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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 December 31, 2002
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period ended
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Commission file number: 0-10990
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CASTLE ENERGY CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
Delaware 76-0035225
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
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
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-------------------------------------------------------------
(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: 6,592,884 shares of
Common Stock, $.50 par value, outstanding as of February 6, 2003.
CASTLE ENERGY CORPORATION
INDEX
Page #
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Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets - December 31, 2002 (Unaudited) and
September 30, 2002.................................................................. 2
Consolidated Statements of Operations - Three Months Ended December 31,
2002 and 2001 (Unaudited)........................................................... 3
Condensed Consolidated Statements of Cash Flows - Three Months Ended
December 31, 2002 and 2001 (Unaudited).............................................. 4
Consolidated Statements of Stockholders' Equity and Other Comprehensive
Income - Year Ended September 30, 2002 and Three Months Ended
December 31, 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....................................................................... 15
Item 3. Qualitative and Quantitative Disclosures About Market Risk.......................... 20
Item 4. Controls and Procedures............................................................. 20
Part II. Other Information
Item 1. Legal Proceedings................................................................... 21
Item 6. Exhibits and Reports on Form 8-K.................................................... 21
Signature ............................................................................................ 22
The accompanying notes are an integral part of these financial statements
-1-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("$000's" Omitted Except Share Amounts)
December 31, September 30,
2002 2002
------------ -------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents ........................................ $ 13,843 $ 15,539
Restricted cash .................................................. 4,248 4,230
Accounts receivable .............................................. 109 108
Marketable securities ............................................ 4,434 3,046
Prepaid expenses and other current assets ........................ 163 197
Note receivable - Networked Energy LLC ........................... 125
Deferred income taxes ............................................ 857 429
--------- ---------
Total current assets ........................................... 23,779 23,549
Estimated realizable value of discontinued net refining assets ....... 612 612
Property, plant and equipment, net:
Furniture, fixtures and equipment ................................ 107 153
Investment in Networked Energy LLC ................................... 354 375
Investment in Delta Petroleum Corporation ............................ 27,072 26,886
Deferred income taxes ................................................ 366 366
--------- ---------
Total assets ...................................................... $ 52,290 $ 51,941
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable ................................................. $ 328 $ 330
Accounts payable ................................................. 191 413
Accrued expenses ................................................. 299 821
Accrued taxes on appreciation of marketable securities ........... 773 274
Fair value of options granted to Delta Petroleum Corporation ..... 234 432
--------- ---------
Total current liabilities ...................................... 1,825 2,270
Net refining liabilities retained .................................... 3,016 3,016
Long-term liabilities ................................................ 11
--------- ---------
Total liabilities .............................................. 4,841 5,297
--------- ---------
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 December 31, 2002 and September 30,
2002 ......................................................... 5,752 5,752
Additional paid-in capital ....................................... 67,365 67,365
Accumulated other comprehensive income - unrealized gains on
marketable securities, net of taxes ............................ 1,375 487
Retained earnings ................................................ 39,624 39,707
--------- ---------
114,116 113,311
Treasury stock at cost - 4,911,020 shares at December 31, 2002 and
September 30, 2002 ............................................. (66,667) (66,667)
--------- ---------
Total stockholders' equity ..................................... 47,449 46,644
--------- ---------
Total liabilities and stockholders' equity ..................... $ 52,290 $ 51,941
========= =========
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)
Three Months Ended December 31,
--------------------------------
2002 2001
----------- -----------
Revenues:
Oil and gas sales ................................................ $ 3,441
-----------
3,441
-----------
Expenses:
Oil and gas production ........................................... 1,254
General and administrative ....................................... $ 611 1,371
Depreciation, depletion and amortization ......................... 15 1,242
----------- -----------
626 3,867
----------- -----------
Operating loss ........................................................... (626) (426)
----------- -----------
Other income (expense):
Interest income .................................................. 63 33
Other income ..................................................... 14 1
Decrease in fair value of option granted to Delta Petroleum
Corporation .................................................... 198
Equity in loss of Networked Energy LLC ........................... (20) (34)
Equity in income of Delta Petroleum Corporation .................. 188
----------- -----------
443 0
----------- -----------
Loss before benefit of income taxes ...................................... (183) (426)
Benefit of income taxes:
State ............................................................ (12) (4)
Federal .......................................................... (416) (150)
----------- -----------
(428) (154)
----------- -----------
Net income (loss) ........................................................ $ 245 ($ 272)
=========== ==========
Net income (loss) per share:
Basic ............................................................ $ .04 ($ .04)
=========== ==========
Diluted .......................................................... $ .04 ($ .04)
=========== ==========
Weighted average number of common and potential dilutive common shares
outstanding:
Basic ............................................................. 6,592,884 6,632,884
=========== ==========
Diluted ........................................................... 6,603,302 6,753,630
=========== ==========
The accompanying notes are an integral part of these financial statements
-3-
CASTLE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
("$000's" Omitted Except Share Amounts)
(Unaudited)
Three Months Ended December 31,
-------------------------------
2002 2001
-------- --------
Net cash flow used in operating activities ........... ($ 1,241) ($ 1,165)
-------- --------
Cash flows from investing activities:
Investment in note to Networked Energy LLC .... (125)
Investment in oil and gas properties .......... (358)
Investment in furniture, fixtures and equipment (1)
-------- --------
Net cash used in investing activities ....... (125) (359)
-------- --------
Cash flows from financing activities:
Dividends paid to stockholders .............. (330) (331)
-------- --------
Net cash used in financing activities ....... (330) (331)
-------- --------
Net decrease in cash and cash equivalents ............ (1,696) (1,855)
Cash and cash equivalents - beginning of period ...... 15,539 5,844
-------- --------
Cash and cash equivalents - end of period ............ $ 13,843 $ 3,989
======== ========
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, 2002 and Three Months Ended December 31, 2002 (Unaudited)
----------------------------------------------------------------------------------
Accumulated
Common Stock Additional Other
---------------------- Paid-In Comprehensive Comprehensive
Shares Amount Capital Income Income
---------- ------ ------- ------------- -------------
Balance - October 1, 2001............... 11,503,904 $5,752 $67,365 $1,600
Stock acquired..........................
Dividends declared ($.15 per share).....
Comprehensive income (loss):............
Net loss.............................. ($2,102)
Other comprehensive loss:.............
Unrealized loss on marketable
securities, net of tax............. (1,113) (1,113)
-------
($3,215)
---------- ------ ------- ======= ======
Balance - September 30, 2002............ 11,503,904 5,752 67,365 487
Dividends declared ($.05 per share).....
Comprehensive income (loss):
Net income............................ $ 245
Other comprehensive income:...........
Unrealized gain on marketable
securities, net of tax............ 888 888
-------
$1,133
---------- ------ ------- ======= ======
Balance - December 31, 2002............. 11,503,904 $5,752 $67,365 $1,375
========== ====== ======= ======
Year Ended September 30, 2002 and Three Months
Ended December 31, 2002 (Unaudited)
-------------------------------------------------
Retained Treasury Stock
Earnings ---------------------
(Deficit) Shares Amount Total
--------- --------- -------- -------
Balance - October 1, 2001............... $42,816 4,871,020 ($66,506) $51,027
Stock acquired.......................... 40,000 (161) (161)
Dividends declared ($.15 per share)..... (1,007) (1,007)
Comprehensive income (loss):............
Net loss.............................. (2,102) (2,102)
Other comprehensive loss:.............
Unrealized loss on marketable
securities, net of tax............. (1,113)
------- --------- -------- -------
Balance - September 30, 2002............ 39,707 4,911,020 (66,667) 46,644
Dividends declared ($.05 per share)..... (328) (328)
Comprehensive income (loss):
Net income............................ 245 245
Other comprehensive income:...........
Unrealized gain on marketable
securities, net of tax............
888
------- --------- -------- -------
Balance - December 31, 2002............. $39,624 4,911,020 ($66,667) $47,449
======= ========= ======== =======
The accompanying notes are an integral part of these financial statements.
-5-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted 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, where applicable, 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 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 period ended December 31, 2002 are not necessarily
indicative of the results that may be expected for the fiscal year ending
September 30, 2003 or subsequent 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, 2002.
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 periods ended December 31, 2002 and 2001 and
for a fair statement of financial position at December 31, 2002.
Note 2 - September 30, 2002 Balance Sheet
The amounts presented in the balance sheet as of September 30, 2002
were derived from the Company's audited consolidated financial statements which
were included in its Annual Report on Form 10-K for the fiscal year ended
September 30, 2002.
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 seven years and are 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 - Environmental Liabilities/Litigation
ChevronTexaco Litigation
On August 13, 2002, three subsidiaries of ChevronTexaco, Inc.
(collectively, "ChevronTexaco") filed Cause No. 02-4162-JPG in the United States
District Court for the Southern District of Illinois against the Company, as
well as against two inactive subsidiaries of the Company and three unrelated
parties. The lawsuit seeks damages and declaratory relief under contractual and
statutory claims arising from environmental damage at the now dismantled Indian
Refinery. In particular, the lawsuit claims that the Company is contractually
obligated to indemnify and defend ChevronTexaco against all liability and costs,
including lawsuits, claims and administrative actions initiated by the EPA and
others, that ChevronTexaco has or will incur as a result of environmental
contamination at and around the Indian Refinery, even if that environmental
contamination was caused by Texaco, Inc. and its present and former subsidiaries
("Texaco" - now merged into ChevronTexaco) which previously owned the refinery
for over 75 years. The suit also seeks costs, damages and declaratory relief
against the Company under the Federal Comprehensive Environmental Response
Compensation Liability Act ("CERCLA"), the Oil Pollution Act of 1990 ("OPA") and
the Solid Waste Disposal Act, as amended, ("RCRA").
-6-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
History
In December 1995, IRLP sold its refinery, the Indian Refinery,
to American Western Refining Limited Partnership ("American Western"), an
unaffiliated party. As part of the related purchase and sale agreement, American
Western assumed all environmental liabilities and indemnified Indian Refining
Limited Partnership, an inactive refining subsidiary of the Company ("IRLP"),
with respect thereto. Subsequently, American Western filed for bankruptcy and
sold large portions of 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 primarily because of legal challenges by Texaco,
and now ChevronTexaco. American Western believes that those challenges have been
resolved and currently estimates that confirmation should occur in late March
2003.
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.
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 an area of approximately 1,000 acres, which the EPA later
designated as the Indian Refinery-Texaco Lawrenceville Superfund Site. In
addition, eighteen other parties were named including Texaco and a subsidiary of
Texaco which 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.
Claims by Texaco
On August 7, 2000, the Company received notice of a claim
against it and two of its inactive refining subsidiaries from Texaco. 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 were liable
to Texaco under the CERCLA as owners and operators of the Indian Refinery. The
Company responded to Texaco disputing the factual and legal contentions 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 October 2001, Texaco merged with
Chevron and the merged Company was named ChevronTexaco.
In May 2002, the Company received a letter from ChevronTexaco
which asserted a new claim against the Company and its subsidiaries pursuant to
OPA for costs and damages incurred or to be incurred by ChevronTexaco resulting
from actual or threatened discharges of oil to navigable waters at or near the
Indian Refinery. ChevronTexaco estimated these costs and damages to be $20,500.
The Company's general counsel subsequently corresponded with
ChevronTexaco and the Company voluntarily provided a number of documents
requested by 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.
-7-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
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 residential
landowners adjacent to the Indian Refinery site had recently filed a toxic torts
suit against ChevronTexaco in Illinois state court. The meeting ended in an
impasse.
Litigation
On August 13, 2002, ChevronTexaco filed the above litigation in
federal court. By letter dated August 28, 2002, ChevronTexaco tendered the
Illinois state court litigation to the Company for indemnification, but the
Company promptly responded, denying responsibility. The Company has retained
Bryan Cave LLP as trial counsel.
On October 25, 2002, the Company filed motions to dismiss as a
matter of law the contractual claims in Texaco's complaint, as well as the OPA
and RCRA claims. At the same time, the Company filed its answer to
ChevronTexaco's lawsuit on the remaining CERCLA claim. The Federal District
Court has not set a preliminary trial date for this matter due to the complexity
of this matter and the crowded docket of the Court. Because of procedural
disputes between ChevronTexaco and other defendants in the case, pre-trial
scheduling and discovery have been delayed. The Company does intend to pursue
all available opportunities for early dismissal of this matter, including
requests for summary judgement prior to trial.
The central argument to both ChevronTexaco's contractual and
statutory claims is that the Company should be treated as a "successor" and
"alter ego" of certain of its present and former subsidiaries, and thereby
should be held directly liable for ChevronTexaco's claims against those
entities. ChevronTexaco makes this argument notwithstanding the fact that the
Company never directly owned the refinery or was a party to any of the disputed
contracts. ChevronTexaco has also claimed that the Company itself directly
operated the refinery. The leading opinion in this area of the law, as 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), supports the Company's positions.
Estimated gross undiscounted clean-up costs for this refinery
are at least $80,000-$150,000 according to public statements by Texaco to the
Company and third parties. In January 2003, the United States and the State of
Illinois filed a motion in the American Western bankruptcy case which stated
that the estimated total response costs for one portion of the site alone could
range from $109,000 to $205,000. ChevronTexaco has asserted in its contractual
claim that the Company should indemnify ChevronTexaco for all environmental
liabilities related to the Indian Refinery. If ChevronTexaco were to prevail on
this theory, the Company could be held liable for the entirety of the estimated
clean up costs, a sum far in excess of the Company's financial capability. On
the other hand, if the Company were found liable by reason of ChevronTexaco's
statutory claims for contribution and reimbursement under CERCLA and/or OPA, the
Company could be required to pay a percentage of the clean-up costs based on
equitable allocation factors such as comparative time of ownership and
operation, toxicity and amount of hazardous materials released, remediation
funded to date, as well as other factors. Since the Company's subsidiary only
operated the Indian Refinery five years, whereas Texaco operated it over
seventy-five years, the Company would expect that its share of remediation
liability would at a minimum be reduced to an amount proportional to the years
of operation by its subsidiary, although such may not be the case. Additionally,
since Texaco and its subsidiaries intentionally disposed of hazardous wastes on
site at the Indian Refinery while the Company's subsidiary arranged to remove
for offsite destruction and disposal any hazardous wastes it may have generated,
any allocation to the Company and its subsidiaries might be further reduced.
-8-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
The Company and its special counsel, Reed Smith LLP, believe that
ChevronTexaco's previous and current claims, including ChevronTexaco's newly
expressed legal theories, are utterly without merit and the Company intends to
vigorously defend itself against all of ChevronTexaco's claims in the litigation
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.
Contingent Environmental Liabilities
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. If funds for environmental clean-up are
not provided by former and/or present owners, it is possible that the Company
and/or one of its former refining subsidiaries could be held responsible or
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.
Although any environmental liabilities related to the Indian 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.
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 and ChevronTexaco has tendered the defense of a
state court toxic torts action to the Company. Whether or not the Company is
ultimately held liable in the current litigation or other proceedings, it is
probable that the Company will incur substantial legal fees and experience a
diversion of corporate resources from other opportunities.
Powerine
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.
Long Trusts Lawsuit
There have been no significant developments since those reported in the
Company's Form 10-K for the year ended September 30, 2002.
Pilgreen Litigation
There have been no significant developments since those reported in the
Company's Form 10-K for the year ended September 30, 2002.
-9-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Dominion Litigation
There have been no significant developments since those reported in the
Company's Form 10-K for the year ended September 30, 2002.
Note 5 - New Accounting Pronouncements
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") were issued in
July 2001. SFAS No. 141 requires that all business combinations entered into
subsequent to June 30, 2001 be accounted for under the purchase method of
accounting and that certain acquired intangible assets in a business combination
be recognized and reported as assets apart from goodwill. SFAS No. 142 requires
that amortization of goodwill be replaced with periodic tests of the goodwill's
impairment at least annually in accordance with the provisions of SFAS No. 142
and that intangible assets other than goodwill be amortized over their useful
lives. The Company adopted SFAS No. 141 in July 2001 and adopted SFAS No. 142 on
October 1, 2002. Amortization of goodwill for the quarter ended December 31,
2001 was $3.
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations" ("SFAS No. 143"), which provides accounting requirements
for retirement obligations associated with tangible long-lived assets,
including: 1) the timing of liability recognition; 2) initial measurement of the
liability; 3) allocation of asset retirement cost to expense; 4) subsequent
measurement of the liability; and 5) financial statement disclosures. SFAS No.
143 requires that asset retirement cost be capitalized as part of the cost of
the related long-lived asset and subsequently allocated to expense using a
systematic and rational method. Any transition adjustment resulting from the
adoption of SFAS No. 143 would be reported as a cumulative effect of a change in
accounting principle. The Company adopted this statement effective October 1,
2002. The adoption of this statement did not have any effect on the Company's
future financial position or results of operations since the Company disposed of
its long-lived assets, its oil and gas properties, to which SFAS No. 143 would
have applied, in May 2002.
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long- Lived Assets" ("SFAS No. 144"), which will be
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. SFAS No. 144
requires that long-lived assets to be disposed of by sale be measured at the
lower of the carrying amount or fair value less cost to sell, whether reported
in continuing operations or in discontinued operations. SFAS No. 144 broadens
the reporting of discontinued operations to include all components of an entity
with operations that can be distinguished from the rest of the entity and that
will be eliminated from the ongoing operations of the entity in a disposal
transaction. After its effective date, SFAS No. 144 will be applied to those
transactions where appropriate. The Company adopted SFAS No 144 effective
October 1, 2002. The Company's adoption of this statement has not had any effect
on its financial position or results of operations.
Statement of Financial Accounting Standards No. 145, Recission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections ("SFAS No. 145") was issued in April 2002. This statement rescinds
SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, which
required all gains and losses from extinguishment of debt to be aggregated and,
if material, classified as an extraordinary item, net of income taxes. As a
result, the criteria in Accounting Principles Board No. 30 ("APB 30") will now
be used to classify those gains and losses. Any gain or loss on the
extinguishment of debt that was classified as an extraordinary item in prior
periods presented that does not meet the criteria in APB 30 for classification
as an extraordinary item shall be reclassified. The provisions of this Statement
are effective for fiscal years beginning after January 1, 2003 and the Company
expects to adopt SFAS No. 145 on October 1, 2003. The Company does not expect at
this time that adoption of this statement will have a material effect on its
future financial position or results of operations.
-10-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Statement of Financial Accounting Standards No. 146,
"Accounting for Exit or Disposal Activities" ("SFAS No. 146"), was issued in
June 2002. SFAS No. 146 addresses significant issues regarding the recognition,
measurement and reporting of disposal activities, including restructuring
activities that are currently accounted in EITF Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Activity." The provisions of SFAS
146 are effective for exit or disposal activities initiated after December 31,
2002. The Company does not expect SFAS No. 146 to have any affect on its future
financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB
Statement No. 123" ("SFAS No. 148"). This Statement amends FASB Statement No.
123, "Accounting for Stock-Based Compensation," to provide alternative methods
of transition for a voluntary change to the fair value method of accounting for
stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of Statement No. 123 to require prominent disclosures in
both annual and interim financial statements. Certain of the disclosure
modifications are required for fiscal years ending after December 15, 2002.
Since the Company has not issued any stock options since January 2002, the
provisions of SFAS No. 148 have not had any effect on the Company's financial
position or results of operations.
In November 2002, the FASB issued Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness to Others, an Interpretation of FASB
Statements No. 5, 57 and 107 and a Rescission of FASB Interpretation No. 34"
("Interpretation No. 45"). This Interpretation elaborates on the disclosures to
be made by a guarantor in its interim and annual financial statements about its
obligations under guarantees issued. The Interpretation also clarifies that a
guarantor is required to recognize, at inception of a guarantee, a liability for
the fair value of the obligation undertaken. The initial recognition and
measurement provisions of Interpretation No. 45 are applicable to guarantees
issued or modified after December 31, 2002. The disclosure requirements are
effective for financial statements of interim and annual periods ending after
December 31, 2002. The Company does not expect Interpretation No. 45 to have a
material effect on the Company's future financial position or results of
operations.
In January 2003, the FASB issued Interpretation No. 46,
"Consolidation of Variable Interests Entities, an Interpretation of ARB No. 51"
("Interpretation No. 46"). This Interpretation addresses the consolidation by
business enterprises of variable interest entities as defined in the
Interpretation. Interpretation No. 46 applies immediately to variable interests
in variable interest entities created after January 31, 2003, and to variable
interests in variable interest entities obtained after January 31, 2003. For
public enterprises with a variable interest in a variable interest entity
created before February 1, 2003, the Interpretation applies to that enterprise
no later than the beginning of the first interim or annual reporting period
beginning after June 15, 2003. The Interpretation requires certain disclosures
in financial statements issued after January 31, 2003 if it is reasonably
possible that the Company will consolidate or disclose information about
variable interest entities when the Interpretation becomes effective. The
Company does not expect Interpretation No. 46 to have any effect on the
Company's future financial position or results of operations.
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 Petroleum Corporation, a public
exploration and production company ("Delta"). The sale was pursuant to a
definitive purchase and sale agreement dated January 15, 2002. 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 $2,682 at May 31, 2002 using the
Black Scholes method and recorded as a liability. At December 31, 2002, the
value of the option granted to Delta had decreased to $234, resulting in income
to the Company. As a result of the sale, the Company owns approximately 44% of
Delta.
-11-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Note 7 - Income Taxes
The Company's deferred taxes are comprised of the following:
December 31, 2002 September 30, 2002
----------------- ------------------
(Unaudited)
Deferred tax assets - gross......... $5,857 $5,792
Valuation allowance................. (4,634) (4,997)
------ ------
Deferred tax assets - net........... $1,223 $ 795
====== ======
At December 31, 2002, the Company determined that $4,634 of its
gross deferred tax asset more likely than not would not be realized and thus
decreased its valuation allowance from $4,997 at September 30, 2002 to $4,634 at
December 31, 2002. If future taxable income (loss) estimates change, the Company
will change its valuation allowance. The net deferred tax asset relates to
income that has been recognized for tax purposes and has not been recognized for
financial reporting purposes.
Note 8 - Restricted Cash
Restricted cash consists of the following:
December 31, 2002 September 30, 2002
----------------- ------------------
(Unaudited)
Funds supporting bond for Long Trusts Lawsuit.......... $4,038 $4,020
Funds supporting letters of credit for operating bonds. 210 210
------ ------
$4,248 $4,230
====== ======
The Company anticipates that the funds supporting letters of
credit for operating bonds will be replaced by Delta before March 31, 2003.
-12-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Note 9 - Investment in Delta Petroleum Corporation
Condensed financial information concerning Delta is as follows:
Condensed Balance Sheet
December 31, 2002 September 30, 2002
----------------- ------------------
(Unaudited)
Assets
Current assets ................................................. $ 7,915 $ 8,392
Oil and gas properties, net .................................... 66,519 66,147
Other assets ................................................... 429 432
------- -------
$74,863 $74,971
======= =======
Liabilities and Stockholders' Equity
Current liabilities, including current portion of long-term debt $ 6,123 $ 7,085
Long-term liabilities .......................................... 22,803 23,584
Stockholders' equity ........................................... 45,937 44,302
------- -------
$74,863 $74,971
======= =======
For the Three Months Ended
December 31,
------------------------------
2002 2001
---- ----
(Unaudited)
Condensed Statement of Operations
Revenue:
Oil and gas sales.............................................. $ 6,091 $ 1,763
Other.......................................................... (387) 26
------- -------
5,704 1,789
------- -------
Expense:
Lease operating expenses....................................... 2,567 1,093
General and administrative..................................... 977 698
Depreciation, depletion and amortization....................... 1,192 869
Other.......................................................... 118 471
------- -------
4,854 3,131
------- -------
Other (expense).................................................. (422) (320)
------- -------
Income (loss) before taxes....................................... 428 (1,662)
Income taxes.....................................................
------- -------
Net income (loss)................................................ $ 428 ($ 1,662)
======= =======
The above condensed financial information has been compiled using
Delta's unaudited quarterly financial statements for the quarters ended December
31, 2002 and 2001 and September 30, 2002.
Delta' stock is traded on the Nasdaq stock market under the symbol
"DPTR." At December 31, 2002, the closing price of Delta's common stock was
$3.40.
At December 31, 2002, there were approximately 5,400,000 options and
warrants to acquire Delta's stock outstanding, including options and warrants
that are out of the money. The Company holds none of these options and warrants.
If all such options and warrants had been exercised at December 31, 2002, the
Company's percentage ownership of Delta would decrease to approximately 36%.
-13-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Note 10 - Amendment of Stockholder Rights Plan
On April 21, 1994, the Board of Directors of the Company adopted a
Stockholder Rights Plan ("Plan") under which one preferred stock purchase right
would be distributed for each outstanding share of the Company's common stock.
Each right initially entitles holders of common stock to buy one-hundredth of
one share of a new series of preferred stock at an exercise price of $35.00. The
rights will be exercisable only if a person or group, without the prior approval
of the Company's Board of Directors, acquires 15% or more of the outstanding
common stock or announces a tender offer as a result of which such person or
group would own 15% or more of the common stock. If a person to whom these
provisions apply becomes a beneficial owner of 15% or more of the outstanding
common stock, each right (other than rights held by such acquiring person) will
also enable its holder to purchase common stock (or equivalent securities) of
the Company having a value of $70.00 for a purchase price of $35.00. In
addition, if the Company is involved in a merger or other business combination
with another entity, at or after the time that any person acquires 15% or more
of the outstanding common stock, each right will entitle its holder to purchase,
at $35.00 per right, common shares of such other entity having a value of $70.00
On December 31, 2002, the Company's Board of Directors amended the Plan
such that the rights will not become exercisable if a person who is an
institutional investor acquires more than 15% but less than 25% of the Company's
outstanding common stock.
-14-
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
("$000's" Omitted Except Share 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 consolidated financial statements as of September 30, 1995 and
retroactively. Accordingly, discussion of results of refining operations has
been confined to 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.
As noted above, the Company sold all of its domestic oil and gas
properties to Delta on May 31, 2002. In addition, on September 6, 2002, the
Company sold all of its oil and gas interests in Romania to the operator of the
Romanian concessions. As a result of these sales the Company has no remaining
operating assets. Furthermore, from May 31, 2002 to December 31, 2002, the
Company reduced the number of its employees from 27 full-time employees to 3
full-time employees and 3 part-time employees. As a result of these asset sales
and the reduction in the Company's employees, comparison of fiscal 2002 and
fiscal 2001 operations by revenue and expense category is not meaningful.
Discussion will, therefore, be limited to analysis of first quarter fiscal 2003
operations with comparisons to prior year's operations only where warranted.
The Company earned no oil and gas sales and incurred no oil and gas
production expenses during the period from October 1, 2002 to December 31, 2002
because the Company sold all of its producing oil and gas properties to Delta in
May 31, 2002.
General and administrative expenses decreased $760 or 55.4% from the
quarter ended December 31, 2001 to the quarter ended December 31, 2002 primarily
because of the reduction of full-time employees from twenty-seven to three. The
decrease was, however, partially offset by increased legal expenses related to
the ChevronTexaco litigation (see Note 4 to the financial statements). Although
the Company has significantly reduced its personnel costs, its continuing public
company costs (audit, printing, legal compliance, stock transfer fees, stock
exchange costs, etc.) continue and significant legal costs related to the
ChevronTexaco litigation are expected in the future. If the Company is able to
terminate this litigation, it anticipates that it will liquidate and both public
company and legal costs would then decrease significantly or disappear
altogether.
Depreciation, depletion and amortization decreased $1,227 from the
first quarter of fiscal 2002 to the first quarter of fiscal 2003 because the
Company sold all of its producing oil and gas properties to Delta in May 2002
and thus incurred no depletion expense for the quarter ended December 31, 2002.
The $15 of depreciation, depletion and amortization for the quarter ended
December 31, 2002 consists primarily of depreciation of the Company's office
equipment and furniture.
-15-
The following other income (expense) items relate to and result from
the sale of the Company's domestic oil and gas properties to Delta on May 31,
2002 and have no counterpart during the quarter ended December 31, 2001:
Decrease in fair value of option granted to Delta Petroleum Corporation......... $198
====
Equity in income (loss) of Delta Petroleum Corporation.......................... $188
====
The $198 decrease in the value of the option granted to Delta is the
result of a decrease in the fair value of the option that the Company granted to
Delta to acquire 3,188,667 of its shares back from the Company at $4.50 per
share through May 31, 2003. The fair market value of Delta's option decreased
primarily as a result of a decrease in Delta's share price since September 30,
2002 and the passage of time. The equity in the income of Delta represents the
Company's share (44%) of Delta's net income for the quarter ended December 31,
2002. Prior to May 31, 2002 the Company owned only 3.4% of Delta and accounted
for its investment in Delta as available-for-sale securities. Commencing June 1,
2002, the Company accounted for its investment in Delta using the equity method.
See "Critical Accounting Policies" below.
The Company's equity in the loss of Networked Energy LLC ("Networked")
decreased $14 from $34 for the quarter ended December 31, 2001 to $20 for the
quarter ended December 31, 2002. The decrease results from decreased expenses
incurred by Network, a start up company engaged in the planning, installation
and operation of natural gas fueled energy generating facilities. Networked has
not yet earned operating revenue. The Company owns 45% of Network. The Company
is monitoring Networked's progress in certain ventures. If developments with
respect to these ventures are not favorable for Networked, the Company may
impair its equity investment in Networked of $354 and note receivable from
Networked of $125 by March 31, 2003.
The $428 tax benefit for the quarter ended December 31, 2002 results
primarily because of changes in the Company's expectations concerning future
taxable income. The Company decreased its valuation allowance by $363 at
December 31, 2002 resulting in a deferred tax asset, net of $773 of accrued
income taxes on appreciation of marketable securities, of $450. The net deferred
tax asset at December 31, 2002 relates to income that has been recognized for
tax purposes, but has not yet been recognized for financial reporting purposes.
Since November of 1996, the Company has reacquired 4,911,020 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 three months ended December 31, 2002, the Company used
$1,241 in operating activities. During the same period the Company invested $125
in Networked and paid $330 for dividends to shareholders. At December 31, 2002,
the Company had $13,843 of unrestricted cash, $21,954 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 and its Romanian
oil and gas concessions to the operator of those concessions in September 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's
Board of Directors has not, however, adopted a plan of liquidation given the
recent lawsuit filed by ChevronTexaco. (See Note 4 to the consolidated financial
statements.) The Company's general counsel, management and special counsel
believe ChevronTexaco's claims are without merit and that ChevronTexaco is using
the legal system to disrupt the Company's business activities and to coerce the
Company to pay ChevronTexaco a settlement in order to allow the Company to
liquidate. The Company expects that it will incur significant legal costs to
defend itself against ChevronTexaco's lawsuit. The Company's management and
Board of Directors are continuously monitoring the legal situation. 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.
LIQUIDATION
If a decision is made to liquidate, the Company anticipates that it
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
-16-
those related to the contingent and litigated environmental claims and other
current litigation. Such provision would include the Company's $4,038
certificate of deposit provided for the letter of credit supporting its
supersedeas bond as required for the Company's appeal of the Long Trust
litigation plus interest (see Note 4 to the consolidated financial statements)
and sufficient assets to provide a reasonable reserve for the Company's other
outstanding litigation liabilities, if any, including any outstanding contingent
environmental litigation 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 Securities and
Exchange Commission ("SEC") seeking relief from continuing 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 defendant in three
significant unsettled lawsuits. Although the Company does not
believe it has any material liabilities with respect to any of
these lawsuits, any or several of the plaintiffs in these
lawsuits 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 prevail on its indemnity
claim in its lawsuit (Note 4 to the 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
Delta's stock price increases significantly 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 had 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 and probably will increase in the future
given the myriad of post Enron regulatory requirements that are
currently being mandated. 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 cash and cash equivalents and the Company's investments
in Penn Octane Corporation (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
-17-
needs cash to distribute to its stockholders or to liquidate
liabilities. In addition, the Company owns 45% of Network. Network
is a private limited liability company with no public market for
its membership units. As a result, the Company expects that it
would be difficult at the present time to sell its interest in
Network if liquidation is required.
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). The Company estimates that its annual general and
administrative costs, if it continues to exist as a public company, would be
$700-$900, excluding litigation - related legal costs. 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. For example,
few analysts believe it is possible to acquire oil and gas properties at
favorable prices at the present time or in the near future given current high
prices for oil and gas production and reserves. 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 continue to
be subject to the following risk factors:
a. Contingent and litigated 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. 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.
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 income and decrease such investment by its share of Delta's 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 estimates 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 ownership
interests in offshore California leases and the related potential recovery from
a lawsuit Delta and other owners of offshore California leases have instituted
against the United States for breach of contract. The Company is required to
evaluate the recoverability of the leases periodically and write off the excess
costs or reduce them to the extent they are not deemed recoverable. In addition,
if Delta incurs recurring losses in the future and/or the market value of its
stock declines significantly, the Company's investment in Delta may be impaired
and the Company may then be required to recognize the impairment.
Discontinued Refining Operations
At September 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 included in this Form 10-Q. ChevronTexaco has
sued the Company for environmental remediation costs that have been estimated at
$80,000-$150,000. In January 2003, the United States and the State of Illinois
filed a motion which estimated the total costs for just one portion of the
Indian Refinery-Texaco-Lawrenceville Superfund Site to be $109,000 to $205,000.
The Company's accounting policy with respect to contingent environmental
liabilities is to record environmental liabilities when and if environmental
-18-
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 and/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 lawsuit filed
against the Company by ChevronTexaco (see Note 4 to this Form 10-Q). 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, if appropriate, for an indicated
impairment of value, recognizing the resultant loss. The Company would then
record the distribution as a charge to retained earnings equal to the book 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 $2,682 using the
Black Scholes method and recorded a liability on its consolidated balance sheet.
The Company is required to account for changes in the value of this option by
recording gains or losses, as applicable, in its Statement of Operations. At
December 31, 2002, the value of option had been reduced to $234 and the Company
had recorded a $2,448 gain since May 31, 2002, including a gain of $198 for the
three months ended December 31, 2002. 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. If Delta exercises
the option the Company would record a gain per share exercised equal to the
difference between $4.50 and the book value per share at the time of exercise.
Valuation Allowance for Deferred Income Tax Asset
At December 31, 2002, the Company recorded a valuation allowance of
$4,634 offsetting its gross deferred tax asset of $5,857 at that date. That
valuation allowance is based upon the Company's assessment that the Company will
not generate future taxable income to utilize all of its gross deferred tax
assets at December 31, 2002 based primarily on the Company's expectations that
it will incur significant general and administrative expenses liquidating its
assets without earning offsetting revenue. In addition, the Company is a party
to several lawsuits, including a complaint for environmental indemnification,
for which the Company has recorded no liabilities except for $3,016 of net
refining liabilities retained. The net deferred tax asset at December 31, 2002
relates to income that has been recognized for tax purposes but has not yet been
recognized for financial reporting purposes. If circumstances change such that
the Company expects future taxable income, the Company will revise its valuation
allowance, resulting in tax recoveries.
-19-
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.
Item 4. Controls and Procedures
The conclusions of the Company's Chief Executive Officer and Chief
Financial Officer concerning the effectiveness of the Company's disclosure
controls and procedures and changes in internal controls as of December 31, 2002
are as follows:
a) They have concluded that the Company's disclosure controls and
procedures are effective in promptly identifying items that should be
included in our reports required under the Exchange Act.
b) There have not been any significant changes in our internal controls
or in other factors that could affect such controls subsequent to
December 31, 2002.
See Exhibits 99.1 and 99.2 to this Form 10-Q.
-20-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For additional 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, 2002. Also see Note 4 to the December 31, 2002 consolidated financial
statements included in Part I.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits:
Exhibit 10.147 Amendment of Rights Agreements between
Castle Energy Corporation and American Stock
Transfer Company as Rights Agent, dated
December 31, 2002
Exhibit 11.1 Statement re: Computation of Earnings Per
Share
Exhibit 99.1 Certificate of Chief Executive Officer
(Section 302 of Sarbanes Oxley Act)
Exhibit 99.2 Certificate of Chief Financial Officer
(Section 302 of Sarbanes Oxley Act)
Exhibit 99.3 Certificate of Chief Executive Officer
(Section 906 of Sarbanes Oxley Act)
Exhibit 99.4 Certificate of Chief Financial Officer
(Section 906 of Sarbanes Oxley Act)
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SIGNATURES
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: February 13, 2003 CASTLE ENERGY CORPORATION
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/s/Richard E. Staedtler
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Richard E. Staedtler
Chief Financial Officer
Chief Accounting Officer
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