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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------
FORM 10-Q
(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
-------------------------------------------------
or
/ /TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period ended
-------------------------------------------------
Commission file number: 0-10990
CASTLE ENERGY CORPORATION
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 76-0035225
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(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
One Radnor Corporate Center, Suite 250, 100 Matsonford Road,
Radnor, Pennsylvania 19087
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 995-9400
------------------------------
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)
Indicate by check X whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes X No .
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date: 6,632,884 shares of
Common Stock, $.50 par value outstanding as of August 9, 2002.
CASTLE ENERGY CORPORATION
INDEX
Page #
------
Part I. Financial Information
---------------------
Item 1. Financial Statements:
Consolidated Balance Sheets - June 30, 2002 (Unaudited) and September 30,
2001.......................................................................................... 1
Consolidated Statements of Operations - Three Months Ended June 30, 2002
and 2001 (Unaudited).......................................................................... 2
Consolidated Statements of Operations - Nine Months Ended June 30, 2002
and 2001 (Unaudited).......................................................................... 3
Consolidated Statements of Cash Flows - Nine Months Ended June 30, 2002
and 2001 (Unaudited).......................................................................... 4
Consolidated Statements of Stockholders' Equity and Other Comprehensive
Income - Year Ended September 30, 2001 and Nine Months Ended June 30,
2002 (Unaudited).............................................................................. 5
Notes to the Consolidated Financial Statements (Unaudited) ................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................................. 13
Item 3. Qualitative and Quantitative Disclosures About Market Risk ................................... 19
Part II. Other Information
-----------------
Item 1. Legal Proceedings............................................................................. 20
Item 6. Exhibits and Reports on Form 8-K.............................................................. 20
Signature .................................................................................................. 21
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("000's" Omitted Except Share Amounts)
June 30, September 30,
2002 2001
---------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents................................................ $ 17,471 $ 5,844
Restricted cash.......................................................... 4,216 370
Accounts receivable...................................................... 174 2,787
Marketable securities.................................................... 4,915 6,722
Prepaid expenses and other current assets................................ 181 277
Estimated realizable value of discontinued net refining assets........... 612
Deferred income taxes.................................................... 2,315 1,879
-------- --------
Total current assets................................................... 29,272 18,491
Estimated realizable value of discontinued net refining assets............... 612
Property, plant and equipment, net:
Natural gas transmission................................................. 51
Furniture, fixtures and equipment........................................ 154 222
Oil and gas properties, net (full cost method):
Proved properties................................................ 39,843
Unproved properties not being amortized.......................... 331 110
Investment in Networked Energy LLC........................................... 418 401
Investment in Delta Petroleum Corporation.................................... 27,129
-------- --------
Total assets........................................................... $ 57,916 $ 59,118
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable......................................................... $ 331
Accounts payable......................................................... $ 572 3,543
Accrued expenses......................................................... 1,119 292
Accrued income taxes on appreciation of marketable securities.......... 946 900
Fair value of option granted to Delta Petroleum Corporation............ 2,043
Net refining liabilities retained...................................... 3,016
-------- --------
Total current liabilities.............................................. 4,680 8,082
Net refining liabilities retained........................................ 3,016
Long-term liabilities........................................................ 10 9
-------- --------
Total liabilities...................................................... 7,706 8,091
-------- --------
Commitments and contingencies................................................
Stockholders' equity:
Series B participating preferred stock; par value - $1.00; 10,000,000 shares
authorized; no shares issued
Common stock; par value - $0.50; 25,000,000 shares authorized;
11,503,904 shares issued at June 30, 2002 and September 30, 2001 5,752 5,752
Additional paid-in capital............................................... 67,365 67,365
Accumulated other comprehensive income - unrealized gains on
marketable securities, net of taxes.................................... 1,682 1,600
Retained earnings........................................................ 41,917 42,816
-------- --------
116,716 117,533
Treasury stock at cost - 4,871,020 shares at June 30, 2002 and
at September 30, 2001.................................................. (66,506) (66,506)
-------- --------
Total stockholders' equity............................................. 50,210 51,027
-------- --------
Total liabilities and stockholders' equity............................. $ 57,916 $ 59,118
======== ========
The accompanying notes are an integral part of these financial statements.
-1-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("000's" Omitted Except Share Amounts)
(Unaudited)
Three Months Ended June 30,
---------------------------
2002 2001
---- ----
Revenues:
Oil and gas sales............................................................ $ 2,525 $ 5,347
---------- -----------
Expenses:
Oil and gas production....................................................... 654 1,929
General and administrative................................................... 2,183 1,195
Depreciation, depletion and amortization..................................... 737 839
Impairment of foreign unproved properties.................................... 873
---------- -----------
3,574 4,836
---------- -----------
Operating income (loss).......................................................... (1,049) 511
---------- -----------
Other income (expense):
Gain on sale of domestic oil and gas properties.......................... 1,403
Interest income.......................................................... 1 125
Other income............................................................. 19 28
Impairment provision - marketable securities............................. (184)
Decrease in fair value of option granted to Delta Petroleum
Corporation............................................................ 638
Equity in loss of Networked Energy LLC................................... (51) (44)
Equity in estimated loss of Delta Petroleum Corporation before
June 1, 2002........................................................... (56)
Equity in estimated loss of Delta Petroleum Corporation after May
31, 2002............................................................... (103)
---------- -----------
1,667 109
---------- -----------
Income before provision for (benefit of) income taxes............................ 618 620
---------- -----------
Provision for (benefit of) income taxes:
State..................................................................... 1 6
Federal.................................................................. (15) 217
---------- -----------
(14) 223
---------- -----------
Net income ...................................................................... $ 632 $ 397
========== ===========
Net income per share:
Basic.................................................................... $ .10 $ .06
========== ===========
Diluted.................................................................. $ .09 $ .06
========== ===========
Weighted average number of common and potential dilutive common shares
outstanding:
Basic..................................................................... 6,632,884 6,632,884
========= ==========
Diluted.................................................................. 6,782,857 6,801,852
========= ==========
The accompanying notes are an integral part of these financial statements.
-2-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("000's" Omitted Except Share Amounts)
(Unaudited)
Nine Months Ended June 30,
--------------------------
2002 2001
---- ----
Revenues:
Oil and gas sales.............................................................. $ 9,224 $ 17,057
--------- ----------
Expenses:
Oil and gas production......................................................... 3,267 5,331
General and administrative..................................................... 4,781 4,369
Depreciation, depletion and amortization....................................... 3,151 2,266
Impairment of foreign unproved properties...................................... 873
--------- ----------
11,199 12,839
--------- ----------
Operating income (loss)............................................................ (1,975) 4,218
--------- ----------
Other income (expense):
Gain on sale of domestic oil and gas properties............................ 1,403
Interest income............................................................ 44 569
Other income............................................................... 20 36
Impairment provision - marketable securities............................... (388)
Decrease in fair value of option granted to Delta Petroleum Corporation 638
Equity in loss of Networked Energy LLC..................................... (133) (77)
Equity in estimated loss of Delta Petroleum Corporation before June 1, (165)
2002.....................................................................
Equity in estimated loss of Delta Petroleum Corporation after May
31, 2002................................................................. (103)
--------- ----------
1,316 528
--------- ----------
Income (loss) before provision for (benefit of) income taxes....................... (659) 4,746
--------- ----------
Provision for (benefit of) income taxes:
State....................................................................... (11) 47
Federal.................................................................... (424) 1,661
--------- ----------
(435) 1,708
--------- ----------
Net income (loss).................................................................. ($ 224) $ 3,038
========= ==========
Net income (loss) per share:
Basic...................................................................... ($ .03) $ .46
========= ==========
Diluted.................................................................... ($ .03) $ .44
========= ==========
Weighted average number of common and potential dilutive common shares
outstanding:
Basic....................................................................... 6,632,884 6,647,304
========= ==========
Diluted..................................................................... 6,765,208 6,837,850
========= ==========
The accompanying notes are an integral part of these financial statements.
-3-
CASTLE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
("000's" Omitted)
(Unaudited)
Nine Months Ended June 30,
--------------------------
2002 2001
---- ----
Net cash flow provided by (used in) operating activities...................... ($ 2,041) $9,015
------- -------
Net cash flows from investing activities:
Investment in furniture, fixtures and equipment........................ (10) (59)
Investment in Networked Energy LLC..................................... (150)
Investment in oil and gas properties................................... (838) (13,689)
Proceeds from sale of oil and gas properties........................... 15,672
------- -------
14,674 (13,748)
------- -------
Net cash flows from financing activities:
Dividends paid to stockholders....................................... (1,006) (995)
Acquisition of treasury stock........................................ (572)
------- -------
(1,006) (1,567)
------- -------
Net increase (decrease) in cash and cash equivalents.......................... 11,627 (6,300)
Cash and cash equivalents - beginning of period............................... 5,844 11,525
------- -------
Cash and cash equivalents - end of period..................................... $17,471 $ 5,225
======= =======
Supplemental schedule of non-cash investing and financing activities:
Exchange of oil and gas properties for Delta Petroleum Corporation
common stock......................................................... $26,952
=======
Estimated value of Delta option to repurchase 3,188,667 Delta shares. $ 2,681
=======
The accompanying notes are an integral part of these financial statements.
-4-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
OTHER COMPREHENSIVE INCOME
("000's" Omitted Except Share Amounts)
Year Ended September 30, 2001 and Nine Months Ended June 30, 2002 (Unaudited)
---------------------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other
----------------- Paid-In Comprehensive Comprehensive Retained
Shares Amount Capital Income Income Earnings
------ ------ ------------- --------------- --------------- ---------
Balance - October 1, 2000...... 11,503,904 $5,752 $67,365 $4,671 $42,422
Stock acquired.................
Dividends declared ($.20 per share) (1,322)
Comprehensive income:
Net income................... $1,716 1,716
Other comprehensive income (loss):
Unrealized gain (loss) on
marketable securities, net of tax (3,071) (3,071)
-------
($1,355)
---------- ------ ------- ======= ------ -------
Balance - September 30, 2001... 11,503,904 5,752 67,365 1,600 42,816
Dividends declared ($.10 per share) (675)
Comprehensive loss:
Net (loss)................... ($ 224) (224)
Other comprehensive (loss):
Unrealized gain on marketable
securities, net of tax.... 82 82
---------
($ 142)
---------- ------ ------- ======= ------ -------
Balance - June 30, 2002........ 11,503,904 $5,752 $67,365 $1,682 $41,917
========== ====== ======= ====== =======
(RESTUBBED TABLE)
Treasury Stock
-------------------------------
Shares Amount Total
------ ------ --------
Balance - October 1, 2000...... 4,791,020 ($65,934) $54,276
Stock acquired................. 80,000 (572) (572)
Dividends declared ($.20 per share) (1,322)
Comprehensive income:
Net income................... 1,716
Other comprehensive income (loss):
Unrealized gain (loss) on
marketable securities, net of tax (3,071)
------
--------- ------- ------
Balance - September 30, 2001... 4,871,020 (66,506) 51,027
Dividends declared ($.10 per share) (675)
Comprehensive loss:
Net (loss)................... (224)
Other comprehensive (loss):
Unrealized gain on marketable
securities, net of tax.... 82
--------- ------- -------
Balance - June 30, 2002........ 4,871,020 ($66,506) $50,210
========= ======= =======
The accompanying notes are an integral part of these financial statements.
-5-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Note 1 - Basis of Preparation
- -----------------------------
The unaudited consolidated financial statements of Castle Energy
Corporation (the "Company") included herein have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC"). Certain
reclassifications have been made to make the periods presented comparable.
Although certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles in the United States have been condensed or omitted pursuant to such
rules and regulations, the Company believes that the disclosures included herein
are adequate to make the information presented not misleading. Operating results
for the three-month and nine-month periods ended June 30, 2002 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 30, 2002 or subsequent fiscal periods. These unaudited
consolidated financial statements should be read in conjunction with the
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended September 30, 2001.
In the opinion of the Company, the unaudited consolidated financial
statements contain all adjustments necessary for a fair statement of the results
of operations for the three-month and nine-month periods ended June 30, 2002 and
2001 and for a fair statement of financial position at June 30, 2002.
Note 2 - September 30, 2001 Balance Sheet
- -----------------------------------------
The amounts presented in the balance sheet as of September 30, 2001
were derived from the Company's audited consolidated financial statements which
were included in its Annual Report for the fiscal year ended September 30, 2001
on Form 10-K.
Note 3 - Discontinued Operations
- --------------------------------
From August 1989 to September 30, 1995, several of the Company's
subsidiaries conducted refining operations. By December 12, 1995, the Company's
refining subsidiaries had sold all of their refining assets and the purchasers
had assumed all related liabilities, including contingent environmental
liabilities. In addition, in 1996, Powerine Oil Company ("Powerine"), one of the
Company's former refining subsidiaries, merged into a subsidiary of the
purchaser of the refining assets sold by Powerine and is no longer a subsidiary
of the Company. The Company's remaining refining subsidiaries own no refining
assets, have been inactive for over six years, and are inactive and in the
process of liquidation. As a result, the Company has accounted for its refining
operations as discontinued operations. Such discontinued refining operations
have not impacted the Company's operations since September 30, 1995, although
they may impact the Company's future operations.
Note 4 - Contingencies/Litigation
- ---------------------------------
Contingent Environmental Liabilities
In December 1995, Indian Refining I Limited Partnership ("IRLP"), an
inactive subsidiary of the Company, sold its refinery, the Indian Refinery, to
American Western Refining L.P. ("American Western"), an unaffiliated party. As
part of the related purchase and sale agreement, American Western assumed all
environmental liabilities and indemnified IRLP with respect thereto.
Subsequently, American Western filed for bankruptcy and sold the Indian Refinery
to an outside party pursuant to a bankruptcy proceeding. The outside party has
substantially dismantled the Indian Refinery. American Western filed a
Liquidation Plan in 2001. American Western anticipated that the Liquidation Plan
would be confirmed in January 2002 but confirmation has been delayed because of
legal challenges by ChevronTexaco, the parent of Texaco Refining and Marketing
("Texaco"), the operator of the Indian Refinery for over 50 years.
During fiscal 1998, the Company was informed that the United States
Environmental Protection Agency ("EPA") had investigated offsite acid sludge
waste found near the Indian Refinery and had investigated and remediated
surface contamination on the Indian Refinery property. Neither the Company nor
IRLP was initially named with respect to these two actions.
-6-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
In October 1998, the EPA named the Company and two of its inactive
refining subsidiaries as potentially responsible parties for the expected
clean-up of the Indian Refinery. In addition, eighteen other parties were named
including Texaco. A subsidiary of Texaco had owned the refinery until December
of 1988. The Company subsequently responded to the EPA indicating that it was
neither the owner nor the operator of the Indian Refinery and thus not
responsible for its remediation.
In November 1999, the Company received a request for information from
the EPA concerning the Company's involvement in the ownership and operation of
the Indian Refinery. The Company responded to the EPA information request in
January 2000.
On August 7, 2000, the Company received notice of a claim against it
and two of its inactive refining subsidiaries from Texaco and its parent. Texaco
had made no previous claims against the Company although the Company's
subsidiaries had owned the refinery from August 1989 until December 1995. In its
claim, Texaco demanded that the Company and its former subsidiaries indemnify
Texaco for all liability resulting from environmental contamination at and
around the Indian Refinery. In addition, Texaco demanded that the Company assume
Texaco's defense in all matters relating to environmental contamination at and
around the Indian Refinery, including lawsuits, claims and administrative
actions initiated by the EPA, and indemnify Texaco for costs that Texaco had
already incurred addressing environmental contamination at the Indian Refinery.
Finally, Texaco also claimed that the Company and two of its inactive
subsidiaries are liable to Texaco under the Federal Comprehensive Environmental
Response Compensation and Liability Act ("CERCLA") as owners and operators of
the Indian Refinery. The Company responded to Texaco disputing the factual and
theoretical basis for Texaco's claims against the Company. The Company's
management and special counsel subsequently met with representatives of Texaco
but the parties disagreed concerning Texaco's claims.
In May 2002, the Company received a letter from ChevronTexaco which
asserted a new claim against the Company and its subsidiaries pursuant to the
Oil Pollution Act of 1990 ("OPA") for costs and damages incurred or to be
incurred by ChevronTexaco resulting from actual or threatened discharges of oil
to navigable waters near the Indian Refinery. ChevronTexaco estimated these
costs and damages to be $20,500. The Company believes that the same defenses the
Company has asserted against other claims by ChevronTexaco are applicable to
this OPA claim and that this claim is also utterly without merit.
In October 2001, Texaco merged with Chevron and the merged Company was
named ChevronTexaco. The Company's general counsel has subsequently corresponded
with ChevronTexaco and provided several requested documents to ChevronTexaco. In
June 2002, ChevronTexaco's counsel indicated to the Company's general counsel
that ChevronTexaco did not intend to sue the Company. Subsequently,
ChevronTexaco requested additional documents from the Company, which the Company
promptly and voluntarily supplied to ChevronTexaco.
In August 2002, the Company's management and special counsel met with
legal and management representatives of ChevronTexaco in an effort to resolve
outstanding issues. At the meeting a special outside counsel of ChevronTexaco
asserted claims against the Company based upon newly expressed legal theories.
ChevronTexaco also informed the Company that landowners adjacent to the Indian
Refinery site had recently filed suit against ChevronTexaco. The meeting ended
in an impasse.
The Company and its special counsel, Reed Smith LLP, believe that
ChevronTexaco's previous and current claims, including Chevron Texaco's newly
expressed legal theories, are utterly without merit and the Company intends to
vigorously defend itself against ChevronTexaco's claims and any lawsuits that
may follow. In addition to the numerous defenses that the Company has against
ChevronTexaco's contractual claim for indemnity, the Company and its special
counsel believe that by the express language of the agreement which
ChevronTexaco construes to create an indemnity, ChevronTexaco has irrevocably
elected to forego all rights of contractual indemnification it might otherwise
have had against any person, including the Company. The Company and its special
counsel also believe that ChevronTexaco's only claim against the Company is
limited to liabilities arising under CERCLA and that ChevronTexaco's
indemnification claims, if any, against the Company are contrary to CERCLA.
-7-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
In September 1995, Powerine sold the Powerine Refinery to Kenyen
Resources ("Kenyen"), an unaffiliated party. In January 1996, Powerine merged
into a subsidiary of Energy Merchant Corp. ("EMC"), an unaffiliated party, and
EMC assumed all environmental liabilities of Powerine. In August 1998, EMC sold
the Powerine Refinery, which it had subsequently acquired from Kenyen, to a
third party.
In July of 1996, the Company was named a defendant in a class action
lawsuit concerning emissions from the Powerine Refinery. In April of 1997, the
court granted the Company's motion to quash the plaintiff's summons based upon
lack of jurisdiction and the Company is no longer involved in the case.
Although any environmental liabilities related to the Indian Refinery
and Powerine Refinery have been transferred to others, there can be no assurance
that the parties assuming such liabilities will be able to pay them. American
Western, owner of the Indian Refinery, filed for bankruptcy and is in the
process of liquidation. EMC, which assumed the environmental liabilities of
Powerine, sold the Powerine Refinery to an unrelated party, which we understand
is still seeking financing to restart that refinery. Furthermore, as noted
above, the EPA named the Company as a potentially responsible party for
remediation of the Indian Refinery and requested and received relevant
information from the Company. Estimated gross undiscounted clean-up costs for
this refinery are at least $80,000- $150,000 according to public statements by
Texaco to third parties. If the Company were found liable for the remediation of
the Indian Refinery, it could be required to pay a percentage of the clean-up
costs. Since the Company's subsidiary only operated the Indian Refinery five
years, whereas Texaco and others operated it over fifty years and since we
understand that Texaco and its subsidiaries disposed of hazardous wastes at the
site of the Indian Refinery whereas the Company's subsidiary did not, the
Company would expect that its share of remediation liability would be
proportional to its years of operation or less, although such may not be the
case. Furthermore, as noted above, ChevronTexaco has claimed that the Company
indemnified it for all environmental liabilities related to the Indian Refinery.
If ChevronTexaco were to sue the Company on this theory and prevail in court,
the Company could be held responsible for the entire estimated clean up costs of
$80,000-$150,000 or more. In such a case, this cost would be far in excess of
the Company's financial capability.
An opinion issued by the U.S. Supreme Court in June 1998 in the
comparable matter of United States v. Bestfoods, 524 U.S. 51, 118 S.Ct. 1876
(1998), and a recent opinion by the U.S. Appeals Court for the Fifth Circuit in
Aviall Services, Inc. v. Cooper Industries Inc., 263 F.3rd 134 (5th Cir. 2001)
vacated and rehearing granted, 278 F.3d 416 (Dec. 19, 2001) support the
Company's positions. Nevertheless, if funds for environmental clean-up are not
provided by these former and/or present owners, it is possible that the Company
and/or one of its former refining subsidiaries could be named parties in
additional legal actions to recover remediation costs. In recent years,
government and other plaintiffs have often sought redress for environmental
liabilities from the party most capable of payment without regard to
responsibility or fault. Whether or not the Company is ultimately held liable in
such a circumstance, should litigation involving the Company and/or IRLP occur,
the Company would probably incur substantial legal fees and experience a
diversion of management resources from other activities.
Although the Company does not believe it is liable for any of its
subsidiaries' clean-up costs and intends to vigorously defend itself in such
regard, the Company cannot predict the ultimate outcome or timing of these
matters due to inherent uncertainties.
-8-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Litigation
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were
defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case,
the Long Trusts, are non-operating working interest owners in wells previously
operated by Castle Texas Production Limited Partnership ("CTPLP"), an inactive
exploration and production subsidiary of the Company. The wells were among those
sold to Union Pacific Resources Corporation ("UPRC") in May 1997. The Long
Trusts claimed that CTPLP did not allow them to sell gas from March 1, 1996 to
January 31, 1997 as required by applicable joint operating agreements, and they
sued CTPLP and the other defendants, claiming (among other things) breach of
contract, breach of fiduciary duty, conversion and conspiracy. The plaintiffs
sought actual damages, exemplary damages, pre-judgment and post-judgment
interest, attorney's fees and court costs. CTPLP counterclaimed for
approximately $150 of unpaid joint interests billings plus interest, attorneys'
fees and court costs.
After a three-week trial, the District Court in Rusk County
submitted 36 questions to the jury which covered all of the claims and
counterclaims in the lawsuit. Based upon the jury's answers, the District Court
entered judgement granting plaintiffs' claims against the Company and its
subsidiaries, as well as CTPLP's counterclaim against the plaintiffs. The
District Court issued an amended judgement on September 5, 2001 which became
final December 19, 2001. The net amount awarded to the plaintiffs was
approximately $2,700. The Company and its subsidiaries and the plaintiffs
subsequently filed notices of appeal and each party submitted legal briefs with
the Tyler Court of Appeals in April 2002 and reply briefs in June and July 2002.
The Company had been notified that the case will be argued before the Tyler
Court of Appeals in October 2002.
Special counsel to the Company, Jenkens & Gilchrist, does not
consider an unfavorable outcome to this lawsuit probable. The Company's
management and special counsel believe that several of the plaintiffs' primary
legal theories are contrary to established Texas law and that the Court's charge
to the jury was fatally defective. They further believe that any judgment for
plaintiffs based on those theories or on the jury's answers to certain questions
in the charge cannot stand and will be reversed on appeal. As a result, the
Company has not accrued any liability for this litigation. Nevertheless, to
pursue the appeal, the Company and its subsidiaries were required to post a bond
to cover the gross amount of damages awarded to the plaintiffs plus interest and
to maintain that bond until the resolution of the appeal, which may take several
years. Originally, the Company and its subsidiaries anticipated posting a bond
of approximately $3,000 based upon the net amount of damages but the Company and
its subsidiaries later decided to post a bond of $3,886 based upon the gross
damages in order to avoid on-going legal expenses and to expeditiously move the
case to the Tyler Court of Appeals. The letter of credit supporting this bond
was provided by the Company's lender pursuant to the Company's line of credit
with that lender. Having sold all of its domestic oil and gas properties, the
Company no longer has any oil and gas assets to collateralize the bond.
Pilgreen Litigation
As part of the oil and gas properties acquired from AmBrit Energy
Corp. ("AmBrit") in June 1999, Castle Exploration Company, Inc., a wholly-owned
subsidiary of the Company ("CECI") acquired a 10.65% overriding royalty interest
("ORRI") in the Simpson lease in south Texas, including the Pilgreen #2ST gas
well. CECI subsequently transferred that interest to Castle Texas Oil and Gas
Limited Partnership ("CTOGLP"), an indirect wholly-owned subsidiary. Because the
operator suspended revenue attributed to the ORRI since first production due to
title disputes, AmBrit had previously filed claims against the operator of the
Pilgreen well, and CTOGLP acquired rights in that litigation with respect to the
period after January 1, 1999. The Company and the operator signed an agreement
to release $282 of the suspended revenue attributable to CTOGLP's ORRI in the
Pilgreen well to CTOGLP subject to judicial approval, which is expected in the
near future. Because of a claim by Dominion Oklahoma Texas Exploration and
Production, Inc. ("Dominion") (see below), a working interest owner in the same
well, that CTOGLP's ORRI in the Simpson lease should be deemed burdened by 3.55%
overriding royalty interest, there is still a title dispute as to approximately
33% of the suspended CTOGLP Pilgreen production proceeds. The Company has named
Dominion as a defendant in a legal action seeking a declaratory judgment that
the Company is entitled to its full 10.65% overriding royalty interest in the
Pilgreen well. The Company believes that Dominion's title exception to CTOGLP's
overriding royalty interest is erroneous and notes that several previous title
-9-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
opinions have confirmed the validity of CTOGLP's interest. CTOGLP has also been
informed that production proceeds from an additional well on the Simpson lease
in which CTOGLP has a 5.325% overriding royalty interest have been suspended by
the court because of title disputes. The Company intends to contest this matter
vigorously. At the present time, the amount held in escrow applicable to both
wells is approximately $532, of which $282 is expected to be released to the
Company in the near future and the remaining $250 will remain in suspense.
The Company's policy with respect to the $282 recovery is to record
any amounts recovered as income only when and if such amounts are actually
received. At June 30, 2002 and August 9, 2002, the $282 recovery had not yet
been received.
Dominion Litigation
In March 18, 2002, Dominion, operator of the Mitchell and
Migl-Mitchell wells in the Southwest Speaks field in south Texas and a working
interest owner in the Pilgreen #2ST well, filed suit in Texas against CTOGLP
seeking declaratory judgement in a title action that the overriding royalty
interest held by CTOGLP in these wells should be deemed to be burdened by
certain other overriding royalty interests aggregating 3.55% and should
therefore be reduced from 10.65% to 7.10%. Dominion is also seeking an
accounting and refund of payments for overriding royalty to CTOGLP in excess of
the 7.10% since April 2000. The Company preliminarily estimates the amount in
controversy to be approximately $1,180 including $136 of the $532 held in escrow
under the Pilgreen litigation (see above). Dominion has threatened to suspend
all revenue payable to the Company from the Mitchell and Migl-Mitchell to offset
its claim. The Company and Dominion are currently examining land and lease
documents concerning the overriding royalty interests. The Company believes that
Dominion's title exception to CTOGLP's overriding royalty interest is erroneous
and notes that several previous title opinions have confirmed the validity of
CTOGLP's interest. The Company intends to contest this matter vigorously and has
accordingly made no provision for Dominion's claim in its June 30, 2002
financial statements.
Note 5 - Information Concerning Reportable Segments
- ---------------------------------------------------
For the periods ended June 30, 2001 and 2002, the Company operated in
only one segment of the energy industry, oil and gas exploration and production.
On May 31, 2002 , the Company consummated the sale of all of its oil and gas
properties to Delta Petroleum Corporation ("Delta") and currently has no
operating assets. See Note 6.
Note 6 - Sale of Domestic Oil and Gas Properties to Delta
- ---------------------------------------------------------
On May 31, 2002, the Company consummated the sale of all of its domestic
oil and gas properties to Delta. The sale was pursuant to a definitive purchase
and sale agreement dated January 15, 2002. At closing, the Company received
$18,236 cash plus 9,566,000 shares of Delta common stock. The $18,236 cash
represents a $20,000 purchase price cash component as of October 1, 2001, the
effective date of the sale, less $1,764 of net cash flow received by the Company
applicable to production from the properties subsequent to the effective date.
It does not include an estimated $2,564 of net production revenue (oil and gas
sales less oil and gas production expenses) applicable to production subsequent
to October 1, 2001 that the Company did not receive but has been or will be
received by Delta. The final settlement of net production revenue from October
1, 2001 to May 31, 2002 is expected to occur by September 30, 2002, at which
time appropriate adjustments will be recorded by the Company. Pursuant to the
governing purchase and sale agreement, the Company granted Delta an option to
repurchase up to 3,188,667 of Delta's shares at $4.50/share for a period of one
year after closing That option was valued at $2,681 at May 31, 2002 using the
Black Scholes method. The Delta stock received by the Company was valued at
$26,952 based upon an evaluation by an independent appraiser, excluding the
value of the option granted to Delta. The value of the 9,566,000 shares of Delta
stock was based upon a share price of $4.025, the average price on the closing
date, May 31, 2002, discounted by 30% based upon a fair market value appraisal
obtained from a third party. The Company believes that the 30% discount to the
traded price is reasonable due to the illiquidity of Delta stock and other
factors. As a result of the sale, the Company owns approximately 44% of Delta,
which will be accounted for under the equity method.
-10-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
For book purposes the Company recorded a gain on the sale of its
domestic oil and gas properties to Delta of $1,403 as follows:
Proceeds received
Cash price at October 1, 2001, effective date........................... $20,000
Cash flow received by the Company October 1, 2001-May 31 2002........... (1,764)
Estimated production revenue earned by the Company October 1,
2001 to May 31, 2002 but received by or to be received by Delta...... (2,564)
-------
15,672
Value of Delta stock received per appraisal (9,566,000 shares x
$2.8175/share)....................................................... 26,952
-------
42,624
Net book value of assets sold:
Oil and gas properties.................................................. (37,388)
Pipeline................................................................ (48)
-------
Gross gain on sale......................................................... 5,188
Estimated value of Delta option to repurchase 3,188,667 shares............. (2,681)
-------
Net gain on sale........................................................... 2,507
Portion of gain deferred (approximately 44%)............................... (1,104)
-------
Net gain recorded.......................................................... $ 1,403
=======
Under generally accepted accounting principles, the Company's gross gain
on the sale is reduced by the fair value of Delta's option which was computed
using the Black Scholes method. In addition, a portion of the net gain on the
sale, equal to the Company's ownership interest in Delta after the transaction,
was deferred and offset against the Company's investment in Delta in accordance
with generally accepted accounting principles in the United States. The
Company's investment in Delta at June 30, 2002, computed using the equity method
of accounting (see below) is as follows:
Book value of the Company's initial investment in Delta (382,289 shares) prior
to May 31, 2002................................................................. $1,733
Reduction of initial investment to market value upon conversion to equity
method of accounting............................................................ (184)
"Catch up" adjustment necessary to convert the Company's initial
investment in Delta to the equity method retroactively.......................... (165)
Value of Delta stock received in Delta transaction (9,566,000 shares).............. 26,952
Portion of gain deferred (approximately 44%)....................................... (1,104)
Estimated share of Delta loss for June 2002 (44% x $234)........................... (103)
-------
$27,129
=======
Under generally accepted accounting principles in the United States an
adjustment is first made to reduce the Company's cost of Delta's stock to its
market value before such market value is added to the Company's equity
investment in Delta. Next, an adjustment is made to record the Company's share
of Delta's net income (loss) under the equity method retroactively ("catch up"
adjustment).
Since Delta's fiscal year ends June 30th, Delta has not yet closed its
books for the quarter ended June 30, 2002. As a result, the Company's share of
Delta's results of operations for June 2002 is based upon estimates provided by
Delta.
The Company expects that its investment in Delta will exceed the
Company's proportional share of Delta's equity by approximately $6,900 at
closing, May 31, 2002. The Company currently believes that the excess should be
allocated to Delta's potential legal recovery from its offshore California oil
and gas leases but the Company is still awaiting additional information,
including Delta's final determination of the valuation of its shares issued to
-11-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
the Company, in order to finalize the allocation of such excess. Delta and eight
other energy companies which own interests in oil and gas leases off the
California coast have sued the United States Government for $1,200,000 for
reimbursement damages for stalling their plans to develop these offshore oil and
gas fields. The lawsuit was filed January 9, 2002 in the U.S. Court of Federal
Claims in Washington, D.C. Delta's claim is far in excess of $152,000 plus
exploration costs and related expenses. The Company expects to finalize the
allocation of its excess investment in Delta within a year.
Note 7 - Related Parties
- ------------------------
In August 2002, CECI purchased a 12.5% net profit interest in the
Company's Romanian concession from an unaffiliated company for $8. An officer of
the Company is a 10% shareholder in the unaffiliated company.
Note 8 - Income Taxes
- ---------------------
The Company's deferred taxes are comprised of the following:
June 30, 2002 September 30, 2001
------------- ------------------
(Unaudited)
Deferred tax assets - gross........................................ $5,676 $5,438
Valuation allowance................................................ (3,361) (3,559)
------ ------
Deferred tax assets - net.......................................... $2,315 $1,879
====== ======
At June 30, 2002, the Company determined that $3,361 of its gross
deferred tax asset more likely than not would not be realized and thus decreased
its valuation allowance from $3,559 to $3,361. If future taxable income (loss)
is not as expected, the Company will change its valuation allowance.
Note 9 - Restricted Cash
Restricted cash consists of the following:
June 30, 2002 September 30, 2001
------------- ------------------
(Unaudited)
Funds supporting bond for Long Trusts Lawsuit...................... $4,006
Funds supporting letters of credit for operating bonds............. 210 $209
Escrowed funds for litigation settlement........................... 154
Drilling deposits in escrow - Romania.............................. 7
------ ----
$4,216 $370
====== ====
The Company anticipates that the funds supporting letters of credit for
operating bonds will be replaced by Delta before September 30, 2002.
-12-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
("$000's" Omitted Except Share and Per Unit Amounts)
RESULTS OF OPERATIONS
All statements other than statements of historical fact contained in this
report are forward-looking statements. Forward-looking statements in this report
generally are accompanied by words such as "anticipate," "believe," "estimate,"
or "expect" or similar statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, no
assurance can be given that such expectations will prove correct. Factors that
could cause the Company's results to differ materially from the results
discussed in such forward-looking statements are disclosed in this report are
discussed below. All forward-looking statements in this Form 10-Q are expressly
qualified in their entirety by the cautionary statements in this paragraph.
During the period from August 1989 to September 30, 1995, two of the
Company's subsidiaries conducted refining operations. By December 12, 1995, the
Company's refining subsidiaries had sold all of their refining assets. In
addition, Powerine merged into a subsidiary of EMC and was no longer a
subsidiary of the Company. The Company's other refining subsidiaries own no
refining assets and are in the process of liquidation. As a result, the Company
accounted for its refining operations as discontinued operations in the
Company's financial statements as of September 30, 1995 and retroactively.
Accordingly, discussion of results of operations has been confined to the
results of continuing exploration and production operations and the anticipated
impact, if any, of liquidation of the Company's remaining inactive refining
subsidiaries and contingent environmental liabilities of the Company and its
refining subsidiaries.
Exploration and Production
As noted above, the Company sold all of its domestic oil and gas
properties to Delta on May 31, 2002. In addition, there has been no production
to date from the Company's investments in Romania. As a result, the following
exploration and production financial data for the nine month period ended June
30, 2002 represent only eight months of revenue and expense whereas the data for
the nine month period ended June 30, 2001 represent a full nine months of
revenue and expense.
Nine Months Ended June 30,
--------------------------
2002 2001
---- ----
Production Volumes:
- ------------------
Barrels of crude oil (net)...................................... 178,933 202,038
Mcf (thousand cubic feet) of natural gas (net).................. 2,160,170 2,393,829
Mcf equivalents (net) *......................................... 3,233,768 3,606,057
Oil/Gas Prices:-
- ----------------
Crude Oil/Barrel:
-----------------
Gross....................................................... $21.50 $26.75
Hedging effects.............................................
------ ------
Net of hedging.............................................. $21.50 $26.75
====== ======
Natural Gas/Mcf:
---------------
Gross....................................................... $ 2.49 $ 4.87
Hedging effects.............................................
------ ------
Net of hedging.............................................. $ 2.49 $ 4.87
====== ======
Oil and Gas Production Expenses/Mcf Equivalent..................... $ 1.01 $ 1.48
- ---------------------------------------------- ====== ======
- ---------
* Barrels of crude oil have been converted to mcf based upon relative energy
content of 6 MCF of natural gas per barrel of crude oil.
-13-
Oil and gas sales decreased approximately $6,072 from the first nine
months of fiscal 2001 to the first nine months of fiscal 2002 due to significant
decreases in oil and gas prices. The average price per mcfe decreased from
$4.73/mcfe for the nine months ended June 30, 2001 to $2.85/mcfe for the nine
months ended June 30, 2002. The decline in the price received for natural gas
was especially precipitous. For the nine months ended June 30, 2001, the average
price received per mcf of natural gas sold was $4.87 versus only $2.49 per mcf
for the nine months ended June 30, 2002.
Oil and gas sales decreased approximately $1,761 as a result of
decreases in oil and gas production. The production decrease was caused
primarily by the sale of the Company's domestic oil and gas properties to Delta
on May 31, 2002. From the nine months ended June 30, 2001 to the nine months
ended June 30, 2002 oil production decreased by 23,105 barrels and natural gas
production decreased by 233,659 mcf.
As a result of the $6,072 decrease in oil and gas sales due to a
decrease in oil and gas prices and the $1,761 decrease due to a decrease in oil
and gas production, there was a net decrease of $7,833 or 45.9% in oil and gas
sales from the nine months ended June 30, 2001 to the nine months ended June 30,
2002.
Oil and gas production expenses decreased $2,064 or 38.7% from the
first nine months of fiscal 2001 to the first nine months of fiscal 2002. A
portion of the decrease is attributable to the sale of the Company's domestic
oil and gas properties to Delta on May 31, 2002, resulting in only 8 months of
production expense during the period ended June 30, 2002 versus nine months of
production expenses during the same period in fiscal 2001. For the nine months
ended June 30, 2002, such expenses were $1.01 per equivalent mcf of production
versus $1.48 per equivalent mcf of production for the nine months ended June 30,
2001. The decrease in production expenses per equivalent mcf is primarily
attributable to a higher amount of nonrecurring repairs and maintenance incurred
during the nine months ended June 30, 2001 than were incurred during the nine
months ended June 30, 2002. The higher level of repairs and maintenance expenses
incurred during the nine month period ended June 30, 2001 related primarily to
the wells acquired from AmBrit in June 1999 since it appeared AmBrit did not
repair such wells pending their sale to the Company. Furthermore, oil and gas
production expenses are typically not incurred ratably throughout any given year
but are incurred when and if certain wells require repair and maintenance. As a
result, such comparisons are more appropriate on an annual or a multi-year basis
than on a nine month basis.
General and administrative expenses increased $412 or 9.43% from the
nine months ended June 30, 2001 to the nine months ended June 30, 2002. General
and administrative expenses increased $951 primarily as a result of severance
expenses related to employees who were or will be terminated as a result of the
sale of the Company's oil and gas properties to Delta. These increases of $951
were offset by decreased legal, insurance and other expenses of $358 and by $181
of costs incurred during the nine months ended June 30, 2001 related to a
previous effort by the Company to sell its oil and gas properties that
terminated in December 2000 without a sale. This resulted in the net increase of
$412.
Depreciation, depletion and amortization increased $885 or 39.1% from
the first nine months of fiscal 2001 to the first nine months of fiscal 2002.
This net increase consists of a decrease of $23 in depreciation of equipment and
furniture and fixtures from $102 to $79 and a $908 increase in depletion of oil
and gas properties from $2,164 to $3,072. The increase in depletion is primarily
attributable to an increase in the depletion rate. For the nine months ended
June 30, 2002, the depletion rate was $.95 per mcfe versus $.60 per mcfe for the
nine months ended June 30, 2001. The increase in depletion rate is indirectly
attributable to the significant decreases in oil and gas prices that occurred
between the two periods being compared. The reserve reports used to compute
depletion rates are prepared annually as of September 30, the Company's fiscal
year end. As a result of lower oil and gas prices at September 30, 2001 as
compared to those at September 30, 2000, the Company's economic oil and gas
reserves decreased significantly and the resultant cost per mcfe and depletion
rate per mcfe increased significantly.
Interest income decreased $525 from the first nine months of fiscal
2001 to the first nine months of fiscal 2002. The decrease was caused by a
significant decrease in invested cash and a decrease in the rate of interest
earned on such invested cash.
-14-
The following other income (expense) items are primarily related to the
sale of the Company's domestic oil and gas properties to Delta at May 31, 2002
and have no counterpart during the nine months ended June 30, 2001:
Gain on sale of domestic oil and gas properties.................................. $1,403
Impairment provision - marketable securities..................................... ($388)
Equity in loss of Delta Petroleum Company before June 1, 2002.................... ($165)
Equity in estimated loss of Delta Petroleum Company after May 31, 2002........... ($103)
Decrease in fair value of option granted to Delta Petroleum Corporation.......... $638
The $1,403 recorded gain on the Delta sale is analyzed in Note 6 to the
consolidated financial statements above. The impairment provision for marketable
securities relates to 382,289 shares of Delta's common stock acquired by the
Company in September 2000. The provision consists of a $204 impairment provision
recorded in the quarter ended March 31, 2002 and a $184 provision recorded at
June 30, 2002 to reduce the book value of the 382,289 shares of Delta to market
value prior to accounting for the Company's investment in Delta using the equity
method of accounting. The $638 decrease in the value of the option granted to
Delta results in income because it decreases the option liability recorded by
the Company in the Delta transaction. The equity in the estimated losses of
Delta represent the Company's share (approximately 44%) of Delta's estimated
losses. The estimated loss prior to May 31, 2002 is applicable only to the
382,289 shares of Delta owned by the Company before May 31, 2002 and
approximates 3.5% of Delta's losses for the period from September 2000 to May
31, 2002. Of the $165 loss recorded, $56 was incurred during the period April 1,
2002 to May 31, 2002 and the remainder was incurred from October 1, 2001 to
March 31, 2002. The estimated loss after May 31, 2002 applies to all 9,948,289
shares of Delta owned by the Company after closing of the Delta transaction on
May 31, 2002. These shares represent approximately 44% of Delta's outstanding
shares.
The Company's equity in the loss of Networked Energy LLC ("Networked")
increased $56 from $77 for the nine months ended June 30, 2001 to $133 for the
nine months ended June 30, 2002. The increase results from increased expenses
incurred by Networked, a start up company that has not yet earned operating
revenue.
The $435 tax benefit for the nine month period ended June 30, 2002
results primarily because of changes in the Company's expectations concerning
its future taxable income. The Company decreased its valuation allowance by $198
at June 30, 2002, resulting in a deferred tax asset, net of $946 of accrued
income taxes on appreciation of marketable securities, of $1,369.
The tax provision for the nine months ended June 30, 2001 represents
the utilization of a net deferred tax asset recorded at September 30, 2000 at an
effective tax rate of 36%. The deferred tax asset at September 30, 2000 resulted
when the Company reevaluated its ability to generate sufficient taxable income
to utilize the gross deferred tax asset attributable to its tax carryforwards.
Since November of 1996, the Company has reacquired 4,871,020 shares or
69% of its common stock (after taking into account a three for one stock split
in January 2000). As a result of these share acquisitions, earnings and losses
per outstanding share have been higher than would be the case if no shares had
been repurchased.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended June 30, 2002, the Company used $2,041
from operating activities. During the same period the Company invested $838 in
oil and gas properties and $150 in Networked. At June 30, 2002, the Company had
$17,471 of unrestricted cash, $24,592 of working capital, no long-term debt and
no operating assets or operating revenues, having sold all of its domestic oil
and gas properties to Delta on May 31, 2002.
At the present time the two most likely future courses of action for
the Company are liquidation and continuing to operate. As noted in previous
public filings, the most likely course of action is liquidation given the
Company's lack of operating assets and the ever-increasing regulatory, legal,
accounting and administrative costs of being a public company. The Company
could, however, continue to operate absent a decision to liquidate or
stockholder approval of any future plan of liquidation. At the present time, the
Company's directors are considering several courses of action based upon the
current impasse with ChevronTexaco (see Note 4 to the consolidated financial
statements). Since the Company's Board of Directors has discussed but not yet
formally adopted a plan of liquidation, the future impacts of both liquidation
and continuing operations are discussed below. The Company's directors are
currently leaning toward liquidation.
-15-
LIQUIDATION
If a decision is made to liquidate, it is anticipated that the Company
would distribute some cash and Delta shares to its stockholders in complete
liquidation of their stock as soon as possible while retaining sufficient assets
to reasonably provide for existing and anticipated future liabilities, including
those related to the contingent environmental claims and some current
litigation. Such provision would include the Company's $3,886 letter of credit
provided for its supersedeas bond as required by the Company's appeal of the
Long Trust litigation (see Note 4 to the consolidated financial statements) and
sufficient assets to provide a reasonable reserve for the Company's outstanding
litigation claims and other liabilities. If any net assets remain after the
Company pays or provides for such remaining liabilities, the net proceeds of
such assets would then be distributed to stockholders as a final distribution.
The Company would probably also file a no action letter with the SEC seeking
relief from continuous SEC reporting requirements. Such a plan of liquidation or
any other plan of liquidation would be subject to prior approval by the
Company's stockholders. The primary risks associated with such a liquidation
scenario are as follows:
a. Litigation - As noted above, the Company is a party in two
significant unsettled lawsuits and has received a claim from
ChevronTexaco for environmental remediation costs of
$80,000-$150,000. Although the Company does not believe it has any
material liabilities with respect to either lawsuit or with respect
to ChevronTexaco's claim, these parties could undertake legal
actions to prevent the Company from making liquidating distributions
to its stockholders. Any resulting litigation could not only cause
the Company to incur significant legal costs but could also delay
any distributions to stockholders for years and/or reduce or
eliminate entirely such distributions. If ChevronTexaco were to
litigate and prevail in such litigation (see Note 4 to the June 30,
2002 consolidated financial statements), ChevronTexaco's recovery
could conceivably exceed the Company's net worth and prevent
liquidating distributions to stockholders. ChevronTexaco could also
conceivably sue larger stockholders of the Company after a
distribution had been made. In addition, even if the Company's
stockholders approve any future plan of liquidation, dissident
stockholders of the Company could conceivably also take legal
actions to prevent the Company from implementing any liquidation
plan.
b. Tax Risks - As a result of the Delta transaction, the Company
received 9,566,000 shares of Delta's common stock in addition to the
382,289 shares of Delta common stock it previously owned. If the
Delta stock price increases before any distribution to stockholders,
the Company could be subject to federal and state income tax at the
corporate level on the interim appreciation of Delta's stock if the
Company's remaining tax carryforwards are not sufficient to offset
income taxes on such appreciation. Under such circumstance the tax
treatment is the same as if the Company sold its Delta shares for
their fair market value and then distributed the proceeds to its
stockholders. Such could be the case if there are delays in making
distributions to stockholders and Delta's stock price increases in
the interim. Any resulting gain would essentially constitute phantom
income to the Company since the Company would realize a taxable gain
without receiving any related proceeds.
c. Continuing Public Company Administrative Burden - If the Company's
directors decide to liquidate, the Company will probably seek relief
from most of its public company reporting requirements. If such a
request is denied by the SEC, the Company would continue incurring
the costs of being a public company while having no operating
revenues to absorb such costs. Such costs are significant. The
result would be a diminution of assets available for distribution to
stockholders.
d. Lack of Liquidity - If the Company's directors decide to liquidate
and the related plan of liquidation is approved by the Company's
stockholders, it is likely that the Company's stock would cease to
trade after the plan of liquidation is filed. In such a case,
stockholders would not be able to trade their stock. Stockholders
who have used their Company stock as collateral for margin loans
would probably be required to provide other collateral to support
such loans. Even if the Company is able to distribute Delta stock as
part of its initial distribution to stockholders without any legal
challenges or other delays, there could be a delay between the date
the Company's stock is delisted and the date when the Company's
stockholders receive Delta shares that could be substituted as
collateral for a margin loan. Stockholders would presumably have to
provide other collateral in the interim.
e. Liquidation of Assets - The Company's primary remaining assets
consist of the Company's investments in Penn Octane Corporation
("Penn Octane") (1,343,000 shares) and Delta (9,948,289 shares).
Although all of the Company's shares of Delta have recently been
registered and most of the Company's shares of Penn Octane are
already registered, both Penn Octane and Delta are small, thinly
capitalized companies with small trading volumes and the Company may
not be able to sell its Penn Octane stock and/or its Delta stock for
their listed market prices if the Company needs cash to distribute
to its stockholders or to liquidate liabilities. In addition, the
-16-
Company owns a 50% interest in a Romanian drilling concession but
has recently decided to sell that interest. The parties to the
related joint venture planned to drill a wildcat well in the Black
Sea but drilling has been postponed several times due to regulatory
matters and difficulties in securing a drilling rig. The Company may
not be able to sell its interest and recover any proceeds given the
risks of international exploratory drilling. If the Company
eventually participates in the wildcat well and it results in a dry
hole, the Company would probably spend at least $1,000 by
participating and such expenditures would reduce the cash available
for future distributions to stockholders.
f. Delta Repurchase Option - As noted above, Delta has the option to
repurchase up to 3,188,667 of its shares from the Company until May
31, 2003 at $4.50/share. As a result, the Company will not be able
to distribute or sell these shares until May 31, 2003 unless Delta
exercises or waives its option sooner.
CONTINUING TO OPERATE
If the Company does not liquidate but instead continues to operate, the
Company would still be subject to several of the risks noted above, including
litigation risk, the continuing public company administrative burden, the lack
of liquidity and liquidation of asset risk (if the Company decides to liquidate
its remaining assets). In addition, the Company would lack operating assets,
operating personnel (since most of its personnel have already been severed) and
a business to operate. Under such circumstances, the Company would be subject to
many competitive disadvantages if it again decides to acquire energy assets or
other assets and businesses. Although some analysts believe it may be possible
to acquire oil and gas properties at favorable prices at the present time or in
the near future, there can be no assurance that such will be the case. Many
energy companies have more financial resources than the Company and could easily
outbid the Company in such an acquisition scenario. Furthermore, failure by the
Company to be engaged primarily in a business other than that of investing,
reinvesting, owning, holding or trading in securities within one year following
closing of the sale to Delta could subject the Company to federal regulation
under the Investment Company Act of 1940, and this would result in even more
significant regulatory compliance costs and obligations.
In addition, if the Company continues to operate, it would be subject
to the following continuing risk factors:
a. Contingent environmental liabilities (see Note 4 to the consolidated
financial statements).
b. Public market for Company's stock - the small trading volumes in the
Company's stock may create liquidation problems for large investors
in the Company.
c. Foreign country operating risks - if the Company participates, the
possibility that the Company's costs to participate in the drilling
of and, if successful, production from the wildcat well planned for
the Black Sea could significantly exceed those estimated by the
Company due to foreign political, operating and insurance risks.
d. Other risks including general business risks, insurance claims
against the Company in excess of insurance coverage, tax liabilities
resulting from tax audits and litigation risk. (See Note 4 to the
consolidated financial statements.)
CRITICAL ACCOUNTING POLICIES:
The accounting policies critical to the Company in the future, are as
follows:
Equity Method of Accounting
The Company currently owns approximately 44% of Delta and accounts for
its investment in Delta using the equity method of accounting. Under this
method, the Company is required to increase its investment in Delta by its share
of Delta's future income and decrease such investment by its share of Delta's
future losses and any distributions from Delta. If Delta incurs future losses,
the Company would thus include its share of such losses in its consolidated
statement of operations. In addition, the Company expects that its investment in
Delta exceeded the Company's proportional share of Delta's equity by
approximately $6,900 at closing. The Company has allocated such excess to
Delta's contingent legal recovery from a lawsuit Delta and other owners of
offshore California leases have instituted
-17-
against the Federal Government for breach of contract. Such contingent legal
recovery is considered an intangible asset, and the Company will be required to
evaluate the recoverability of such contingent legal recovery periodically and
write it off or reduce it to the extent it is not deemed recoverable. If Delta
incurs recurring losses in the future and/or the market value of its stock
declines significantly, the Company's investment may be impaired and the Company
may then be required to recognize the impairment.
Discontinued Refining Operations
At June 30, 2002, the Company had recorded net refining liabilities
retained of $3,016 and an estimated value of discontinued net refining assets of
$612, resulting in a recorded net liability of $2,404. As noted in Note 4 to the
consolidated financial statements, ChevronTexaco has made a claim against the
Company for environmental costs that have been estimated at $80,000-$150,000 and
the Company and ChevronTexaco are currently discussing these claims against the
Company. The Company's accounting policy with respect to contingent
environmental liabilities is to record environmental liabilities when and if
environmental assessment and/or remediation costs are probable and can be
reasonably estimated. Although the Company and its special counsel believe that
ChevronTexaco's claims are utterly without merit, the Company would be required
to record additional environmental liabilities if it becomes probable that the
Company will incur liabilities related to ChevronTexaco's claims or other
environmental liabilities and such liabilities exceed $2,404. As noted above, if
such liabilities exceed the value of the Company's assets, the Company would not
have the financial capability to pay such liabilities. The Company has
classified the estimated realizable value of discontinued net refining assets
and net refining liabilities retained as non current because it appears that
these items will not be realized in the next year given the recent legal
challenges by ChevronTexaco against the Plan of Liquidation of American Western
(see Note 4 to the consolidated financial statements). The amounts and
classification of the estimated values of discontinued net refining assets and
net refining liabilities retained could change significantly in the future as a
result of litigation or other factors.
Future Distributions to Stockholders, If Any
If the Company's Board of Directors decides to liquidate the Company, it
is probable that the related plan of liquidation would contemplate distributions
to stockholders of shares of Delta common stock and perhaps of other assets of
the Company. If the Company distributes Delta stock or other assets to
stockholders, the Company will first adjust the book value of the assets to be
distributed to their fair market values, recognizing the resultant gain or loss
as if the Company had first sold the related assets for their fair market
values. The Company would then record the distribution as a charge to retained
earnings equal to the adjusted book value (fair market value) of the assets
being distributed.
Changes in the Value Allocated to the Delta's Repurchase Option
As part of the Delta sale, the Company granted Delta an option to
repurchase up to 3,188,667 of its shares for $4.50/share until May 31, 2003. At
closing on May 31, 2002, the Company valued that option at $2,681 using the
Black Scholes method. The Company will be required to account for changes in the
value of this option by recording gains or losses, as applicable, in its
Statement of Operations. If the option expires by its own terms or is only
partially exercised at expiration, the Company would then record a gain equal to
the remaining book value of the unexercised options.
Valuation Allowance for Deferred Income Tax Asset
At June 30, 2002, the Company recorded a valuation allowance of $3,361
offsetting its gross deferred tax asset of $5,676 at that date. The valuation
allowance is based upon the Company's assessment of the Company's future
prospects for generating future taxable income to utilize some or all of its
deferred tax asset at June 30, 2002. At June 30, 2002, the Company has several
assets where the Company's tax basis either exceeds or is less than the fair
market value of the related assets. In addition, the Company is a party to
several lawsuits and a claim for environmental indemnification for which the
Company has recorded no liability. Finally, the Company expects to incur
significant general and administrative expenses liquidating its assets without
earning offsetting revenue. Based upon its current analysis, the Company expects
future taxable income only to the extent it will allow the Company to utilize
only $2,315 of its gross deferred tax asset and has thus decreased its valuation
allowance to $3,361 at June 30, 2002. If circumstances change such that the
Company expects future taxable income, the Company will revise its valuation
allowance, resulting in tax recoveries.
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Item 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company has sold all of its oil and gas production and currently is
not subject to market risk on the prices received for oil and gas production as
in the past.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For information regarding lawsuits, reference is made to Item 3 of the
Company's Form 10-K (Annual Report) for the fiscal year ended September 30,
2001. Also see Note 4 to the June 30, 2002 financial statements included in Part
I.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits:
Exhibit 11.1 - Statement re: Computation of Earnings Per Share
Exhibit 99.1 Certification of Chief Executive Officer
Exhibit 99.2 Certification of Chief Financial Officer
(B) Reports on Form 8-K: - Form 8-K dated
May 31, 2002 concerning the Sale of the
Company's Domestic Oil and Gas
Properties to Delta Petroleum
Corporation
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 16, 2002 CASTLE ENERGY CORPORATION
---------------
/s/ Richard E. Staedtler
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Richard E. Staedtler
Chief Financial Officer
Chief Accounting Officer
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