan,
Uzbekistan, Kyrgyzstan and Tajikistan) in October 1992. These Suspension
Agreements applied price related volume quotas to CIS uranium permitted to be
imported into the U.S, so that to rectify prior damage to domestic United States
uranium producers from dumping sales of U3O8, all spot sales of U3O8 delivered
into the U.S. now reflect quota restrictions on U3O8 imports from the CIS.
Exceptions are allowed by provisions which allow CIS uranium to be imported for
certain long-term uranium sales contracts entered into with domestic utilities
prior to March 5, 1992 ("grandfathered contracts").
The Suspension Agreement with Russia was amended in March 1994 allowing
for up to 43,000,000 pounds of Russian uranium to be imported into the U.S. over
the 10 years beginning March 1994, but only if it is matched with an equal
volume of new U.S. production. Based on U.S. consumption for the 1994-2003
period (as reported or projected by the Department of Energy), the matched
volumes could account for up to 18% of the supply to the U.S. market during this
period.
In 1995, the Republics of Kazakhstan and Uzbekistan concluded
negotiations with the U.S. DOC to amend their respective Suspension Agreements.
Both amendments lowered initial prices relating to their respective import
quotas allowing imports to occur. Additionally, the amendments require that
uranium mined in those Republics and enriched in another country for importation
in the U.S. will count against their respective quotas. The Uzbekistan amendment
replaces the price-tied quota system with one based upon U.S. production rates
after October 1997. As U.S. production rates increase, additional imports from
Uzbekistan are allowed.
Although these amendments to three of the Suspension Agreements may
increase the supply of uranium to the U.S. market, they also provide increased
predictability concerning CIS imports into the U.S. Due to declining production
levels in the CIS republics, uranium from these sources has recently been
difficult to obtain. Consequently, the market impact of CIS primary production
may be diminishing.
In January 1994, the U.S. and Russia entered into an agreement (the
"Russian HEU Agreement") to convert highly enriched uranium ("HEU"), derived
from dismantling nuclear weapons, to low enriched
18
uranium ("LEU") suitable for use in nuclear power plants. At a projected maximum
conversion rate for HEU to LEU, approximately 24,000,000 pounds of U3O8 per year
will be available to Western World markets.
In 1996, the U.S. Congress passed legislation in compliance with the
Suspension Agreements, which allows the converted Russian HEU material to be
sold in the U.S. market at an annual rate not to exceed 2,000,000 pounds in
1998, increasing gradually to 20,000,000 pounds in 2009. At this maximum rate,
HEU material could supply approximately 40% of annual U.S. reactor requirements
projected for 2009. However, the Russians may require much of the material for
its own internal use and the amounts which may be imported into the U.S. cannot
be predicted. In addition, an uncertain amount of HEU material is allowed to be
used in the U.S. for overfeeding of enrichment facilities and as a source of
Russian uranium for matching sales.
Industry analysts expect annual Western World consumption to be at
levels between 135,000,000 and 165,000,000 pounds U3O8 through 2001. USE
management estimates that between 30,000,000 and 40,000,000 pounds U3O8 of this
demand could be filled by a combination of government stockpiles (including
converted Russian and U.S. HEU) and imports from CIS republics and former
Eastern Bloc countries. To achieve market equilibrium by 2001, primary
production in the Western World will need to supply between 95,000,000 and
120,000,000 pounds U3O8 on an annual basis subject to some adjustment for any
remaining inventory drawdown and limited uranium reprocessing. Production from
existing facilities in the Western World, however, is projected to decline from
current levels (78,000,000 pounds in 1998) to approximately 57,000,000 pounds
U3O8 by 2001 as reserves are depleted. New production therefore will have to be
brought on line to fill a potential annual gap of between 38,000,000 and
63,000,000 pounds U3O8. While current price levels may sustain 1998 production
levels, USE believes that higher prices will be needed to support the required
investment by other uranium producers in new higher cost production facilities
as lower cost production reserves are depleted.
Overall, Crested believes that adequate supply of U3O8 material to meet
firm demand (i.e. to supply future long term contracts with utilities) cannot be
sustained at spot price levels below $15.00 per pound. And, while production
remains at levels just above 50% of consumption in the Western World, existing
and planned new production combine will not equal consumption even if the new
production comes on stream as planned.
Published reports indicate that approximately 31 percent of the
worldwide nuclear-powered electrical generating capacity is in the U.S., 49
percent is in Western Europe, and 14 percent is in the Far East. Although the
reactors in Western Europe have a greater aggregate generating capacity and fuel
usage, the supply of uranium for those reactors has been secured for relatively
long periods. The market requiring the greatest supply of uranium for the next
few years is believed to be the United States. The Asia Pacific region is also
developing into a significant uranium consumer, due to announced plans for rapid
expansion of nuclear power programs in Japan, Korea, Taiwan and the Russian
Federation. This region accounts for most of the 98 power plants which are
ordered or under construction.
U.S. ENRICHMENT CORPORATION. The United States Enrichment Corporation
("USEC") was created by the United States Congress as part of the Energy Policy
Act of 1992. USEC began operations in July 1993 when the United States
Department of Energy ("DOE") transferred the DOE's uranium enrichment facilities
to USEC. USEC enriches uranium at two gaseous diffusion process plants (at
Paducah, Kentucky and near Portsmouth, Ohio) as part of the process to transform
natural uranium into fuel for commercial power plants. USEC has a substantial
share of the world market for enrichment services, and dominates the North
American market for enrichment services. In 1996, Congress enacted the "USEC
Privatization Act of 1996" to privatize USEC and allowed the DOE to transfer
certain amounts of various forms of uranium to USEC.
19
In July 1998, USEC became a wholly-owned subsidiary of USEC Inc. (herein
"USEC") when it completed its privatization through a $1.4 billion public
offering. USEC represented in filings with the Securities and Exchange
Commission that it now holds or intends to acquire 95 metric tons enriched
uranium (50 tons highly enriched, 45 tons low enriched) and 10,800 tons of
natural uranium (uranium oxide as produced from uranium milling, prior to
concentration). USEC has represented its intention to supplement uranium
enrichment services revenues through sales of natural uranium.
Based upon the amounts of uranium USEC purportedly has, or will be
acquiring in shipments from DOE, USEC may be seeking to sell up to 75 million
pounds of uranium or uranium equivalents through the year 2005. On an annual
basis, such sales would adversely impact the domestic uranium market for
producers such as USE and Crested, because USEC's sales would amount to more on
an annual basis than all domestic producers (including USE and Crested) will
produce and plan to sell combined.
USE and Crested believe that a substantial portion of the uranium (45
metric tons of low enriched uranium and 7,000 tons of natural uranium) which
USEC has acquired and will acquire from the DOE, in fact was transferred and
will be transferred by DOE in violation of the USEC Privatization Act of 1996.
USE and Crested have joined with other uranium producers and the Uranium
Producers of America ("UPA") in the filing of a lawsuit for declaratory judgment
and injunctive relief against the Department of Energy, with respect to the
excess transfers, in an attempt to prevent USEC from enjoying a market advantage
over the domestic uranium producers which is prohibited by law. See "Legal
Proceedings" below.
MARKET SUMMARY - IMPLICATIONS FOR FUTURE URANIUM PRICES. With the
privatization of USEC and the prospect of natural uranium coming to the market
from USEC inventories, uranium prices may not rise significantly over the next
12 months, as previously had been anticipated in reports by industry analysts
and by Crested management. Nevertheless, Crested believes that uranium prices
eventually will be determined and moved up significantly by the fundamentals of
the market, because all excess inventories built up in the 1980s will eventually
be consumed. In addition, USEC has stated that USEC would sell its uranium in a
rational and responsible manner indicating (in the opinion of Crested
management) that USEC may keep its market sales at levels which would not drive
down uranium prices.
As detailed below, many projects have been delayed or postponed since
mid-1997 for various reasons, which will have a significant impact on future
supply/demand fundamentals. If, as it appears to be the case, the possible
introduction of the new USEC inventories currently has a depressing effect on
the price of uranium concentrates, then new planned uranium production will be
curtailed more than indicated below.
Delay/Loss of
Annual
Production Potential
Date The Events Reported lbs. of U3O8
---- ------------------- ------------
July 1997 Former Soviet Union production 5 million
delcines 27% (1992-1996)
July 28, 1997 Russia announces it may require 30-50% of 6-10 million
the HEU feed for internal use
August 11, 1997 Kazakhs annul World Wide Contract at 1-2 million
Tselinney Project, Kazakhstan
September 1, 1997 Rio Tinto suspends development at Kintyre 3-4 million
20
September 1, 1997 McClean Lake, Can., schedule slips 6 million
from 1997 to 1998
November 3, 1997 Rio Algom begins product at Smith Ranch, 1-2 million
Wyo. behind schedule
November 10, 1997 Midwest and Cigar Lake, Can., timing delayed 18 million
from 1999 to 2001
November 24, 1997 Aborigines veto ERA's plan to truck ore 6 million
to Ranger Mill, Aust.
July 1998 U.S. Energy/Crested Corp. suspend operations 2-4 million
at Green Mountain, Wyoming
August 1998 World Wide Minerals puts the Dornod project in 1-2 million
Mongolia on standby citing market conditions
August 1998 Cogema will put Cluff Lake, Can., Mine on 2-3 million
standby on Dec. 31, 2000. -----------
Total 51-62 million
With these delays, postponements, and possible further delays or
cancellations of planned uranium production projects, Crested believes that it
is possible that the market price for uranium may increase substantially in mid
- - to late 1999, in spite of possible sales from the USEC inventory. The
fundamentals for higher uranium prices are ascertainable. Currently, all nuclear
reactors worldwide consume approximately 160 million lbs. of natural uranium per
year and by most estimates, will continue at that rate for at least the next 20
years. Total world production for 1997 was approximately 90 million lbs. Over
the next four years, three mines located in Canada (Key Lake, Cluff Lake and
Rabbit Lake) will have exhausted their reserves and will be shut down. Three new
Canadian mines (McArthur River, McClean Lake/Midwest and Cigar Lake) are
scheduled to produce approximately 40 million lbs. of U3O8 annually when they
are in full production.
Crested management believes that other delays and cancellations of
projects may be imminent and that eventually all inventories (government and
public) will be consumed. New significant production will be needed to fuel
existing and planned reactors into the 21st century. USE management believes
that prices must rise significantly from current levels of $10.50/lb., and
possibly up to the $18.00/lb. range over the next 2-3 years, to motivate
existing and new mines to move forward as planned. In addition, no new mine/mill
construction would be justifiable for selling into only the spot market. At
least 80 percent of a uranium producer's production has to be sold to long term
contracts, because only with long term contracts can the mine/ mill process over
the life of the mine be planned and financed.
In contrast to finding, developing and mining new properties and
building new mills, USE's uranium properties are believed to contain well
defined uranium deposits delineated by others which do not require further
exploration work prior to beginning production. Development work is
significantly advanced at both the principal Wyoming site (the Jackpot Mine) and
the Utah mines. The uranium mills in Wyoming and Utah were acquired fully built
at no cost to USE and Crested, and the remaining work required to put the mills
into operating status will not consume significant amounts of capital. For these
reasons, Crested believes that its uranium properties will be low cost uranium
producers compared to some of the other uranium mines now in operation, and also
compared to the costs to develop new properties and build new uranium mills.
21
Nonetheless, the decision by USE and Crested to put any mine into
production, and the commitment of funds necessary to implement that commitment,
must be made well in advance of the time when revenues from the mined resource
are received. Price fluctuations between the time the production commitment is
made, and the time when production and sales occur, can significantly impact the
economics of the mine. If the sales revenues fall below production costs for a
substantial period of time, it is possible that USE and Crested could determine
that it is not then economically feasible to continue production operations.
Taking into account all of the relevant factors discussed above, Crested intends
throughout fiscal 1999 to seek the financing to put the uranium properties into
production, and in the meantime to seek long term utility contracts to take the
uranium production, with the ultimate goal of being in full production in
Wyoming in April 2000, and milling the stockpiled uranium in Utah in late fiscal
1999 or early fiscal 2000. There is no assurance such financing will be
obtained, nor is there assurance prices will not decrease, which would make
obtaining such financing more expensive or impossible.
NUEXCO EXCHANGE VALUE. The market related contracts to sell uranium
oxide to utilities usually are based on an average of the Nuexco Exchange Value
("NEV") or some other market quotes for 2, 3 or more months before the uranium
delivery. The high and low NEV reported on U3O8 sales during USE's past seven
fiscal years are shown below. NUEXCO Exchange Values are now reported weekly by
TradeTech and represents its judgment of the price at which spot and near term
transactions for significant quantities could be concluded. NEVs for fiscal 1993
are higher for U.S. transactions, due to the impact of CIS import restrictions
since late 1992. These prices ("US NEV") were reported by NUEXCO for spot sales
in the restricted U.S. market.
NUEXCO EXCHANGE VALUE
US $/pound of U3O8
Years Ended ------------------
May 31, High Low
------------- ---- ---
1992 $ 9.05 $ 7.75
1993 10.05 7.75
1994 9.60 9.05
1995 12.20 9.65
1996 16.50 13.00
1997 14.25 10.20
1998* 12.05 10.50
* Through August 10, 1998 when it was $10.50/lb.
NUEXCO's restricted market values ("U.S. NEV") apply to all products and
services delivered in the U.S. as well as non-CIS origin products and services
delivered outside the U.S.
The foregoing prices represent the "spot" market only, and indicate
transactions primarily by utilities purchasing to cover short positions.
Long-term supply contracts, which cover up to 10 to 15 percent of the uranium
sold from year to year, carry prices which are in excess of the spot market.
This price premium is paid by the utilities to assure long term price stability;
the producer demands the premium to compensate for future price increases which
could (but may not) exceed the premium. Utilities keep their long term contract
provisions confidential, so it is difficult to assess any one utility company's
long term contract plans or needs. The amount of the price premium will vary
from time to time.
22
GOLD
LINCOLN PROJECT (CALIFORNIA)
SUTTER GOLD MINING COMPANY. In fiscal 1991, USE acquired an interest in
the Lincoln Project (including the underground Lincoln Mine and the 2,800 foot
Stringbean Alley decline) in the Mother Lode Mining District of Amador County,
California, held by a mining joint venture known as the Sutter Gold Venture
("SGV"). The entire interest of SGV is now owned by USECC Gold L.L.C., a Wyoming
limited liability company, which is a subsidiary of Sutter Gold Mining Company,
a Wyoming corporation ("SGMC").
In fiscal 1997, SGMC completed private financings totaling a net of
US$7,115,400 ($1,272,000 through a private placement conducted in the United
States by RAF Financial Corporation ("RAF"), and $5,843,400 through a private
placement conducted in Toronto, Ontario, Canada by C.M. Oliver & Company
Limited). The net proceeds of $6,511,200 from these financings (after deduction
of commissions and offering costs) are being applied to pre-production mine
development, mill design, and property holding and acquisition cost. Additional
financing of up to $15,000,000 will be sought to fund the development and
construction of the mine/mill. SGMC's properties contain an estimated amount of
proven reserves (see below). Because the properties are not yet in production
and the needed funding is not yet available to do so (gold is at $290 per ounce,
which has hampered efforts to raise capital), the recorded value of SGMC's
mineral properties has been reduced as of May 31, 1998. See "Item 7,
Management's Discussion and Analysis Financial Condition and Results of
Operations." If such financing is not available by the end of fiscal 1999, or if
gold prices do not improve, the value of Crested's investment in SGMC could be
deemed further impaired and more of such investment written off during fiscal
1999. SGMC intends to fund the development and construction of the project
through private or public debt and/or equity financing. At Report date SGMC is
in discussions with certain investment banks, however, no agreements for
financing have been reached, and there is no assurance any agreements will be
reached.
In fiscal 1998, due to the depressed gold price and gold equity market,
SGMC suspended the start of construction of the 1,000 ton-per-day gold mill
complex and development of the underground mine. SGMC initially anticipated
production mining would commence in mid-calendar 1998 and by that time,
construction of a 1,000 ton per day gold mill would have been completed. Once a
decision to commence production is made, from that date, it is estimated it will
take approximately 18 months to complete the mill complex construction and pour
the first bar of gold. During fiscal 1998, SGMC pursued amendments to its
approved 1993 Conditional Use Permit (see "Permits and Future Plans"), finalized
the process flow of the mill, entered into the final design engineering contract
with the engineering firm of Lockwood Greene of Dallas, Texas and started to
build the entrance road to the mine.
SGMC does not have any class of its securities registered with the
Securities and Exchange Commission, and none of its securities are traded in the
United States.
After completion of the two private financings, and taking into account
a restructuring of the ownership of USE and Crested in SGMC, USE and Crested
each own the following securities of SGMC:
(a) Together, a majority (after the April 1998 transaction, discussed
below) of the outstanding shares of SGMC Common Stock, which would be reduced in
the event outstanding warrants held by the remaining Canadian investors to
purchase 564,900 more shares of Common Stock are exercised at Cdn$6.00 per share
18 months from the date of closing of the private offerings (which were
completed in May 1997) and the outstanding warrants held by C.M. Oliver to
purchase 145,480 more shares of Common Stock are exercised at Cdn$5.50 per
share, before May 13, 1999. The preceding does not reflect SGMC shares that may
be acquired by USE and Crested pursuant to the USECC $10,000,000 Contingent
Stock Purchase Warrant (described below) issued as consideration for the
voluntary reductions in the ownership of SGMC shares by
23
USE and Crested. One reorganization of the capital structure was made in
contemplation of its private placement of SGMC shares, and a second
reorganization was made in contemplation of the Canadian private placement.
(b) A $10,000,000 Contingent Stock Purchase Warrant (the "USECC
Warrant") was issued to USE and Crested in connection with the restructuring of
SGMC for the Canadian private placement. The USECC Warrant is owned 88.9% by USE
and 11.1% by Crested. The USECC Warrant provides that for each ounce of gold
over 300,000 ounces added to the proven and probable category of SGMC's reserves
(up to a maximum of 400,000 additional ounces), using a cut-off grade of 0.10
ounces of gold per ton (at a minimum vein thickness of 4 feet), USE and Crested
will be entitled to cash or additional shares of Common Stock from SGMC (without
paying additional consideration) at SGMC's election. The number of additional
shares issuable for each new ounce of gold reserves will be determined by
dividing US$25 by the greater of $5.00 or the weighted average closing price of
the Common Stock for the 20 trading days before exercise of the USECC Warrant.
The USECC Warrant is exercisable semi-annually. If SGMC decides against the
exercise of the USECC Warrant, it can pay USE and Crested US$25 in cash for each
new ounce of gold (payable out of a maximum of 60% of net cash-flow from SGMC's
mining operations). Additions to reserves will be determined by an independent
geologist agreed upon by the parties.
APRIL 1998 TRANSACTION FOR CASH AND SGMC SPECIAL WARRANTS. As of April
7, 1998, USE entered into four separate Stock Purchase Agreements with four
Canadian investment funds, for the issuance of 658,895 shares of Common Stock of
USE, in consideration of the funds' payment to USE of $1,190,000 in cash and the
delivery to USE of 888,900 Special Warrants of SGMC. The funds had paid SGMC a
total of Cdn$4,888,950 in May 1997, pursuant to a private offering in Canada, to
purchase the Special Warrants from SGMC. Each Special Warrant entitles the
holder to acquire from SGMC, at no further cost, one share of Common Stock of
SGMC, and one Purchase Warrant; each Purchase Warrant entitles the holder to
purchase one share of Common Stock of SGMC, at a price of Cdn$6.00 per whole
share (the "Purchase Warrants"), through November 13, 1998. For further
information on this transaction, reference is made to USE's Annual Report on
Form 10-K for fiscal year ended May 31, 1998.
USECC MANAGEMENT AGREEMENT WITH SGMC. Effective June 1, 1996, SGMC
entered into a Management Agreement (dated as of May 22, 1996) with USE under
which USECC provides administrative staff and services to SGMC. USECC is
reimbursed for actual costs incurred, plus an extra 10% during the exploration
and development phases; 2% during the construction phase; and 2.5% during the
mining phase (such 2.5% charge to be replaced with a fixed sum which the parties
will negotiate at the end of two years starting when the mining phase begins).
The Management Agreement replaces a prior agreement by which USECC provided
administrative services to SGMC.
PROPERTIES. SGMC (through its subsidiary USECC Gold) holds approximately
14 acres of surface and mineral rights (owned), 55 acres of surface rights
(owned), 436 acres of surface rights (leased), 158 acres of mineral rights
(leased), and 380 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 miles outside of Sutter Creek.
On October 1, 1996, SGMC entered into three letter agreements (the
"Lincoln Letter Agreements") with the property owners of 185 acres ("185 Acre
Property") on the west side of California State Highway 49 ("Hwy 49") and 32.58
acres ("32 Acre Property") of minerals which include 20.5 acres of surface on
the east side of Hwy 49 adjacent to the Stringbean Decline. The 185 Acre
Property is the proposed new location
24
for the Surface Fill Unit and the 32 Acre Property provides the land necessary
for access and utility easements to Hwy 49.
Surface and mineral rights holding costs will aggregate approximately
$225,000 from June 1, 1998 through May 31, 1999. Property taxes for fiscal 1998
are estimated to be $30,000.
The leases are for varying terms, and require rental fees, advance
production royalties, real property taxes and insurance. The lease that was to
expire in February 1998 has been extended through its force majeure clause due
to the low price of gold. Leases expiring before 2010 will generally be extended
automatically, so long as minerals are continuously produced from the property
that is subject to the lease or minimum payments are made . Other leases may be
extended for various periods on terms similar to those contained in the original
leases. Production royalties are from 2.5% to 6% (most are 4%). The various
leases have different methods of calculating royalty payments (net smelter
return and gross proceeds).
A separate holder of four of the properties that were assembled by
Meridian into the Lincoln Project holds a 5 percent net profits interest on
production from such properties, which was granted by Meridian when it acquired
the properties. The "net profits" generally will be equal to gross mineral
revenues less an amount equal to 105 percent of numerous categories of costs and
expenses. An additional 0.5 percent net smelter return royalty is held by a
consultant to a lessee prior to Meridian's acquisition of the properties, which
0.5 percent interest covers the same four properties in the Lincoln Project.
Through May 31, 1998, an estimated $21,000,000 was spent on the Lincoln
Project by Meridian, USECC Gold and other of their predecessors to acquire the
Lincoln Project and for mine development, mining and processing bulk samples of
mineralization, exploration, feasibility studies, permitting costs, holding
costs, and related general and administrative costs. The amount of such
expenditures during the 1998 fiscal year was approximately $1,410,800 ($572,700
in 1997).
GEOLOGY AND RESERVES. The minerals consulting firm Pincock, Allen & Holt
of Lakewood, CO ("PAH") prepared a prefeasibility study of the Lincoln Project
in fiscal 1994 (and updated the study in 1997). PAH reviewed core drilling data
on the Lincoln Zone on 100-foot centers from the surface, and drilling on the
Comet Zone from both surface and underground. PAH also reviewed data from
drilling on the Keystone Zone from surface on 200-foot centers. Total data is
from 162 exploration core holes (surface and underground), with total footage of
64,700 feet. PAH based its estimate of proven reserves on mineralized material
within 25 feet of sample information; probable reserves were based on material
located between 25 and 50 feet of sample information.
Using a cutoff grade of 0.15 ounces of gold per ton in place, PAH
estimates the Lincoln Project contains approximately 350,000 tons of proven and
probable reserves grading approximately 0.4 ounces of gold per ton. If operating
economics indicate a lower cutoff grade is feasible, the tonnages for the stated
reserves would be increased. Historical data (underground maps and production
records) from historic (now closed) mines within the Lincoln Project boundaries
indicate certain areas of those mines were not "mined out," such that additional
mineralized resources may exist on the property.
The geology within the Lincoln Project is typical of the historic Mother
Lode region of California, with a steeply dipping to vertical sequence of
metavolcanic and metasedimentary rocks hosting the gold- bearing veins.
Depending on location along the strike length on the vein systems, the
gold-bearing veins are slate, metavolcanic greenstone, or an interbedded unit of
slates and volcanics. The Lincoln Project covers over 11,000 feet of strike
length along the Mother Lode vein systems.
25
PERMITS AND FUTURE PLANS. In August 1993, the Amador County Board of
Supervisors issued a Conditional Use Permit ("CUP") allowing mining of the
Lincoln Mine and milling of production, subject to conditions relating to land
use, environmental and public safety issues, road construction and improvement,
and site reclamation. The permit will allow construction of the mine and mill
facilities in stages as the project gets underway, thereby reducing initial
capital outlays. Additional permits (for road work, dust control and
construction of mill and other surface improvements) need to be applied for in
due course. On July 14, 1998 the Amador County Planning Commission certified the
Final Subsequent Environmental Impact Report ("FSEIR:) and approved all of the
amendments requested by SGMC. The decision by the Planning Commission has been
appealed to the Amador County Board of Supervisors by a local citizens' group
and will be heard by the Board of Supervisors in August 1998; further appeal
would be available to the Amador County Superior Court if the opposition lost at
the Board of Supervisors level. The appeal deals only with the adequacy of the
FSEIR; since SGMC already has a valid CUP, SGMC could continue to move forward
on certain parts of the development of the mine/mill. In any event, SGMC does
not expect the appeal process to materially impact the development plan or
schedule. Amendments to the CUP will remove two tailings dams, eliminate the
need to use cyanide on-site, and eliminate mine related traffic on two county
roads.
PROPOSED MINE PLAN
In should be noted that the mine workings actually developed may vary
substantially from the plan adopted, depending on the different conditions and
grades of mineralization that are encountered. SGMC proposes to mine the Lincoln
and Comet Zones initially by access through the existing Stringbean Alley
decline. Production will be by overhand cut-and-fill and open sub-level stoping
techniques. Screened tailings from the mill (support fill) will be used to back
fill the stopes, which will stabilize the hanging and foot wall vein rocks, and
greatly reduce the volume of processed ore going into the Surface Fill Unit.
Mining at startup is expected to increase up to 500 tons per day ("tpd")
during the first six months of mining operations. Ore will be conveyed to the
surface through an off shoot portal from the Stringbean Alley decline. a new
underground level is planned to be driven at 1,000 feet above sea level,
(approximately 120 feet below surface) during the next six months. Mining will
coincide with development of additional stopes and may allow an increase in mine
production up to 1,000 tpd in approximately the third year of operation.
Concurrently with production mining, SGMC intends to maintain an aggressive
underground development program to delineate (on an on-going basis) two to three
years of developed ore in sight.
MILL PLAN
There are three stages of milling and processing the ore. The first
stage involves wet grinding of the ore to the size of fine sand in a
semi-autogenous grinding ("SAG") mill. The resulting finely-milled ore is
treated in a gravity separator which employs centrifugal force to separate the
heavier free gold particles from the lighter rock particles. Next, the gold
concentrate is run across a set of cleaning tables to upgrade the gold
concentrate. The second stage takes the middlings and tails from the first and
again involves wet grinding in a ball mill to a finer size particle. This ground
ore is again treated in a similar gravity separator which is tuned for this
finer size particle and the gold concentrate is run across a different set of
cleaning tables. The third stage separates the remaining gold by flotation
wherein minute quantities of non-toxic chemicals are added to the ground ore
which makes the gold bearing particles attach to air bubbles. The gold bearing
particles are then separated from the ground ore into a flotation concentrate.
At this stage, the flotation concentrate is either reground and processed with a
dilute solution of sodium cyanide or shipped offsite. SGMC is planning on
shipping the flotation concentrate offsite, even though its CUP allows
processing with sodium cyanide. The mill is designed to produce several
gold-bearing products: a high-grade gravity concentrate; a flotation concentrate
or a gold precipitate if the cyanide process is used. These gold-bearing
products will be smelted to dore bullion for shipment to a precious metal
refinery. During processing, 95 to 97% of the processed ore
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will be removed. Of this material, approximately 65% will be placed underground
as structural fill and 35% will be placed into the Surface Fill Unit.
MOLYBDENUM
As holders 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 (one-half to each). AMAX Inc. (which was acquired by Cyprus
Minerals Company and was renamed Cyprus Amax Minerals Company in November 1993)
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. USECC did not receive any advance royalties during fiscal
1996 because of an arrangement with Cyprus Amax described below. These royalties
are shown in the Consolidated Statements of Operations as a component of gains
from restructuring mineral properties agreements. See "Note F to the USE
Consolidated Financial Statements." The advance royalty payments reduce the
operating royalties (six percent of gross production proceeds) which would
otherwise be due from Cyprus Amax from production. There is no obligation to
repay the advance royalties if the property is not placed in production.
The Agreement with AMAX also provides that USE and Crested are to
receive $2,000,000 (one-half to each), at such time as the Mt. Emmons properties
are put into production and, in the event AMAX sells its interest in the
properties, USE and Crested would receive 15 percent of the first $25,000,000
received by AMAX. USE and Crested have asserted that the acquisition of AMAX by
Cyprus Minerals Company was a sale of AMAX's interest in the properties which
would entitle USE and Crested to such payment. Cyprus Amax has rejected such
assertion and USE and Crested are considering their remedies.
In fiscal 1995, USE and Crested reached agreement with Cyprus Amax to
forego six quarters of advance royalties (starting fourth quarter calendar 1994)
as payment for the option exercise price for certain real estate in Gunnison,
Colorado owned by Cyprus Amax and the subject of a purchase option held by USE
and Crested. The option exercise price is valued at $266,250. USE and Crested
exercised their option in August 1994 and subsequently sold that property for
$970,300 in cash and notes receivable. The advance royalties resumed in the
second quarter of calendar 1996, however, the payment was not received until
June 1996, being the first quarter of fiscal 1997. Crested recognized $105,500
and $103,600 of revenues in fiscal 1998 and 1997, respectively related to this
royalty interest.
MOLYBDENUM MARKET INFORMATION
Molybdenum is a metallic element with applications in both metallurgy
and chemistry. Principal consumers include the steel industry, which uses
molybdenum alloying agents to enhance strength and other characteristics of its
products, and the chemical, super-alloy and electronics industries, which
purchase molybdenum in upgraded product forms.
The molybdenum market is cyclical with prices influenced by production
costs and the rate of production of foreign and domestic primary and by-product
producers, world-wide economic conditions particularly in the steel industry,
the U.S. dollar exchange rate, and other factors such as the rate of consumption
of molybdenum in end-use products. When molybdenum prices rose dramatically in
the late 1970s, for example, steel alloys were modified to reduce reliance on
molybdenum. AMAX and Cyprus Minerals Company were the two major primary
producers of molybdenum in the United States until November 1993, when AMAX was
acquired by Cyprus.
27
Worldwide demand for molybdic oxide in calendar 1996 was reported at
approximately 230,000,000 pounds, its highest level ever. Production for that
period was about 225,000,000 pounds. There is, however, excess capacity from the
primary molybdenum mines which are currently not producing. In addition, by-
product molybdenum (primarily from Chilean copper mining companies) has a major
impact on available supplies. It is unlikely that any major new primary deposits
will be developed during fiscal 1999.
Molybdenum prices on the open spot market increased substantially, from
$3.35 per pound of technical grade molybdic oxide (the principal product) in
September 1994, to $15.50 - $17.50 per pound in February 1995. However, by May
31, 1996, prices declined to $3.00 - $3.35 per pound but were in the $4.00 to
$4.40 per pound range in September 1997 and $3.75 in July 1998.
PARADOR MINING (NEVADA)
USE and Crested are sublessees and assignees from Parador Mining Co.,
Inc. ("Parador"), of certain rights under two patented mining claims located in
the Bullfrog Mining District of Nye County, Nevada. The claims are immediately
adjacent to and part of a gold mine operated by Bond Gold Bullfrog, Inc.
("BGBI"), a non-affiliated third party (now known as Barrick Bullfrog, Inc.).
USE and Crested have also been assigned certain extralateral rights associated
with the claims and certain royalty rights relating to a prior lease on those
properties. The lease to USE and Crested is for a ten year primary term, is
subject to a prior lease to BGBI on the properties, and allows USE and Crested
to explore for, develop and mine minerals from the claims. If USE and Crested
conduct activities on the claims, they are entitled to recover costs out of
revenues from extracted minerals. After recovering any such costs, USE and
Crested will pay Parador a production royalty of 50 percent of the net value of
production sold from the claims.
USE, Crested and Parador presently are in litigation concerning this
property. See Item 3, "Legal Proceedings - BGBI Litigation."
OIL AND GAS.
FORT PECK LUSTRE FIELD (MONTANA). USECC conducts a small oil production
operations at the Lustre Oil Field on the Ft. Peck Indian Reservation in
north-eastern Montana; four wells are producing, and USE and Crested receive a
fee based on oil produced. USE is the operator of record. No further drilling is
expected in this field. This fee and certain real property of USE and Crested,
have been pledged or mortgaged as security for a $1,000,000 line of credit from
a bank.
ENERGX, LTD. FORT PECK GAS PROJECT. Energx, Ltd., a Wyoming corporation
owned 45% by USE, 45% by Crested, and 10% by the Fort Peck (Montana) Assiniboine
and Sioux Tribes, had certain rights to explore Montana properties for shallow
natural gas. Exploration efforts were unsuccessful prior to 1998, and Energx was
released from the property agreements in 1998. Other Energx projects have also
been unsuccessful. Accordingly, in fiscal 1998 Energx decided to cease all
operations pending evaluation of future options.
REAL ESTATE AND OTHER COMMERCIAL OPERATIONS
Crested owns varying interests, alone and with USE, in affiliated
companies engaged in real estate, transportation, and commercial businesses. The
affiliated organizations include Western Executive Air, Inc. ("WEA") and Canyon
Homesteads, Inc. (through Plateau). Activities of these and other subsidiaries
in the business sectors include ownership and management of a commercial office
building, the townsite of Jeffrey City, Wyoming and the townsite, motel,
convenience store and other commercial facilities in Ticaboo, Utah.
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WYOMING PROPERTIES. USECC owns a 14-acre tract in Riverton, Wyoming,
with a two-story 30,400