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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 March 31, 2005
--------------
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 of Incorporation or Organization
(I.R.S. Employer Identification No.)
357 South Gulph Road, Suite 260, King of Prussia, Pennsylvania 19406
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 992-9900
- --------------------------------------------------------------------------------
(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 by check X whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act) Yes |_| No |x|.
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date: 6,990,384 shares of
Common Stock, $.50 par value, outstanding as of May 6, 2005.
CASTLE ENERGY CORPORATION
INDEX
PAGE #
Part I. Financial Information ------
---------------------
Item 1. Financial Statements:
Consolidated Balance Sheets - March 31, 2005 (Unaudited) and
September 30, 2004............................................................ 2
Consolidated Statements of Operations - Three Months Ended March 31,
2005 and 2004 (Unaudited)..................................................... 3
Consolidated Statements of Operations - Six Months Ended March 31,
2005 and 2004 (Unaudited)..................................................... 4
Condensed Consolidated Statements of Cash Flows - Six Months Ended
March 31, 2005 and 2004 (Unaudited)........................................... 5
Consolidated Statements of Stockholders' Equity and Other Comprehensive
Income - Year Ended September 30, 2004 and Six Months Ended March 31, 2005
(Unaudited)................................................................... 6
Notes to the Consolidated Financial Statements (Unaudited).................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations................................................................. 18
Item 3. Qualitative and Quantitative Disclosures About Market Risk.................... 23
Item 4. Controls and Procedures........................................................ 23
Part II. Other Information
-----------------
Item 1. Legal Proceedings.............................................................. 24
Item 4. Submission of Matters to a Vote of Security Holders............................ 24
Item 6. Exhibits....................................................................... 24
Signature ...................................................................................... 25
-1-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
MARCH 31, SEPTEMBER 30,
2005 2004
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 36,783 $ 33,742
Restricted cash.................................................................. 898 120
Accounts receivable.............................................................. 723 582
Account receivable - Delta Petroleum Corporation................................. 339
Marketable securities............................................................ 20 19
Prepaid expenses and other current assets........................................ 130 203
Note receivable - Networked Energy LLC, net of allowance for doubtful account
of $125.........................................................................
--------- --------
Total current assets........................................................... 38,554 35,005
Property, plant and equipment, net:
Furniture, fixtures, equipment and vehicles...................................... 177 111
Oil and gas properties, net (full cost method):
Proved properties.............................................................. 8,773 9,012
Unproved properties not being amortized........................................
Investment in Networked Energy LLC, net of impairment reserve of $354................ 8
Investment in Delta Petroleum Corporation............................................ 38,486 39,698
--------- --------
Total assets.................................................................... $ 85,998 $ 83,826
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable................................................................. $ 349 $ 343
Accounts payable................................................................. 509 749
Contingent note payable.......................................................... 792
Accrued expenses................................................................. 156 906
Accrued taxes on appreciation of marketable securities........................... 2 1
Asset retirement obligations..................................................... 4 3
Net refining liabilities retained................................................ 700
--------- --------
Total current liabilities...................................................... 2,512 2,002
Net refining liabilities retained.................................................... 1,405 2,404
Asset retirement obligations......................................................... 244 227
Deferred income taxes................................................................ 5,095 5,170
Other liabilities.................................................................... 19 19
---------- ----------
Total liabilities.............................................................. 9,275 9,822
---------- ----------
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; 11,901,404
shares issued at March 30, 2005 and 11,781,404 shares issued at
September 30, 2004............................................................. 5,951 5,891
Additional paid-in capital....................................................... 86,887 85,691
Accumulated other comprehensive income, net of taxes............................. (897) 170
Retained earnings................................................................ 51,449 48,919
---------- ----------
143,390 140,671
Treasury stock at cost - 4,911,020 shares at March 31, 2005 and
September 30, 2004............................................................ (66,667) (66,667)
---------- ----------
Total stockholders' equity..................................................... 76,723 74,004
---------- ----------
Total liabilities and stockholders' equity..................................... $ 85,998 $ 83,826
========== ==========
The accompanying notes are an integral part of these financial statements
-2-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------------
2005 2004
------------- -------------
Revenue:
Oil and gas sales....................................................... $ 812
-------------
812
-------------
Expenses:
Oil and gas production................................................... 148
General and administrative............................................... 1,263 $ 1,185
Depreciation, depletion and amortization................................. 141 13
------------- -------------
1,552 1,198
------------- -------------
Operating income (loss)...................................................... (740) (1,198)
------------- -------------
Other income (expense):
Gain on sale of marketable securities.................................... 538
Gain on sale of Delta Petroleum Corporation investments.................. 3,066 12,547
Interest income.......................................................... 140 36
Other income (expense)................................................... (8) 448
Equity in income of Networked Energy LLC................................. 8
Equity in income of Delta Petroleum Corporation.......................... 848 246
------------- -------------
4,054 13,815
------------- -------------
Income (loss) before provision for (benefit of) income taxes................. 3,314 12,617
------------- -------------
Provision for (benefit of) income taxes:
State.................................................................... 12 12
Federal.................................................................. 422 437
------------- -------------
434 449
------------- -------------
Net income (loss)............................................................ $ 2,880 $ 12,168
============= =============
Net income (loss) per share:
Basic.................................................................... $ .41 $ 1.83
============= =============
Diluted.................................................................. $ .40 $ 1.77
============= =============
Weighted average number of common and potential dilutive common shares
outstanding:
Basic.................................................................... 6,987,084 6,651,203
============= =============
Diluted.................................................................. 7,147,683 6,889,729
============= =============
The accompanying notes are an integral part of these financial statements
-3-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
SIX MONTHS ENDED MARCH 31,
----------------------------------
2005 2004
------------- -------------
Revenue:
Oil and gas sales....................................................... $ 1,511
-------------
1,511
-------------
Expenses:
Oil and gas production................................................... 243
General and administrative............................................... 2,206 $ 2,424
Depreciation, depletion and amortization................................. 270 25
------------- -------------
2,719 2,449
------------- -------------
Operating income (loss)...................................................... (1,208) (2,449)
------------- -------------
Other income (expense):
Gain on sale of marketable securities.................................... 538
Gain on sale of Delta Petroleum Corporation investments.................. 3,066 12,547
Interest income.......................................................... 280 72
Other income (expense)................................................... 1 448
Equity in income of Networked Energy LLC................................. 8
Equity in income of Delta Petroleum Corporation.......................... 1,690 506
------------- -------------
5,045 14,111
------------- -------------
Income (loss) before provision for (benefit of) income taxes................. 3,837 11,662
------------- -------------
Provision for (benefit of) income taxes:
State.................................................................... 17 21
Federal.................................................................. 597 721
------------- -------------
614 742
------------- -------------
Net income (loss)............................................................ $ 3,223 $ 10,920
============= =============
Net income (loss) per share:
Basic.................................................................... $ .46 $ 1.65
============= =============
Diluted.................................................................. $ .45 $ 1.61
============= =============
Weighted average number of common and potential dilutive common shares
outstanding:
Basic.................................................................... 6,939,249 6,622,269
============= =============
Diluted.................................................................. 7,130,781 6,803,515
============= =============
The accompanying notes are an integral part of these financial statements
-4-
CASTLE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
("000'S" OMITTED)
(UNAUDITED)
SIX MONTHS ENDED MARCH 31,
----------------------------------
2005 2004
------------- -------------
Net cash flow provided by (used in) operating activities................. ($ 1,670) ($ 2,195)
------------- -------------
Cash flows from investing activities:
Investment in furniture, fixtures equipment and vehicles............. (87) (43)
Investment in oil and gas properties................................. (9,512)
------------- -------------
Net cash used in investing activities........................... (87) (9,555)
------------- -------------
Cash flows from financing activities:
Proceeds from exercise of stock options.............................. 687 514
Proceeds from sale of marketable securities.......................... 2,809
Proceeds from sale of investment in Delta Petroleum Corporation...... 4,800 20,914
Dividends paid to stockholders....................................... (689) (659)
------------- -------------
Net cash provided by (used in) financing activities.............. 4,798 23,578
------------- -------------
Net increase (decrease) in cash and cash equivalents..................... 3,041 11,828
Cash and cash equivalents - beginning of period.......................... 33,742 10,615
------------- -------------
Cash and cash equivalents - end of period................................ $36,783 $22,443
============= =============
The accompanying notes are an integral part of these financial statements
-5-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
OTHER COMPREHENSIVE INCOME
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30, 2004 AND SIX MONTHS ENDED MARCH 31, 2005 (UNAUDITED)
------------------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TREASURY STOCK
------------------- PAID-IN COMPREHENSIVE COMPREHENSIVE RETAINED -----------------
SHARES AMOUNT CAPITAL INCOME INCOME (LOSS) EARNINGS SHARES AMOUNT TOTAL
---------- ------- ---------- ------------- ------------- -------- -------- -------- --------
Balance - October 1, 2003..... 11,503,904 $5,752 $68,532 $1,383 $36,643 4,911,020 ($66,667) $45,643
Options exercised............ 277,500 139 1,232 1,371
Tax benefit of options
exercised.... 468 468
Issuance of additional stock
by Delta Petroleum
Corporation, net of
$4,595 tax................. 15,459 15,459
Dividends declared
($.20 per share)........... (1,344) (1,344)
Comprehensive income (loss):
Net income (loss).......... $13,620 13,620 13,620
Other comprehensive income
(loss):
Reclassification
adjustment, net of
$649 tax............... (1,153) (1,153) (1,153)
Equity in other
comprehensive
income (loss) of Delta
Petroleum Corporation,
net of $32 tax
benefit............... (60) (60) (60)
---------- ------ -------- -------- ------- -------- --------- -------- -------
$12,407
=======
Balance - September 30,
2004....................... 11,781,404 5,891 85,691 170 48,919 4,911,020 (66,667) 74,004
Options exercised............ 120,000 60 627 687
Tax benefit of options
exercised.................. 249 249
Issuance of additional stock
by Delta Petroleum
Corporation, net of
$180 tax................... 320 320
Dividends declared
($.10 per share)........... (693) (693)
Comprehensive income (loss):
Net income (loss).......... $3,223 3,223 3,223
Other comprehensive income
(loss):
Equity in other
comprehensive income
(loss) of Delta
Petroleum Corporation,
net of $600 tax
benefit............... (1,067) (1,067) (1,067)
---------- ------ -------- -------- -------- -------- --------- -------- -------
$2,156
========
Balance - March 31, 2005..... 11,901,404 $5,951 $86,887 ($ 897) $51,449 4,911,020 ($66,667) $76,723
========== ====== ======== ======== ======= ========= ======== ========
The accompanying notes are an integral part of these financial statements.
-6-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER 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 and six month periods ended March 31, 2005 are not necessarily
indicative of the results that may be expected for the fiscal year ending
September 30, 2005 or for 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, 2004.
In the opinion of the Company, the unaudited consolidated financial
statements contain all adjustments (normal and recurring) necessary for a fair
statement of the results of operations for the three and six month periods ended
March 31, 2005 and 2004 and for a fair statement of financial position at March
31, 2005.
Note 2 - September 30, 2004 Balance Sheet
- -----------------------------------------
The amounts presented in the balance sheet as of September 30, 2004
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, 2004.
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. The Company's refining subsidiaries own no refining assets, have
been inactive for over nine 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. Net refining liabilities retained represent the
remaining liabilities from discontinued refining operations. Such amounts remain
on the consolidated balance sheet pending final resolution.
Note 4 - Environmental Liabilities/Litigation
- ---------------------------------------------
ChevronTexaco Litigation
On August 13, 2002, three subsidiaries of 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 United States Environmental
Protection Agency ("EPA") and others, that ChevronTexaco has incurred 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").
-7-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
History
In December 1995, Indian Refining Limited Partnership, an inactive
refining subsidiary of the Company ("IRLP") 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 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
was delayed primarily because of legal challenges by Texaco, and subsequently
ChevronTexaco. American Western's liquidation plan was confirmed in April 2003.
In the plan, IRLP reduced a $5,400 secured claim against American Western to
$800. In exchange the EPA and Illinois EPA entered into an Agreement and
Covenant Not to Sue with IRLP, which extinguished all CERCLA claims against
IRLP. Under the American Western liquidation plan, IRLP received $599 which it
distributed to its creditors.
During fiscal 1998, the Company was informed that the 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 subsequently corresponded with ChevronTexaco and
voluntarily provided a number of documents requested by ChevronTexaco. In June
2002, ChevronTexaco indicated to the Company that ChevronTexaco did not intend
to sue the Company. Subsequently, ChevronTexaco requested additional documents
from the Company, which
-8-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
the Company promptly and voluntarily again 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 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. Following the initiation of
litigation the Company 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. A pre-trial scheduling conference was
held May 5, 2003 and on May 8, 2003 two unrelated defendants were dismissed from
the case with prejudice under a stipulation with ChevronTexaco on undisclosed
terms. On June 2, 2003, the Federal District Court denied the Company's motions
to dismiss, following which, on July 9, 2003, the Company filed answers to the
contractual, OPA and RCRA claims. The parties are currently conducting discovery
and depositions. The presumptive trial date for this case has been set for
November 2005 by the Federal District Court. The Company expects to pursue
motions for summary judgment 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 and never 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 to $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/or its subsidiaries might be further reduced.
-9-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
The Company and its special counsel, Reed Smith LLP, do not consider an
unfavorable outcome for the Company in ChevronTexaco's lawsuit to be probable,
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 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, emerged from 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.
OTHER 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 certain 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 Company's other subsidiaries, claiming (among other
things) breach of contract, breach of fiduciary duty, conversion and conspiracy.
The Long Trusts sought actual damages, exemplary damages, prejudgment and
post-judgment interest, attorney's fees and court costs. CTPLP counterclaimed
for approximately $150 of unpaid joint interest billings plus interest,
attorney's fees and court costs.
After a three-week trial, the District Court in Rusk County submitted 36
questions to the jury which covered the claims and counterclaim in the lawsuit.
Based upon the jury's answers, the District Court entered judgment on some of
the Long Trusts' claims against the Company and its subsidiaries, as well as
CTPLP's counterclaim against the Long Trusts. The District Court issued an
amended judgment 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 Long Trusts subsequently filed
notices of appeal, submitted legal briefs in April 2002, reply briefs in June
and July 2002, and ultimately argued the case before the 12th Court of Appeals
in Tyler, Texas in October 2002. On July 31, 2003, that court reversed and
remanded in part the trial court's judgment against the Company and its
subsidiaries while affirming the judgment against the Long Trusts which had
awarded
-10-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
damages on the counterclaim asserted by CTPLP. In its decision, the
appellate court held that the trial court had submitted erroneous theories to
the jury, expressly rejecting the Long Trusts' claims for breach of fiduciary
duty, conversion, implied covenants and exemplary damages. It also remanded the
Long Trusts' claims for breach of contract to the district court for retrial.
The appellate court upheld the trial court's award to CTPLP on its counterclaim
for approximately $150 of unpaid joint interests billings, $450 in attorneys'
fees, plus interest and court costs. Both the Company and its subsidiaries and
the Long Trusts thereafter submitted motions for a rehearing on certain rulings
to the 12th Court of Appeals. That court denied both motions for a rehearing.
The Long Trusts subsequently filed a petition for review with the
Supreme Court of Texas. On March 26, 2004, the Texas Supreme Court denied the
Long Trusts petition for review and the Long Trusts filed a petition for
rehearing with that court two weeks later. That petition was also subsequently
denied, whereupon the Court of Appeals issued its mandate on June 9, 2004,
completing the appellate process. Certain breach of contract claims by the Long
Trusts which were reversed and remanded by the appellate court may be retried by
the plaintiffs. Based on the evidence at the initial trial coupled with the
guidance to the trial court given in the appellate decision, the Company
believes that it will be able to prove that there was no breach of contract and
that Long Trusts suffered no damages, and that any such breach of contract
claims, even if decided adversely to the Company, will not result in a material
loss to the Company.
Pursuant to the mandate of the Texas Court of Appeals, the Company moved
to sever CTPLP's claims against the Long Trusts from any retrial of the Long
Trust's contract claims against the Company and to collect on CTPLP's judgment
against the Long Trusts which is secured by a letter of credit posted by the
Long Trusts with the trial court. The Company estimates the judgment to be in
excess of $1,000, including accrued interest, as of March 31, 2005. Subsequent
to June 30, 2004, upon issue of the mandate by the Texas Court of Appeals, the
Company's $3,886 supersedeas bond was released under Texas law. The Company's
$4,110 letter of credit, including accrued interest, securing that bond, was
also released and those funds are no longer restricted cash.
On September 17, 2004, the Long Trusts filed a Motion for Clarification
with the Court of Appeals which in essence sought to reverse that court's
severance of CTPLP's claims from the retrial of the Long Trusts' breach of
contract claims. A Petition for Writ of Mandamus was filed with the Court of
Appeals by the Company on December 3, 2004, requesting that the trial court be
stayed from proceeding further, and be ordered to comply with the June mandate
of the Court of Appeals. On January 31, 2005, the Court of Appeals stayed the
trial court from proceeding and subsequently denied the Motion for Clarification
on March 3, 2005 and the Petition for Writ of Mandamus on March 16, 2005. On May
2, 2005, the trial court from the bench announced that CTPLP's severed claim
would be assigned a new case number, but took all other requests for action from
the parties under advisement.
The Company has not accrued any recoveries for this litigation as of
March 31, 2005, but will record recoveries if and when they are ultimately
realized (collected).
Pilgreen Litigation
As part of the oil and gas properties acquired from AmBrit Energy
Corporation ("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 attributable to the ORRI from
first production due to title disputes, AmBrit, the previous owner, 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. In August 2002,
$282 was released to the Company of which $249 was recorded as income by the
Company and the remaining $33 paid to Delta Petroleum Corporation ("Delta").
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 $120 of
suspended CTOGLP Pilgreen #2ST
-11-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
production proceeds for the Company's account. (The Company sold all of its
oil and gas assets, including the Pilgreen #2ST well, to Delta on May 31, 2002
but effective as of October 1, 2001.) 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 opinions
have confirmed the validity of CTOGLP's interest. The litigation is related to
the Dominion litigation (see below). Accordingly, the Company believes that
CTOGLP will prevail in this litigation if CTOGLP prevails in the Dominion
Litigation or that CTOGLP will fail in this litigation if it fails in the
Dominion Litigation. Since the Company has not recorded any revenue related to
the $120 of suspended revenue, it expects to record $120 of revenue if it
prevails, but no expense if it fails in this litigation.
CTOGLP, along with several unrealized parties, has also filed suit to
collect production proceeds from an additional well on the Simpson lease in
which CTOLGP had a 5.325% ORRI suspended by the operator because of title
disputes. The Company intends to contest this matter vigorously. At the present
time, the amount held in escrow applicable to the additional well attributable
to the Company's interest is approximately $66 although approximately $22 of
that amount would be subject to Dominion's claims in the Pilgreen Litigation.
The Company has not recorded any of the $66 of suspended revenue as income but
will record it as income when and if it is realized (collected).
Dominion Litigation
On 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 judgment in a title action that the ORRI held by CTOGLP in these
wells should be deemed to be burdened by certain other ORRI's 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 currently estimates the amount in
controversy to be approximately $783. Dominion threatened to suspend all revenue
payable to the Company from the Mitchell and Migl-Mitchell to offset its claim.
The Company and Dominion subsequently examined the land and lease documents
concerning the ORRI's. The Company believes that Dominion's title exception to
CTOGLP's ORRI is erroneous and notes that several previous title opinions have
confirmed the validity of CTOGLP's interest.
In July 2003, Dominion filed a motion for partial summary judgment
concerning the Company's claim that it had assumed the liabilities of its
predecessor in interest and CTOGLP filed its response to Dominion's motion as
well as its own cross motion for partial summary judgment. In September 2003,
the District Court of Lavaca County granted Dominion's partial motion for
partial summary judgment. In January 2004, Dominion filed a motion for final
summary judgment on this matter to which CTOGLP and the other defendants filed a
response. In May 2004, the District Court of Lavaca County granted Dominion's
motion for final summary judgment. The Company has filed an appeal of both the
District Court's summary judgments with the Court of Appeals in Corpus Christi.
By agreement between Dominion and the Company, CTOGLP executed a
promissory note for $783 guaranteed by the Company and deposited this amount in
a separate restricted cash account of CTOGLP to support the note to avoid the
cost of a supersedeas bond. Such note is payable only if the Company fails in
its appeal. At March 31, 2005, $792 of the amount previously accrued is
represented by the contingent note payable plus accrued interest at 5% annually
and the remaining $39 is included in accrued expenses.
Note 5 - New Accounting Pronouncements
- --------------------------------------
On September 28, 2004, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 106 ("SAB No. 106"). SAB No. 106 applies to companies
using the full cost method of accounting for oil and gas properties and
equipment costs, such as the Company. SAB No. 106 affects the way in which the
Company calculates its full cost ceiling limitation (the Company now excludes
asset retirement costs related to proved developed properties in the
-12-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
calculation of the ceiling) and the way the Company calculates depletion on
its gas properties (only asset retirement costs for new recompletions and new
wells are now included in calculating depletion rates). The Company adopted SAB
No. 106 on October 1, 2004. The Company expects the adoption of SAB No. 106 on
future operating costs, operating income (loss) and net income (loss) to be
immaterial.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)").
SFAS No. 123(R) requires an entity to recognize the grant-date fair value of
stock options and other equity-based compensation issued to employees in the
income statement. Pursuant to a delay in the implementation date by the SEC,
SFAS No. 123(R) will be effective for the Company beginning October 1, 2005. The
Company does not expect SFAS No. 123(R) to have a material impact on its results
of operations. The Company has not issued any stock options since January 2002
and all stock options issued were vested by July 31, 2002.
In December 2004, the FASB issued FASB Staff Position FAS 109-1,
"Application of FASB Statement No. 109, Accounting for Income Taxes, for the Tax
Deduction Provided to U.S. Based Manufacturers by the American Jobs Creation Act
of 2004" ("FSP 109"). FSP 109 clarifies how to apply Statement No. 109 to the
new tax deduction for income attributable to "domestic production activities."
The Company expects that the new tax deduction will first be effective for the
Company's fiscal year ending September 30, 2006 and that the affect on future
income tax expense, deferred income taxes and income taxes payable will be
immaterial.
Note 6 - Restricted Cash
- ------------------------
Restricted cash consists of the following:
MARCH SEPTEMBER
2005 2004
----------- -----------
(Unaudited) (Unaudited)
Certificates of deposit supporting operating bonds.......... $110 $120
Deposit securing promissory note in Dominion litigation..... 788
------- -------
$898 $120
======= =======
The certificates of deposit support letters of credit for operating and
drilling bonds provided to state or county regulatory agencies.
Note 7 - Acquisition of Oil and Gas Properties
- ----------------------------------------------
On March 31, 2004, the Company acquired interests in 138 western
Pennsylvania gas wells from Delta Petroleum Corporation ("Delta"). The Company
previously owned most of these properties through May 31, 2002 when it sold all
of its United States oil and gas properties to Delta. The purchase price paid by
the Company was effective January 1, 2004 and was reduced by purchase price
adjustments to the closing date of March 31, 2004. For accounting purposes the
Company allocated $43 of the purchase price to trucks and the remainder to oil
and gas properties.
The Company owned approximately 25% of Delta (see Note 10) at the time
of purchase, and three of the Company's directors were also directors of Delta.
Prior to approving the purchase, the Company appointed a committee of
independent directors to evaluate and make a recommendation to the Board of
Directors with respect to the proposed transaction. The Committee engaged an
outside consultant to evaluate the fairness of the proposed purchase. Based upon
that consultant's recommendation that the purchase price was reasonable and fair
and the favorable recommendation of the committee, the full Board of Directors
of the Company unanimously approved the transaction.
At the same time the Company also purchased another owner's interests in
the same gas properties for $334 subject to similar final closing adjustments.
The other owner's interests in the properties were approximately four percent of
-13-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
Delta's interests in the same properties.
On March 30, 2004, the Company acquired interests in 28 western
Pennsylvania gas wells for $1,100 from five limited partnerships effective
January 1, 2004. That transaction closed March 30, 2004. The President of the
general partner of the five selling limited partnerships was and still is an
officer and director of the Company. As a result, the Company appointed a
committee of independent directors to evaluate and make recommendations to the
Board with respect to the proposed transaction. The committee engaged an outside
consultant to evaluate the fairness of the proposed purchase. Based upon that
consultant's opinion that the proposed purchase price was reasonable and fair
and the favorable recommendation of the committee, the full Board of Directors
of the Company unanimously approved the transaction.
The final adjusted purchase price for the oil and gas properties
acquired in March 2004 was $8,985.
The Company's petroleum reservoir engineer estimated the proved reserves
applicable to the three Pennsylvania purchases to be approximately eight billion
cubic feet of natural gas, of which approximately 87% represents proved
producing reserves, while the remaining 13% represents behind pipe and
undeveloped reserves. Approximately 130 of 166 wells in which the Company
acquired interests are operated by the Company. The Company also entered into an
operations management agreement with Delta whereby Delta performed certain well
operations functions for the Company on a transitional basis from April 1, 2004
to September 30, 2004. That agreement terminated September 30, 2004 and the
Company is now performing the well operations functions previously performed by
Delta.
Note 8 - Asset Retirement Obligations
- -------------------------------------
Changes in the Company's asset retirement obligations are as follows:
SIX MONTHS ENDED MARCH 31,
--------------------------
2005 2004
----------- ------------
(Unaudited) (Unaudited)
Balance - beginning of period................... $230
Acquisitions.................................... $222
Adjustments..................................... 10
Acretion of discount............................ 8
---------- -----------
Balance - end of period......................... $248 $222
========== ===========
Note 9 - Investment in Networked Energy LLC ("Network")
- -------------------------------------------------------
At March 31, 2003, the Company recorded a $480 impairment provision
related to its investment in Network. This provision consisted of $354 provision
related to the Company's 45% equity investment in Network and a $126 provision
related to the Company's $126 note receivable from Network. As a result of these
impairment provisions, the Company's investment in Network was reduced to zero
and the Company ceased recording any share of Network's losses since the Company
had no obligation to fund such losses. The impairment provisions were recorded
because Network had not entered into any revenue-generating contracts by May 7,
2003.
Subsequently, Network entered into several revenue-generating contracts,
and, as of March 31, 2005, Network's revenues for the period April 1, 2003 to
March 31, 2005 exceeded its expenses for the same period by $21. As a result,
the Company resumed recording its share of Network's net income (loss) under the
equity method of accounting. Whereas the Company previously owned 45% of Network
at March 31, 2003, its ownership percentage had been reduced to 40% by March 31,
2005 as a result of the issuance of additional membership units to officers of
Network. As a result, the Company recorded $8 of equity income from its
investment in Network during the quarter ended March 31, 2005.
-14-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
Note 10 - Investment in Delta
- -----------------------------
Condensed financial information concerning Delta is as follows:
CONDENSED BALANCE SHEETS
MARCH 31, SEPTEMBER 30,
2005 2004
----------- -----------
(Unaudited) (Unaudited)
Assets
Current assets...................................................... $ 41,481 $ 15,896
Oil and gas properties, net.......................................... 392,398 261,907
Other assets........................................................ 6,901 1,330
---------- ---------
$440,780 $279,133
========== =========
Liabilities and Stockholders' Equity
Current liabilities, including current portion of long-term debt.... $ 42,447 $ 15,177
Long-term liabilities and minority interests........................ 182,592 63,445
Stockholders' equity................................................ 215,741 200,511
---------- ---------
$440,780 $279,133
========== =========
FOR THE THREE MONTHS ENDED
MARCH 31,
--------------------------------
2005 2004
---------- -----------
(Unaudited) (Unaudited)
CONDENSED STATEMENT OF OPERATIONS
Revenue:
Oil and gas sales................................................. $ 24,578 $10,628
Other............................................................. 1,988 (286)
---------- ---------
26,566 10,342
---------- ---------
Expense:
Lease operating expenses.......................................... 6,032 2,506
General and administrative........................................ 4,613 2,030
Depreciation, depletion and amortization.......................... 5,393 3,085
Other............................................................. 3,694 1,908
---------- ---------
19,732 9,529
---------- ---------
Other income (expense).............................................. (1,894) 1,452
---------- ---------
Discontinued operations............................................. 189
---------- ---------
Income (loss) before taxes.......................................... 4,940 2,454
Income taxes........................................................
---------- ---------
Net income (loss)................................................... $ 4,940 $2,454
========== =========
-15-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
MARCH 31,
--------------------------------
2005 2004
---------- ---------
(Unaudited) (Unaudited)
CONDENSED STATEMENT OF OPERATIONS
Revenue:
Oil and gas sales................................................. $45,019 $18,702
Other............................................................. 2,076 (354)
---------- ---------
47,095 18,348
---------- ---------
Expense:
Lease operating expenses.......................................... 10,952 4,847
General and administrative........................................ 8,627 3,866
Depreciation, depletion and amortization.......................... 9,071 5,391
Other............................................................. 5,500 2,223
---------- ---------
34,150 16,327
---------- ---------
Other income (expense).............................................. (3,196) 891
---------- ---------
Discontinued operations............................................. 194
---------- ---------
Income (loss) before taxes.......................................... 9,749 3,106
Income taxes........................................................
---------- ---------
Net income (loss)................................................... $ 9,749 $ 3,106
========== =========
The Company currently owns 6,700,000 shares of Delta's common stock or
approximately 16%. The Company currently accounts for its investment in Delta on
the equity method as two of the Company's directors are directors of Delta.
At September 30, 2004, the Company owned 7,000,000 shares of Delta. In
March 2005, the Company sold 300,000 shares of Delta for net proceeds of $4,800
and recognized a gain of $3,066 on the sale. The book value of the shares sold
was based upon the book value per share of the Company's investment in Delta on
the day of the sale.
The above condensed financial information has been compiled using
Delta's unaudited quarterly financial statements for the quarters ended March
31, 2005 and 2004 and September 30, 2004.
Delta's stock is traded on the Nasdaq stock market under the symbol
"DPTR." At March 31, 2005, the closing price of Delta's common stock was $14.54
per share. Subsequent to March 31, 2005 the price of Delta's stock decreased to
less than $11.00 per share and closed at $11.17 per share on May 4, 2005.
At March 31, 2005, there were approximately 4,000,000 options and
warrants to acquire Delta's stock outstanding, including options and warrants
that were out of the money. The Company holds none of these options and
warrants. If all such options and warrants had been exercised at March 31, 2005,
the Company's percentage ownership of Delta would have decreased from
approximately 16% to approximately 15%.
Note 11 - Compensation Expense
- ------------------------------
SFAS 123 allows an entity to continue to measure compensation costs in
accordance with Accounting Principles Board Opinion No. 25 ("APB 25"). The
Company has elected to continue to measure compensation cost in accordance with
APB 25 and to comply with the required disclosure- only provisions of SFAS 123.
Proforma net income and earnings per share had the Company accounted for
its options under the fair value method of SFAS 123 is as follows:
-16-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
--------------------------------
2005 2004
---------- ---------
Net income (loss) as reported...................................... $ 2,880 $ 12,168
Adjustment required by SFAS 123....................................
---------- ---------
Pro-forma net income (loss)........................................ $ 2,880 $ 12,168
========== =========
Pro-forma net income (loss) per share:
Basic........................................................... $ .41 $ 1.83
========== =========
Diluted......................................................... $ .40 $ 1.77
========== =========
Net income (loss) per share as reported:
Basic........................................................... $ .41 $ 1.83
========== =========
Diluted......................................................... $ .40 $ 1.77
========== =========
SIX MONTHS ENDED MARCH 31,
--------------------------------
2005 2004
---------- ---------
Net income (loss) as reported...................................... $ 3,223 $ 10,920
Adjustment required by SFAS 123....................................
---------- ---------
Pro-forma net income (loss)........................................ $ 3,223 $ 10,920
========== =========
Pro-forma net income (loss) per share:
Basic........................................................... $ .46 $ 1.65
========== =========
Diluted......................................................... $ .45 $ 1.61
========== =========
Net income (loss) per share as reported:
Basic........................................................... $ .46 $ 1.65
========== =========
Diluted......................................................... $ .45 $ 1.61
========== =========
Pro forma net income (loss) and pro forma net income (loss) per share
are the same as net income (loss) and net income (loss) per share because the
Company has not issued any options since January of 2002 and all options issued
were fully vested by July 31, 2002.
Note 12 - Subsequent Event
- --------------------------
On May 2, 2005, the Company's directors declared a special dividend of
$1.00 per share payable to holders of record on June 6, 2005.
Subsequent to March 31, 2005, a director of the Company exercised
options to acquire 105,000 shares of the Company's common stock. Proceeds to the
Company were $590. After such exercise, options to acquire 210,000 shares
remained outstanding.
-17-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
("$000'S" OMITTED EXCEPT SHARE AND PER 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 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.
Since November 1996, the Company has reacquired 4,911,020 shares or
approximately 69% of its then outstanding 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 have been the case if no shares had been repurchased.
COMPARISON OF THE SIX MONTHS ENDED MARCH 31, 2005 AND 2004
Gas sales increased $1,511 for the six months ended March 31, 2005 as a
result of the Company's acquisition of 166 Appalachian gas properties on March
30 and 31, 2004 (see Note 7 to the consolidated financial statements included in
this Form 10-Q). The Company owned no oil and gas properties from September 2002
to March 30, 2004.
Production expenses increased $243 for the six months ended March 31,
2005 as a result of the Company's acquisition of 166 Appalachian gas properties
on March 30, and 31, 2004 (see Note 7 to the consolidated financial statements
included in this Form 10-Q). The Company owned no oil and gas properties from
September 2002 to March 30, 2004.
Depreciation, depletion and amortization increased $245 from the first
six months of fiscal 2004 to the first six months of fiscal 2005. The increase
was entirely attributable to depletion of the gas properties acquired by the
Company in March 2004. The Company owned no oil and gas properties from
September 2002 to March 30, 2004.
General and administrative costs decreased $218 or 9.0% from the six
months ended March 31, 2004 to the six months ended March 31, 2005. The decrease
was caused primarily by decreased legal expenses, offset partially by increased
compensation costs. In addition, during the six months ended March 31, 2004, the
Company recorded an $86 bad debt provision related to accounts receivable that
were then over eighteen months old. No bad debt provision was recorded for the
six months ended March 31, 2005.
Interest income increased $208 from the six months ended March 31, 2004
to the six months ended March 31, 2005. The increase results from higher rates
of interest and an increase in the Company's cash and cash equivalents. At March
31, 2004, cash and cash equivalents aggregated $22,443 versus $36,783 at March
31, 2005.
The Company's equity in Delta's net income increased $1,184 or 234% from
the six months ended March 31, 2004 to the six months ended March 31, 2005. The
increase was caused by Delta's increased net income, notwithstanding
-18-
that the Company's percentage ownership of Delta decreased from approximately
25% at March 31, 2004 to approximately 16% at March 31, 2005.
The $614 tax provision for the six months ended March 31, 2005
represented approximately 15.6% of pre-tax income and consists of $575 of
deferred income taxes and $39 of Federal alternative minimum taxes.
The $742 tax provision for the six months ended March 31, 2004 resulted
primarily because of changes in the Company's expectations concerning future
taxable income.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
From the three months ended March 31, 2004 to the three months ended
March 31, 2005 gas sales, oil and gas production expenses and depreciation,
depletion and amortization increased $812, $148 and $128, respectively, as a
result of the Company's acquisition of 166 Appalachian gas properties on March
30 and 31, 2004. The Company owned no oil and gas properties from September 2002
to March 30, 2004.
General and administrative expenses increased $78 from the three months
ended March 31, 2004 to the three months ended March 31, 2005 primarily due to
increased compensation costs.
Interest income increased $104 from the three months ended March 31,
2004 to the three months ended March 31, 2005 due to increased interest rates
and an increase in cash and cash equivalents.
The Company's equity in Delta's income increased $602 from the three
months ended March 31, 2004 to the three months ended March 31, 2005 because of
Delta's increased net income during these periods despite a decrease in the
Company's ownership of Delta (see Note 10).
For the quarter ended March 31, 2004, the Company's tax provision
constituted 3.6% of pre-tax income versus 13.1% of pre-tax income for the
quarter ended March 31, 2005. The increase in that ratio resulted primarily due
to changes in the Company's expectations concerning future taxable income. The
Company's tax provision blended rate (Federal and state combined) was
significantly below the Federal and state statutory rate (36%) primarily because
the Company was able to utilize much of its tax carryforwards to offset such
pre-tax income.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended March 31, 2005, the Company used $1,670 in
operating activities. During the same period the Company paid $689 for dividends
to stockholders. During the same period the Company received $687 in proceeds
from the exercise of stock options. At March 31, 2005, the Company had $36,783
of unrestricted cash, $36,042 of working capital and no long-term debt.
At the present time, the Company's anticipated future cash expenditures
are primarily recurring general and administrative costs, including substantial
legal costs related to the ChevronTexaco litigation (see Note 4 to this Form
10-Q), recurring dividends and lease operating costs and some capital
expenditures related to the Appalachian gas properties acquired by the Company.
In addition, the Company continues to review possible future acquisitions of oil
and gas properties and, if the Company is successful in such pursuits,
additional expenditures would be required. To the extent that such anticipated
expenditures cannot be funded from cash flow from the Company's oil and gas
operations, the Company can fund such expenditures using its available cash. If
the Company were to make another substantial acquisition in excess of its
current cash and other liquid working capital, the Company believes it could
fund such acquisitions by selling additional shares of Delta or by renewing its
previous oil and gas borrowing arrangements with an energy bank and using the
related loan proceeds for the acquisition.
The Company's future operations are subject to the following risks:
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 unrecorded liabilities with respect to
any of these lawsuits, the Company could incur significant
liabilities if it ultimately is judged to be liable in these
lawsuits. This litigation has caused and could continue to cause the
Company to incur significant legal costs. If ChevronTexaco were to
prevail on its indemnity claim in its lawsuit (see Note 4 to this
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Form 10-Q), the Company could be held liable for the entirety of
the estimated cleanup costs. Although the Company does not believe
that the aggregate clean up costs currently exceeds the Company's
financial capability, such may not be the case and it is possible
that such clean up costs could exceed the Company's financial
capacity if the Company were required to fund the entire clean up.
b. Exploration and Production Price Risk - The Company has not hedged
any of its anticipated future gas production because the cost to do
so appears excessive when compared to the risk involved. As a
result, the Company remains exposed to future gas price changes with
respect to all of its anticipated future gas production. Such
exposure could be significant given the volatility of gas prices.
For example, natural gas prices have increased over 50% from 2002 to
2005 and could either increase or decrease a similar percentage in
the future. When the Company acquired its gas properties in March
2004, the prices being received for natural gas were $5.00 to $6.00
per mcf sold. The Company paid for its gas reserve acquisitions
using such pricing. Subsequent to the acquisitions, natural gas
prices have increased 10% to 20%. If natural gas prices decrease in
the future, the decrease will directly impact the Company's gas
sales, operating income and/or net income. In addition, if gas
prices are low at the end of the Company's quarterly and annual
reporting periods, the value of the Company's gas reserves may
decrease such that the Company would be forced to record an
impairment provision - see "Critical Accounting Policies" below.
c. Exploration and Production Operating Risk - All of the Company's
current gas properties are onshore properties with relatively low
operating risk. Nevertheless, the Company faces the risks
encountered from operating approximately 130 gas wells - including
the risk of gas leaks, resulting environmental damage, third party
liability claims related to operations, including claims by
landowners where the operated wells are located, as well as general
operating risks.
d. Public Market for the Company Stock - Although there presently
exists a market for the Company's stock, such market is volatile
and the Company's stock is thinly traded. This volatility may
adversely affect the market price and liquidity of the Company's
common stock.
e. Other Risks - In addition to the specific risks noted above, the
Company is subject to general business risks, including insurance
claims in excess of insurance coverage, tax liabilities resulting
from tax audits and the risks associated with increased litigation
generally.
f. Market Value of Delta Stock - The Company currently owns 6,700,000
shares of Delta. At March 31, 2005, the market value of such shares
was approximately $97,400 and constituted the largest asset of the
Company. Subsequent to March 31, 2005, the market value of such
Delta shares decreased to approximately $74,800 as of May 4, 2005.
In the past year Delta's stock price has increased significantly and
has fluctuated significantly over short periods of time. If Delta's
stock price decreases significantly - especially at a time when the
Company expects to liquidate some or all of its Delta stock - the
Company would be adversely affected.
g. Future of the Company - Although the Company has recently acquired
interests in 166 gas wells in Pennsylvania (see Note 7), the Company
is smaller than most of its competitors which benefit from better
fixed cost efficiencies than the Company given their larger sizes
and revenues. The Company's fixed costs (computer system, technical
skills, field offices, public company compliance costs, etc.) have
consumed and are expected to continue to consume a greater
percentage of the Company's oil and gas revenues than do those of
most of its larger competitors unless the Company is able to make
additional future acquisitions at favorable prices. Upon resolution
of the Company's outstanding litigation - whether by settlement or
judgment - the Company's directors may consider options to liquidate
the Company or merge the Company into another company to maximize
stockholder value. If such were the case, the Company would face
risks concerning the value of the Delta shares it owns, resultant
tax liabilities and risks in the liquidation of its assets.
If the Company's directors decide to liquidate the Company and
distribute the 6,700,000 Delta shares owned by the Company to its shareholders
as part of the plan of liquidation, the Company would be subject to a tax
liability on the difference between its tax basis in the Delta stock,
approximately $18,400, and the fair market value of the Delta stock at the time
it is distributed to stockholders. Since the Company has utilized essentially
all of its tax carryovers at March
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31, 2005, the Company would face Federal income tax liabilities of approximately
35% of the difference between the Company's tax basis in the Delta stock and its
fair market value on the date of liquidation. For example, at March 31, 2005,
such tax liability would have been approximately $27,700. Any such taxes would
reduce distributions available for stockholders.
CRITICAL ACCOUNTING POLICIES:
The accounting policies critical to the Company are as follows:
EQUITY METHOD OF ACCOUNTING
At March 31, 2005, the Company owned approximately 16% of Delta and
accounted 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 $3,750 at March 31, 2005. The Company has allocated such excess to
Delta's ownership interests in offshore California leases due to the 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
could become impaired and the Company would then be required to recognize the
impairment. In addition, since the Company only owns 16% of Delta currently, it
is possible that the Company may commence accounting for its investment in Delta
as a marketable security if management considers the Company's influence on
Delta to be less than significant. Although the Company's interest in Delta has
decreased below 20%, the Company has continued to account for its investment in
Delta using the equity method because two of the Company's directors currently
comprise 22% of Delta's directors and thus the Company can be deemed to still
exercise significant influence on Delta. If the Company's influence in Delta
continues to decrease to a level at which it no longer is considered to have a
significant influence, the Company would record its investment as a marketable
security using the provisions of SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities."
DISCONTINUED REFINING OPERATIONS
At March 31, 2005, the Company had recorded net refining liabilities
retained of $2,105. The Company anticipates that it will pay approximately $700
of such liabilities in the next year although that may not be the case. As noted
in Note 4 to this Form 10-Q, ChevronTexaco has sued the Company for
environmental remediation costs that have been estimated at $80,000 to $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 assessment
and/or remediation costs are probable and can be reasonably estimated. Although
the Company and its special counsel do not consider an unfavorable and final
outcome for the Company in ChevronTexaco's lawsuit to be probable, 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
$2,105. 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 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.
INVESTMENT IN NETWORK
Although Network has recently recorded profitable operations and the
Company recommenced recording its share of Network's net income during the
quarter ended March 31, 2005, the Company may not reverse any of the $480
impairment provision recorded at March 31, 2003 pursuant to the equity method of
accounting.
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FULL COST METHOD OF ACCOUNTING FOR OIL AND GAS PROPERTIES
The Company follows the full-cost method of accounting for oil and gas
properties and equipment costs. Under this method of accounting, net capitalized
costs, less related deferred income taxes, in excess of the present value of net
future cash inflows (oil and gas sales less production expenses) from proved
reserves, tax effected and discounted at 10%, and the cost of properties not
being amortized, if any, are charged to expense (full cost ceiling test). If at
a future reporting date oil and gas prices decline, it is possible that the
Company's book value will exceed the allowable full cost ceiling and the Company
would have to write down its oil and gas properties. Even if oil and gas prices
subsequently increase, the write down would not be restored under the full cost
method of accounting. Although the Company recorded no full cost ceiling
provision through March 31, 2005, it could be required to record such a
provision in the future - especially if there were a significant decrease in gas
prices by the end of a quarterly or annual financial reporting period.
See "New Accounting Pronouncements."
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ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
On March 30 and 31, 2004, the Company acquired interests in Pennsylvania
gas wells (see Note 7). The Company has not hedged its share of the expected
natural gas production from these wells. As a result, the Company remains at
risk with respect to such unhedged expected production. If market prices
increase, gas sales applicable to the unhedged production will increase. If
market prices decrease, gas sales and the gross margin related to such unhedged
production will decrease.
At March 31, 2005, the Company owned 6,700,000 shares of Delta. The
stock price of Delta has fluctuated significantly in the last three years and
thus the market value of the Company's investment in Delta remains subject to
significant changes in the market price of Delta stock.
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 March 31, 2005
are as follows:
a) They have concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required to be
disclosed by the Company in the reports it files or submits under
the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified
in the rules and forms of the SEC.
b) There were no changes in the Company's internal controls during the
quarter ended March 31, 2005 that have materially affected, or are
reasonably likely to materially affect, the Company's internal
control over financial reporting.
See Exhibits 31.1 and 31.2 to this Form 10-Q.
The Company expected that it would be subject to certain attestation
requirements concerning the effectiveness of its internal controls pursuant to
the Section 404 of the Sarbanes Oxley Act, effective September 30, 2005. These
requirements include management's documenting and testing the Company's internal
controls and attesting as to their effectiveness and a reporting by the
Company's independent accountants concerning management's attestation. Recently,
the SEC extended by one year the effective date when non-accelerated filers,
such as the Company, would become subject to such requirements.
Although the Company is working to comply with these requirements, the
Company has only eleven employees and these employees work at four widely
scattered locations. The Company's small number of employees and their
geographical separation is expected to make compliance with Section 404 -
especially with segregation of duty control requirements - very difficult and
cost ineffective, if not impossible.
While the SEC had indicated it expects to issue supplementary regulations
easing the burden of Section 404 requirements for small entities like the
Company, such regulations have not yet been issued.
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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, 2004. Also see Note 4 to the March 31, 2005 consolidated financial
statements included in Part I.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on March 10, 2005. Proxies
were solicited pursuant to the Notice of Annual Meeting of Stockholders, dated
February 15, 2005. A total of 6,870,616 shares (representing approximately 98%
of outstanding shares) were present in person or by proxy.
Messrs. Russell S. Lewis and Martin R. Hoffmann were elected to serve as
directors until the 2008 Annual Meeting. The number of votes cast with respect
to Messrs. Lewis and Hoffmann were as follows:
FOR WITHHELD
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Russell S. Lewis 6,849,857 20,759
Martin R. Hoffmann 6,848,288 22,328
At the Annual Meeting, the stockholders also approved the appointment of
Grant Thornton LLP as the Company's independent registered public accountants
for the fiscal year ending September 30, 2005 by a vote of 6,842,545 votes for
such appointment, 160 votes against such appointment and 27,911 abstentions.
In addition to the above, John P. Keller, Joseph L. Castle, Sidney F.
Wentz and Richard E. Staedtler continued on the Board of Directors.
ITEM 6. EXHIBITS
Exhibit 11.1 - Statement re: Computation of Earnings Per Share
Exhibit 31.1 Certificate of Chief Executive Officer (Section 302 of Sarbanes Oxley Act)
Exhibit 31.2 Certificate of Chief Financial Officer (Section 302 of Sarbanes Oxley Act)
Exhibit 32.1 Certificate of Chief Executive Officer (Section 906 of Sarbanes Oxley Act)
Exhibit 32.2 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: May 13, 2005 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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