PRELIMINARY COPY
Dear Delta Shareholders:
On behalf of the Board of Directors, it is a pleasure to invite you to
attend the Annual Meeting of Shareholders to be held at 10:00 a.m. on ______
__, 2002 in Denver, Colorado at Delta's corporate offices located at 475
Seventeenth Street, Suite 1400, Denver, Colorado 80202.
Business matters expected to be acted upon at the meeting are described
in detail in the accompanying Notice of the Annual Meeting and Proxy
Statement. Members of management will report on our operations, followed by a
period for questions and discussion.
We hope you can attend the meeting. Regardless of the number of shares
you own, your vote is very important. Please ensure that your shares will be
represented at the meeting by signing and returning your proxy now, even if
you plan to attend the meeting.
Thank you for your continued support.
Sincerely,
Aleron H. Larson, Jr.
Chairman of the Board
PRELIMINARY COPY
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
______ __, 2002
TO THE SHAREHOLDERS OF DELTA PETROLEUM CORPORATION:
As a shareholder of Delta Petroleum Corporation, a Colorado corporation
("Delta" or the "Company"), you are invited to be present in person or to be
represented by proxy at the Annual Meeting of Shareholders, to be held at
Delta's corporate offices, 475 17th Street, Suite 1400, Denver, Colorado
80202, on _______, ______ __, 2002, at 10:00 a.m. (local time) for the
following purposes:
1) To elect four directors;
2) To consider and vote upon the approval of Delta's 2002 Incentive
Plan;
3) To consider and vote upon the approval of the proposed issuance
of shares and warrants pursuant to an Investment Agreement with
Swartz Private Equity, LLC;
4) To consider and vote upon the ratification of the appointment of
KPMG LLP as independent auditors for Delta for the fiscal year
ending June 30, 2002;
5) To consider and vote on an amendment to Delta's Articles of
Incorporation to reduce the quorum and voting requirements for
meetings of shareholders;
6) To consider and vote upon the approval of the proposed issuance
of shares pursuant to a Purchase and Sale Agreement with Castle
Energy Corporation; and
7) To transact such other business as may be properly brought before
the meeting and any adjournments thereof.
Shareholders of Delta of record at the close of business on ______ __,
2002 are entitled to vote at the meeting and all adjournments thereof.
A majority of the outstanding shares of Common Stock of Delta must be
represented at the meeting to constitute a quorum. Therefore, all
shareholders are urged either to attend the meeting or to be represented by
proxy. If a quorum is not present at the meeting, a vote for adjournment will
be taken among the shareholders present or represented by proxy. If a
majority of the shareholders present or represented by proxy vote for
adjournment, it is Delta's intention to adjourn the meeting until a later date
and to vote proxies received at such adjourned meeting(s).
If you do not expect to attend the meeting in person, please complete,
sign, date and return the accompanying proxy card in the enclosed business
reply envelope. If you later find that you can be present or for any other
reason desire to revoke your proxy, you may do so at any time before the
voting.
By Order of the Board of Directors
Aleron H. Larson, Jr.
Chairman\Secretary
______ __, 2002
PRELIMINARY COPY
PROXY STATEMENT
OF
DELTA PETROLEUM CORPORATION
ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON ______ __, 2002
This Proxy Statement is furnished in connection with the solicitation by
the Board of Directors (our "Board" or our "Board of Directors") of Delta
Petroleum Corporation ("us," "our," "we" or "Delta") of proxies to be voted
at our Annual Meeting of Shareholders (the "Annual Meeting" or the "Meeting")
to be held on ______ __, 2002 at our corporate offices, 475 17th Street, Suite
1400, Denver, Colorado 80202, at 10:00 a.m., and at any adjournment thereof.
Each shareholder of record at the close of business on ______ __, 2002 of
shares of our Common Stock, par value $0.01 per share (the "Common Stock"),
will be entitled to one vote for each share so held. As of March 10, 2002
there were 12,930,790 shares of Common Stock issued and outstanding.
Shares represented by properly executed proxy cards received by us at or
prior to the Annual Meeting will be voted according to the instructions
indicated on the proxy card. Unless contrary instructions are given, the
persons named on the proxy card intend to vote the shares so represented for
(i) the election of the nominees for directors; (ii) the adoption of Delta's
2002 Incentive Plan; (iii) the approval of the proposed issuance of shares and
warrants pursuant to the Investment Agreement with Swartz Private Equity, LLC;
(iv) the ratification of the appointment of KPMG LLP as our independent
auditors for the fiscal year ending June 30, 2002; (v) the approval of an
amendment to Delta's Articles of Incorporation to reduce the quorum and voting
requirements for meetings of shareholders; and (vi) the approval of the
proposed issuance of shares pursuant to a Purchase and Sale Agreement with
Castle Energy Corporation.
As to any other business which may properly come before the Meeting, the
persons named on the proxy card will vote according to their judgement. The
enclosed proxy may be revoked prior to the Meeting by written notice to our
Secretary at 475 17th Street, Suite 1400, Denver, Colorado 80202, or by
written or oral notice to the Secretary at the Annual Meeting prior to being
voted. This Proxy Statement and the enclosed proxy card are expected to be
first sent to our shareholders on or about ___________, 2002.
Votes cast in favor of and against proposed actions (whether in person or
by proxy) will be counted for us by our Secretary at the Meeting, but this
count may be at least partially based upon information tabulated for us by our
transfer agent or others. Abstentions and broker non-votes represented at the
Meeting will be counted as being present for the purpose of determining
whether or not a quorum is present, but will not be counted as votes for or
against particular agenda items.
If a quorum is not present at the Meeting, a vote for adjournment will be
taken among the shareholders present or represented by proxy. If a majority
of the shareholders present or represented by proxy vote for adjournment, it
is our intention to adjourn the Meeting until a later date and to vote proxies
received at such adjourned meeting(s).
Page 1
SUMMARY OF ACQUISITION OF ASSETS OF
CASTLE ENERGY CORPORATION
This summary highlights selected information concerning the proposed
acquisition of assets from Castle Energy Corporation discussed later in this
Proxy Statement. To better understand the transaction and for a more complete
description, you should carefully read all of the information concerning the
proposal.
Delta is proposing to acquire substantially all of the interests of
Castle Energy Corporation ("Castle") in oil, gas and mineral leases located in
the United States. Castle is a publicly-held company, and its common stock is
quoted on the Nasdaq National Market System under the symbol "CECX." No vote
of Castle's shareholders is needed to approve the transaction.
Summary Term Sheet
- ------------------
On January 15, 2002, Delta entered into a Purchase and Sale Agreement
with Castle under which we propose to acquire all of Castle's interest in oil
and gas leases and wells located in the United States and assets related to
these properties. (Page 31)
. The purchase price for the assets will be $20,000,000 in cash and
9,566,000 shares of Delta's Common Stock with certain adjustments
for operations from the effective date of October 1, 2001. The
cash for the purchase is expected to be obtained from a commercial
bank. (Page 33)
. The closing is conditioned on Delta obtaining the approval of the
shareholders at the Annual Meeting and satisfying the terms of the
agreement. (Page 33)
. After the closing, Castle will own approximately 44% of Delta's
Common Stock. Delta may issue additional shares to Castle if an
insufficient amount of cash is obtained from bank financing. The
total number of shares issued to Castle would not exceed 49.9% of
the shares then outstanding. (Page 33)
. Immediately after closing, Delta's Board of Directors will be
expanded from four to seven persons. Three new Directors selected
by Castle will be appointed to the Board. (Page 37)
. Delta has agreed to register the shares issued to Castle under the
Securities Act of 1933 after the closing. Delta will have the
right to repurchase up to 3,188,667 of such shares at $4.50 for one
year after closing. (Page 37)
. The agreement may be cancelled for a number of reasons. Under
certain conditions Delta may be required to pay Castle a
termination fee in shares of its Common Stock. (Page 38)
. The Board of Directors believes that the proposed purchase is in
the best interests of Delta and its shareholders and recommends a
vote for approving the transaction. (Page 39)
Page 2
ELECTION OF DIRECTORS
(Proposal 1 of the Proxy)
Our Directors are elected annually by the shareholders to serve until the
next Annual Meeting of Shareholders and until their respective successors are
duly elected. Our bylaws provide that the number of directors comprising the
whole Board shall from time to time be fixed and determined by resolution
adopted by our Board of Directors. Our Board has established the size of the
Board for the ensuing year at four directors. Accordingly, our Board is
recommending that our four current directors be re-elected. If any nominee
becomes unavailable for any reason, a substitute nominee may be proposed by
our Board and the shares represented by proxy will be voted for any substitute
nominee, unless the Board reduces the number of directors. We have no reason
to expect that any nominee will become unavailable. Assuming the presence of
a quorum, the affirmative vote of the holders of a majority of the outstanding
shares of Common Stock represented in person or by proxy at the Annual Meeting
is required for the election of directors.
At the Annual Meeting, the shares of Common Stock represented by proxies
will be voted in favor of the election of the nominees named below unless
otherwise directed.
We recommend a vote for these nominees.
NOMINEES FOR ELECTION AS DIRECTORS TO SERVE
UNTIL NEXT ANNUAL MEETING
The following information with respect to Directors and Executive
Officers is furnished pursuant to Item 401(a) of Regulation S-B.
Name Age Positions Period of Service
Aleron H. Larson, Jr.* 56 Chairman of the Board, May 1987 to Present
Secretary and a Director
Roger A. Parker* 40 President, Chief May 1987 to Present
Executive Officer and
a Director
Jerrie F. Eckelberger* 57 Director September 1996
to Present
James B. Wallace* 72 Director November 2001 to
Present
Kevin K. Nanke 37 Treasurer and Chief December 1999
Financial Officer to Present
* nominees for re-election as directors
The following is additional biographical information as to the business
experience of each of our current officers and directors.
ALERON H. LARSON, JR., age 56, has operated as an independent in the oil
and gas industry individually and through public and private ventures since
1978. From July of 1990 through March 31, 1993, Mr. Larson served as the
Chairman, Secretary, CEO and a Director of Chippewa Resources Corporation (now
called "Underwriters Financial Group, Inc."), a public company then listed on
the American Stock Exchange which was previously our parent ("UFG").
Page 3
Subsequent to a change of control, Mr. Larson resigned from all positions with
UFG effective March 31, 1993. Mr. Larson serves as Chairman of the Board,
Secretary and a Director of Amber Resources Company ("Amber"), a public oil
and gas company which is our majority-owned subsidiary. He has also served,
since 1983, as the President and Board Chairman of Western Petroleum
Corporation, a public Colorado oil and gas company which is now inactive. Mr.
Larson practiced law in Breckenridge, Colorado from 1971 until 1974. During
this time he was a member of a law firm, Larson & Batchellor, engaged
primarily in real estate law, land use litigation, land planning and municipal
law. In 1974, he formed Larson & Larson, P.C., and was engaged primarily in
areas of law relating to securities, real estate, and oil and gas until 1978.
Mr. Larson received a Bachelor of Arts degree in Business Administration from
the University of Texas at El Paso in 1967 and a Juris Doctor degree from the
University of Colorado in 1970.
ROGER A. PARKER, age 40, served as the President, a Director and Chief
Operating Officer of Chippewa Resources Corporation (now called "Underwriters
Financial Group, Inc.") from July of 1990 through March 31, 1993. Mr. Parker
resigned from all positions with UFG effective March 31, 1993. Mr. Parker
also serves as President, Chief Executive Officer and a Director of Amber. He
also serves as a Director and Executive Vice President of P & G Exploration,
Inc., a private oil and gas company (formerly Texco Exploration, Inc.). Mr.
Parker has also been the President, a Director and sole shareholder of Apex
Operating Company, Inc., which holds oil and gas property interests, since its
inception in 1987. He has operated as an independent in the oil and gas
industry individually and through public and private ventures since 1982. He
was at various times, from 1982 to 1989, a Director, Executive Vice President,
President and shareholder of Ampet, Inc., a small oil and gas company. He
received a Bachelor of Science in Mineral Land Management from the University
of Colorado in 1983. He is a member of the Rocky Mountain Oil and Gas
Association and the Independent Producers Association of the Mountain States
(IPAMS).
JERRIE F. ECKELBERGER, age 57, is an investor, real estate developer and
attorney who has practiced law in the State of Colorado since 1971. He
graduated from Northwestern University with a Bachelor of Arts degree in 1966
and received his Juris Doctor degree in 1971 from the University of Colorado
School of Law. From 1972 to 1975, Mr. Eckelberger was a staff attorney with
the eighteenth Judicial District Attorney's Office in Colorado. From 1982 to
1992 Mr. Eckelberger was the senior partner of Eckelberger & Feldman, a law
firm with offices in Englewood, Colorado. In 1992, Mr. Eckelberger founded
Eckelberger & Associates of which he is still the principal member. Mr.
Eckelberger previously served as an officer, director and corporate counsel
for Roxborough Development Corporation. Since March 1996, Mr. Eckelberger
has acted as President and Chief Executive Officer of 1998, Ltd., a Colorado
corporation actively engaged in the development of real estate in Colorado.
He is the Managing Member of The Francis Companies, L.L.C., a Colorado limited
liability company, which actively invests in real estate and has been since
June, 1996. Additionally, since November, 1997, Mr. Eckelberger has served as
the Managing Member of the Woods at Pole Creek, a Colorado limited liability
company, specializing in real estate development.
JAMES B. WALLACE, age 72, has been involved in the oil and gas business
for over 40 years and has been a partner of Brownlie, Wallace, Armstrong and
Bander Exploration in Denver, Colorado since 1992. From 1980 to 1992 he was
Chairman of the Board and Chief Executive Officer of BWAB Incorporated. Mr.
Wallace currently serves as Chairman of the Board of Directors of Tom Brown,
Inc., an oil and gas exploration company listed on the Nasdaq National Market
Page 4
System. He received a B.S. Degree in Business Administration from the
University of Southern California in 1951.
KEVIN K. NANKE, age 37, Treasurer and Chief Financial Officer, joined
Delta in April 1995. Since 1989, he has been involved in public and private
accounting with the oil and gas industry. Mr. Nanke received a Bachelor of
Arts in Accounting from the University of Northern Iowa in 1989. Prior to
working with Delta, he was employed by KPMG LLP. He is a member of the
Colorado Society of CPA's and the Council of Petroleum Accounting Society.
Mr. Nanke is not a nominee for election as a director.
There is no family relationship among or between any of our Officers
and/or Directors.
Messrs. Eckelberger and Wallace currently serve as the audit committee
and as the compensation committee. Messrs. Eckelberger and Wallace currently
also constitute our Incentive Plan Committee for our incentive plans.
All directors will hold office until the next annual meeting of
shareholders.
All of our officers will hold office until the next annual directors'
meeting. There is no arrangement or understanding among or between any such
officers or any persons pursuant to which such officer is to be selected as
one of our officers.
BOARD OF DIRECTORS AND COMMITTEES
During fiscal year 2001 our Board of Directors met on 15 occasions either
in person or by phone or in lieu thereof acted by consent. Our Board has
appointed three committees: the Audit, Compensation and Incentive Plan
Committees. The non-employee directors, Messrs. Eckelberger and Wallace,
currently serve on all three committees and both are necessary to constitute a
quorum. During fiscal year 2001 our Compensation Committee met on seven
occasions, our Audit Committee on one occasion, and our Incentive Plan
Committee on eight occasions, either in person or by phone or, in lieu
thereof, acted by consent. Each Director attended at least 75% of the
aggregate number of meetings held by the Board of Directors and its committees
held in person or by phone during the time each such Director was a member of
the Board or of any committee of the Board.
Our Compensation Committee makes recommendations to our Board in the area
of executive compensation. Our Audit Committee is appointed for the purpose
of overseeing and monitoring our independent audit process. It is also
charged with the responsibility for reviewing all related party transactions
for potential conflicts of interest. The Incentive Plan Committee is charged
with the responsibility for selecting individual employees to be issued
options and other grants under our 2001 Incentive Plan. Members of the
Incentive Plan Committee, as non-employee directors, are automatically awarded
options on an annual basis under a fixed formula under our 2001 Incentive
Plan. The Compensation Committee will also have these responsibilities under
our 2002 Incentive Plan. (See "Compensation of Directors").
Page 5
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE
ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires our executive officers, directors and persons who beneficially own
more than ten percent (10%) of a registered class of our equity securities, to
file initial reports of securities ownership of Delta and reports of changes
in ownership of equity securities of Delta with the Securities and Exchange
Commission ("SEC"). Such persons also are required by SEC regulation to
furnish us with copies of all Section 16(a) forms they file.
To our knowledge, during the fiscal year ended June 30, 2001, our
officers and directors complied with all applicable Section 16(a) filing
requirements. These statements are based solely on a review of the copies of
such reports furnished to us by our officers and directors and their written
representations that such reports accurately reflect all reportable
transactions.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
SHAREHOLDERS AND MANAGEMENT
(a) Security Ownership of Certain Beneficial Owners:
The following table presents information concerning persons known by
us to own beneficially 5% or more of our issued and outstanding voting
securities at March 11, 2002:
Name and Address Amount and Nature
of Beneficial of Beneficial Percent
Title of Class (1) Owner Ownership of Class(2)
Common stock Aleron H. Larson, Jr. 1,406,801 shares(3) 9.83%
(includes options 475 17th St., #1400
for common stock) Denver, CO 80202
Common stock Roger A. Parker 1,362,101 shares(4) 9.77%
(includes options 475 17th St., #1400
for common stock) Denver, CO 80202
Common stock GlobeMedia AG 829,846 shares(5) 6.14%
(includes options Immanuel Hohlbauch
for common stock) Strasse 41
Goppingen/Germany
Common stock Burdette A. Ogle 761,891 shares(6) 5.85%
(includes options 1224 Coast Village Rd, #24
for common stock) Santa Barbara, CA 93108
Common stock BWAB Limited Liability 702,930 shares(7) 5.21%
Company
475 17th Street, #1390
Denver, CO 80202
- ------------------------------
(1) We have an authorized capital of 300,000,000 shares of $.01 par value
Common Stock of which 12,916,030 shares were issued and outstanding as of
March 11, 2002. We also have an authorized capital of 3,000,000 shares of
$.10 par value preferred stock of which no shares are outstanding.
Page 6
(2) The percentage set forth after the shares listed for each beneficial
owner is based upon total shares of Common Stock outstanding at March 11, 2002
of 12,916,030. The percentage set forth after each beneficial owner is
calculated as if any warrants and/or options owned had been exercised by such
beneficial owner and as if no other warrants and/or options owned by any other
beneficial owner had been exercised. Warrants and options are aggregated
without regard to the class of warrant or option.
(3) Includes 2,211 shares owned by Mr. Larson's wife and 4,000 shares owned
by his children; and 375,590 options to purchase 375,590 shares of Common
Stock at $0.05 per share until September 21, 2008 for 151,690 of the options,
until September 1, 2008 for 175,000 of the options and until December 10, 2008
for 100,000 of the options. Also includes options to purchase 100,000 shares
of Common Stock at $1.75 per share until November 5, 2009; options to purchase
300,000 shares of Common Stock at $3.75 per share until July 14, 2010; options
to purchase 250,000 shares of Common Stock at $5.00 per share until October 9,
2010; options to purchase 200,000 shares of Common Stock at $3.29 per share
until January 8, 2011; and options to purchase 175,000 shares of Common Stock
at $2.38 per share until October 5, 2011.
(4) Includes 337,101 shares owned by Mr. Parker directly. Also includes
options to purchase 100,000 shares of Common Stock at $1.75 until November 5,
2009; options to purchase 300,000 shares of Common Stock at $3.75 per share
until July 14, 2010; options to purchase 250,000 shares of Common Stock at
$5.00 per share until October 9, 2010; options to purchase 200,000 shares of
Common Stock at $3.29 per share until January 8, 2011; and options to purchase
175,000 shares of Common Stock at $2.38 per share until October 5, 2011.
(5) Consists of 90,692 shares owned directly by GlobeMedia AG; 54,000 shares
owned by its president, Karl Spoddig; 10,000 shares owned by GlobeMedia Gmbh;
46,154 shares owned by Quadrafin AG; options to purchase 5,000 shares of
Common Stock at $2.50 per share until April 10, 2002; options to purchase
200,000 shares of Common Stock at $4.5625 per share for a period of one year
beginning with the effective date of a registration statement covering the
shares underlying the options; options in the name of Pegasus Finance Limited,
an affiliate of GlobeMedia AG, to purchase Common Stock for periods beginning
with the effective date of a registration statement covering the common shares
underlying the options as follows: 100,000 shares at $2.50 per share for one
year; 100,000 shares at $3.00 per share for one year; 100,000 shares at $6.00
per share for one year; and options, also in the name of Pegasus Finance
Limited, to purchase 100,000 shares of Common Stock at $3.125 per share until
January 9, 2004. Mr. Spoddig is the ultimate beneficial owner of GlobeMedia
AG, Pegasus Finance Limited and Quadrafin AG.
(6) Includes 635,264 shares owned by Mr. Ogle directly, 26,627 shares owned
beneficially by Sunnyside Production Company, and warrants to purchase 100,000
shares of Common Stock at $3.00 per share until August 31, 2004, with a call
provision that allows us to repurchase any unexercised warrants for an
aggregate sum of $1,000 after our stock has traded for $6.00 per share or
greater for 30 consecutive trading days. Sunnyside Production Company is
owned 50% each by Mr. Ogle and Mr. Charles Shearer.
(7) Includes 672,680 shares owned directly and 30,250 shares owned by an
affiliate, Franklin Energy, LLC. Both BWAB and Franklin Energy, LLC are
wholly owned by Steven Roitman.
Page 7
(b) Security Ownership of Management:
Name and Address Amount and Nature
of Beneficial of Beneficial Percent
Title of Class (1) Owner Ownership of Class(2)
Common Stock Aleron H. Larson, Jr. 1,406,801 shares(3) 9.83%
Common Stock Roger A. Parker 1,362,101 shares(4) 9.77%
Common Stock Kevin K. Nanke 584,047 shares(5) 4.33%
Common stock Jerrie F. Eckelberger 40,725 shares(6) .31%
Common stock James B. Wallace 32,500 shares(7) .25%
Common stock Officers and Directors 3,426,174 shares(8) 21.49%
as a Group (5 persons)
- ------------------------------
(1) See Note (1) to preceding table; includes options.
(2) See Note (2) to preceding table.
(3) See Note (3) to preceding table.
(4) See Note (4) to preceding table.
(5) Consists of 25,000 shares of Common Stock owned directly by Mr. Nanke;
options to purchase 34,047 shares of Common Stock at $1.125 per share until
September 1, 2008; options to purchase 25,000 shares of Common Stock at
$1.5625 per share until December 12, 2008; options to purchase 100,000 shares
of Common Stock at $1.75 per share until May 12, 2009; options to purchase
75,000 shares of Common Stock at $1.75 per share until November 5, 2009;
options to purchase 125,000 shares of Common Stock at $3.75 per share until
July 14, 2010; options to purchase 100,000 shares of Common Stock at $3.29
until January 9, 2011; and options to purchase 100,000 shares of Common Stock
at $2.38 per share until October 5, 2011.
(6) Includes 725 options to purchase shares of Common Stock at $2.98 per
share until December 31, 2006; options to purchase 20,000 shares of Common
Stock at $1.95 until September 10, 2011 and options to purchase 20,000 shares
of Common Stock at $2.02 until February 5, 2012.
(7) Includes 30,000 shares of Common Stock and options to purchase 2,500
shares at $2.02 per share until February 5, 2002.
(8) Includes all warrants, options and shares referenced in footnotes (3),
(4), (5), (6) and (7) above as if all warrants and options were exercised and
as if all resulting shares were voted as a group.
Page 8
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION
Long-Term
Compensation
Annual ------------
Compensation Awards
-------------------- ------------
Securities
Underlying
Name and Options/ All Other
Principal Position Period Salary(1) Bonus SARs(#) Compensation($)
- ------------------------ ---------- --------- -------- ----------- ---------------
Roger A. Parker
President, Chief Executive Year Ended
Officer and Director 6/30/01 $198,000 $ 91,000 750,000(2) -0-
Year Ended
6/30/00 198,000 75,000 100,000(3) -0-
Year Ended
6/30/99 198,000 105,000 510,663(4) -0-
Aleron H. Larson, Jr.
Chairman, Secretary Year Ended
and Director 6/30/01 $198,000 $ 91,000 750,000(2) -0-
Year Ended
6/30/00 198,000 75,000 100,000(3) -0-
Year Ended
6/30/99 198,000 105,000 559,500(5) -0-
Kevin K. Nanke Year Ended
Chief Financial Officer 6/30/01 $120,000 55,000 225,000(6) -0-
and Treasurer Year Ended
6/30/00 105,000 15,000 100,000(7) -0-
- ------------------------
(1) Includes reimbursement of certain expenses.
(2) Includes options to purchase 300,000 shares of Common Stock at $3.75 per
share until July 14, 2010; options purchase 250,000 shares of Common Stock at
$5.00 per share until October 9, 2010; and options to purchase 200,000 shares
of Common Stock at $3.29 per share until January 8, 2011.
(3) Option to purchase 100,000 shares of Common Stock at $1.75 per share
until November 5, 2009.
(4) Represents all options held by individual at June 30, 1999. Includes
320,977 previously granted options and 100,000 options granted during fiscal
1999 for which the exercise price was repriced during fiscal 1999 to $0.05 per
share and the expiration date extended to 9/01/08 for 320,977 options and to
12/10/08 for 100,000 options. Also includes a grant of options to purchase
89,686 shares of Common Stock at $0.05 per share until 5/20/09.
Page 9
(5) Represents all options held by individual at June 30, 1999. Includes
459,500 previously granted options and 100,000 options granted during fiscal
1999 for which the exercise price was repriced during fiscal 1999 to $0.05 per
share and the expiration date extended to 9/01/08 for 459,500 options and to
12/01/08 for 100,000 options.
(6) Includes options to purchase 125,000 shares of Common Stock at $3.75 per
share until July 14, 2010; and options to purchase 100,000 shares of Common
Stock at $3.29 per share until January 8, 2011.
(7) Represents options to purchase 75,000 shares of Common Stock at $1.75 per
share until November 5, 2009 and options to purchase 25,000 shares of Common
Stock at $.01 per share until December 31, 2009.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS
Percent
Number of of Total
Securities Options/SAR's Exercise Market
Underlying Granted to or Base Price on
Options/SAR's Employees in Price Date of Expiration
Name Granted Fiscal Year ($/Sh) Grant($/sh) Date
- --------------------- ------------- ------------- -------- ----------- ----------
Roger A. Parker 300,000 15.94% $3.75 $3.75 07/14/10
250,000 13.28% 5.00 5.00 10/09/10
200,000 10.62% 3.29 3.29 01/08/11
Aleron H. Larson, Jr. 300,000 15.94% $3.75 $3.75 07/14/10
250,000 13.28% 5.00 5.00 10/09/10
200,000 10.62% 3.29 3.29 01/08/11
Kevin K. Nanke 125,000 6.64% $3.75 $3.75 07/14/10
100,000 5.31% 3.29 3.29 10/01/10
Page 10
AGGREGATED OPTIONS/EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/VALUES
Number of
Securities Value of
Underlying Unexercised
Unexercised in-the-Money
Options Options
Shares at at
Acquired June 30, 2001 (#) June 30, 2001 ($)
on Realized Exercisable/ Exercisable/
Name Exercise (#) $ Unexercisable Unexercisable
- --------------------- ------------ ----------- ---------------- ------------------
Roger A. Parker 250,236 $1,048,000 850,000/0 $ 802,000/0
President, Chief Executive
Officer and Director
Aleron H. Larson, Jr. 92,810 $ 406,000 1,276,690/0 $2,743,000/0
Chairman, Secretary
and Director
Kevin K. Nanke 59,725 $ 194,000 464,175/0 $ 946,000/0
Chief Financial
Officer and Treasurer
Compensation of Directors
As a result of elections made by non-employee directors under the
formulas provided in our 2001 Incentive Plan, as amended, we granted options
to non-employee directors after the fiscal year end as follows:
Number Exercise Expiration
Director of Options Price Date
Terry D. Enright 20,000 $1.95/sh 9/10/2011
Jerrie F. Eckelberger 20,000 1.95/sh 9/10/2011
In addition, the outside non-employee directors are each paid $500 per
month. Jerrie F. Eckelberger and Terry D. Enright were each paid $6,000
during the year ended June 30, 2001. Mr. Enright resigned as a Director on
November 15, 2001. In connection with his resignation, Mr. Enright received
2,500 shares of our restricted Common Stock and is also entitled to receive
his compensation for the portion of the calendar year 2001 served (January 1,
2001 through November 15, 2001) in the form of either Common Stock or options,
at his election, under our 2001 Incentive Plan.
Employment Contracts and Termination of Employment and Change-in-Control
Agreement
On November 1, 2001, our Compensation Committee authorized us to enter
into employment agreements with our Chairman, President and Chief Financial
Officer, which employment agreements replaced and superseded the prior
Page 11
employment agreements with these persons. Under the new employment agreements
our Chairman and President each receive a salary of $240,000 per year and our
Chief Financial Officer receives a salary of $144,000 per year. Their
employment agreements have three-year terms and include provisions for cars,
parking and health insurance. Terms of their employment agreements also
provide that the employees may be terminated for cause but that in the event
of termination without cause or in the event we have a change in control, as
defined in our 2001 Incentive Plan, then the employees will continue to
receive the compensation provided for in the employment agreements for the
remaining terms of the employment agreements. Also in the event of a change
of control and irrespective of any resulting termination, we will immediately
cause all of each employee's then outstanding unexercised options to be
exercised by us on behalf of the employee and we will pay the employee's
federal, state and local taxes applicable to the exercise of the options and
warrants.
Retirement Savings Plan
During 1997 we began sponsoring a qualified tax deferred savings plan in
the form of a Savings Incentive Match Plan for Employees ("SIMPLE") IRA plan
available to companies with fewer than 100 employees. Under the SIMPLE IRA
plan, our employees may make annual salary reduction contributions of up to
three percent (3%) of an employee's base salary up to a maximum of $6,000
(adjusted for inflation) on a pre-tax basis. We will make matching
contributions on behalf of employees who meet certain eligibility
requirements. During the fiscal year ended June 30, 2001, we contributed
$18,000 under the plan.
REPORT OF THE COMPENSATION AND INCENTIVE PLAN COMMITTEES
REGARDING COMPENSATION ISSUES
The objective of our Compensation Committee is to design our executive
compensation program to enable us to attract, retain and motivate executive
personnel deemed necessary to maximize return to shareholders. The
fundamental concept of the program is to align the amount of an executive's
total compensation with his contribution to our success in creating
shareholder value.
In furtherance of this objective, the Compensation Committee has
determined that the program should have the following components:
BASE SALARIES: Our Committee believes that we should offer competitive
base salaries to enable us to attract, motivate and retain capable executives.
Our Committee has in the past determined levels of the base compensation using
published compensation surveys and other information for energy and similar
sized companies. Our Committee may or may not use such surveys or other
information to determine levels of base compensation in the future.
LONG-TERM INCENTIVES: Our Committee believes that long-term compensation
should comprise a substantial portion of each executive officer's total
compensation. Long-term compensation provides incentives that encourage our
executive officers to own and hold our stock and tie their long-term economic
interests directly to those of our shareholders. Long-term compensation can
be provided in the form of restricted stock or stock options or other grants
under our 2001 Incentive Plan, as amended.
With specific reference to our officers, our Committee attempts to
exercise great latitude in setting salary and bonus levels and granting stock
options. Philosophically, our Committee attempts to relate executive
Page 12
compensation to those variables over which the individual executive generally
has control. These officers have the primary responsibility for improving
shareholder value for us.
Our Committee believes that its objective of linking executive
compensation to corporate performance results in alignment of compensation
with corporate goals and shareholder interest. When performance goals are met
or exceeded, shareholder value is increased and executives are rewarded
commensurately. Corporate performance includes circumstances that will result
in long-term increases in shareholder value notwithstanding that such
circumstances may not be reflected in the immediate increase in our profits or
share price. It is our Committee's objective to emphasize and promote
long-term growth of shareholder value over short-term, quarter to quarter
performance whenever these two concepts are in conflict. Our Committee
believes that compensation levels during 2001 adequately reflect our
compensation goals and policies.
In 1993, the Internal Revenue Code was amended to add section 162(m),
which generally disallows a tax deduction for compensation paid to senior
executive officers in excess of $1 million per person in any year. Excluded
from the $1 million limitation is compensation which meets pre-established
performance criteria or results from the exercise of stock options which meet
certain criteria. While we generally intend to qualify payment of
compensation under section 162(m), we reserve the right to pay compensation to
our executives from time to time that may not be tax deductible.
REPORT OF THE AUDIT COMMITTEE
Delta has a standing Audit Committee of the Board of Directors (the
"Audit Committee"). The Audit Committee consists of Messrs. Wallace and
Eckelberger, who are independent (as defined in the Nasdaq listing standards).
The Audit Committee operates pursuant to a charter (the "Audit Committee
Charter") approved and adopted by the Board. A copy of the Audit Committee
Charter was attached to the Proxy Statement for the Annual Meeting held in
August 2001. The Audit Committee held one (1) meeting in fiscal 2001. The
Audit Committee, on behalf of the Board, oversees Delta's financial reporting
process. In fulfilling its oversight responsibilities, the Audit Committee
reviewed and discussed the audited financial statements and footnotes thereto
in Delta's fiscal 2001 Annual Report to Shareholders with management.
The Audit Committee has discussed with Delta's independent public
accountants the matters required to be discussed by Statement on Auditing
Standards No. 61.
The Audit Committee has discussed with Delta's independent public
accountants their independence from management and Delta, and received from
them the written disclosures and the letter concerning the independent public
accountants' independence required by the Independence Standards Board
Standard No. 1.
Based on the Audit Committee's review of the foregoing and discussions
with management and Delta's independent public accountants, the Audit
Committee recommended to the Board of Directors that the audited financial
statements be included in Delta's Annual Report on Form 10-KSB for the last
fiscal year for filing with the SEC.
Page 13
MEMBERS OF THE AUDIT COMMITTEE:
Jerrie F. Eckelberger
James B. Wallace
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The following is a list of certain relationships and related party
transactions that occurred during our past fiscal year and the two previous
fiscal years, as well as transactions that occurred since the beginning of our
last fiscal year or are currently proposed:
(a) Effective October 28, 1992, we entered into a five year consulting
agreement with Burdette A. Ogle and Ronald Heck which provides for an
aggregate fee to the two of them of $10,000 per month. We agreed to extend
this agreement for one year during the 1998 fiscal year and, subsequent to
June 30, 1998, agreed to extend it through December 1, 1999. Subsequent to
December 1, 1999 we have retained Messrs. Ogle and Heck on a month to month
basis at the same monthly rate. At March 11, 2002, Messrs. Ogle and Heck
owned beneficially 5.85% and 1.94%, respectively, of our outstanding Common
Stock. To our best knowledge and belief, the consulting fee paid to Messrs.
Ogle and Heck is comparable to those fees charged by Messrs. Ogle and Heck to
other companies owning interests in properties offshore California for
consulting services rendered to those other companies with respect to their
own offshore California interests. It is our understanding that, in the
aggregate, Mr. Ogle represents, as a consultant, a significant percentage of
all of the ownership interests in the various properties that are located in
the same general vicinity of our offshore California properties. Mr. Ogle
also consults with and advises us relative to properties in areas other than
offshore California, relative to potential property acquisitions and with
respect to our general oil and gas business. It is our opinion that the fees
paid to Messrs. Ogle and Heck for the services rendered are comparable to fees
that would be charged by similarly qualified non-affiliated persons for
similar services.
(b) Effective February 24, 1994, at the time Ogle was the owner of
21.44% of our stock, he granted us an option to acquire working interests in
three undeveloped offshore Santa Barbara, California, federal oil and gas
units. In August 1994, we issued a warrant to Ogle to purchase 100,000 shares
of our Common Stock for five years at a price of $8 per share in consideration
of the agreement by Ogle to extend the expiration date of the option to
January 3, 1995. On January 3, 1995, we exercised the option from Ogle to
acquire the working interests in three proved undeveloped offshore Santa
Barbara, California federal oil and gas units. The purchase price of
$8,000,000 is represented by a production payment reserved in the documents of
Assignment and Conveyance and will be paid out of three percent (3%) of the
oil and gas production from the working interests with a requirement for
minimum annual payments. We paid Ogle $1,550,000 through fiscal 1999 and are
to continue to pay a minimum of $350,000 annually until the earlier of: 1)
when the production payments accumulate to the $8,000,000 purchase price; 2)
when 80% of the ultimate reserves of any lease have been produced; or 3) 30
years from the date of the conveyance. Under the terms of the agreement, we
may reassign the working interests to Ogle upon notice of not more than 14
months nor less than 12 months, thereby releasing us from any further
obligations to Ogle after the reassignment.
On December 17, 1998, we amended our Purchase and Sale Agreement with
Ogle dated January 3, 1995. As a result of this amended agreement, at the
time of each minimum annual payment we will be assigned an interest in the
Page 14
three undeveloped offshore Santa Barbara, California federal oil and gas units
proportionate to the total $8,000,000 production payment. Accordingly, the
annual $350,000 minimum payment is recorded as an addition to undeveloped
offshore California properties. In addition, pursuant to this agreement, we
extended and repriced the previously issued warrant to purchase 100,000 shares
of our Common Stock. Prior to fiscal 1999, the minimum royalty payment was
expensed in accordance with the purchase and sale agreement with Ogle dated
January 3, 1995. As of September 30, 2001, we had paid a total of $2,250,000
in minimum royalty payments. On December 3, 2001, we entered into a letter
agreement that amended certain provisions of this agreement. In accordance
with the terms of the letter agreement, Delta did not pay the $350,000 payment
which would otherwise have been due on January 3, 2002, and instead paid Ogle
$87,500 and executed a promissory note for $262,500 which is payable in
installments through October 3, 2002, with interest at 10% per annum. Delta
also entered into an amendment effective January 3, 2002 that requires
additional payments to Ogle upon receipt of certain compensation by Delta.
Such payments are to be equal to the lesser of 6% of the compensation or the
remaining balance of the production payment. If the final payment of the
promissory note occurs on or after February 15, 2002, the percentage amount is
to be changed to an amount ranging from 7.33% to 10%, depending on the date of
payment.
The terms of the original transaction and the amendment with Mr. Ogle
were arrived at through arms-length negotiations initiated by our management.
We are of the opinion that the transaction is on terms no less favorable to us
than those which could have been obtained from non-affiliated parties. No
independent determination of the fairness and reasonableness of the terms of
the transaction was made by any outside person.
(c) Our Board of Directors has granted our President and Chairman each
the right to participate, on the same basis as Delta, in up to a five percent
(5%) working interest in any well drilled, re-entered, completed or
recompleted by us on our acreage (provided that any well to be re-entered or
recompleted is not then producing economic quantities of hydrocarbons).
Messrs. Larson and Parker are required to pay us the actual cost thereof. In
addition, our Chief Financial Officer is given the right to participate, on
the same basis as Delta, in up to a 2.5% working interest in these same types
of drilling activities and is required to pay the actual cost thereof.
(d) On November 1, 2001, our Compensation Committee authorized us to
enter into employment agreements with our Chairman, President and Chief
Financial Officer, which employment agreements replaced and superseded the
prior employment agreements with such persons. The employment agreements have
three year terms and include provisions for cars, parking and health
insurance. Terms of the employment agreements also provide that the employees
may be terminated for cause but that in the event of termination without cause
or in the event we have a change in control, as defined in our 2001 Incentive
Plan, as amended, then the employees will continue to receive the compensation
provided for in the employment agreements for the remaining terms of the
employment agreements. Also in the event of a change of control and
irrespective of any resulting termination, we will immediately cause all of
each employee's then outstanding unexercised options to be exercised by us on
behalf of the employee with us paying the employee's federal, state and local
taxes applicable to the exercise of the options and warrants.
(e) On January 6, 1999, we and our Compensation Committee authorized our
officers to purchase shares of the common stock of another company, Bion
Environmental Technologies, Inc. ("Bion"), which were held by us as
"securities available for sale," at the market closing price on that date not
Page 15
to exceed $105,000 per officer. Our Chairman, Aleron H. Larson, Jr.,
purchased 29,900 shares of Bion from us for $89,000.
(f) On January 3, 2000, we and our Compensation Committee authorized our
officers to purchase shares of Bion which were held by us as "securities
available for sale" at the market closing price on that day. Our officers
purchased 47,250 shares for $238,000.
(g) Our officers, Aleron H. Larson, Jr., our current Chairman and
Secretary, and Roger A. Parker, our current President and CEO, loaned us
$1,000,000 to make our June 8, 1999 payment to Whiting Petroleum Corporation
("Whiting") required under our agreement with Whiting, also dated June 8,
1999, to acquire Whiting's interests in the Point Arguello Unit and the
adjacent Rocky Point Unit. In connection with this loan, Mr. Parker was
issued options under our 1993 Incentive Plan, as amended, to purchase 89,868
shares at $.05 per share and the exercise prices of the existing options of
Messrs. Parker and Larson were reduced to $.05 per share. (See Form 8-K/A
dated June 9, 1999.)
(h) On July 30, 1999, we borrowed $2,000,000 from an unrelated entity
which was personally guaranteed by Aleron H. Larson, Jr., our current Chairman
and Secretary, and Roger A. Parker, our current President and CEO. The
proceeds were applied to the acquisition of Whiting's interests in the Point
Arguello Unit and adjacent Rocky Point Unit. As consideration for the
guarantee of our indebtedness we agreed to assign a 1% overriding royalty
interest to each officer in the properties acquired with the proceeds of the
loan (proportionately reduced to the interest we acquired in each property).
(See Form 8-K dated August 25, 1999.)
(i) On November 1, 1999 we borrowed approximately $2,800,000 from an
unrelated entity which was personally guaranteed by Aleron H. Larson, Jr., our
current Chairman and Secretary, and Roger A. Parker, our current President and
CEO. The loan proceeds were used to purchase eleven producing wells and
associated acreage in New Mexico and Texas. As consideration for the
guarantee of our indebtedness we agreed to assign a 1% overriding royalty
interest to each officer in the properties acquired with the proceeds of the
loan (proportionately reduced to the interest we acquired in each property).
(See Form 8-K dated November 1, 1999.)
(j) On December 1, 1999, our Incentive Plan Committee granted Kevin K.
Nanke, our Treasurer and Chief Financial Officer, 25,000 options to purchase
our Common Stock at $.01 per share.
(k) We operate wells in which our officers or employees or companies
affiliated with one of them own working interests. At June 30, 2001 we had
$272,000 of net receivables from these related parties (including affiliated
companies) primarily for drilling costs and lease operating expenses on wells
operated by us.
(l) On July 10, 2000, we borrowed $3,795,000 from an unrelated entity
which was personally guaranteed by Aleron H. Larson, Jr., our current Chairman
and Secretary, and Roger A. Parker, our current President and CEO. The loan
proceeds were used by us to purchase interests in producing wells and acreage
in the Eland and Stadium fields in Stark County, North Dakota. As
consideration for the guarantee of our indebtedness we agreed to issue 300,000
options to each of Messrs. Larson and Parker to purchase our Common Stock for
$3.75 per share until July 14, 2010.
Page 16
(m) During the two years ended September 30, 2001 we issued options to
GlobeMedia AG and its affiliate, Pegasus Finance, Ltd., as consideration for
services relating to raising capital for us in Europe as follows: November
23, 1999, options to purchase 250,000 shares of Common Stock at $2.50 per
share; July 5, 2000, options to purchase 100,000 shares of Common Stock at
$2.50 per share; July 5, 2000, options to purchase 100,000 shares at $3.00 per
share; and January 8, 2001, options to purchase 100,000 shares of Common Stock
at $3.125 per share. During the same period we issued options to GlobeMedia
AG for services relating to shareholder and public relations in Europe as
follows: November 23, 1999, options to purchase 250,000 shares of Common
Stock at $2.50 per share; February 17, 2000, options to purchase 200,000
shares of Common Stock at $2.50 per share; July 5, 2000, options to purchase
100,000 shares of Common Stock at $6.00 per share; and March 21, 2001, options
to purchase 200,000 shares of Common Stock at $4.5625 per share. In addition,
during this period we sold 30,692 shares of restricted Common Stock to
GlobeMedia AG on October 11, 2000 at $3.25 per share and we sold 46,154 shares
of restricted Common Stock to Quadrafin AG, an affiliate of GlobeMedia AG, on
October 11, 2000 at $3.25 per share. During the past two years we have paid
GlobeMedia approximately $105,000 for services and expenses relating to
shareholder and public relations in Europe and approximately $285,000 in
commissions for raising additional capital.
(n) On January 4, 2000 we sold 175,000 shares of restricted Common Stock
at a price of $2.00 per share and on January 3, 2001 we sold 116,667 shares of
restricted Common Stock at a price of $3.00 per share to Evergreen Resources,
Inc. In connection with these purchases we gave Evergreen Resources, Inc. an
option to acquire an interest in some of our undeveloped properties until
September 30, 2001. The option has expired.
(o) During the past two years ended September 30, 2001 we issued 315,000
shares of restricted Common Stock to BWAB in exchange for services related to
the acquisition of properties. On September 26, 2000 we exchanged 127,430
shares of restricted Common Stock and paid $382,000 to BWAB in exchange for
producing properties in Louisiana. On January 8, 2001 we issued 200,000
shares of restricted Common Stock to BWAB as a result of the conversion of a
promissory note in the amount of $500,000.
(p) On September 29, 2000 we acquired the West Delta Block 52 Unit from
Castle Offshore LLC and BWAB as described in our Form 8-K dated September 29,
2000, by paying $1,529,000 and issuing 509,719 shares of our restricted Common
Stock at $3.00 per share. We borrowed $1,464,000 of the cash portion of the
purchase price from an unrelated entity. To induce this lender to make the
loan to us, two of our officers, Aleron H. Larson, Jr., Chairman and
Secretary, and Roger A. Parker, President and CEO, agreed to personally
guarantee the loan. As consideration for the guarantees of our indebtedness
we permitted each of these two officers to purchase up to 5% of the working
interest acquired by us in the West Delta Block 52 Unit by delivering shares
of our Common Stock at $3.00 per share equal to up to 5% of the purchase price
paid by us. We also permitted our Chief Financial Officer and Treasurer,
Kevin Nanke, to purchase up to 2-1/2% of the working interest upon the same
terms. Messrs. Larson and Parker each delivered 58,333 shares of Common Stock
and Mr. Nanke delivered 29,167 shares of Common Stock, thereby purchasing the
maximum permitted to each. These shares have been retired.
(q) On February 12, 2001, we permitted our officers, Aleron H. Larson,
Jr., Chairman and Secretary, Roger A. Parker, President and CEO, and Kevin K.
Nanke, Chief Financial Officer and Treasurer, to purchase interests owned by
us in the Cedar State gas property in Eddy County, New Mexico, with its
Page 17
existing gas well, and in our Ponderosa Prospect with its approximately 52,000
gross exploratory leasehold acres in Harding and Butte Counties, South Dakota,
based upon our purchase price in each property. We permitted these officers
to purchase their interests by exchanging their shares of our Common Stock at
the market closing price on February 12, 2001 of $5.125 per share. Messrs.
Larson and Parker each exchanged 31,310 shares for a 5% interest in each
property and Mr. Nanke exchanged 15,655 shares for a 2-1/2% interest in each
property. On the same date we permitted our officers to participate in the
drilling of our Austin State #1 well in Eddy County, New Mexico, by
immediately making a commitment to participate in the well (prior to any bore
hole knowledge or information relating to the objective zone or zones) and pay
their share of our working interest costs of drilling and completing or
abandoning the well. The costs may be paid in either cash or our Common Stock
at the February 12, 2001 closing price of $5.125 per share. Messrs. Larson
and Parker each committed to pay the costs associated with a 5% working
interest in the well and Mr. Nanke likewise committed to a 2-1/2% working
interest in the well.
Directors and officers were issued options and warrants as disclosed in
"Executive Compensation" above.
All past and future and ongoing transactions with affiliates are and will
be on terms which our management believes are no less favorable than could be
obtained from non-affiliated parties. All future and ongoing loans to our
affiliates, officials and shareholders will be approved by the majority vote
of disinterested directors.
2002 INCENTIVE PLAN
(Proposal 2 of the Proxy)
The Board of Directors adopted the 2002 Incentive Plan (the "2002 Plan")
on October 25, 2001, subject to approval by the shareholders of Delta at the
Annual Meeting.
PURPOSE OF THE 2002 PLAN
The purpose of the 2002 Plan is to enable Delta to attract officers and
other key employees and consultants and to provide them with appropriate
incentives and rewards for superior performance. The 2002 Plan affords Delta
the ability to respond to changes in the competitive and legal environments by
providing Delta with flexibility in key employee and executive compensation.
This plan is designed to be an omnibus plan allowing Delta to grant a wide
range of compensatory awards including stock options, stock appreciation
rights, phantom stock, restricted stock, stock bonuses and cash bonuses. The
2002 Plan is intended to encourage stock ownership by recipients by providing
for or increasing their proprietary interests in Delta, thereby encouraging
them to remain in Delta's employment.
DESCRIPTION OF THE 2002 PLAN
GENERAL. The following general description of certain features of the
2002 Plan is qualified in its entirety by reference to the 2002 Plan, which is
attached as Appendix A. Subject to adjustment as provided in the 2002 Plan,
the number of shares of Common Stock that may be issued or transferred, plus
the amount of shares of Common Stock covered by outstanding awards granted
under the 2002 Plan, shall not in the aggregate exceed 2,000,000.
Page 18
ELIGIBILITY. Officers, including officers who are members of the Board
of Directors, and other key employees of and consultants and advisors to Delta
may be selected by the Committee (as defined below) to receive benefits under
the 2002 Plan. Non-employee Directors will only participate under special
provisions set forth in the 2002 Plan.
TERMS OF OPTIONS AND OTHER POSSIBLE AWARDS. The 2002 Plan authorizes the
granting of options to purchase shares of Common Stock, stock appreciation
rights ("SARs"), limited subscription rights ("LSARs"), phantom stock,
restricted shares, stock bonuses and cash bonuses. The terms applicable to
these various types of awards, including those terms that may be established
by the Board of Directors when making or administering particular awards, are
set forth in detail in the 2002 Plan.
TRANSFERABILITY OF AWARDS. Except as may be limited by the Committee at
the time of grant, and except for Restricted Stock, awards granted under the
2002 Plan may be transferred or assigned to others. The transfer of options
and other awards could have the effect of reducing the incentive effect of the
award to the extent that after a transfer the holder may not have any direct
relationship with us.
OPTIONS. The Committee may grant Options that entitle the optionee to
purchase shares of Common Stock at a price less than, equal to or greater than
market value on the date of grant. The option price is payable at the time of
exercise (i) in cash or cash equivalent, or (ii) by the transfer to Delta of
shares of Common Stock that are already owned by the optionee and have a value
at the time of exercise equal to the option price. In addition, at the time
of grant the Committee may provide that an Option may be exercised in a
"cashless" transaction in which the holder may surrender all or a portion of
the Option and receive the number of shares of Common Stock equal in value to
the Fair Market Value per share at the date of surrender less than the
exercise price per share of the Option, multiplied by the number of shares
which may be purchased under the Option, or portion thereof, being
surrendered.
Options granted under the 2002 Plan may be Options that are intended to
qualify as incentive stock options ("ISOs") within the meaning of Section 422
of the Internal Revenue Code of 1986 ("Code") or Options that are not intended
to so qualify. The 2002 Plan permits the granting of incentive stock options
or nonqualified stock options at the discretion of the Committee. The
exercise price for nonqualified stock options granted may not be less than the
fair market value per share of Common Stock on the date of grant. The exercise
price for ISOs may not be less than the fair market value per share of Common
Stock on the date of grant, and ISOs granted to persons owning more than 10%
of Delta's voting stock must have an exercise price of not less than 110% of
the fair market value per share of Common Stock on the date of grant. All
ISOs granted must be exercised within ten years of grant, except that ISOs
granted to 10% or more shareholders must be exercised within five years of
grant. The aggregate market value (as determined as of the date of grant) of
the Common Stock for which any optionee may be awarded ISOs which are first
exercisable by such optionee during any calendar year may not exceed $100,000.
The Committee may specify the conditions, including as and to the extent
determined by the Committee, the period or periods of continuous employment of
the optionee by Delta or any subsidiary that are necessary before the Options
will become exercisable. The 2002 Plan also provides that in the event of a
change in control of Delta or other similar transaction or event, each Option
granted under the 2002 Plan shall become fully and immediately exercisable.
Page 19
STOCK APPRECIATION RIGHTS. Stock Appreciation Rights ("SARs")granted
under the 2002 Plan may be either freestanding or granted in tandem with an
Option. Limited Stock Appreciation Rights ("LSARs") may only be granted in
connection with the grant of an Option and may only be exercisable in the
event of a change in control in lieu of exercising the Option. SARs and LSARs
represent the right to receive from Delta the difference ("Spread"), or a
percentage thereof not in excess of 100 percent, between the base price per
share of Common Stock in the case of a free-standing SAR, or the option price
of the related Options in the case of a tandem SAR or LSAR, and the market
value of the Common Stock on the date of exercise of the SAR or LSAR. Tandem
SARs may only be exercised at a time when the related Option Right is
exercisable, and the exercise of a tandem SAR requires the surrender of the
related Option Right for cancellation. A free-standing SAR must specify the
conditions that must be met before the SAR becomes exercisable and may not be
exercised more than 10 years from the date of grant.
PHANTOM STOCK. The Committee may grant shares of Phantom Stock under the
2002 Plan pursuant to an agreement approved by the Committee which provides
for vesting conditions it deems appropriate. Upon vesting of a share of
Phantom Stock the participant will receive in cash a sum equal to the fair
market value of a share of Common Stock on the date of vesting plus an amount
of cash equal to the aggregate amount of cash dividends paid on each share of
Delta's Common Stock commencing on the date of grant of the Phantom Stock. In
the event of a change in control, all shares of unvested Phantom Stock
outstanding shall become immediately vested.
RESTRICTED SHARES. An award of Restricted Shares involves the immediate
transfer by Delta to a participant of ownership of a specific number of shares
of Common Stock in consideration of the performance of services or, as and to
the extent determined by the Committee, the achievement of certain performance
criteria. The participant is entitled immediately to voting, dividend and
other ownership rights in the shares. The transfer may be made without
additional consideration from the participant or in consideration of a payment
by the participant that is less than the market value of the shares on the
date of grant, as the Board of Directors may determine. In the event of a
change in control, unvested Restricted Stock shall become immediately vested.
STOCK BONUSES. The Committee may grant Stock Bonuses under the 2002 Plan
in such amounts as it shall determine from time to time. Stock Bonuses shall
be paid at such times and subject to the conditions the Committee determines
at the time of the grant.
CASH BONUSES. Subject to the provisions of the Plan, the Committee may
grant, in connection with any grant of Restricted Stock or Stock Bonus or at
any time thereafter, a cash bonus, payable after the date on which a
Participant is required to recognize income for federal income tax purposes in
connection with such Restricted Stock or Stock Bonus, in such amounts as the
Committee shall determine. However, in no event shall the amount of a Cash
Bonus exceed 50% of the fair market value of the related shares of Restricted
Stock or Stock Bonus.
INCENTIVE AWARDS TO NONEMPLOYEE DIRECTORS. The Plan will be administered
as to Nonemployee Directors by the Board of Directors. No Nonemployee
Director will be eligible for an Incentive Award if, at the time of the Award,
the Nonemployee Director (i) is directly or indirectly the beneficial owner of
five percent or more of any class of equity security of Delta which is
registered pursuant to Section 12 of the Exchange Act or of any security
convertible into or exercisable for such class of equity security (excluding
shares covered by the 2002 Plan); or (ii) is an officer, director, 10% or
Page 20
greater shareholder, employee or agent of a person or entity which is directly
or indirectly the beneficial owner of more than five percent of any class of
equity security of Delta which is registered pursuant to Section 12 of the
Exchange Act or of any security convertible into or exercisable for such class
of equity security (excluding shares covered by the 2002 Plan). Incentive
Award grants, if any, to any non-eligible Nonemployee Directors shall be
determined by the Board.
Unless the Board of Directors otherwise directs, Options or Common Stock
will automatically be granted to Nonemployee Directors in each calendar year
during the term of the 2002 Plan as of December 31. Annually each eligible
Nonemployee Director will be granted either: (1) an option for 20,000 shares
of Common Stock, or, if a director for less than the prior 12 months, a pro
rata portion of 20,000 shares of Common Stock based upon the number of months
such Participant was a Nonemployee Director of Delta; or (2) at the election
of the participating Nonemployee Director, in lieu of an option, 10,000 shares
of Common Stock.
The exercise price of Options granted to Nonemployee Directors pursuant
to the 2002 Plan will be 50% of the average market price during the year then
ended as quoted on the Nasdaq Small-Cap Market. Each Option will be
exercisable for a ten year period commencing on the date of grant.
ADJUSTMENTS. The maximum number of shares of Common Stock that may be
issued or transferred under the 2002 Plan, the number of shares covered by
outstanding awards and the option prices or base prices per share applicable
thereto, are subject to adjustment in the event of stock dividends, stock
splits, combinations of shares, recapitalizations, mergers, consolidations,
spin-offs, reorganizations, liquidations, issuances of rights or warrants, and
similar transactions or events.
ADMINISTRATION AND AMENDMENTS. The 2002 Plan is administered by the
Committee designated by the Board of Directors. In connection with its
administration of the 2002 Plan, the Committee is authorized to interpret the
2002 Plan and related agreements and other documents. The Committee may make
grants to participants under any or a combination of all of the various
categories of awards that are authorized under the 2002 Plan. The Committee
may, with the concurrence of the affected participant, cancel any agreement
evidencing an award granted under the 2002 Plan. In the event of any such
cancellation, the Committee may authorize the granting of a new award under
the 2002 Plan in such manner, at such price and subject to such other terms,
conditions and discretion as would have been applicable under the 2002 Plan
had the canceled award not been granted.
The 2002 Plan may generally be amended from time to time by the Board of
Directors, but without further approval by the shareholders of Delta, except
that no such amendment (unless expressly allowed pursuant to the adjustment
provisions described above) may increase the aggregate number of shares that
may be issued under the 2002 Plan.
TAX CONSEQUENCES TO DELTA. To the extent that a participant recognizes
ordinary income in the circumstance described above, Delta will be entitled to
a corresponding deduction provided that, among other things, (i) the income
meets the test of reasonableness, is an ordinary and necessary business
expense, is not subject to the annual compensation limitation set forth in
Section 162(m) of the Code and is not an "excess parachute payment" within the
meaning of Section 280G of the Code, and (ii) any applicable withholding
obligations are satisfied.
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NEW PLAN BENEFITS
No options or awards have been granted under the 2002 Plan. The future
benefits or amounts that would be received under the 2002 Plan by executive
officers and the non-executive officer employees are discretionary and are
therefore not determinable at this time.
Had the 2002 Plan been applicable for the calendar year 2001 and the
non-employee directors elected to receive the shares of Common Stock, the
grants would have been as follows:
2002 Plan
---------
Dollar Number of
Name and Position Value ($)(1) Shares
Jerrie F. Eckelberger $38,500 10,000
Non-employee Director
James B. Wallace $ 4,813 1,250 (2)
Non-employee Director
Non-Employee Director $43,313 11,250
Group
(1) Based on the closing price on December 31, 2001, on the Nasdaq Small-Cap
Market of $3.85 per share.
(2) Represents the pro rata number of shares he would have received.
Had the 2002 Plan been applicable for the calendar year 2001 and the
non-employee directors elected to receive the options to purchase shares of
Common Stock, the grants would have been as follows:
2002 Plan
---------
Number
Exercise of Ten Year
Name and Position Price(3) Options
Jerrie F. Eckelberger $2.02 20,000
Non-employee Director
James B. Wallace $2.02 2,500 (4)
Non-employee Director
Non-Employee Director $2.02 22,500
Group
(3) Based on 50% of the average trading price during 2001 as quoted on the
Nasdaq Small-Cap Market.
(4) Represents the pro rata number of options he would have received.
Page 22
VOTE REQUIRED FOR APPROVAL; BOARD RECOMMENDATION
Pursuant to the Nasdaq shareholder approval requirements, the affirmative
vote of a majority of the votes cast on the proposal in person or by proxy is
required to approve the 2002 Plan. In order for Delta to be able to grant
incentive stock options under the 2002 Plan, the affirmative vote of a
majority of the shares outstanding, in person or by proxy, is required.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THIS PROPOSAL.
ISSUANCE OF SHARES AND WARRANTS
PURSUANT TO THE INVESTMENT AGREEMENT WITH
SWARTZ PRIVATE EQUITY, LLC
(Proposal 3 of the Proxy)
On April 4, 2001, we entered into an amended and restated investment
agreement (the "Investment Agreement") with Swartz Private Equity, LLC. The
Investment Agreement entitles us to issue and sell up to $20 million of our
Common Stock to Swartz, subject to a formula based on our stock price and
trading volume, from time to time over a three year period following the
effective date of the registration statement that we filed on May 1, 2001.
The formula is described below under the heading "The Delta-Swartz Investment
Agreement-Put Rights."
Nasdaq rules require us to obtain the approval of our shareholders prior
to the issuance of securities in connection with a transaction other than a
public offering involving the sale or issuance by us of our Common Stock and
securities exercisable for Common Stock at a price less than the greater of
book or market value which (together with any sales by officers, directors or
substantial shareholders of the company) equals 20% or more of Common Stock or
20% or more of the voting power outstanding before the issuance.
Shareholder approval is also required by the Investment Agreement if the
number of shares sold to Swartz, together with any shares previously sold to
Swartz, would equal 20% of the shares of our Common Stock that would be
outstanding prior to the sale.
As of March 10, 2002, we had 12,930,790 shares issued and outstanding.
Pursuant to the terms of the Investment Agreement with Swartz, we will
register an aggregate of 6,000,000 shares for sale, including the 500,000
shares underlying a commitment warrant already issued to Swartz. The resale
of the shares underlying the commitment warrant is subject to a dribble out
provision which is discussed in more detail later. A registration statement
to register these shares was filed on May 1, 2001, and has not yet become
effective.
If we were to sell all 6,000,000 shares to Swartz and if Swartz exercised
all of its warrant and did not resell any of the shares, Swartz would own
approximately 33% of our outstanding Common Stock based on the number of
shares that we currently have issued and outstanding. However, pursuant to
the terms of the Investment Agreement, Swartz will never beneficially own more
than 9.9% of our outstanding stock at any one time. Pursuant to the terms of
the Investment Agreement with Swartz, we are not obligated to sell any of the
shares to Swartz nor do we intend to sell shares to Swartz unless it is
beneficial to us.
Swartz is engaged in the business of investing in publicly-traded equity
securities for its own use. Other than the 500,000 shares underlying the
Page 23
warrant we issued to Swartz in connection with the closing of the Investment
Agreement, Swartz does not currently beneficially own any of our Common Stock
or any of our other securities. Other than its obligations to purchase Common
Stock under the Investment Agreement and the warrant, it has no other
commitments or arrangements to purchase or sell any of our securities.
Swartz will also be considered an "underwriter" within the meaning of the
Securities Act of 1933, as amended, in connection with the sale of these
shares. Swartz has not had any relationship with us, any predecessor or
affiliate within the past three years.
THE DELTA-SWARTZ INVESTMENT AGREEMENT
On July 21, 2000, we entered into an Investment Agreement with Swartz
Private Equity, LLC (the "Investment Agreement"). The Investment Agreement was
amended and restated on April 4, 2001. As amended and restated, the
Investment Agreement entitles us to issue and sell up to $20 million of our
Common Stock to Swartz, subject to a formula based on our stock price and
trading volume, from time to time over a three year period following the
effective date of the registration statement filed May 1, 2001. That
registration statement has not yet become effective, and so no shares have
been issued or sold under the Investment Agreement. We refer to each election
by us to sell stock to Swartz as a "Put."
As partial consideration for executing the Investment Agreement, Swartz
was issued a warrant to purchase 500,000 shares of Common Stock exercisable at
$3.00 per share until May 31, 2005, which is referred to as the commitment
warrant. The commitment warrant contains an anti-dilution provision, which
provides, if we complete a "reverse stock split" at a time when our
shareholders' equity is less than $1 million, Swartz shall be issued
additional warrants in an amount so that the sum of its warrants equals at
least 6.2% of our fully diluted shares. At December 31, 2001 our
shareholders' equity was $16,808,000. Any unexercised portion of the
commitment warrant will be canceled and returned to us, if both (1) we are not
in default of any provision of our agreements with Swartz, and (2) Swartz
fails to pay for any Puts after one month of being notified in writing by us
that such amount is past due.
The commitment warrant was amended to include a dribble-out provision
that prevents Swartz from exercising the warrant in excess of a number of
shares equal to fifteen percent (15%) of the aggregate trading volume of our
Common Stock, on the primary exchange or market upon which our Common Stock is
then listed for trading, during the twenty (20) trading days preceding the
date of such exercise. The dribble-out provision does not apply if the
average closing price of our Common Stock for the five (5) trading days
immediately preceding the date of exercise is greater than or equal to eight
dollars ($8.00) per share or if we are acquired by another entity.
- PUT RIGHTS
We may begin exercising Puts on the date of effectiveness of the
registration statement that was filed on May 1, 2001, and continue for a
three-year period. We currently do not intend to issue any shares to Swartz
under the Investment Agreement until we obtain shareholder approval. To
exercise a Put, we must have an effective registration statement on file with
the Securities and Exchange Commission covering the resale to the public by
Swartz of any shares that it acquires under the Investment Agreement. Also, we
must give Swartz at least 10, but not more than 20, business days advance
notice of the date on which we intend to exercise a particular Put right. The
Page 24
notice must indicate the date we intend to exercise the Put and the maximum
number of shares of Common Stock we intend to sell to Swartz. At our option,
we may also specify a maximum dollar amount (not to exceed $2 million) of
Common Stock that we will sell under the Put. We may also specify a minimum
purchase price per share at which we will sell shares to Swartz. The minimum
purchase price cannot exceed 80% of the closing bid price of our Common Stock
on the date we give Swartz notice of the Put.
The number of common shares we sell to Swartz may not exceed 15% of the
aggregate daily reported trading volume of our common shares during the 20
business days before and 20 days after the date we exercise a Put. Further, we
cannot issue additional shares to Swartz that, when added to the shares Swartz
previously acquired under the Investment Agreement during the 31 days before
the date we exercise the Put, will result in Swartz holding over 9.99% of our
outstanding shares upon completion of the Put.
Swartz will pay us a percentage of the market price for each share of
Common Stock under the Put. The market price of the shares of Common Stock
during the 20 business days immediately following the date we exercise a Put
is used to determine the purchase price Swartz will pay and the number of
shares we will issue in return. This 20 day period is the pricing period. For
each share of Common Stock, Swartz will pay us the lesser of:
- the market price for each share, minus $.25; or
- 91% of the market price for each share.
The Investment Agreement defines market price as the lowest closing bid
price for our Common Stock during the 20 business day pricing period. However,
Swartz must pay at least the designated minimum per share price, if any, that
we specify in our notice. If the price of our Common Stock is below the
greater of the designated minimum per share price plus $.25, or the designated
minimum per share price divided by .91 during any of the 20 days during the
pricing period, that day is excluded from the 15% volume limitation described
above. Therefore, the amount of cash that we can receive for that Put may be
reduced if we elect a minimum price per share and our stock price declines.
We must wait a minimum of five business days after the end of the 20
business day pricing period for a prior Put before exercising a subsequent
Put. We may, however, give advance notice of our subsequent Put during the
pricing period for the prior Put. We can only exercise one Put during each
pricing period.
- LIMITATIONS AND CONDITIONS TO OUR PUT RIGHTS
Our ability to Put shares of our Common Stock, and Swartz's obligation to
purchase the shares, is subject to the satisfaction of certain conditions.
These conditions include:
- we have satisfied all obligations under the agreements entered
into between us and Swartz in connection with the Investment
Agreement;
- our Common Stock is listed and traded on Nasdaq or an exchange,
or quoted on the O.T.C. Bulletin Board;
- our representations and warranties in the Investment Agreement
are accurate as of the date of each Put;
Page 25
- we have reserved for issuance a sufficient number of shares of
our Common Stock to satisfy our obligations to issue shares
under any Put and upon exercise of warrants;
- the registration statement for the shares we will be issuing
to Swartz must remain effective as of the Put date and no stop
order with respect to the registration statement is in effect;
- shareholder approval is required by Nasdaq rules in connection
with a transaction other than a public offering involving the
sale by the issuer of Common Stock at a price less than the
greater of book or market value which, together with sales by
officers, directors or substantial shareholders of the issuer,
equals 20% or more of Common Stock outstanding before the
issuance; and
- shareholder approval is required by the Investment Agreement if
the number of shares Put to Swartz, together with any shares
previously Put to Swartz, would equal 20% of all shares of our
Common Stock that would be outstanding upon completion of the
Put.
Swartz is not required to acquire and pay for any additional shares of
our Common Stock once it has acquired $20 million worth of Put Shares.
Additionally, Swartz is not required to acquire and pay for any shares of
Common Stock with respect to any particular Put for which, between the date we
give advance notice of an intended Put and the date the particular Put closes:
- we announced or implemented a stock split or combination of
our Common Stock;
- we paid a dividend on our Common Stock;
- we made a distribution of all or any portion of our assets or
evidences of indebtedness to the holders of our Common Stock; or
- we consummated a major transaction, such as a sale of all or
substantially all of our assets or a merger or tender or
exchange offer that results in a change in control.
We may not require Swartz to purchase any subsequent Put shares if:
- we, or any of our directors or executive officers, have
engaged in a transaction or conduct related to us that
resulted in:
- a Securities and Exchange Commission enforcement action,
administrative proceeding or civil lawsuit; or
- a civil judgment or criminal conviction or for any other
offense that, if prosecuted criminally, would constitute
a felony under applicable law;
- the aggregate number of days which this registration statement
is not effective or our Common Stock is not listed and traded
on Nasdaq or an exchange or quoted on the O.T.C. Bulletin Board
exceeds 120 days;
Page 26
- we file for bankruptcy or any other proceeding for the relief
of debtors; or
- we breach covenants contained in the Investment Agreement.
- COMMITMENT AND TERMINATION FEES
If we do not Put at least $2,000,000 worth of Common Stock to Swartz
during each one year period following the effective date of the Investment
Agreement (the date the registration statement is declared effective by the
Securities and Exchange Commission), we must pay Swartz an annual non-usage
fee. This fee equals the difference between $200,000 and 10% of the value of
the shares of Common Stock we Put to Swartz during the one year period. The
fee is due and payable on the last business day of each one year period. Each
annual non-usage fee is payable to Swartz, in cash, within five (5) business
days of the date it accrued. We are not required to pay the annual non-usage
fee to Swartz in years we have met the Put requirements. We are also not
required to deliver the non-usage fee payment until Swartz has paid us for all
Puts that are due.
If the Investment Agreement is terminated, we must pay Swartz the greater
of (i) the non-usage fee described above, or (ii) the difference between
$200,000 and 10% of the value of the shares of Common Stock Put to Swartz
during all Puts to date.
- SHORT SALES
The Investment Agreement prohibits Swartz and its affiliates from
engaging in short sales of our Common Stock unless Swartz has received a Put
notice and the amount of shares involved in the short sale does not exceed the
number of shares we specify in the Put notice. In addition, in accordance
with Section 5(b)(2) of the Securities Act of 1933, Swartz must deliver a
Prospectus when they enter into a short position.
- CANCELLATION OF PUTS
We must cancel a particular Put if:
- we discover an undisclosed material fact relevant to Swartz's
investment decision;
- the registration statement registering resales of the common
shares becomes ineffective; or
- our shares of Common Stock are delisted from Nasdaq, the
O.T.C. Bulletin Board or an exchange.
If we cancel a Put, it will continue to be effective, but the pricing period
for the Put will terminate on the date we notify Swartz that we are canceling
the Put. Because the pricing period will be shortened, the number of shares
Swartz will be required to purchase in the canceled Put may be smaller than it
would have been had we not canceled the Put.
- TERMINATION OF INVESTMENT AGREEMENT
We may terminate our right to initiate further Puts or terminate the
Investment Agreement at any time by providing Swartz with written notice of
our intention to terminate. However, any termination will not affect any other
Page 27
rights or obligations we have concerning the Investment Agreement or any
related agreement.
- CAPITAL RAISING LIMITATIONS
During the term of the Investment Agreement and for a period of ninety
(90) days after the termination of the Investment Agreement, we are prohibited
from entering into any private equity line agreements similar to the Swartz
Investment Agreement without obtaining Swartz's prior written approval. We
have agreed to give Swartz a Right of First Offer during this same period, the
term of the Investment Agreement plus ninety (90) days. If we commence or
plan to commence negotiations with another investor during this time period,
for a private capital raising transaction, we will first notify and negotiate
in good faith with Swartz regarding the potential financing transaction. If
Swartz is more than five (5) business days late in paying for the Put shares,
then it is not entitled to the benefits of these restrictions until the date
amounts due are paid.
Neither of the above restrictions applies to the following items and we
may engage in and issue securities in the following transactions without
notifying or obtaining approval from Swartz;
- in connection with a merger, consolidation, acquisition, or
sale of assets;
- in connection with a strategic partnership or joint venture,
the primary purpose of which is not simply to raise money;
- in connection with our disposition or acquisition of a
business, product or license;
- upon exercise of options by employees, consultants or
directors;
- in an underwritten public offering of our Common Stock;
- upon conversion or exercise of currently outstanding options,
warrants or other convertible securities;
- under any option or restricted stock plan for the benefit of
employees, directors or consultants; or
- upon the issuance of debt securities with no equity feature for
working capital purposes.
- SWARTZ'S RIGHT OF INDEMNIFICATION
We have agreed to indemnify Swartz, including its owners, employees,
investors and agents, from all liability and losses resulting from any
misrepresentations or breaches we make in connection with the Investment
Agreement, the registration rights agreement, other related agreements, or the
registration statement. We have also agreed to indemnify these persons for any
claims based on violation of Section 5 of the Securities Act caused by the
integration of the private sale of our Common Stock to Swartz and the public
offering under the registration statement.
Page 28
- EFFECT ON OUTSTANDING COMMON STOCK
The issuance of Common Stock under the Investment Agreement will not
affect the rights or privileges of existing holders of Common Stock except
that the issuance of shares will dilute the economic and voting interests of
each shareholder.
As noted above, we cannot determine the exact number of shares of our
Common Stock issuable under the Investment Agreement and the resulting
dilution to our existing shareholders, which will vary with the extent to
which we utilize the Investment Agreement, the market price of our Common
Stock, and exercise of the related warrants. The potential effects of any
dilution on our existing shareholders include the significant dilution of the
current shareholders' economic and voting interests in us.
The Investment Agreement provides that we cannot issue shares of Common
Stock that would exceed 20% of the outstanding stock on the date of a Put
unless and until we obtain shareholder approval of the issuance of Common
Stock.
REASONS FOR PROPOSAL, BOARD OF DIRECTORS
RECOMMENDATION AND VOTE REQUIRED
We believe that the Delta-Swartz Investment Agreement will provide us a
means of accessing additional capital when we need it. We presently do not
intend to sell all of the shares covered by the Agreement. We expect the
proceeds from sales to Swartz will be used for working capital, capital
expenditures and general corporate purposes. We currently have no plans,
understandings or arrangements to make any material acquisitions or other
material capital expenditures.
Pursuant to the Nasdaq shareholder approval requirements, the affirmative
vote of a majority of the votes cast on the proposal in person or by proxy is
required to approve the Delta-Swartz Investment Agreement.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THIS PROPOSAL.
APPOINTMENT OF INDEPENDENT AUDITORS
(Proposal 4 of the Proxy)
Subject to ratification by our shareholders, the Board has designated the
firm of KPMG LLP, Suite 2300, 707 17th Street, Denver, Colorado 80202, as
independent auditors to examine and audit our financial statements for the
fiscal year 2002. This firm has audited our financial statements for five
years and is considered to be well qualified. The designation of such firm as
auditors is being submitted for ratification or rejection at the Annual
Meeting. Action by shareholders is not required under the law for the
appointment of independent auditors, but the ratification of their appointment
is submitted by the Board in order to give our shareholders the final choice
in the designation of auditors. The Board will be governed by the decision of
a majority of the votes entitled to be cast. A majority of the votes
represented at the Annual Meeting by shares of Common Stock entitled to vote
is required to ratify the appointment of KPMG LLP.
Audit Fees. The fees billed for professional services rendered by the
independent auditors for the audit of Delta's financial statements for the
year ended June 30, 2001, and for the reviews of the financial statements
included in Delta's Forms 10-QSB during the last fiscal year, amounted to
$85,000.
Page 29
Financial Information Systems Design and Implementation Fees. The
independent auditors did not provide professional services during fiscal 2001
relating to financial information systems design and implementation.
All Other Fees. The fees billed by the independent auditors during the
fiscal year ended June 30, 2001 for non-audit services rendered amounted to
$42,000. These fees were related to research, quarterly reviews and other
Securities and Exchange Commission filings. The Audit Committee has
considered the other fees paid to KPMG LLP and concluded that they do not
impair the independence of KPMG LLP.
A representative of KPMG LLP will be present at the Annual Meeting with
the opportunity to make a statement if he desires to do so and will also be
available to respond to appropriate questions.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THIS PROPOSAL.
AMENDMENT TO ARTICLES OF INCORPORATION TO REDUCE QUORUM
AND VOTING REQUIREMENTS FOR MEETINGS OF SHAREHOLDERS
(Proposal 5 of the Proxy)
The Board of Directors has adopted a proposal to amend our Articles of
Incorporation to reduce the number of shares required to be present for a
quorum at meetings of Delta's shareholders and to reduce the voting
requirement for matters approved by the shareholders and is now presenting
this proposal for consideration and adoption by the shareholders. The
Articles of Incorporation currently require that with respect to any action
taken by the shareholders a vote or concurrence of the holders of a majority
of the outstanding shares entitled to vote is required. The proposed
amendment would reduce the voting requirement to a majority of the shares
present at the meeting.
The Articles of Incorporation currently do not contain any provisions
that address the quorum requirement, and so, under the Colorado Business
Corporation Act, the presence of at least a majority of the shares
outstanding is required to establish a quorum at meetings of Delta's
shareholders. The proposed amendment would reduce the requirement for a
quorum to one-third of the outstanding shares.
The proposed amendment to Delta's Articles of Incorporation would replace
the current Article XII with a new Article XII that reads as follows:
"ARTICLE XII
QUORUM FOR SHAREHOLDERS' MEETINGS
AND ACTS OF SHAREHOLDERS
Thirty-three and one-third percent (33-1/3%) of the shares entitled
to vote, represented in person or by proxy, shall constitute a quorum at
meetings of shareholders.
At all meetings of shareholders the affirmative vote of a majority
of the shares represented at the meeting and entitled to vote on the
subject matter shall be the act of the shareholders."
The Board of Directors has determined that the adoption of the proposed
amendment is in the best interests of Delta and its shareholders because
lowering the number of shares required for a quorum and shareholder vote will
reduce the risk of incurring additional expenses and delays in connection with
Page 30
postponing a shareholders' meeting and the business to be acted on for lack of
a quorum or adequate vote. At our last annual meeting of shareholders, we
achieved a quorum by only a small margin.
We believe that if the voting results in connection with shareholders'
meetings continue to be low, the Company may be forced to postpone an annual
or special meeting and incur significant additional expenses in connection
with the organization and shareholder communications which would be necessary
in order to reschedule such a meeting. Further, the inability to produce a
quorum or adequate vote could result in delays in taking shareholder action
with respect to important matters. In some cases, such delays could result in
additional costs or an adverse effect on ongoing business matters.
The proposed change to the voting requirement would make Delta's Articles
of Incorporation consistent with most Colorado companies and most public
companies. Currently, Delta has a higher voting requirement for actions of
the shareholders. In most instances, the Colorado Business Corporation Act
only requires the affirmative vote of a majority of the shares present, in
person or by proxy, at a meeting at which a quorum has been established to
approve matters submitted, unless the Articles of Incorporation provide for a
greater voting requirement. The proposed amendment will not reduce the vote
required to approve mergers, the sale of substantially all of Delta's assets
and similar transactions, which will remain at a majority of the shares
outstanding.
Taken together, the changes to the quorum and voting requirements will
substantially reduce the minimum number of shares needed to take action at
meetings of Delta's shareholders. Currently, the affirmative vote of a
majority of the shares (50.1%) entitled to vote, in person or by proxy, is
needed to take shareholder action. If the proposed amendment is approved, the
affirmative vote of at least 16.7% of the shares entitled to vote, in person
or by proxy, will be needed to take shareholder action. This reduced
percentage is based on minimum quorum of one-third of the shares entitled to
vote.
VOTE REQUIRED FOR APPROVAL; BOARD RECOMMENDATION
The affirmative vote of a majority of the shares outstanding, in person
or by proxy, will be required to approve the amendment to the Articles of
Incorporation.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THIS PROPOSAL.
ISSUANCE OF SHARES PURSUANT TO
THE PURCHASE AND SALE AGREEMENT WITH CASTLE ENERGY CORPORATION
(Proposal 6 of the Proxy)
On January 15, 2002 we entered into a Purchase and Sale Agreement with
Castle Energy Corporation and three of its subsidiaries ("Castle") pursuant to
which Delta and one of its subsidiaries agreed to purchase all of Castle's
United States oil and gas properties in exchange for $20 million in cash and
9,566,000 shares of Delta's Common Stock. As a part of the acquisition, upon
closing, Delta has granted the right to acquire a 4% working interest in the
properties acquired for a cost of $974,000 to BWAB, a less than 10%
shareholder of Delta, for its consultation and assistance related to the
acquisition. The agreement is to be effective as of October 1, 2001. The
Page 31
difference between the price to be paid by BWAB and 4% of the cost of the
Castle properties will be treated as an additional acquisition cost by Delta.
On March 14, 2002 we entered into an amendment to the Purchase and Sale
Agreement which amended the provisions relating to the payment of the purchase
price so that Castle will not hold more than 49.9% of Delta's Common Stock,
and add provisions relating to the intent of the parties that Delta is to be
considered the acquiring party for accounting purposes.
Nasdaq rules require us to obtain the approval of our shareholders prior
to the issuance of securities in connection with a transaction other than a
public offering involving the sale or issuance by us of Common Stock equal to
20% or more of the Common Stock outstanding prior to the issuance. As of
March 11, 2002 we had 12,916,030 shares issued and outstanding. As a result,
the 9,566,000 shares proposed to be issued would represent an amount equal to
approximately 74% of the shares currently outstanding, or approximately 42.5%
of the shares outstanding after giving effect to the issuance of the shares to
Castle.
In addition to the shares proposed to be issued to Castle at closing, it
should be noted that Castle currently owns 382,289 of our shares, or 3.33% of
our shares currently outstanding, and there is a possibility that we might
issue additional shares to Castle if we are unable to obtain sufficient bank
or other financing to pay the cash portion of the purchase price at closing.
If this occurs, we may elect to pay all or a portion of the cash in the form
of a bridge note. The bridge note would provide for the payment of the unpaid
cash portion of the purchase price within 270 days of the closing with
interest at 8% per annum. The bridge note would be payable in either cash or
shares of Delta's common stock at $3.00 per share, at our election. However,
in no event will shares be issued to Castle that would result in Castle
holding more than 49.9% of Delta's Common Stock outstanding. In the event
that Delta is unable to obtain sufficient cash to pay the bridge note when
due, and the number of shares that would be issued to Castle to fully pay the
bridge note would result in Castle holding more than 49.9% of the outstanding
shares, Delta will only issue the maximum number of shares of Common Stock
that is possible without causing Castle to own more than 49.9% of the
outstanding shares. Any remaining amounts due shall continue to be due and
payable in either cash or shares of Delta Common Stock as soon as it is
possible for Delta to issue sufficient shares to pay the remaining amounts
without causing Castle to own more than 49.9% of the outstanding shares.
The closing of the Purchase and Sale Agreement is contingent on the
approval of our shareholders at the Annual Meeting, although failure by our
shareholders to approve the agreement may cause us to pay Castle a termination
fee of up to 1,400,000 shares of our Common Stock.
Shareholders will have no right to dissent from the proposed issuance of
shares to Castle and demand payment for their shares. The Colorado Business
Corporation Act does not provide for dissenters' rights for this type of
transaction.
Background and Reasons for the Proposed Purchase of Assets
- ----------------------------------------------------------
Our management became aware of the possibility that Castle might be
willing to sell its domestic oil and gas properties as the result of an
introduction made by BWAB, one of our principal shareholders. BWAB is in the
business of buying and selling oil and gas properties and occasionally acts as
a broker in some oil and gas transactions, including several acquisition and
Page 32
divestiture transactions involving both Delta and Castle. On September 29,
2000 we acquired 100% of the West Delta Block 52 unit, which was owned 75% by
Castle and 25% by BWAB. Although BWAB is not an affiliate of Castle, it has
had numerous business dealings with Castle over the past several years and it
is our understanding that Steven Roitman, the President of BWAB, became aware
of the possible availability of the Castle properties through his contact with
Joseph Castle. Mr. Roitman then presented the opportunity to purchase the
properties to Roger Parker who on our behalf negotiated the terms of the
transaction directly with Joseph Castle over the course of a number of months
in 2001 leading up to the execution of the Purchase and Sale Agreement. After
reviewing the engineering reports related to Castle's domestic oil and gas
properties and considering the market value of our common stock at the time,
the parties agreed upon a price that we believe is reasonable.
During the course of negotiations, BWAB continued to provide both parties
with helpful insights because of its familiarity with some of the properties.
BWAB also made its employees and analysis tools available to both parties to
enhance their ability to make various decisions as negotiations continued.
Since BWAB had relationships with both Castle and us, it was also able to
facilitate communication between us, minimize our misunderstandings and help
us to reach a final agreement. BWAB's right to acquire an interest in the
properties was determined by the parties at the outset of negotiations,
contingent upon our reaching an agreement and closing the transaction.
The Board of Directors of Delta believes that the proposed purchase of
the assets of Castle provides an opportunity for Delta to significantly expand
its operations and acquire undeveloped reserve potential for future
development activities. The Board also believes that the acquisition will be
beneficial to Delta and its shareholders as the combined company will have a
larger asset base, better access to capital financing and better cash flow
than Delta alone.
The Board believes that the acquisition will provide Delta with valuable
oil and gas properties in a cost effective manner. Delta has been actively
seeking potential acquisition or merger candidates and has held discussions
with several companies. In the Board of Directors' and management's opinion,
the acquisition of the assets of Castle represents a cost efficient
transaction providing Delta with significant new oil and gas properties with
development potential.
Reports, Opinions and Appraisals
- --------------------------------
Delta has not engaged an independent firm to render a fairness opinion.
Management believes that an independent fairness opinion is unnecessary for
the following reasons: the assets being acquired consist almost entirely of
oil and gas leases, the most valuable of which have recent engineering
reports; management believes such reports in themselves provide an independent
valuation of the assets similar to what would be expected from an independent
fairness opinion; and the Board believes that Delta's management possesses
sufficient skills and experience to negotiate a fair price for the assets to
be acquired.
The engineering reports reviewed by management were prepared by Huntley &
Huntley and Ralph E. Davis Associates, Inc., independent petroleum reservoir
engineers.
Huntley & Huntley, Inc. of Monroeville, PA is an oil and gas consulting
firm that has provided reservoir engineering and geological services to the
Page 33
petroleum industry since 1912. The principal services offered by this firm
are geological feasibility and due diligence reports, well engineering and
drilling, and reserves and economics evaluations. Huntley & Huntley provides
oil and gas reserve reports to numerous publicly-held companies.
Ralph E. Davis Associates, Inc., Houston, Texas, is a consulting firm
that has provided reservoir engineering and geological services to the
petroleum industry since 1924. This firm currently has a staff of six
engineers and geologists who specialize in petroleum reservoir evaluation and
analysis. Ralph E. Davis Associates, Inc. provides oil and gas reserve
reports and other services to many publicly-held companies.
Huntley & Huntley and Ralph E. Davis Associates, Inc. were selected by
and paid by Castle to prepare the reserve estimates used in Castle's Annual
Report on Form 10-K for the fiscal year ended September 30, 2001. Delta has
not paid either of these firms any compensation in connection with the
proposed transaction with Castle, nor is any compensation expected to be paid
in connection with the transaction. Upon completion of the proposed
acquisition, Delta may use the services of either or both of these firms in
the future for the preparation of reserve estimates or other services.
The reserve estimates reviewed by Delta are based upon subjective
engineering judgments made by Huntley & Huntley and Ralph E. Davis Associates,
Inc. and may be affected by the limitations inherent in such estimations. The
process of estimating reserves is subject to continuous revisions as
additional information is made available through drilling, testing, reservoir
studies and production history. There can be no assurance such estimates will
not be materially revised in subsequent periods.
Estimated quantities of proved reserves as of September 30, 2001, all of
which are domestic reserves, combined from the reports provided by Huntley &
Huntley and Ralph E. Davis Associates, Inc., are summarized below:
Net MCF (1) of gas:
Proved developed ......................... 26,480,000
Proved undeveloped ....................... 4,212,000
----------
Total .................................... 30,692,000
==========
Net barrels of oil:
Proved developed ......................... 1,890,000
Proved undeveloped ....................... 1,470,000
----------
Total 3,360,000
==========
- ------------------
(1) Thousand cubic feet
The following is a standardized measure of discounted future net cash
flows and changes therein relating to estimated proved oil and gas reserves,
as prescribed in Statement of Financial Accounting Standards No. 69. The
standardized measure of discounted future net cash flows does not purport to
present the fair market value of the Company's oil and gas properties. An
estimate of fair market value would also take into account, among other
factors, the likelihood of future recoveries of oil and gas in excess of
proved reserves, anticipated future changes in prices of oil and gas and
related development and production costs, a discount factor based on market
Page 34
interest rates in effect at the date of valuation and the risks inherent in
reserve estimates.
September 30, 2001
------------------
Future cash inflows $138,594,000
Future production costs (43,288,000)
Future development costs (8,655,000)
Future income tax expense (13,102,000)
------------
Future net cash flows 73,549,000
Discount factor of 10% for estimated timing of (37,269,000)
future cash flows ------------
Standardized measure of discounted future cash flows $36,280,000
============
The future cash flows were computed using the applicable year-end prices
and costs that related to the then existing proved oil and gas reserves in
which Castle has interests. The estimates of future income tax expense are
computed at the blended rate (Federal and state combined) of 36%.
The following were the sources of changes in the standardized measure of
discounted future net cash flows:
September 30, 2001
------------------
Standardized measure, beginning of year $ 91,119,000
Sale of oil and gas, net of production costs (13,745,000)
Net changes in prices (60,403,000)
Purchase of reserves in place 7,662,000
Changes in estimated future development costs 1,408,000
Development costs incurred during the period that
reduced future development costs 2,113,000
Revisions in reserve quantity estimates (26,591,000)
Net changes in income taxes 30,528,000
Accretion of discount 9,112,000
Other:
Change in timing of production (1,228,000)
Other factors (3,695,000)
------------
Standardized measure, end of year $ 36,280,000
============
Past Contacts and Transactions
- -------------------------------
In December 1999, a subsidiary of Castle purchased a majority interest in
twenty-six offshore Louisiana wells from Whiting Petroleum Company
("Whiting"), a public company engaged in oil and gas exploration and
development. The adjusted purchase price was $890,000. In September 2000,
the subsidiary sold its interests in the offshore Louisiana wells to Delta.
The effective date of the sale was July 1, 2000. The adjusted purchase price
of $3,059,000 consisted of $1,122,000 cash plus 382,289 shares of Delta's
Common Stock valued at the closing market price of $1,937,000. Delta became
aware of this opportunity as a result of an introduction by BWAB Limited
Liability Company, a principal shareholder of Delta.
Page 35
THE PURCHASE AND SALE AGREEMENT
Assets to be Purchased
- ----------------------
The Purchase and Sale Agreement with Castle provides that Delta will
purchase the following assets:
. all of Castle's interest in oil, gas and mineral leases located in
the United States, including working interests, royalty interests
and other similar interests;
. all of Castle's interest in oil and gas wells located in the
United States and all oil, gas and other minerals produced by these
wells;
. all of Castle's interest in unitization and pooling agreements,
working interest units created by operating agreements, partnership
agreements and orders covering the leases;
. all of Castle's interest in tangible personal property, tools,
machinery, materials, pipelines, plants, gathering systems,
equipment, platforms and facilities, fixtures and improvements,
which are attributable to the leases and wells with the production,
transportation, treatment, sale or disposal of hydrocarbons or
water produced;
. all of Castle's general and limited partnership interests in
Castle Texas Exploration Limited Partnership and Castle Texas Oil
and Gas Limited Partnership;
. all of Castle's interest in the licenses, permits, contracts and
other instruments that relate to the leases and wells;
. all of Castle's interest in the records, files and other data
relating to the leases and wells; and
. all of Castle's interest in payments and the rights to receive
payments from the production of oil and gas from the leases and
wells after the effective date of October 1, 2001.
Retained Assets
- ---------------
Pursuant to the terms of the Purchase and Sale Agreement, Castle will
retain all of its business records, cash, bank accounts, letters of credit and
prepaid insurance; the management information systems, accounting software and
other intellectual property used in the administration of Castle's businesses;
all claims that Castle may have under any policy of insurance, indemnity or
bond other than claims relating to property damage or casualty loss affecting
the leases and wells occurring between the effective date and closing; all
accounts receivable, trade credits or notes receivable relating to
transactions processed by Castle prior to closing; any files or records that
Castle is contractually or otherwise obligated not to disclose to Delta; all
claims and causes of action arising from acts, omissions or events, or damage
or destruction of property occurring prior to the effective date; engineering
studies or reserve reports relating to the leases and wells; and all interests
and rights not related to the leases and wells to be purchased. Castle will
also retain ownership of a fifty percent interest in a drilling concession in
Page 36
Romania and a thirty-five percent membership interest in Networked Energy LLC,
a private company engaged in the operation of energy facilities that supply
power, heating and cooling services directly to retail customers.
Consideration to be Paid by Delta
- ---------------------------------
Total Consideration. If the asset purchase is completed, Delta will be
required to pay Castle $20,000,000 in cash and 9,566,000 shares of Delta's
Common Stock. Delta currently intends to pay the cash portion of the purchase
price from a bank loan to be obtained from a commercial bank. It is currently
unknown whether Delta will be able to successfully negotiate a commercial bank
loan for this transaction. If a satisfactory loan is not obtained, Delta may
elect not to close the transaction which would result in Delta issuing
1,400,000 shares to Castle as a termination fee. In the event that the loan
is obtained for less than $20,000,000, Castle will receive cash equal to the
amount of the loan and a bridge note from Delta equal to the shortfall. The
bridge note will be due and payable 270 days after the closing, together with
accrued interest at 8% per annum. The bridge note may be paid either in cash
or, if not paid in cash, in shares of Delta's Common Stock computed at a rate
of $3.00 per share. However, in no event will shares be issued to Castle that
would result in Castle holding more than 49.9% of Delta's Common Stock
outstanding. In the event that Delta is unable to obtain sufficient cash to
pay the bridge note when due, and the number of shares that would be issued to
Castle to fully pay the bridge note would result in Castle holding more than
49.9% of the outstanding shares, Delta will only issue the maximum number of
shares of Common Stock that is possible without causing Castle to own more
than 49.9% of the outstanding shares. Any remaining amounts due shall
continue to be due and payable in either cash or shares of Delta Common Stock
as soon as it is possible for Delta to issue sufficient shares to pay the
remaining amounts without causing Castle to own more than 49.9% of the
outstanding shares.
Adjustment of Consideration. The consideration to be paid will be
increased by all actual operating or capital expenditures attributable to the
leases and wells between the effective date and the closing date; the value of
all oil and gas in storage as of the effective date; $7,500 per month from the
effective date to the closing date for insurance premiums; and $20,000 per
month from the effective date (October 1, 2001) to the closing date for
corporate overhead. The consideration to be paid will be reduced by any
amounts provided for as a result of any title failures, title defects or
environmental defects; net proceeds of oil and gas sales earned by Castle from
the leases and wells from the effective date to the closing date; any
reduction as a result of denials to consent and of exercise of preferential
rights; and certain revenues received by Castle from the effective date to the
closing date.
Determination of Purchase Price. The purchase price to be paid by Delta
for the assets purchased from Castle was arrived at through arm's length
negotiations between Delta and Castle. The purchase price was not determined
by or based on the recommendation of any outside party.
Expected Timing of the Transaction
- ----------------------------------
The parties expect that the asset sale will close as soon as possible
after the necessary stockholder approval has been obtained. The Purchase and
Page 37
Sale Agreement provides that if the closing has not occurred by April 1, 2002,
then, subject to certain conditions described more fully below, Castle may
terminate the agreement.
Conditions to Closing
- ---------------------
Delta and Castle will complete the asset sale only if a number of
conditions are satisfied or waived, including the following:
. the approval of Delta's shareholders at the annual meeting;
. the representations and warranties of Delta and Castle contained
in the Purchase and Sale Agreement shall have been true and
correct on the date made and as of the closing date;
. Delta and Castle shall have performed or complied in all material
respects with all agreements and covenants required by the Purchase
and Sale Agreement;
. there shall have been no material adverse change in the physical
condition of the assets, except depletion through normal
production, depreciation of equipment through ordinary wear and
tear, and other transactions permitted under the agreement or
approved in writing by Delta;
. no suit, action or other proceeding shall be pending or threatened
before any court, arbitration panel or governmental agency seeking
to restrain, prohibit or declare illegal, or seeking substantial
damages in connection with the purchase and sale contemplated by
the agreement, or which might result in a material loss of any
portion of the assets, a material diminution in the value of any of
the assets, or materially interfere with the use of the assets,
except matters that have been disclosed or any suit or proceeding
affecting only a portion of the assets, which portion could be
treated as subject to a title defect;
. Delta has not issued or contracted to issue Delta Common Stock
prior to closing in excess of ten percent (10%) of the outstanding
stock of Delta on December 31, 2001, excluding the issuance of up
to 1,431,000 shares to Piper Petroleum Company, without the prior
written consent of Castle.
Representations and Warranties
- ------------------------------
The Purchase and Sale Agreement contains various representations and
warranties made by each party thereto regarding aspects related to each
party's assets, business, financial condition, structure and other facts
pertinent to the asset sale. Some of the representations and warranties will
survive until ten months after the closing date. However, the representations
relating to the condition of the assets to be purchased will not survive after
closing.
The representations and warranties made by Castle cover the following
topics:
. the due organization, authority and power of Castle and similar
matters;
Page 38
. the authorization, execution, delivery and enforceability of the
Purchase and Sale Agreement as against Castle;
. the contracts related to the assets to be purchased;
. the payment of taxes and assessments relating to the assets to be
purchased;
. the absence of any obligations to pay finders' fees in connection
with the sale;
. any litigation that relates to the assets to be purchased;
. the validity and enforceability of existing agreements to be
transferred to Delta;
. the condition of the equipment to be transferred to Delta;
. compliance with laws and regulations relating to the wells to be
transferred to Delta; and
. compliance with environmental and other laws covering the
operations relating to the assets to be transferred to Delta.
The representations and warranties made by Delta cover the following
topics:
. the due organization, authority and power of Delta and similar
matters;
. the authorization, execution, delivery and enforceability of the
Purchase and Sale Agreement as against Delta;
. the valid issuance and non-assessability of the shares of Common
Stock of Delta to be issued to Castle;
. the absence of any finders' fee for which Castle is responsible;
. that prior to closing Delta will have completed an inspection of
the assets to be purchased and that Delta is relying on its own
investigations concerning the condition of the assets;
. that as of the closing Delta will meet all of the bonding and
other requirements needed to own the assets; and
. that Delta is an experienced and knowledgeable investor and
operator in the oil and gas business.
Conduct of Castle's Business and Other Activities Prior to Closing
- ------------------------------------------------------------------
During the period from December 31, 2001 until the closing, Castle has
agreed:
. not to sell, transfer or encumber any of the assets;
. not to make any expenditures in excess of $25,000 except as
required under existing contracts or in an emergency;
Page 39
. not to sell any oil or gas from the assets except in the ordinary
course of business;
. not to enter into any agreements modifying or terminating any
leases;
. not to take any other actions that would materially affect the
value or use of the assets;
. to allow Delta and its representatives to examine Castle's records
concerning the assets to be purchased;
. to obtain any consents needed to transfer the assets to be
purchased;
. not to engage in any trading in Delta Common Stock, and not permit
affiliates, agents or brokers to trade in such stock;
. to assist Delta in the transfer of software licenses to be
transferred to Delta; and
. to maintain the liability insurance policies held by Castle.
Limitations on Delta's Activities Prior to Closing
- --------------------------------------------------
During the period from December 31, 2001 until the closing, Delta has
agreed:
. not to engage in any trading in the common stock of Castle, and
not permit any of its affiliates, agents or brokers to trade in
such stock;
. not to issue or agree to issue shares of Delta's Common Stock in
excess of 10% of the shares outstanding except as permitted by the
agreement; or
. not to increase the number of directors on Delta's Board of
Directors.
Environmental Matters
- ----------------------
Prior to the closing, Delta and its representatives have the right to
inspect the assets to be purchased and to perform tests and assessments to
determine if any environmental defects exist. If Delta finds any
environmental defects, it may waive the defects or request that Castle to cure
the defects. If Delta requests that Castle cure any defects and the aggregate
amount of all environmental defects exceeds 4% of the total purchase price,
Castle may either cure the defects or exclude the assets affected from the
sale. If assets are excluded as a result of environmental defects, the
purchase price will be reduced, but only to the extent that the value of the
affected assets exceeds 4% of the purchase price.
If Castle elects to cure any defect but has not completed the work prior
to closing, the purchase price will be reduced by the amount allocated to that
asset and the amount placed into escrow pending completion of the work.
Page 40
Title Matters
- -------------
Prior to the closing, Delta and its representatives have the right to
examine all of the title records, opinions and other documents relating to the
assets to determine if any title defects exist as defined in the agreement.
Delta is required to notify Castle at least five days prior to closing of any
title defects. If Castle agrees that any title defects exist, the purchase
price may be reduced by the value of the affected assets as described below,
unless Castle believes it unlikely that any material expenses will be
experienced and Castle agrees to indemnify Delta for any such expenses.
If Castle disputes any title defects or the amount assigned to the
defects, it must notify Delta and an amount for any uncured defects will be
placed into escrow at closing pending the cure of the title defects. If any
title defects are not cured within 90 days of closing, the amount in escrow
will be returned to Delta and the related assets returned to Castle.
Amounts will be deducted from the purchase price only if the amount of
the title defects exceeds 4% of the purchase price. In the event that the
total amount for title defects exceeds 15%, either party may terminate the
Purchase and Sale Agreement without any liability to the other party.
Post Closing Matters
- --------------------
Upon closing of the Purchase and Sale Agreement, Delta will diligently
pursue the filing and other requirements to assume the operation and ownership
of the assets. Delta will also provide transitional accounting personnel at
Delta's expense for at least two months before assuming full accounting
responsibilities for the assets.
Effective immediately after the closing, Delta will expand its Board of
Directors to seven persons and appoint three persons selected by Castle to
serve as additional directors. However, Castle has agreed to limit or delay
its representation on Delta's Board of Directors if necessary to assure that
Delta will not be treated as the acquiring party for accounting purposes.
Castle has only identified one of the persons to be selected to serve as an
additional director. That person is Joseph L. Castle II, whose business
experience is as follows:
Joseph L. Castle II (age 69) has been a Director of Castle since 1985.
Mr. Castle is the Chairman of the Board of Directors and Chief Executive
Officer of Castle, having served as Chairman from December 1985 through May
1992 and since December 20, 1993. Mr. Castle also served as President of
Castle from December 1985 through December 20, 1993, when he reassumed his
position as Chairman of the Board. Previously, Mr. Castle was Vice President
of Philadelphia National Bank, a corporate finance partner at Butcher and
Sherrerd, an investment banking firm, and a Trustee of The Reading Company.
Mr. Castle has worked in the energy industry in various capacities since 1971.
Mr. Castle is a director of Comcast Corporation and Charming Shoppes, Inc.
Since May of 2000, Mr. Castle has served as the Chairman of the Board of
Trustees of the Diet Drug Products Liability ("Phen-Fen") Setlement Trust.
Castle has agreed to vote the shares of Delta Common Stock it receives in
this transaction in favor of the nominees for Director selected by the Board
of Directors and will generally support actions recommended by the Board as to
other matters at meetings of Delta's shareholders so long as it directly holds
Page 41
those shares. In addition, during this same period Castle has agreed not to
attempt to take any further control of Delta, or request that any special
meetings of Delta's shareholders be held.
Delta has agreed to file a registration statement with the Securities and
Exchange Commission within 30 days of the closing to register the 9,566,000
shares issued to Castle in connection with the sale of the assets under the
terms of a Registration Rights Agreement described below. For a period of one
year after the closing, Delta will have the right to repurchase up to
3,188,667 of the shares issued to Castle at $4.50 per share. Castle has
agreed to retain at least 3,188,667 shares of Delta Common Stock during this
period for possible repurchase.
Registration Rights Agreement
- -----------------------------
In connection with the closing Delta will enter into a Registration
Rights Agreement with Castle which will require that Delta file a registration
statement with the Securities and Exchange Commission to register the
9,566,000 shares to be issued for resale or distribution by Castle under the
Securities Act of 1933, as amended. Delta is required to file the
registration statement within 30 days of the closing. The expenses of the
registration statement are to be borne by Delta.
Termination of the Purchase and Sale Agreement
- ----------------------------------------------
The Purchase and Sale Agreement may be terminated by mutual agreement of
all of the parties at any time without any liability to any party. In
addition, either Castle or Delta may terminate the agreement if any
adjustments to the purchase price exceed 15% or more of the purchase price
without liability to any party.
Castle may terminate the agreement if the closing does not occur on or
before April 1, 2002, which date may be extended by Castle, or if Delta issues
Common Stock prior to closing in excess of 3% of the shares outstanding,
excluding the issuance of up to 1,431,000 shares to Piper Petroleum Company,
without any liability to any party.
Castle may also terminate the agreement in the event that the closing
does not occur within 60 days of the date on which the Securities and Exchange
Commission advises Delta that the staff has no further comments on the proxy
materials for the annual meeting of shareholders, as a result of a failure to
obtain a sufficient vote of Delta's shareholders to approve the agreement. If
such a termination occurs, Castle will be entitled to receive 700,000 shares
of Delta Common Stock which were placed into escrow in connection with the
execution of the agreement.
Castle may also terminate the agreement in the event that the closing
does not occur by June 30, 2002 due to Delta's failure to timely respond to
comments received from the Securities and Exchange Commission, unless such
failure is due to Castle's failure to provide any information needed to
respond to the comments, a determination by Delta to not proceed with the
transaction, or any other delay or failure of Delta to meet the conditions of
closing, other than the failure to obtain a quorum for the shareholders'
meeting or the failure to obtain shareholder approval of the agreement solely
as a result of broker non-votes on the proposal. If such a termination
occurs, Castle will be entitled to receive the 700,000 shares of Delta Common
Stock placed into escrow plus an additional 700,000 shares of Delta Common
Stock.
Page 42
Delta may also terminate the agreement if Castle either fails to close
within ten days of the receipt of shareholder approval of the agreement or
fails to materially satisfy the closing conditions. In such case the 700,000
shares placed into escrow will be returned to Delta and Castle will pay
700,000 shares of Castle's common stock, or the equivalent in cash, to Delta
as liquidated damages, unless such failure to close is due solely to judicial
restraint caused by certain unrelated litigation in which case no liquidated
damages will be required.
Expenses
- --------
The Purchase and Sale Agreement generally provides that Delta and Castle
will pay their own respective costs and expenses incurred in connection with
the agreement and the transactions contemplated by the agreement.
In connection with the transaction, BWAB Limited Liability Company
("BWAB") has served as a consultant and will receive a fee from Delta in the
form of a right to purchase a 4% interest in the properties Delta acquires
from Castle for $974,000. The difference between the price to be paid by BWAB
and 4% of the cost of the Castle properties will be treated as an additional
acquisition cost by Delta. The amount that BWAB will be required to pay for
the 4% interest may be reduced in the event that the purchase price to be paid
by Delta is reduced for the reasons described in the Purchase and Sale
Agreement. In the event that the Purchase and Sale Agreement is terminated
and Delta is required to deliver 1,400,000 shares to Castle as a result of the
termination, Delta will be required to deliver 28,000 shares to BWAB as a
breakup fee.
Amendments
- ----------
The Purchase and Sale Agreement may only be amended by a written
instrument signed on behalf of all parties to the agreement.
Accounting Treatment
- --------------------
The acquisition of Castle properties will be accounted for by Delta using
the purchase method of accounting. The purchase price will be allocated to
the identifiable assets acquired and will be recorded on Delta's books at
their respective fair values as determined on the closing date.
Vote Required and Board Recommendation
- --------------------------------------
Pursuant to the Nasdaq shareholder approval requirements, the affirmative
vote of a majority of the votes cast on the proposal in person or by proxy
will be required to approve the Purchase and Sale Agreement with Castle.
DELTA'S BOARD OF DIRECTORS RECOMMENDS A VOTE FOR THE APPROVAL OF THE
PURCHASE AND SALE AGREEMENT.
Page 43
Selected Financial Data
- -----------------------
SELECTED FINANCIAL DATA OF DELTA
The following selected financial information of Delta, which uses the
successful efforts method of accounting, should be read in conjunction with
the financial statements and the accompanying notes of Delta.
Six Months Ended
December 31, Fiscal Years Ended June 30,
------------------------- --------------------------------------------------------------
2001 2000 2001 2000 1999 1998 1997
---- ---- ---- ---- ---- ---- ----
Total Revenues $ 4,232,000 5,807,000 12,877,000 3,576,000 1,695,000 2,164,000 1,812,000
Income/(Loss) from
Operations $(1,237,000) 1,181,000 1,678,000 (2,080,000) (2,905,000) (1,010,000)
(2,457,000)
Income/(Loss)
Per Share $ (.17) .06 .03 (0.46) (0.51) (0.18)
(0.49)
Total Assets $29,073,000 32,195,000 29,832,000 21,057,000 11,377,000 10,350,000 10,438,000
Total Liabilities $12,265,000 14,493,000 11,551,000 10,094,000 1,531,000 845,000 1,268,000
Stockholders' Equity $16,808,000 17,702,000 18,281,000 10,963,000 9,846,000 9,505,000 9,171,000
Total Long Term Debt $ 8,886,000 11,688,000 9,434,000 8,245,000 1,000,000 -0- -0-
SELECTED FINANCIAL DATA OF CASTLE
During the five fiscal years ended September 30, 2001, Castle consummated
a number of transactions affecting the comparability of the financial
information set forth below. In May 1997, Castle sold its Rusk County, Texas
oil and gas properties and pipeline. In June 1999, Castle acquired all of the
oil and gas assets of AmBrit Energy Corp. See Information Concerning the
Properties to be Acquired from Castle-"Management's Discussion and Analysis of
Financial Condition and Results of Operations" and Note 4 to Castle's
Consolidated Financial Statements.
The following selected financial data have been derived from Castle's
Consolidated Financial Statements, which are prepared using the full cost
method of accounting, for each of the five years ended September 30, 2001, and
for the three months ended December 31, 2001 and 2000. The information should
be read in conjunction with Castle's Consolidated Financial Statements and
notes thereto. Since Delta is acquiring only producing properties and some
undeveloped acreage from Castle, no attempt has been made to conform Castle's
full cost accounting method to the successful efforts method used by Delta.
Page 44
For the Three For the Fiscal Year Ended September 30,
Months Ended -------------------------------------------------
December 31, (in Thousands, except per share amounts)
-----------------
2001 2000 2001 2000 1999 1998 1997
------- ------- ------- ------- -------- ------- -------
(Unaudited)
Net sales:
Natural gas marketing
and transmissions (gas sales
less gas purchases) $ - $ - $ - - $50,067 $70,001 $64,606
Exploration and production 3,441 5,394 $21,144 $17,959 $ 7,190 $ 2,603 $ 7,113
Gross Margin (exclusive of depre-
ciation and amortization)
Natural gas marketing
and transmission - - $ - $ - $19,005 $26,747 $24,640
Exploration and production (oil
and gas sales less production
costs) $ 2,187 $3,990 $13,745 $11,765 $ 4,802 $ 1,828 $ 5,173
Income (loss) from continuing
operations $ (426) $1,735 $ 2,097 $ 2,778 $11,222 $15,260 $31,529
Income (loss) from continuing
operations per share
outstanding (diluted) $ (.04) $ .16 $ .25 $ .71 $ .99 $ 1.22 $ 1.55
Dividends declared per common shares
outstanding $ .05 $ .05 $ .20 $ .20 $ .25 $ .15 $ .10
September 30,
--------------------------------------------------
December 31,
2000 2001 2000 1999 1998 1997
------------ ------- ------- -------- ------- -------
(Unaudited)
Total assets $55,920 $59,118 $63,295 $60,796 $67,004 $82,717
Long-term obligations 0 9 6 0 1 20
Redeemable preferred stock 0 0 0 0 0 0
Capital leases 0 0 0 0 0 0
Share data have been retroactively restated to reflect the 200% stock
dividend that was effective January 31, 2000.
Page 45
Pro Forma Financial Information
- -------------------------------
DELTA PETROLEUM CORPORATION
CONDENSED PRO FORMA FINANCIAL STATEMENTS
Delta entered into a Purchase and Sale Agreement to purchase all of the
United States domestic oil and gas properties of Castle for $20,000,000,
payable in proceeds from bank financing in cash, plus 9,566,000 shares of
Delta's Common Stock valued at approximately $37,977,000 based on the five-day
average closing price surrounding the announcement of the acquisition. The
effective date is October 1, 2001 and closing is expected by no later than
June 30, 2002, or shortly thereafter. Pursuant to the terms of the Purchase
and Sale Agreement, the cash portion of the purchase price payable at closing
will be reduced by the cash flow from the properties between the effective
date and the closing date. The sale is subject to approval by the
shareholders of Delta. Each party is subject to a penalty in the amount of
700,000 shares of their respective common stock for failure to close the
transaction. Delta has an additional penalty in the amount of 700,000 shares
of its Common Stock if the transaction is terminated by Castle because the
closing does not occur by June 30, 2002 due to Delta's failure to timely
respond to SEC comments, a determination by Delta not to proceed with the
transaction or any other delay or failure to meet the conditions of closing,
other than a failure to obtain a quorum in a situation where less than a
majority of shares issued and outstanding can be voted, exclusive of broker
non-votes, for, against or abstaining on the proposal to approve the agreement
with Castle. Delta may repurchase up to 3,188,667 of its shares from Castle
for $4.50 per share for a period of one year after closing. The option to
repurchase up to 3,188,667 of our shares for $4.50 will preserve the potential
upside relating to future value relating to our offshore oil and gas
properties. If we decide to exercise our option to repurchase our shares, the
value of the repurchased shares will be recorded as treasury stock. As a part
of the acquisition, upon closing, Delta has granted an option to acquire a 4%
working interest in the properties acquired for a cost of $974,000 to BWAB
Limited Liability Company, a less than 10% shareholder of Delta. The
difference between the $974,000 paid by BWAB, which is less than fair value,
and 4% of the cost of the Castle properties will be treated is a component of
the acquisition cost incurred by Delta for BWAB's consultation and assistance
related to the transaction.
Even though Delta has had conversations with a bank to provide the
necessary financing at closing and has obtained a preliminary commitment
letter from a bank for a loan to be collateralized by all unencumbered oil and
gas properties in an amount of up to $20,000,000 with an interest rate of
prime + 1-1/2% and a 3 year maturity date, the commitment is preliminary, may
be withdrawn at any time and all of the stated terms are subject to change.
If the Company chooses to close the acquisition with a bridge note payable to
Castle, there is no assurance that it could repay all or part of the bridge
note with borrowed or other funds. If Delta is unable to pay all or a portion
of the bridge note in cash, it may pay the unpaid portion in shares of Delta's
Common Stock at $3.00 per share. However, in no event will Delta issue shares
to Castle that would result in Castle holding more than 49.9% of Delta's
outstanding Common Stock. In the event that Delta is unable to obtain
sufficient cash to pay the bridge note when due, and the number of shares that
would be issued to Castle to fully pay the bridge note would result in Castle
holding more than 49.9% of the outstanding shares, Delta will only issue the
maximum number of shares of Common Stock that is possible without causing
Castle to own more than 49.9% of the outstanding shares. Any remaining
amounts due shall continue to be due and payable in either cash or shares of
Page 46
Delta Common Stock as soon as it is possible for Delta to issue sufficient
shares to pay the remaining amounts without causing Castle to own more than
49.9% of the outstanding shares.
The following unaudited condensed pro forma balance sheet assumes that
Delta is the acquirer and that the acquisition of 100% of the property
interests of the Castle Properties occurred on December 31, 2001 and reflects
the historical consolidated balance sheet of Delta giving pro forma effect to
the proposed asset acquisition using the purchase method of accounting.
Management of Delta believes this is the most likely scenario. The unaudited
condensed pro forma combined balance sheet should be read in conjunction with
the historical statements and related notes of Delta and Castle.
The accompanying unaudited condensed pro forma statements of operations
for the six months ended December 31, 2001 and for the year ended June 30,
2001 assume that Delta is the acquirer and that the acquisition of the Castle
Properties occurred as of July 1, 2000. The year ended June 30, 2001
unaudited condensed pro forma statement of operations includes Delta's
historical year ended June 30, 2001 and Castle's historical year ended
September 30, 2001 statement of operations. Management of Delta believes this
is the most likely scenario. These statements should be read in conjunction
with the historical financial statements and related notes of Delta and
Castle.
Page 47
DELTA PETROLEUM CORPORATION
Unaudited Condensed Pro Forma Balance Sheet
As of December 31, 2001
("000's" Omitted)
Pro Forma
Delta Adjustments Pro Forma
Historical (Note B) Delta
---------- ----------- ---------
Current Assets:
Cash $ 444 $ 974 (1) $ 1,418
Accounts receivable 1,447 1,447
Prepaid assets 742 742
Other current assets 328 328
------- ------- -------
Total current assets 2,961 974 3,935
------- ------- -------
Property and Equipment:
Oil and gas properties, at cost, using
the successful efforts method of accounting 31,452 57,003 (1) 88,455
Less: accumulated depreciation and depletion (6,692) (6,692)
------- ------- -------
Net property and equipment 24,760 57,003 81,763
------- ------- -------
Long term assets:
Other long term assets 263 263
Partnership net assets 1,089 1,089
------- ------- -------
Total long term assets 1,352 - 1,352
------- ------- -------
$29,073 57,977 $87,050
======= ======= =======
Current Liabilities:
Current portion of long-term debt $ 2,839 $ 3,077 (1) $ 5,916
Accounts payable 3,312 3,312
Other accrued liabilities 67 67
------- ------- -------
Total current liabilities 6,218 3,077 9,295
------- ------- -------
Long-term debt 6,047 16,923 (1) 22,970
------- ------- -------
Stockholders' Equity:
Preferred stock, $.10 par value - -
Common stock, $.01 par value 114 96 (1) 210
Additional paid-in capital 41,267 37,881 (1) 79,148
Accumulated other comprehensive loss (67) (67)
Accumulated deficit (24,506) (24,506)
------- ------- -------
Total stockholders' equity 16,808 37,977 54,785
------- ------- -------
Commitments
$29,073 57,977 $87,050
======= ======= =======
See accompanying notes to condensed pro forma financial statements.
Page 48
DELTA PETROLEUM CORPORATION
Unaudited Condensed Pro Forma Statement of Operations
Six Months Ended December 31, 2001
("000's" Omitted)
Delta Castle
Historical Historical Pro Forma
Six Months Ended Six Months Ended Adjustments Pro Forma
December 31, 2001 December 31, 2001 Note (C) Delta
Revenue:
Oil and gas sales $ 4,179 7,528 (301)(2) $11,406
Gain on sale of oil and gas properties - - - -
Other revenue 53 - 53
------- ------ ------ -------
Total revenue 4,232 7,528 (301) 11,459
------- ------ ------ -------
Exploration and Production
Lease operating expenses 1,923 4,006 (160)(2) 5,769
Depreciation and depletion 1,662 2,446 (2,446)(3)
2,887 (3) 4,549
Abandoned and impaired properties 162 1,892 (1,892)(6) 162
Dry hole costs 381 - 381
------- ------ ------ -------
4,128 8,344 (1,611) 10,861
Corporate general and administrative 1,341 2,315 - (5) 3,656
------- ------ ------ -------
Total operating expenses 5,469 10,659 (1,611) 14,517
------- ------ ------- -------
Income (loss) from operations (1,237) (3,131) 1,310 (3,058)
Other income and expenses:
Other income 4 112 (112) (1) 4
Other expense - (56) 56 (1) -
Interest expense and financing costs (673) - (650) (4) (1,323)
------- ------ ------- -------
Total other income and expenses (669) 56 (706) (1,319)
------- ------ ------- -------
Net income (loss) before tax effect $(1,906) (3,075) 604 $(4,377)
Provision for income tax expense - - - (7) -
------- ------ ------- -------
Net income $(1,906) (3,075) 604 (4,377)
======= ====== ======= =======
Income (loss) per share:
Basic $ (0.17) $ (0.21)
======= =======
Diluted $ (0.17) $ (0.21)
======= =======
Weighted average number of common and
potential dilutive shares outstanding:
Basic 11,214 9,566 20,780
======= ======= =======
Diluted 11,214 * 9,566 20,780
======= ======= =======
*Potentially dilutive securities outstanding were anti-dilutive.
See accompanying notes to condensed pro forma financial statements.
Page 49
DELTA PETROLEUM CORPORATION
Unaudited Condensed Pro Forma Statement of Operations
Year Ended June 30, 2001
("000's" Omitted)
Delta Castle
Historical Historical
Year Ended Year Ended Adjustments Pro Forma
June 30,2001 September 30, 2001 (Note C) Delta
------------ ------------------ ----------- ---------
Revenue:
Oil and gas sales $12,254 21,144 (846)(2) $32,552
Gain on sale of oil and gas properties 458 - 458
Other revenue 165 - 165
------- ------- ------- -------
Total revenue 12,877 21,144 (846) 33,175
------- ------- ------- -------
Exploration and Production
Lease operating expenses 4,787 9,227 (296)(2) 13,718
Depreciation and depletion 2,533 3,470 (3,470)(3)
5,444 (3) 7,977
Abandoned and impaired properties 798 2,765 (2,765)(6) 798
Dry hole costs 94 - - 94
------- ------- ------- -------
8,212 15,462 (1,160) 22,514
Corporate general and administrative 2,987 4,169 - (5) 7,156
------- ------- -------- -------
Total operating expenses 11,199 19,631 (1,160) 29,670
------- ------- -------- -------
Income (loss) from operations 1,678 1,513 314 3,505
------- ------- -------- -------
Other income and expenses:
Other income 528 683 (683)(1) 528
Other expense - (99) 99 (1) -
Interest expense and financing costs (1,861) - (1,300)(4) (3,161)
------- ------- -------- -------
Total other income and expenses (1,333) 584 (1,884) (2,633)
------- ------- -------- -------
Net income (loss) before tax effect $ 345 2,097 (1,570) $ 872
Provision for income tax expense - (381) (381)(7) -
------- ------- -------- -------
Net income 345 1,716 (1,189) 872
======= ======= ======== =======
Income (loss) per share:
Basic $ 0.03 $ 0.04
======= =======
Diluted $ 0.03 $ 0.04
======= =======
Weighted average number of common and
potential dilutive shares outstanding:
Basic 10,289 9,566 19,855
======= ======= =======
Diluted 11,753 9,566 21,319
======= ======= =======
See accompanying notes to condensed pro forma financial statements.
Page 50
NOTES TO CONDENSED PRO FORMA
FINANCIAL STATEMENTS (UNAUDITED)
A) BASIS OF PRESENTATION
The accompanying unaudited condensed pro forma balance sheet assumes that
Delta is the acquirer for accounting purposes and that the acquisition of oil
and gas properties from Castle Energy Corporation referred to as ("the Castle
Properties") occurred on December 31, 2001 and reflects the historical
consolidated balance sheet of Delta Petroleum Corporation ("Delta") at that
date giving pro forma effect to the proposed acquisition using the purchase
method of accounting. The unaudited condensed pro forma balance sheet should
be read in conjunction with the historical financial statements and related
notes of Delta and Castle.
The accompanying unaudited condensed pro forma statements of operations
for the six months ended December 31, 2001 and for the year ended June 30,
2001 assume that Delta is the acquirer for accounting purposes and that the
acquisition of the Castle Properties occurred as of July 1, 2000. The year
ended June 30, 2001 unaudited condensed pro forma statement of operations
includes Delta's historical year ended June 30, 2001 and Castle's historical
year ended September 30, 2001 statement of operations.
Even though Delta has had conversations with a bank to provide the
necessary financing at closing and has obtained a preliminary commitment,
there is no assurance that a bank loan for all or part of the $20 million cash
purchase price will be available. If the Company chooses to close the
acquisition with a bridge note payable to Castle, there is no assurance that
it could repay all or part of the bridge note with borrowed or other funds.
If the Company chooses to close the acquisition with a bridge note payable to
Castle, there is no assurance that it could repay all or part of the bridge
note with borrowed or other funds. If Delta is unable to pay all or a portion
of the bridge note in cash, it may pay the unpaid portion in shares of Delta's
Common Stock at $3.00 per share. However, in no event will Delta issue shares
to Castle that would result in Castle holding more than 49.9% of Delta's
outstanding Common Stock. In the event that Delta is unable to obtain
sufficient cash to pay the bridge note when due, and the number of shares that
would be issued to Castle to fully pay the bridge note would result in Castle
holding more than 49.9% of the outstanding shares, Delta will only issue the
maximum number of shares of Common Stock that is possible without causing
Castle to own more than 49.9% of the outstanding shares. Any remaining
amounts due shall continue to be due and payable in either cash or shares of
Delta Common Stock as soon as it is possible for Delta to issue sufficient
shares to pay the remaining amounts without causing Castle to own more than
49.9% of the outstanding shares.
B) ACQUISITION OF CASTLE PROPERTIES - BALANCE SHEET
Delta Petroleum Corporation ("Delta"), an independent energy exploration
and development company, has entered into a purchase and sale agreement to
purchase all of the United States domestic oil and gas properties of Castle
Energy Corporation ("Castle") for $20,000,000, payable in proceeds from bank
financing with interest at prime plus 1-1/2% and a three year maturity date in
cash plus 9,566,000 shares of Delta's common stock valued at approximately
$37,977,000 based on the five-day average closing price surrounding the
announcement of the acquisition. The effective date is October 1, 2001 and
closing is expected by June 30, 2002 or shortly thereafter. Pursuant to the
terms of the purchase and sale agreement, the cash portion of the purchase
price payable at closing will be reduced by the cash flow from the properties
Page 51
between the effective date and the closing date. The sale is subject to
approval by the shareholders of Delta. Each party is subject to a penalty in
the amount of 700,000 shares of their respective common stock for failure to
close the transaction. Delta has an additional penalty in the amount of
700,000 shares of its Common Stock if the transaction is terminated by Castle
because the closing does not occur by June 30, 2002 due to Delta's failure to
timely respond to SEC comments, a determination by Delta not to proceed with
the transaction or any other delay or failure to meet the conditions of
closing, other than a failure to obtain shareholder approval in a situation
where less than a majority of shares issued and outstanding can be voted, for,
against or abstaining on the proposal to approve the agreement with Castle.
Delta may repurchase up to 3,188,667 of its shares from Castle for $4.50 per
share for a period of one year after closing. The option to repurchase up to
3,188,667 of our shares for $4.50 will preserve the potential upside relating
to future value relating to our offshore oil and gas properties. If we decide
to exercise our option to repurchase our shares, the value of the repurchased
shares will be recorded as treasury stock. As a part of the acquisition, upon
closing, Delta has granted an option to acquire a 4% working interest in the
properties acquired for a cost of $974,000 to BWAB Limited Liability Company
("BWAB"), a less than 10% shareholder of Delta. The difference between the
$974,000 paid by BWAB which is less than fair value, and 4% of the cost of the
Castle properties will be treated as an additional acquisition cost by Delta
for their consultation and assistance related to the transaction.
(1) The accompanying historical balance sheet of Delta at December
31, 2001 has been adjusted to record the purchase price of the Castle
Properties by Delta, net of the interest that BWAB is likely to acquire,
assuming a stock price of $3.97 and debt incurred of $20,000,000 as follows
("000's" omitted):
Cash (from BWAB) $ 974
Oil and gas properties, net
of BWAB interest 57,003
-------
57,977
=======
Current portion of long term debt 3,077
Long term debt 16,923
Common stock 96
Additional paid in capital 37,881
-------
$57,977
=======
C) ACQUISITION OF CASTLE PROPERTIES - STATEMENT OF OPERATIONS
The accompanying unaudited condensed pro forma statements of operations
for the six months ended December 31, 2001 and for the year ended June 30,
2001 assume that Delta is the acquirer and that the acquisition of the Castle
Properties occurred as of July 1, 2000. The year ended June 30, 2001
unaudited condensed pro forma statement of operations includes Delta's
historical year ended June 30, 2001 and Castle's historical year ended
September 30, 2001 statement of operations. Delta utilizes the successful
efforts method of accounting for its oil and gas properties while Castle
utilizes the full cost method of accounting for its oil and gas properties.
Based on the properties acquired, it is not practical to convert the results
of the Castle properties from the full cost method of accounting to the
Page 52
successful efforts method of accounting for the periods presented. In
addition, the following adjustments have been made to the accompanying
condensed pro forma statements of operations for six months ended December 31,
2001 and the year ended June 30, 2001:
(1) To adjust the unaudited pro forma statement of operations for
items that would not be affected by the acquisition transaction.
(2) To adjust revenue and direct lease operating expenses of the
Castle properties to reflect the effect of the interest to be
acquired by BWAB.
(3) To remove Castle's depletion calculation and adjust Delta's
depletion expense to reflect the pro forma depletion expense
giving effect to the proposed acquisition of the Castle
Properties. The depletion expense was calculated using estimated
proved reserves by field and assumed 80% of the acquisition cost
was allocable to the producing properties which represent the
fair market value of producing oil and gas properties acquired.
The pro forma depletion and the allocation to producing
properties allocation is based on the reserve report prepared by
Delta in evaluating the Castle properties.
(4) To record interest expense for interest associated with the
debt incurred in connection with the acquisition of the Castle
Properties at a rate of prime plus 1-1/2% per annum (assumed
6.5% per annum), which assumes the bank loan is obtained based on
the Company's preliminary commitments. A one-eighth change in
interest rate would have a $163,000 annual impact on interest
expense.
(5) There are duplicative costs that will be eliminated once this
transaction is closed. As these amounts are not supportable,
there has been no pro forma adjustment to reduce general and
administrative expenses.
(6) To eliminate abandoned and impaired properties expense incurred
by Castle relating to foreign properties not acquired by Delta.
(7) Taxes have been eliminated as a result of Delta's net operating
loss carry forward position and income tax valuation or a pro
forma statement of operation loss as a result of the acquisition
of the Castle properties.
D) ACQUISITION OF CASTLE PROPERTIES - RESERVE QUANTITIES AND STANDARIZED
MEASURE OF DISCOUNTED FUTURE CASH FLOWS
The accompanying proforma combined reserve quantities and standardized
measure of discounted future cash flows are as follows:
The properties to be acquired from Castle ("Castle Properties") consist
of interests in approximately 525 producing wells in fourteen (14) states,
plus associated undeveloped acreage.
Page 53
Reserve Quantities
(000's Omitted)
Delta Castle
June 30, 2001 September 30, 2001 Combined
------------------ ------------------ ------------------
Oil Natural Gas Oil Natural Gas Oil Natural Gas
(BBLS) (MCF) (BBLS) (MCF) (BBLS) (MCF)
Proved developed and
undeveloped reserves 1,557 4,682 3,360 30,692 4,917 35,374
Proved developed reserves 1,250 4,474 1,890 26,480 3,140 30,954
Standardized Measures of
Discounted Future Cash Flows
(000's Omitted)
Delta Castle
June 30, 2001 September 30, 2001 Combined
------------- ------------------ --------
Future cash flows $ 24,570 $138,594 $163,164
Future production costs (7,971) (43,288) (51,259)
Future development costs (382) (8,655) (9,037)
Future income tax expense - (13,102) (13,102)
-------- -------- --------
Future net cash flows 16,217 73,549 89,766
Discounted factor of 10%
for estimated timing of
future cash flows (6,267) (37,269) (43,536)
-------- -------- --------
Standardized measure of
discounted future cash flows $ 9,950 $ 36,280 $ 46,230
======== ======== ========
Page 54
Information Concerning the Properties to be Acquired from Castle
- ----------------------------------------------------------------
Castle Energy Corporation ("Castle") is currently engaged in oil and gas
exploration and production in the United States and Romania. The information
contained herein concerning Castle only pertains to the properties to be
acquired from Castle and omits disclosures that do not pertain to Castle's
domestic oil and gas operations. Castle is currently operating exclusively in
the exploration and production segment of the energy industry. As of
September 30, 2001, Castle's exploration and production subsidiaries owned
interests in 522 producing oil and gas wells located in fourteen states. Of
these interests, 430 were working interests, where Castle is responsible for
operating costs applicable to the well, and 92 were royalty interests, where
Castle bears no expense burden. Castle's subsidiaries operate approximately
half of the wells that are working interests, which Delta will operate after
the acquisition closes. At September 30, 2001, Castle's exploration and
production assets included proved reserves (estimated at September 30, 2001
spot prices) of approximately 31 billion cubic feet of natural gas and
approximately 3,400,000 barrels of oil.
In July 2000, Castle engaged Energy Spectrum Advisors of Dallas, Texas to
advise Castle concerning strategic alternatives including the possible sale of
its oil and gas assets. In December 2000, several companies submitted bids for
Castle's domestic oil and gas assets. The total of the highest bids for all of
Castle's properties aggregated approximately $48,000,000 with an effective
date of October 1, 2000. Castle's Board of Directors decided not to sell its
oil and gas assets at the prices offered.
We negotiated the Castle transaction using a stock price of $3.00, the
trading price during negotiations, thus valuing the Castle properties at
approximately $48,700,000. The Securities and Exchange Commission requires us
to value our stock using an average price based on the announcement of the
transaction. The acquisition cost of Castle will be recorded using a price of
approximately $57,003,000, which will be reduced by the net cash flow from the
properties acquired from October 1, 2001 through the closing date.
OIL AND GAS EXPLORATION AND PRODUCTION
General
- -------
On June 1, 1999, Castle consummated the purchase of all of the oil and
gas properties of AmBrit Energy Corp. ("AmBrit"). The oil and gas properties
purchased include interests in approximately 180 oil and gas wells in Alabama,
Louisiana, Mississippi, Montana, New Mexico, Oklahoma, Texas and Wyoming, as
well as undrilled acreage in several of these states. The effective date of
the sale was January 1, 1999. The adjusted purchase price after accounting for
all transactions between the effective date, January 1, 1999, and the closing
date was $20,170,000. The entire adjusted purchase price was allocated to "Oil
and Gas Properties - Proved Properties." Based upon reserve reports initially
prepared by Castle's petroleum reservoir engineers, the proved reserves
(unaudited) associated with the AmBrit oil and gas assets approximated
2,000,000 barrels of crude oil and 12,500,000 mcf (thousand cubic feet) of
natural gas, which, together, approximated 150% of Castle's oil and gas
reserves before the acquisition. In addition, the production acquired
initially increased Castle's consolidated production by approximately 425%.
In fiscal 1999, Castle entered into two drilling ventures to participate
in the drilling of up to sixteen exploratory wells in south Texas. During
fiscal 2000, Castle participated in the drilling of nine exploratory wells
Page 55
pursuant to the related joint venture operating agreements. Eight wells
drilled resulted in dry holes and one well was completed as a producer. Castle
has no further drilling obligations under these joint ventures and has
terminated participation in each drilling venture. The total cost incurred to
participate in the drilling of the exploratory wells was $6,003,000.
In December 1999, a subsidiary of Castle purchased majority interests in
twenty-six offshore Louisiana wells from Whiting Petroleum Company
("Whiting"), a public company engaged in oil and gas exploration and
development. The adjusted purchase price was $890,000.
In September 2000, the subsidiary sold its interests in the offshore
Louisiana wells to Delta. The effective date of the sale was July 1, 2000.
The adjusted purchase price of $3,059,000 consisted of $1,122,000 cash plus
382,289 shares of Delta's common stock valued at the closing market price of
$1,937,000.
In November and December 1999, Castle acquired additional outside
interests in several Alabama and Pennsylvania wells, which it operates, for
$2,580,000.
On April 30, 2001, Castle consummated the purchase of several East Texas
oil and gas properties from a private company. The effective date of the
purchase was April 1, 2001. These properties included majority interests in
twenty-one (21) operated producing oil and gas wells and interests in
approximately 6,500 gross acres in three counties in East Texas. Castle
estimated the proved reserves acquired to be approximately 12.5 billion cubic
feet of natural gas and 191,000 barrels of crude oil. The consideration paid,
net of purchase price adjustments, was $10,040,000. Castle used its own
internally generated funds to make the purchase.
Properties - Proved Oil and Gas Reserves
- ----------------------------------------
The following is a summary of Castle's oil and gas reserves as of
September 30, 2001. All estimates of reserves are based upon engineering
evaluations prepared by Castle's independent petroleum reservoir engineers,
Huntley & Huntley and Ralph E. Davis Associates, Inc., in accordance with the
requirements of the Securities and Exchange Commission and are based upon
September 30, 2001 spot prices. Such estimates include only proved reserves.
Castle reports its reserves annually to the Department of Energy.
Castle's estimated reserves as of September 30, 2001 were as follows:
Net MCF (1) of gas:
Proved developed............................................. 26,480,000
Proved undeveloped........................................... 4,212,000
----------
Total........................................................ 30,692,000
==========
Net barrels of oil:
Proved developed............................................. 1,890,000
Proved undeveloped........................................... 1,470,000
----------
Total........................................................ 3,360,000
==========
- -----------------
(1) Thousand cubic feet
Page 56
Oil and Gas Production
- ----------------------
The following table summarizes the net quantities of oil and gas
production of Castle for each of the three fiscal years in the period ended
September 30, 2001, including production from acquired properties since the
date of acquisition.
Fiscal Year Ended September 30, 2001 2000 1999
---- ---- ----
Oil -- Bbls (barrels)................. 262,000 279,000 124,000
Gas -- MCF............................ 3,083,000 3,547,000 1,971,000
Average Sales Price and Production Cost Per Unit
The following table sets forth the average sales price per barrel of oil
and MCF of gas produced by Castle, including hedging adjustments, and the
average production cost (lifting cost) per equivalent unit of production for
the periods indicated. Production costs include applicable operating costs and
maintenance costs of support equipment and facilities, labor, repairs,
severance taxes, property taxes, insurance, materials, supplies and fuel
consumed in operating the wells and related equipment and facilities.
Fiscal Year Ended September 30, 2001 2000 1999
---- ---- ----
Average Sales Price per Barrel of Oil.......... $27.39 $27.94 $18.36
Average Sales Price per MCF of Gas............. $ 4.53 $ 2.87 $ 2.25
Average Production Cost per Equivalent MCF(1).. $ 1.59 $ 1.19 $ .70
- --------------
(1) For purposes of equivalency of units, a barrel of oil is assumed equal
to six MCF of gas, based upon relative energy content.
No production was hedged in fiscal 2001.
The average sales price per barrel of crude oil decreased $4.64 per
barrel for the year ended September 30, 2000 and increased $.11 per barrel for
the year ended September 30, 1999 as a result of hedging. The average sales
price per mcf (thousand cubic feet) of natural gas decreased $.07 for each of
the years ended September 30, 2000 and 1999 as a result of hedging. Oil and
gas sales were not hedged after July 2000.
Productive Wells and Acreage
The following table presents the oil and gas properties in which Castle
held an interest as of September 30, 2001. The wells and acreage owned by
Castle and its subsidiaries are located primarily in Alabama, California,
Illinois, Louisiana, Mississippi, Montana, New Mexico, Oklahoma, Pennsylvania,
Texas and Wyoming.
Page 57
As of September 30, 2001
Gross(2) Net (3)
-------- -------
Productive Wells:(1)
Gas Wells........................................... 521 203
Oil Wells........................................... 103 49
Acreage:
Developed Acreage................................... 129,517 31,351
Undeveloped Acreage................................. 85,686 29,678
- ----------------
(1) A "productive well" is a producing well or a well capable of
production. Fifty-nine wells are dual wells producing oil and
gas. Such wells are classified according to the dominant mineral
being produced.
(2) A gross well or acre is a well or acre in which a working
interest is owned. The number of gross wells is the total number
of wells in which a working interest is owned.
(3) A net well or acre is deemed to exist when the sum of fractional
working interests owned in gross wells or acres equals one. The
number of net wells or acres is the sum of the fractional working
interests owned in gross wells or acres.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
("$000's" Omitted Except Per Unit Amounts)
RESULTS OF OPERATIONS
GENERAL
From August 1989 to September 30, 1995, two of Castle's
subsidiaries conducted refining operations. By December 12, 1995, Castle'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
Castle. Castle's other refining subsidiary, IRLP, owns no refining assets and
is in the process of liquidation. As a result, Castle has accounted for its
refining operations as discontinued operations in Castle's financial
statements as of September 30, 1995 and retroactively. Accordingly, discussion
of results of operations has been confined to the results of continuing
operations and the anticipated impact, if any, of liquidation of Castle's
remaining inactive refining subsidiary and contingent environmental
liabilities of Castle or its refining subsidiaries.
Also, as noted above, Castle acquired the oil and gas properties of
AmBrit on June 1, 1999. The oil and gas reserves associated with the
acquisition were estimated at approximately 12.5 billion cubic feet of natural
gas and 2,000,000 barrels of crude oil, roughly 150% of the reserves owned by
Castle before the acquisition. Furthermore, as a result of the acquisition,
Castle's production of oil and gas increased by approximately 425%. This
acquisition impacted consolidated operations for the last four months of
fiscal 1999 only.
Page 58
Gas marketing sales and purchases ceased effective May 31, 1999 by virtue
of the scheduled termination of its subsidiaries' gas sales and gas purchase
contracts with Lone Star and MGNG. Castle has not replaced these contracts
although it continues to seek similar gas marketing acquisitions. As a
result, natural gas marketing operations impacted consolidated operations for
all of fiscal 1999 and none of fiscal 2000 or fiscal 2001.
Quarter Ended December 31, 2001 vs Quarter Ended December 31, 2000
- ------------------------------------------------------------------
Key exploration and production data for the quarters ended December 31,
2001 and 2000 are as follows:
Three Months
Ended December 31,
------------------
2001 2000
---- ----
Production Volumes:
Barrels of crude oil (net) 69,315 67,798
Mcf (thousand cubic feet) of natural gas (net) 857,043 751,064
Mcf equivalents (mcfe) (net)* 1,272,933 1,157,852
Oil/Gas Prices:
Crude Oil/Barrel: $20.47 $29.46
====== ======
Natural Gas/Mcf: $ 2.36 $ 4.52
====== ======
Oil and Gas Production Expenses/Mcf Equivalent $ .99 $ 1.21
====== ======
- -------------------
* Barrels of crude oil have been converted to mcf based upon relative energy
content of 6 MCF of natural gas per barrel of crude oil.
Oil and gas sales decreased $2,490 from the first quarter of fiscal 2001
to the first quarter of fiscal 2002 due to a decrease in oil and gas prices.
The average price per equivalent mcfe decreased from $4.66/mcfe for the
quarter ended December 31, 2000 to $2.70/mcfe for the quarter ended December
31, 2001. The decline in the price received for natural gas was especially
precipitous. For the quarter ended December 31, 2000, the average price
recorded per mcf of natural gas was $4.52 versus only $2.36 per mcf for the
quarter ended December 31, 2001. Since the Castle has not hedged its oil and
gas production, Castle's oil and gas sales can be expected to increase or
decrease roughly parallel with increases and decreases in oil and gas prices.
Although most reputable industry experts are predicting only a modest increase
in average oil and gas prices over the next two or three years, such prices
have proved to be extremely volatile in the past. Changes in weather, the
economy, international politics and worldwide political and other factors
could cause similar volatility in oil and gas prices in the future.
Oil and gas sales increased $537 as a result of increases in oil and gas
production. From the quarter ended December 31, 2000 to the quarter ended
December 31, 2001 oil production increased 1,517 barrels (approximately 16
barrels a day) and natural gas production increased 105,979 mcf
(approximate1y, 1,152 mcf/day). The increase in production is primarily due
to production from the acquisition of interests in twenty-one East Texas oil
and gas wells on April 30, 2001, recent recompletions and reworks on existing
wells in which Castle owns an interest as well as several successful new wells
in which Castle participated during the last six months. Such increases in
production more than offset the natural depletion of Castle's remaining wells.
Page 59
As a result of the $2,490 decrease due to oil and gas prices and the $537
increase due to oil and gas production, there was a net decrease of $1,953 or
36.2% in oil and gas sales from the quarter ended December 31, 2000 to the
quarter ended December 31, 2001.
Oil and gas production expenses decreased $150 or 10.7% from the first
quarter of fiscal 2001 to the first quarter of fiscal 2002. For the quarter
ended December 31, 2001, such expenses were $.99 per equivalent mcf of
production versus $1.21 per equivalent mcf of production for the quarter ended
December 31, 2000. The decrease is primarily attributable to a higher amount
of nonrecurring repairs and maintenance incurred during the quarter ended
December 31, 2000 than during the quarter ended December 31, 2001. Such
expenses are typically not incurred ratably throughout the year but are
incurred when and if certain wells require repair and maintenance. As a
result, such comparisons are more appropriate on an annual or a multi-year
basis than on a quarterly basis.
As noted above, the net cash flow (oil and gas sales less oil and gas
production expenses) from Castle's oil and gas properties from October 1, 2001
to the expected closing of the Delta transaction will reduce the cash portion
of the purchase price Castle expects to receive from the sale of its domestic
oil and gas properties. Accordingly, the net cash flow for the quarter ended
December 31, 2001 of $2,187, subject to some minor adjustments, will
ultimately accrue to Delta's account rather than to Castle's account if the
sale to Delta is ultimately consummated as planned.
General and administrative expenses decreased $387 or 22% from the
quarter ended December 31, 2000 to the quarter ended December 31, 2001. The
decrease was primarily attributable to decreased legal expenses and $181 of
non-recurring costs related to Castle's previous effort to sell its oil and
gas properties that terminated in December 2000 without a sale.
Depreciation, depletion and amortization increased $543 or 77.7% from the
first quarter of fiscal 2001 to the fiscal quarter of fiscal 2002. This net
increase consists of a decrease of $15 in depreciation of equipment and
furniture and fixtures and a $558 increase in depletion of oil and gas
properties. The increase in depletion is primarily attributable to an
increase in the depletion rate. For the quarter ended December 31, 2001, the
depletion rate was $.95 per mcfe versus $.57 per mcfe for the quarter ended
December 31, 2000. The increase in depletion rates is indirectly attributable
to the significant decreases in oil and gas prices that occurred between the
two periods being compared. As a result of lower oil and gas prices at
December 31, 2001, Castle's economic oil and gas reserves decreased
significantly and the resultant cost per mcfe and depletion rate per mcfe
increased significantly.
Although Castle recorded no impairment provision for its domestic oil and
gas properties for either of the quarters ended December 31, 2000 or December
31, 2001, it is possible that Castle could be required to record such an
impairment provision at March 31, 2002 or thereafter if oil and gas prices
decline. Under the full cost method of accounting for oil and gas properties,
net capitalized costs, less related deferred taxes, in excess of the present
value of net future cash inflows from proved reserves, tax effected and
discounted at 10%, are charged to current expense. Since December 31, 2001,
oil and gas prices have decreased significantly and as a result the present
value of future cash flows has also decreased. It is thus possible that an
impairment provision could be required in the future, although none was
required at either December 31, 2000 or December 31, 2001.
Page 60
Fiscal 2001 vs Fiscal 2000
- --------------------------
OIL AND GAS SALES
Oil and gas sales increased $3,185 or 17.7% from fiscal 2000 to fiscal
2001. An analysis of the increase is as follows:
Fiscal Year Ended September 30, Increase
2001 2000 (Decrease)
---- ---- ----------
Production (Net):
Barrels of crude oil .............. 262,000 279,000 (17,000)
Mcf of natural gas ................ 3,083,000 3,547,000 (464,000)
Equivalent net of natural gas ..... 4,655,000 5,221,000 (566,000)
Oil and Gas Sales:
Before hedging .................... $ 21,144 $ 19,487 $ 1,657
Effect of hedging ................. (1,528) 1,528
----------- ----------- -----------
Net of hedging .................... $ 21,144 $ 17,959 $ 3,185
=========== =========== ===========
Average Price/MCFE:
Before hedging ......................... $ 4.54 $ 3.73 $ .81
Effect of hedging ...................... (0.29) 0.29
----------- ----------- -----------
Net .................................... $ 4.54 $ 3.44 $ 1.10
=========== =========== ===========
Analysis of Increase:
Price (5,221,000 mcfe x $.81/mcfe) ..... $ 4,229
Volume (566,000 mcfe x $4.54/mcfe) ..... (2,570)
Decrease in hedging losses ............. 1,528
Rounding ............................... (2)
-----------
$ 3,185
===========
For the year ended September 30, 2001, Castle's net production averaged
718 barrels of crude per day and 8,447 mcfe of natural gas per day versus 764
barrels of crude oil per day and 9,718 mcf of natural gas per day for the year
ended September 30, 2000.
The decline in production volumes is primarily attributable to the
depletion of Castle's oil and gas reserves and the fact that all but one of
the exploratory wells drilled in fiscal 2000 and 2001 by Castle resulted in
dry holes rather than production. The decline in production would have been
greater by 467,000 mcfe had Castle not acquired twenty-one producing East
Texas properties in April 2001.
At the present time, natural gas spot prices are averaging less than
$3.00/mcf - far less than the average price of $4.53/mcf for the year ended
September 30, 2001 and the record prices of $9.00/mcf received for some
production in January 2001. In addition, current crude prices are slightly
below $20.00 per barrel - significantly less than the average price of $27.39
received by Castle for the year ended September 30, 2001. Since Castle has not
hedged its production and since most credible experts are not predicting
significant increases for oil and gas prices in the short term, Castle expects
that its oil and gas revenues will decrease significantly in fiscal 2002
Page 61
unless Castle successfully drills or acquires new reserves and/or oil and as
prices increase significantly. If Castle consummates the intended sale of its
domestic oil and gas properties to Delta, oil and gas price or volume
increases will affect both operations until closing of the sale and the
ultimate purchase price Castle receives. Net cash flow between October 1,
2001, the effective date, and the closing date, would be retained by Castle
but would reduce the purchase price paid by Delta.
Oil and gas production expenses increased $1,205 or 19.5% from fiscal
2000 to fiscal 2001. The increase is primarily attributable to the acquisition
of twenty-one (21) producing properties in East Texas in April 2001. For the
year ended September 30, 2001 oil and gas production expenses, net of income
from well operations, were $1.59 per equivalent mcf sold versus $1.19 per
equivalent mcf sold for the year ended September 30, 2000. The increase
results primarily from two factors. When oil and gas prices increased
substantially in the beginning of fiscal 2001, so did operating costs. Such
operating costs, however, did not decrease or decreased less than oil and gas
prices when oil and gas prices receded sharply later in the fiscal year. A
second factor contributing to the increase is the fact that the average age of
Castle's producing properties is increasing - especially given the
unsuccessful results of Castle's exploratory drilling programs and the
resultant lack of reserves added by new drilling. Mature wells typically carry
a higher production expense burden than do newer wells that have not yet been
significantly depleted.
Page 62
FINANCIAL STATEMENTS OF CASTLE
Delta entered into a Purchase and Sale Agreement to purchase all of the
United States domestic oil and gas properties of Castle for $20,000,000,
payable in cash or a combination of cash and bridge note convertible at $3.00
per share of Delta stock, plus 9,566,000 shares of Delta's Common Stock. The
effective date is October 1, 2001 and closing is expected by April 30, 2002 or
shortly thereafter.
The properties to be acquired from Castle consist of interests in
approximately 525 producing wells in fourteen (14) states, plus associated
undeveloped acreage. Because Delta is acquiring substantially all of Castle's
revenue generating assets, the historical financial statements of Castle are
presented herein as being those of the acquired properties pursuant to Rule
3.05 of Regulation S-X. Since Delta is acquiring only producing properties
and some undeveloped acreage from Castle, no attempt has been made to conform
Castle's full cost method of accounting to the successful efforts method used
by Delta. These statements should be read in conjunction with the pro forma
financial statements and related notes of Delta presented herein.
Index to Castle Financial Statements
- ------------------------------------
CONSOLIDATED FINANCIAL STATEMENTS: PAGE
Independent Auditors' Report ................................. 64
Consolidated Statements of Operations for the Years Ended
September 30, 2001, 2000 and 1999 ........................... 65
Consolidated Balance Sheets as of September 30, 2001 and
2000 ........................................................ 66
Consolidated Statement of Cash Flows for the Years Ended
September 30, 2001, 2000 and 1999 ........................... 67-68
Consolidated Statements of Stockholders' Equity and Other
Comprehensive Income for the Years Ended September 30,
2001, 2000 and 1999 ......................................... 69
Notes to Consolidated Financial Statements ................... 70-119
Page 63
Independent Auditors' Report
The Board of Directors
Castle Energy Corporation:
We have audited the accompanying consolidated balance sheets of Castle Energy
Corporation and subsidiaries as of September 30, 2001 and 2000, and the
related consolidated statements of operations, stockholders' equity and other
comprehensive income, and cash flows for each of the years in the three year
period ended September 30, 2001. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United State of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Castle
Energy Corporation and subsidiaries as of September 30, 2001 and 2000, and the
results of their operations and their cash flows for each of the years in the
three year period ended September 30, 2001 in conformity with accounting
principles generally accepted in the United States of America.
/s/ KPMG LLP
KPMG LLP
Houston, Texas
December 18, 2001
Page 64
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("$000's" Omitted Except Share and Per Share Amounts)
Year Ended September 30,
------------------------
2001 2000 1999
---------- ---------- ----------
Revenues:
Natural gas marketing and transmission:
Gas sales $ 50,067
Exploration and production:
Oil and gas sales $ 21,144 $ 17,959 6,712
---------- ---------- ----------
21,144 17,959 56,779
---------- ---------- ----------
Expenses:
Natural gas marketing and transmission:
Gas purchases 31,062
General and administrative 35
Transportation 1,123
Depreciation and amortization 6,284
----------
38,504
----------
Exploration and production:
Oil and gas production 7,399 6,194 1,910
General and administrative 1,828 2,038 1,038
Depreciation, depletion and amortization 3,470 3,209 2,046
Impairment of foreign unproved properties 2,765 832
---------- ---------- -----------
15,462 12,273 4,994
---------- ---------- ----------
Corporate general and administrative 4,169 3,717 4,112
---------- ---------- ----------
19,631 15,990 47,610
---------- ---------- ----------
Operating income 1,513 1,969 9,169
---------- ---------- ----------
Other income (expense):
Interest income 641 784 1,701
Other income 42 25 352
Equity in loss of Networked Energy LLC (99)
---------- ---------- ----------
584 809 2,053
---------- ---------- ----------
Income before provision for (benefit of) income taxes 2,097 2,778 11,222
---------- ---------- ----------
Provision for (benefit of) income taxes:
State 11 (64) 79
Federal 370 (2,227) 2,877
---------- ---------- ----------
381 (2,291) 2,956
---------- ---------- ----------
Net income $ 1,716 $ 5,069 $ 8,266
========== ========== ==========
Net income per share:
Basic $ .26 $ .73 $ 1.01
========== ========== ==========
Diluted $ .25 $ .71 $ .99
========== ========== ==========
Weighted average number of common and potential
dilutive shares outstanding:
Basic 6,643,724 6,939,350 8,205,501
========== ========== ==========
Diluted 6,818,855 7,102,803 8,347,932
========== ========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 65
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("$000's" Omitted Except Share and Per Share Amounts)
September 30,
2001 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents $ 5,844 $ 11,525
Restricted cash 370 1,742
Accounts receivable 2,787 3,758
Marketable securities 6,722 10,985
Prepaid expenses and other current assets 277 251
Estimated realizable value of discontinued net refining assets 612 800
Deferred income taxes 1,879 2,256
-------- --------
Total current assets 18,491 31,317
Property, plant and equipment, net:
Natural gas transmission 51 55
Furniture, fixtures and equipment 222 258
Oil and gas properties, net (full cost method):
Proved properties 39,843 29,218
Unproved properties not being amortized 110 1,447
Investment in Networked Energy LLC 401 500
Note receivable - Penn Octane Corporation 500
-------- --------
Total assets $ 59,118 $ 63,295
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable $ 331 $ 333
Accounts payable 3,543 2,433
Accrued expenses 292 265
Accrued taxes on appreciation of marketable securities 900 2,628
Stock subscription payable 150
Net refining liabilities retained 3,016 3,204
-------- --------
Total current liabilities 8,082 9,013
Long-term liabilities 9 6
-------- --------
Total liabilities 8,091 9,019
-------- --------
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 September 30, 2001 and 2000 5,752 5,752
Additional paid-in capital 67,365 67,365
Accumulated other comprehensive income - unrealized gains
on marketable securities, net of taxes 1,600 4,671
Retained earnings 42,816 42,422
-------- --------
117,533 120,210
Treasury stock at cost - 4,871,020 shares at
September 30, 2001 and 4,791,020 shares at
September 30, 2000 (66,506) (65,934)
-------- --------
Total stockholders' equity 51,027 54,276
-------- --------
Total liabilities and stockholders' equity $ 59,118 $ 63,295
======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 66
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
("$000's" Omitted Except Share and Per Share Amounts)
Year Ended September 30,
------------------------
2001 2000 1999
-------- -------- --------
Cash flows from operating activities:
Net income $ 1,716 $ 5,069 $ 8,266
-------- -------- --------
Adjustments to reconcile net income to cash provided by
operating activities:
Depreciation, depletion and amortization 3,470 3,209 8,330
Impairment of foreign unproved properties 2,765 832
Deferred income taxes (benefit) 377 (2,256) 2,765
Unrealized gain on marketable securities (481)
Impairment of Penn Octane preferred stock 423
Equity in loss of Networked Energy LLC 99
Changes in assets and liabilities:
(Increase) decrease in restricted cash 1,372 (972) (157)
Decrease in accounts receivable 971 1,414 3,209
Decrease in prepaid transportation 1,123
(Increase) decrease in prepaid expenses and other
current assets (26) 343 (301)
Decrease in other assets 29
Decrease in prepaid gas purchases 852
Increase (decrease) in accounts payable 1,110 (436) (5,740)
Increase (decrease) in accrued expenses 27 (537) (861)
Increase in other long-term liabilities 3 6
-------- -------- --------
Total adjustments 10,168 1,632 9,162
-------- -------- --------
Net cash flow provided by operating activities 11,884 6,701 17,428
-------- -------- --------
Cash flows from investment activities:
Investment in note receivable - Penn Octane Corporation (500)
Investment in marketable securities (34) (269)
Proceeds from sale of oil and gas assets 48 1,427
Realization from (liquidation of) discontinued net
refining assets 900
Acquisition of AmBrit oil and gas properties (20,170)
Investment in other oil and gas properties (15,449) (11,226) (3,794)
Investment in Networked Energy LLC (150) (350)
Purchase of furniture, fixtures and equipment (82) (173) (98)
Other (35)
-------- -------- --------
Net cash used in investing activities (15,667) (10,857) (23,431)
-------- -------- --------
(continued on next page)
The accompanying notes are an integral part of these consolidated
financial statements.
Page 67
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
("$000's" Omitted)
(continued from previous page)
Year Ended September 30,
------------------------
2001 2000 1999
-------- -------- --------
Net income $ 1,716 $ 5,069 $ 8,266
Cash flows from financing activities:
Acquisition of treasury stock (572) (5,208) (6,919)
Dividends paid to stockholders (1,326) (1,363) (1,681)
Proceeds from exercise of stock options 255
-------- -------- --------
Net cash (used in) financing activities (1,898) (6,571) (8,345)
-------- -------- --------
Net (decrease) in cash and cash equivalents (5,681) (10,727) (14,348)
Cash and cash equivalents - beginning of period 11,525 22,252 36,600
-------- -------- --------
Cash and cash equivalents - end of period $ 5,844 $ 11,525 $ 22,252
======== ======== ========
Supplemental disclosures of cash flow information
are as follows:
Cash paid during the period:
Income taxes $ 11 $ 188 $ 108
======== ======== ========
Accrued dividends $ 331 $ 333 $ 368
======== ======== ========
Conversion of Penn Octane Corporation note
and accrued interest receivable
to marketable securities $ 521 $ 1,000
======== ======== ========
Unrealized gain (loss) on investment in
available-for-sale marketable
securities ($ 3,071) $ 2,275 $ 2,396
======== ======== ========
Exchange of oil/gas properties for Delta
Petroleum Company common
stock $ 1,937
========
The accompanying notes are an integral part of these consolidated
financial statements.
Page 68
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND OTHER COMPREHENSIVE INCOME
("$000's" Omitted Except Per Share Amounts)
Year Ended September 30, 2001, 2000 and 1999
---------------------------------------------------------------------------------------------
Accumulated
Addi- Other
Common Stock tional Compre- Compre- Treasury Stock
------------------ Paid-In hensive hensive Retained -------------------
Shares Amount Capital Income Income (Loss) Earnings Shares Amount Total
---------- ------- ------- ------- ------------- -------- --------- --------- -------
Balance-September 30, 1998 6,803,646 $3,402 $67,122 $34,836 3,862,917 ($53,807) $51,553
Stock acquired 419,300 (6,919) (6,919)
Options exercised 25,000 12 243 255
Dividends declared
($.25 per share) (2,048) (2,048)
Comprehensive income
Net income $ 8,266 8,266 8,266
Other comprehensive income
Unrealized gain (loss) on
marketable securities,
net of tax 2,396 $2,396 2,396
-------
$10,662
=======
Balance-September 30, 1999 6,828,646 3,414 67,365 2,396 41,054 4,282,217 (60,726) 53,503
Stock split ratio
retroactively applied 4,675,258 2,338 (2,338)
---------- ------ -------
Balance-September 30, 1999
-restated 11,503,904 5,752 67,365 2,396 38,716 4,282,217 (60,726) 53,503
Stock acquired 508,803 (5,208) (5,208)
Dividends declared
($.20 per share) (1,363) (1,363)
Comprehensive income
Net income $ 5,069 5,069 5,069
Other comprehensive income:
Unrealized gain on
marketable securities,
net of tax 2,275 2,275 2,275
======= ------
$ 7,344
---------- ------ ------- ------- ------ ------- --------- ------- -------
Balance-September 30, 2000 11,503,904 5,752 67,365 4,671 42,422 4,791,020 (65,934) 54,276
Stock acquired 80,000 (572) (572)
Dividends declared
($.20 per share) (1,322) (1,322)
Comprehensive income
Net income $1,716 1,716 1,716
Other comprehensive income
(loss): Unrealized gain
(loss) on marketable
securities, net of tax (3,071) (3,071) (3,071)
======
($1,355)
---------- ------ ------- ======= ------ ------- --------- ------- -------
Balance-September 30, 2001 11,503,904 $5,752 $67,365 $1,600 $42,816 4,871,020 ($66,506) $51,027
========== ====== ======= ====== ======= ========= ======= =======
The accompanying notes are an integral part of these consolidated
financial statements.
Page 69
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 1 - BUSINESS AND ORGANIZATION
Business
Castle Energy Corporation (the "Company") is a public company
incorporated in Delaware. Mr. Joseph L. Castle II, Chairman of the Board and
Chief Executive Officer, and his wife own approximately twenty-three percent
(23%) of the Company's outstanding common stock at September 30, 2001.
The Company's only line of business at September 30, 2001 and at present
is oil and gas exploration and production. The Company's operations are
conducted in the United States and in Romania. Prior to September 30, 1995,
several of the Company's subsidiaries and former subsidiaries were involved in
the refining business. These subsidiaries discontinued refining operations
effective September 30, 1995; however, several contingencies related to
closure of these refining assets are still outstanding. From December 1992 to
May 31, 1999, several of the Company's subsidiaries were involved in the
natural gas marketing business and from December 1992 to May 1997, another
subsidiary was involved in the gas transmission business. In May 1997, the
Company sold its gas transmission pipeline. All of the related long-term gas
sales and gas purchase contracts applicable to the Company's natural gas
marketing business expired by their terms on May 31, 1999.
On December 11, 2001, the Company entered into a letter of intent to sell
all of its domestic oil and gas properties to another public oil and gas
exploration company. See Note 21.
References to the Company mean Castle Energy Corporation, the parent,
and/or one or more of its subsidiaries. Such references are used for
convenience and are not intended to describe legal relationships.
Oil and Gas Exploration and Production
In June 1999, the Company acquired all of the oil and gas assets of
AmBrit Energy Corp. ("AmBrit"). The AmBrit oil and gas assets included
interests in approximately 180 wells located in eight states. The proved oil
and gas reserves associated with the AmBrit acquisition were estimated to be
approximately 12.5 billion cubic feet of natural gas and 2,000,000 barrels of
crude oil or approximately one hundred and fifty percent (150%) of the
Company's proved reserves before such acquisition. See Note 4.
During fiscal 2000, the Company participated in the drilling of nine
exploratory wells in south Texas pursuant to two drilling ventures with other
exploration and production companies. Eight of the wells drilled resulted in
dry holes while the ninth well was completed as a producing well. During
fiscal 2000 and 2001, the Company participated in the drilling of five wildcat
wells in Romania. Four of the wells drilled resulted in dry holes. The fifth
well produced some volumes of natural gas when tested. The Company considered
participating in a four well drilling program offsetting the fifth well but
Page 70
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
has currently decided not to do so because of the current low prices
obtainable for production and the potential costs of constructing a pipeline
to transport production to potential purchasers. The Company has also agreed
to participate in the drilling of a sixth well in the Black Sea in the spring
or early summer of 2002. In December 1999, the Company acquired majority
interests in twenty-six (26) offshore Louisiana wells. The Company then sold
these wells to Delta Petroleum Company ("Delta"), a public company involved in
oil and gas exploration and development, in September 2000.
In April 2001, the Company consummated the purchase of twenty-one (21)
operated producing East Texas oil and gas properties from a private company.
See Note 4.
Natural Gas Marketing
In December 1992, the Company acquired a long-term natural gas sales
contract with Lone Star Gas Company ("Lone Star Contract"). The Company also
entered into a gas sales contract and one gas purchase contract with MG
Natural Gas Corp. ("MGNG"), a subsidiary of MG Corp. ("MG"), which, in turn,
is a United States subsidiary of Metallgesellschaft A.G. ("MGAG"), a German
conglomerate. In May 1997, the Company sold its Rusk County, Texas natural
gas pipeline to a subsidiary of UPRC and thus exited the gas transmission
business while still conducting gas marketing operations. Effective May 31,
1999, the aforementioned gas sales and gas purchases contracts expired by
their own terms and were not replaced by other third party gas marketing
business.
Refining
IRLP
The Company indirectly entered the refining business in 1989 when one of
its subsidiaries acquired the operating assets of an idle refinery located in
Lawrenceville, Illinois (the "Indian Refinery"). The Indian Refinery was
subsequently operated by one of the Company's subsidiaries, Indian Refining I
Limited Partnership ("IRLP"), until September 30, 1995 when it was shut down.
On December 12, 1995, IRLP sold the Indian Refinery assets to American Western
Refining, L.P. ("American Western"). American Western subsequently filed for
bankruptcy and sold the Indian Refinery to an outside party which has
substantially dismantled it. American Western subsequently filed a Plan of
Liquidation which it expects to be confirmed by the governing bankruptcy court
in January 2002. If the Plan is confirmed, IRLP expects to receive $612 which
it would then distribute to its vendors.
Page 71
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Powerine
In October 1993, a former subsidiary of the Company purchased Powerine
Oil Company ("Powerine"), the owner of a refinery located in Santa Fe Springs,
California (the "Powerine Refinery"), from MG. On September 29, 1995,
Powerine sold substantially all of its refining plant to Kenyen Projects
Limited ("Kenyen"). On January 16, 1996, Powerine merged into a subsidiary of
Energy Merchant Corp. ("EMC"), an unaffiliated entity, and EMC acquired the
refinery from Kenyen. EMC subsequently sold the refinery to an outside party
which, we are informed, continues to seek financing to restart it.
As a result of the transactions with American Western, Kenyen and EMC,
the Company's refining subsidiaries disposed of their interests in the
refining business. The results of refining operations were shown as
discontinued operations in the Consolidated Statement of Operations for the
year ended September 30, 1995 and retroactively. Discontinued refining
operations have not impacted operations since fiscal 1995. Amounts on the
balance sheet reflect the remaining assets and liabilities that are pending
final resolution of related contingencies.
Investment In Networked Energy LLC
In August 2000, the Company purchased thirty-five percent (35%) of the
membership interests of Networked Energy LLC ("Network") for $500. Network is
a private company engaged in the operation of energy facilities that supply
power, heating and cooling services directly to retail customers.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
The significant accounting policies discussed are limited to those
applicable to the business segments in which the Company operated during the
fiscal years ended September 30, 2001, 2000 and 1999 - natural gas marketing
and transmission and exploration and production. References should be made to
previous Forms 10-K for summaries of accounting principles applicable to the
discontinued refining segment.
Principles of Consolidation
The consolidated financial statements presented include the accounts of
the Company and all of its subsidiaries. All intercompany transactions have
been eliminated in consolidation.
Revenue Recognition
Natural Gas Marketing
Revenues were recorded when deliveries were made. Essentially all of the
Company's deliveries were made under two long-term gas sales contracts, the
Lone Star Contract and a gas sales contract with MGNG. These contracts
expired May 31, 1999.
Page 72
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Exploration and Production
Oil and gas revenues are recorded under the sales method when oil and gas
production volumes are delivered to the purchaser. Reimbursement of costs
from well operations is netted against the related oil and gas production
expenses.
Cash and Cash Equivalents
The Company considers all highly liquid investments, such as time
deposits and money market instruments, purchased with a maturity of three
months or less, to be cash equivalents.
Natural Gas Transmission
Natural gas transmission assets included gathering systems and pipelines
and were depreciated on a straight-line basis over fifteen years, their
estimated useful life.
Marketable Securities
The Company currently classifies its investment securities as
available-for-sale securities. Pursuant to Statement of Financial Accounting
Standards No. 115 ("SFAS 115"), such securities are measured at fair market
value in the financial statements with unrealized gains or losses recorded in
other comprehensive income until the securities are sold or otherwise disposed
of. At such time gain or loss is included in earnings. Prior to July 1,
1999, the Company classified its investment securities as trading securities
and included the difference between cost and fair market value in earnings.
Prepaid Gas Purchases
Prepaid gas purchases represented payments made by one of the Company's
subsidiaries for gas that the subsidiary was required to take but did not.
All prepaid gas purchases related to gas purchases from MGNG. Under the terms
of the related gas purchase contracts, the subsidiary was entitled to and did
make up the prepaid gas, i.e., to take it and not pay for it, once it had
taken the required minimum contract volume for the contract year. Prepaid gas
purchase costs were expensed as the subsidiary took delivery of the prepaid
gas.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are depreciated on a straight-line
basis over the estimated useful lives of the assets. Furniture, fixtures and
equipment are depreciated on a straight-line basis over periods of three to
ten years and rolling stock is depreciated on a straight-line basis over four
to five years.
Page 73
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
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, all
productive and nonproductive costs incurred in the acquisition, exploration
and development of oil and gas reserves are capitalized. Capitalized costs
are amortized on a composite unit-of-production method by country using
estimates of proved reserves. Capitalized costs which relate to unevaluated
oil and gas properties are not amortized until proved reserves are associated
with such costs or impairment of the related property occurs. Management and
drilling fees earned in connection with the transfer of oil and gas properties
to a joint venture and proceeds from the sale of oil and gas properties are
recorded as reductions in capitalized costs unless such sales are material and
involve a significant change in the relationship between the cost and the
value of the remaining proved reserves, in which case a gain or loss is
recognized. Expenditures for repairs and maintenance of wellhead equipment
are expensed as incurred. 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 current expense. Amortization and excess capitalized costs, if
any, are computed separately for the Company's investment in Romania.
Environmental Costs
The Company is subject to extensive federal, state and local
environmental laws and regulations. These laws, which are constantly
changing, regulate the discharge of materials into the environment and may
require the Company to remove or mitigate the environmental effects of the
disposal or release of petroleum or chemical substances at various sites.
Environmental expenditures are expensed or capitalized depending on their
future expected economic benefit to the Company. Expenditures that relate to
an existing condition caused by past operations and that have no future
economic benefits are expensed. Liabilities for expenditures are recorded
when environmental assessment and/or remediation is probable and the costs can
be reasonably estimated. Environmental liabilities are accrued on an
undiscounted basis unless the aggregate amount of the obligation and the
amount and timing of the cash payments are fixed and reliably determined for
that site.
Impairment of Long-Term Assets
The Company reviewed its long-term assets other than oil and gas
properties for impairment whenever events or changes in circumstances
indicated that the carrying amount of an asset may not be recoverable. If the
sum of the expected future cash flows expected to result from the use of the
asset and its eventual disposition were less than the carrying amount of the
asset, an impairment loss would have been recognized. Measurement of an
impairment loss would be based on the fair market value of the asset.
Impairment for oil and gas properties is computed in the manner described
above under "Oil and Gas Properties." The Company currently has no
significant long-term assets except for its oil and gas properties, for which
impairment is recorded pursuant to full cost accounting as described above.
Page 74
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Hedging Activities
Natural Gas Marketing
The Company used hedging strategies to hedge its future natural gas
purchase requirements for its gas sales contracts with Lone Star and MGNG (see
Note 1). The Company hedged future commitments using natural gas swaps, which
were accounted for on a settlement basis. Gains and losses from hedging
activities were included in the item being hedged, the cost of gas purchased
for the Lone Star Contract or for the contract with MGNG. In order to qualify
as a hedge, the change in fair market value of the hedging instrument had to
be highly correlated with the corresponding change in the hedged item.
Exploration and Production
The Company used hedging strategies to hedge a significant portion of
its crude oil and natural gas production through July 31, 2000. The Company
used futures contracts to hedge such production. Gains and losses from
hedging activities were deferred and debited or credited to the item being
hedged, oil and gas sales, when they occurred. In order to qualify as a hedge
the change in fair market value of the hedging instrument was highly
correlated with the corresponding change in the hedged item. When the hedging
instrument ceased to qualify as a hedge, changes in fair value were charged
against or credited to earnings.
Gas Contracts
The purchase price allocated to the Lone Star Contract was capitalized
and amortized over the term of the related contract, 6.5 years.
Gas Balancing
Gas balancing activities have been immaterial during the periods
reported.
Investment In Networked
The Company's investment in Network (the Company owns 35% of Network) is
recorded on the equity method. Under this method, the Company records its
share of Network's income or loss with an offsetting entry to the carrying
value of the Company's investment. Cash distributions, if any, are recorded
as reductions in the carrying value of the Company's investment.
The Company's investment in Network exceeded the fair value of the
Company's share of Network's assets by $350. Such excess (goodwill) is being
amortized on a straight-line method over forty (40) years.
Page 75
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Comprehensive Income
Comprehensive income includes net income and all changes in an
enterprise's other comprehensive income including, among other things,
unrealized gains and losses on certain investments in debt and equity
securities.
Stock Based Compensation
SFAS 123, "Accounting for Stock-Based Compensation," allows an entity to
continue to measure compensation costs in accordance with Accounting Principle
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.
Income Taxes
The Company follows Statement of Financial Accounting Standards No. 109
("SFAS 109"), "Accounting for Income Taxes." SFAS 109 is an accounting
approach that requires the recognition of deferred tax assets and liabilities
for the expected future tax consequences of events that have been recognized
in the Company's financial statements and tax returns. In estimating future
tax consequences, SFAS 109 generally considers all expected future events
other than anticipated enactments of changes in the tax law or tax rates.
SFAS 109 also requires that deferred tax assets, if any, be reduced by a
valuation allowance based upon whether realization of such deferred tax asset
is or is not more likely than not. (See Note 17)
Earnings Per Share
Basic earnings per common share are based upon the weighted average
number of common shares outstanding. Diluted earnings per common share are
based upon maximum possible dilution calculated using average stock prices
during the year.
Reclassifications
Certain reclassifications have been made to make the periods presented
comparable.
Use of Estimates
The preparation of financial statements in accordance with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from these estimates.
Page 76
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 133, as amended,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS No.
133"), was issued by the Financial Accounting Standards Board in June 1998.
Subsequently, SFAS No. 138 "Accounting for Certain Derivative Instruments"
("SFAS No. 138"), an amendment of SFAS No. 133, was issued. SFAS 133 and SFAS
138 standardize the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts. Under the standard,
entities are required to carry all derivative instruments in the statement of
financial position at fair value. The accounting for changes in the fair
value (i.e., gains or losses) of a derivative instrument depends on whether
such instrument has been designated and qualifies as part of a hedging
relationship and, if so, depends on the reason for holding it. If certain
conditions are met, entities may elect to designate a derivative instrument as
a hedge of exposures to changes in fair values, cash flows, or foreign
currencies. If the hedged exposure is a fair value exposure, the gain or loss
on the derivative instrument is recognized in earnings in the period of change
together with the offsetting loss or gain on the hedged item attributable to
the risk being hedged. If the hedged exposure is a cash flow exposure, the
effective portion of the gain or loss on the derivative instrument is reported
initially as a component of other comprehensive income (not included in
earnings) and subsequently reclassified into earnings when the forecasted
transaction affects earnings. Any amounts excluded from the assessment of
hedge effectiveness, as well as the ineffective portion of the gain or loss,
is reported in earnings immediately. Accounting for foreign currency hedges
is similar to the accounting for fair value and cash flow hedges. If the
derivative instrument is not designated as a hedge, the gain or loss is
recognized in earnings in the period of change. The Company adopted SFAS No.
133 and SFAS No. 138 effective October 1, 2000. The Company ceased hedging
its oil and gas production in July 2000. At September 30, 2001 and 2000, the
Company had no freestanding derivative instruments in place and had no
embedded derivative instruments. As a result, the Company's adoption of SFAS
No. 133 and SFAS No. 138 had no impact on its results of operations or
financial condition.
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 will adopt SFAS No. 142 in the first quarter of fiscal 2003. The
Company does not believe that its future adoption of SFAS No. 142 will have a
material effect on its results of operations.
Page 77
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
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 will adopt the statement effective October 1, 2002. At this time, the
Company cannot reasonably estimate the effect of the adoption of this
statement on either its financial position or results of operations.
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 will adopt SFAS No 144
effective October 1, 2002. At this time the Company is unable to determine
what the future impact of adopting this statement will have on its financial
position or results of operations.
NOTE 3 - DISCONTINUED REFINING OPERATIONS
Effective September 30, 1995, the Company's refining subsidiaries
discontinued their refining operations.
An analysis of the assets and liabilities related to the refining segment
for the period October 1, 1998 to September 30, 2001 is as follows:
Page 78
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Estimated
Realizable Value
of Discontinued Net Refining
Net Refining Assets Liabilities Retained
------------------- --------------------
Balance - October 1, 1998 $ 3,623 $ 5,129
Reduction in estimated MG SWAP litigation recovery (129) (129)
Collection of MG SWAP litigation proceeds (575) (575)
Additional recovery in connection with
the Powerine Arbitration 900
Reduction in estimated recoverable value of note
receivable from American Western (2,119)
Adjustment of vendor liabilities (2,119)
Other (1)
------- --------
Balance - September 30, 1999 800 3,205
Cash transactions (153)
Adjustment of vendor liabilities 152
------- --------
Balance - September 30, 2000 800 3,204
Cash transactions (80)
Adjustment of vendor liabilities 80
Adjustments resulting from American Western's Plan of
Liquidation (188) (188)
------- --------
Balance - September 30, 2001 $ 612 $ 3,016
As of September 30, 2001, the estimated realizable value of discontinued
net refining assets consists of $612 of estimated recoverable proceeds from
the American Western note. The estimated value of net refining liabilities
retained consisted of net vendor liabilities of $1,281 and accrued costs
related to discontinued refining operations of $2,155, offset by cash of $420.
"Estimated realizable value of discontinued net refining assets" is based
on the transactions consummated by the Company with American Western and
transactions consummated by American Western and IRLP subsequently with others
and includes management's best estimates of the amounts expected to be
realized upon the complete disposal of the refining segment. "Net refining
liabilities retained" includes management's best estimates of amounts expected
to be paid and amounts expected to be realized on the settlement of this net
liability. The amounts the Company ultimately realizes or pays could differ
materially from such amounts.
See Notes 12 and 13.
Page 79
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 4 - ACQUISITIONS AND DISPOSITIONS
On June 1, 1999, the Company consummated the purchase of all of the oil
and gas properties of AmBrit. The oil and gas properties purchased include
interests in approximately 180 oil and gas wells in Alabama, Louisiana,
Mississippi, Montana, New Mexico, Oklahoma, Texas and Wyoming, as well as
undrilled acreage in several of these states. The effective date of the sale
for purposes of determining the purchase price was January 1, 1999. The
adjusted purchase price after accounting for all transactions between the
effective date, January 1, 1999, and the closing date was $20,170. The entire
adjusted purchase price was allocated to "Oil and Gas Properties - Proved
Properties". Based upon reserve reports initially prepared by the Company's
petroleum reservoir engineers, the proved reserves (unaudited) associated with
the AmBrit oil and gas assets approximated 2,000,000 barrels of crude oil and
12,500,000 mcf (thousand cubic feet) of natural gas, which, together,
approximated 150% of the Company's oil and gas reserves before the
acquisition. In addition, the production acquired initially increased the
Company's consolidated production by approximately 425%.
The results of operations on a pro-forma basis as though the oil and gas
properties of AmBrit had been acquired as of the beginning of the periods
indicated are as follows:
Year Ended September 30, 1999
-----------------------------
(Unaudited)
Revenues $62,719
Net income $ 7,958
Net income per share $ .95
Shares outstanding (diluted) 8,347,932
These proforma results are presented for comparative purposes only and
are not necessarily indicative of the results which would have been obtained
had the acquisition been consummated as presented.
Operations related to the AmBrit oil and gas properties have been
included in the Company's Consolidated Statements of Operations since June 1,
1999, the closing date of the AmBrit acquisition.
Investment in Drilling Joint Ventures
In fiscal 1999, the Company entered into two drilling ventures to
participate in the drilling of up to sixteen exploratory wells in south Texas.
Page 80
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
During fiscal 2000, the Company participated in the drilling of nine
exploratory wells pursuant to the related joint venture operating agreements.
Eight wells drilled resulted in dry holes and one well was completed as a
producer. The Company has no further drilling obligations under these joint
ventures and has terminated participation in each drilling venture. The total
cost incurred to participate in the drilling of the exploratory wells was
$6,003.
Offshore Louisiana Property Acquisition
In December 1999, a subsidiary of the Company purchased majority
interests in twenty-six offshore Louisiana wells from Whiting Petroleum
Company ("Whiting"), a public company engaged in oil and gas exploration and
development. The adjusted purchase price was $890.
In September 2000, the subsidiary of the Company sold its interests in
the offshore Louisiana wells to Delta. The effective date of the sale was
July 1, 2000. The adjusted purchase price of $3,059 consisted of $1,122 cash
plus 382,289 shares of Delta's common stock valued at the market price or
$1,937 (see Note 8).
Investment in Romanian Concessions
In April 1999, the Company purchased an option to acquire a fifty percent
(50%) interest in three oil and gas concessions granted to a subsidiary of
Costilla Energy Corporation ("Costilla"), a public oil and gas exploration and
production company, by the Romanian government. The Company paid Costilla $65
for the option. In May 1999, the Company exercised the option. As of
September 30, 2001, the Company had participated in the drilling of five
onshore wildcat wells. Four of those wells resulted in dry holes. Although
the fifth well produced some volumes of natural gas when tested, the Company
has not been able to obtain a sufficiently high gas price to justify future
production and has elected at the present not to undertake an offset drilling
program where the fifth well was drilled. As a result, the Company recorded
impairment provisions of $2,765 and $832 for the years ended September 30,
2001 and 2000, respectively, for costs incurred for the five onshore wells.
The Company has agreed to participate in the drilling of a sixth well,
offshore, in the Black Sea in the spring or early summer of 2002.
See Note 10.
Other Exploration and Production Investments
In November and December 1999, the Company acquired additional outside
interests in several Alabama and Pennsylvania wells, which it operates, for
$2,580.
Page 81
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
East Texas Property Acquisition
On April 30, 2001, the Company consummated the purchase of several East
Texas oil and gas properties from a private company. The effective date of
the purchase was April 1, 2001. These properties included majority interests
in twenty-one (21) operated producing oil and gas wells and interests in
approximately 6,500 gross acres in three counties in East Texas. The Company
estimates the proved reserves acquired were approximately 12.5 billion cubic
feet of natural gas and 191,000 barrels of crude oil. The consideration paid,
net of purchase price adjustments, was $10,040. The Company used its own
internally generated funds to make the purchase.
NOTE 5 - RESTRICTED CASH
Restricted cash consists of the following:
September 30,
-------------
2001 2000
---- ------
Funds supporting letters of credit for offshore Louisiana wells $1,519
Drilling deposits in escrow - Romania $ 7 4
Funds supporting letters of credit issued for operating bonds 209 219
Funds escrowed for litigation settlement 154
-----
$ 370 $1,742
===== ======
The drilling deposits in escrow in Romania are to be used only to conduct
exploratory drilling activities in Romania and cannot be withdrawn or used for
other purposes by the Company.
The funds escrowed for litigation settlement pertain to Larry Long
Litigation (see Note 13).
NOTE 6 - ACCOUNTS RECEIVABLE
Based upon past customer experiences, the limited number of customer
accounts receivable relationships, and the fact that the Company's
subsidiaries can generally offset unpaid accounts receivable against an
outside owner's share of oil and gas revenues, management believes
substantially all receivables are collectible. All of the Company's accounts
receivable at September 30, 2001 and 2000 consisted of exploration and
production trade receivables.
Page 82
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 7 - NOTE RECEIVABLE - PENN OCTANE
In January 2000, the Company invested $500 in a note due from Penn Octane
Corporation ("Penn Octane"), a public company involved in the sale of liquid
propane gas into Mexico. The note was originally due on December 15, 2000 and
bore interest at 9%, payable quarterly.
In December 2000, the Company agreed to extend the note until June 15,
2002. In return, Penn Octane increased the interest rate on the note to 13.5%
and issued to the Company warrants to acquire an additional 62,500 shares of
Penn Octane common stock at $3.00 per share. Subsequently, the interest rate
was increased to 16.5% and the exercise price on the 62,500 options issued was
reduced to $2.50 per share.
Effective September 14, 2001, the Company exercised options to acquire
275,933 shares of common stock of Penn Octane by exchanging its $500 note plus
$21 of accrued interest for the shares.
NOTE 8 - MARKETABLE SECURITIES
The Company's investment in marketable securities consists of common
shares of Penn Octane, Delta and Chevron/Texaco.
At September 30, 1998, the Company accounted for its investment as
trading securities. In March 1999, the Company began to account for its
investment as available-for-sale securities. The Company's investments in
Penn Octane, Delta and Chevron/Texaco common stock and options to buy Penn
Octane stock were as follows:
Common Stock
------------
Penn Octane Delta Chevron/Texaco Total
----------- ----- -------------- -----
September 30, 2001:
Cost $2,271 $1,937 $14 $ 4,222
Unrealized gain (loss) 3,308 (808) 2,500
Book value (market value) $5,579 $1,129 $14 $ 6,722
September 30, 2000:
Cost $1,750 $1,937 $ 3,687
Unrealized gain 7,298 7,298
Book value (market value) $9,048 $1,937 $10,985
The fair market values of Penn Octane, Delta and Chevron/Texaco shares
were based on one hundred percent (100%) of the closing price on September
28, 2001, the last trading day in the Company's fiscal year ending September
30, 2001.
Page 83
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
At September 30, 2001 and 2000, the fair market values of the Penn Octane
shares include $164 and $1,641, respectively, related to options to acquire
Penn Octane common stock held by the Company. The value of such options was
computed using the Black-Scholes method (see Note #16).
The Company owned 1,343,600 shares of Penn Octane, 382,289 shares of
Delta and 177 shares of Chevron/Texaco at September 30, 2001. Of these
501,000 shares of Penn Octane and all 177 shares of Chevron/Texaco were
registered. The remaining shares are either in the process of being
registered or the Company has registration rights with respect to such shares.
At September 30, 2001, the Company also owned options to purchase 74,067
common shares of Penn Octane common stock at $2.50 per share.
At September 30, 2000, the Company owned 1,067,667 shares of Penn Octane
and 382,289 shares of Delta, as well as options to purchase 454,167 common
shares of Penn Octane at exercise prices of $1.75 to $6.00 per share.
NOTE 9 - FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are as follows:
September 30,
-----------------
2001 2000
---- ----
Cost:
Furniture and fixtures $ 693 $ 660
Automobile and trucks 269 222
----- -----
962 882
Accumulated depreciation (740) (624)
----- -----
$ 222 $ 258
===== =====
Page 84
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 10 - OIL AND GAS PROPERTIES (Unaudited)
Oil and gas properties consist of the following:
September 30, 2001
------------------
United
States Romania Total
------ ------- -------
Proved properties $56,100 $56,100
Less: Accumulated depreciation, depletion and amortization (16,257) (16,257)
------- -------
Proved properties 39,843 39,843
Unproved properties not being amortized $ 3,707 3,707
Impairment of unproved properties ------- (3,597) (3,597)
------- -------
$39,843 $ 110 $39,953
======= ====== =======
September 30, 2000
------------------
United
States Romania Total
------ ------- -------
Proved properties $42,127 $42,127
Less: Accumulated depreciation, depletion and amortization (12,909) (12,909)
------- -------
Proved properties 29,218 29,218
Unproved properties not being amortized $2,279 2,279
Impairment of unproved properties (832) (832)
------- ------ -------
$29,218 $1,447 $30,665
======= ====== =======
Page 85
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Capital costs incurred by the Company in oil and gas activities are as
follows:
Year Ended September 30,
------------------------
2001 2000
---- ----
United United
States Romania Total States Romania Total
------ ------- ----- ------ ------- -----
Acquisition of properties:
Proved properties $10,002 $10,002 $ 3,642 $ 3,642
Unproved properties 346 346 678 $ 999 1,677
Exploration 1,560 $1,428 2,988 2,966 346 3,312
Development 2,113 2,113 2,595 2,595
------- ------ ------- ------- ------- -------
$14,021 $1,428 $15,449 $ 9,881 $ 1,345 $11,226
======= ====== ======= ======= ======= =======
September 30, 1999
------------------
United
States Romania Total
------ ------- -------
Acquisition of properties
Proved properties $21,029 $21,029
Unproved properties 928 $ 934 1,862
Exploration 1,073 1,073
------- ------ -------
$23,030 $ 934 $23,964
======= ====== =======
Page 86
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Results of operations, excluding corporate overhead and interest expense,
from the Company's oil and gas producing activities are as follows:
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
Revenues:
Crude oil, condensate, natural gas liquids and natural gas sales $21,144 $17,959 $6,712
------- ------- ------
Costs and expenses:
Production costs $ 7,399 $ 6,194 1,910
Depreciation, depletion and amortization 3,348 2,990 1,937
Impairment of foreign unproved properties 2,765 832
------- ------- ------
Total costs and expenses 13,512 10,016 3,847
------- ------- ------
Income tax provision (benefit) 1,387 (6,553) 753
------- ------- ------
Income from oil and gas producing activities $ 6,245 $16,569 $2,112
======= ======= ======
The income tax provision is computed at the effective tax rate for the
related fiscal year.
Page 87
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Assuming conversion of oil and gas production into common equivalent
units of measure on the basis of energy content, depletion rates per
equivalent MCF (thousand cubic feet) of natural gas were as follows:
Year Ended September 30,
------------------------
2001 2000 1999
---- ---- ----
Depletion rate per equivalent MCF of natural gas $0.72 $0.57 $0.71
===== ===== =====
The increase in the depletion rate in fiscal 2001 resulted primarily
because the Company's reserves qualitites decreased significantly as a result
of lower oil and gas prices at September 30, 2001. The decrease in reserve
quantities without a similar decrease in related costs resulted in a higher
depletion rate. In addition, in fiscal 2001, the Company acquired significant
East Texas reserves at a higher cost per mcfe than the cost for the Company's
existing reserves at the time of the acquisition (see Note 4).
The decrease in the depletion rate in fiscal 2000 resulted primarily
because the Company's reserve quantities increased significantly as a result
of higher oil and gas prices at September 30, 2000. The increase in reserve
quantities without a similar increase in costs resulted in the lower depletion
rate.
See Note 21.
NOTE 11 - PROVED OIL AND GAS RESERVES AND RESERVE VALUATION (UNAUDITED)
Reserve estimates are based upon subjective engineering judgements made by
the Company's independent petroleum reservoir engineers, Huntley & Huntley
and Ralph E. Davis Associates, Inc. and may be affected by the limitations
inherent in such estimations. The process of estimating reserves is subject
to continuous revisions as additional information is made available through
drilling, testing, reservoir studies and production history. There can be no
assurance such estimates will not be materially revised in subsequent periods.
Estimated quantities of proved reserves and changes therein, all of which
are domestic reserves, are summarized below:
Page 88
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
("000's" Omitted)
Oil (BBLS) Natural Gas (MCF)
---------- -----------------
Proved developed and undeveloped reserves:
As of October 1, 1998 255 15,324
Acquisitions 2,021 12,529
Revisions of previous estimates (122) 2,520
Production (124) (1,971)
------ -------
As of September 30, 1999 2,030 28,402
Acquisitions 1,063 6,639
Divestitures (974) (236)
Discoveries 1 317
Revisions of previous estimates 2,894 12,728
Production (279) (3,547)
------ -------
As of September 30, 2000 4,735 44,303
Acquisitions 266 10,183
Revisions of previous estimates (1,379) (20,711)
Production (262) (3,083)
------ -------
As of September 30, 2001 3,360 30,692
====== =======
Proved developed reserves:
September 30, 1998 162 13,589
====== =======
September 30, 1999 1,788 23,547
====== =======
September 30, 2000 2,963 35,815
====== =======
September 30, 2001 1,890 26,480
====== =======
Although the Company has participated in the drilling of five exploratory
wells in Romania, no proved reserves have yet been assigned to any of these
wells. As a result, all of the Company's proved oil and gas reserves are
located in the United States.
The following is a standardized measure of discounted future net cash
flows and changes therein relating to estimated proved oil and gas reserves,
as prescribed in Statement of Financial Accounting Standards No. 69. The
standardized measure of discounted future net cash flows does not purport to
present the fair market value of the Company's oil and gas properties. An
estimate of fair value would also take into account, among other factors, the
likelihood of future recoveries of oil and gas in excess of proved reserves,
anticipated future changes in prices of oil and gas and related development
and production costs, a discount factor based on market interest rates in
effect at the date of valuation and the risks inherent in reserve estimates.
Page 89
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
September 30,
-------------
2001 2000 1999
-------- -------- --------
Future cash inflows $138,594 $371,784 $118,794
Future production costs (43,288) (87,162) (42,934)
Future development costs (8,655) (12,620) (4,229)
Future income tax expense (13,102) (84,445) (8,538)
-------- -------- --------
Future net cash flows 73,549 187,557 63,093
Discount factor of 10% for estimated timing of future cash flows (37,269) (96,438) (21,849)
-------- -------- --------
Standardized measure of discounted future cash flows $ 36,280 $ 91,119 $ 41,244
======== ======== ========
The future cash flows were computed using the applicable year-end prices
and costs that related to then existing proved oil and gas reserves in which
the Company has interests. The estimates of future income tax expense are
computed at the blended rate (Federal and state combined) of 36%.
The following were the sources of changes in the standardized measure of
discounted future net cash flows:
September 30,
2001 2000 1999
-------- -------- --------
Standardized measure, beginning of year $ 91,119 $ 41,244 $ 9,946
Sale of oil and gas, net of production costs (13,745) (11,083) (4,324)
Net changes in prices (60,403) 45,757 2,163
Sale of reserves in place (1,457)
Purchase of reserves in place 7,662 6,757 22,215
Changes in estimated future development costs 1,408 (5,039) 2,405
Development costs incurred during the period that reduced
future development costs 2,113 2,595 1,073
Revisions in reserve quantity estimates (26,591) 76,355 1,438
Discoveries of reserves 963
Net changes in income taxes 30,528 (32,031) 745
Accretion of discount 9,112 4,286 995
Other:
Change in timing of production (1,228) (36,168) 12,055
Other factors (3,695) (1,060) (7,467)
-------- -------- --------
Standardized measure, end of year $ 36,280 $ 91,119 $ 41,244
======== ======== ========
Page 90
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 12 - CONTINGENT ENVIRONMENTAL LIABILITY
In December 1995, IRLP, an inactive subsidiary of the Company, sold its
refinery, the Indian Refinery, to American Western, an unaffiliated party. As
part of the related purchase and sale agreement, American Western assumed all
environmental liabilities and indemnified IRLP with respect thereto.
Subsequently, American Western filed for bankruptcy and sold the Indian
Refinery to an outside party pursuant to a bankruptcy proceeding. The outside
party has substantially dismantled the Indian Refinery.
American Western recently filed a Plan of Liquidation. American Western
anticipates that the Plan of Liquidation will be confirmed in January 2002.
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 the Indian Refinery. In addition, eighteen other parties were
named including Texaco Refining and Marketing, Inc. ("Texaco"), the refinery
operator for over 50 years. A subsidiary of Texaco had owned the refinery
until December of 1988. The Company subsequently responded to the EPA
indicating that it was neither the owner nor the operator of the Indian
Refinery and thus not responsible for its remediation.
In November 1999, the Company received a request for information from the
EPA concerning the Company's involvement in the ownership and operation of the
Indian Refinery. The Company responded to the EPA information request in
January 2000.
On August 7, 2000, the Company received notice of a claim against it and
two of its inactive refining subsidiaries from Texaco and its parent. Texaco
had made no previous claims against the Company although the Company's
subsidiaries had owned the refinery from August 1989 until December 1995. In
its claim, Texaco demanded that the Company and its former subsidiaries
indemnify Texaco for all liability resulting from environmental contamination
at and around the Indian Refinery. In addition, Texaco demanded that the
Company assume Texaco's defense in all matters relating to environmental
contamination at and around the Indian Refinery, including lawsuits, claims
and administrative actions initiated by the EPA and indemnify Texaco for costs
that Texaco has already incurred addressing environmental contamination at the
Indian Refinery. Finally, Texaco also claimed that the Company and two of its
inactive subsidiaries are liable to Texaco under the Federal Comprehensive
Environmental Response Compensation and Liability Act as owners and operators
of the Indian Refinery. The Company responded to Texaco disputing the factual
and theoretical basis for Texaco's claims against the Company. The Company's
management and special counsel subsequently met with representatives of Texaco
but the parties disagreed concerning Texaco's claims.
Page 91
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
The Company and its special counsel, Rod Smith, LLP, believe that Texaco's
claims are utterly without merit and the Company intends to vigorously defend
itself against Texaco's claims and any lawsuits that may follow. In addition
to the numerous defenses that the Company has against Texaco's contractual
claim for indemnity, the Company and its special counsel believe that by the
express language of the agreement which Texaco construes to create an
indemnity, Texaco has irrevocably elected to forgo all rights of contractual
indemnification it might otherwise have had against any person, including the
Company.
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. In August 1998, EMC sold the Powerine
Refinery to a third party, which, we are informed, continues to seek financing
to restart the Powerine Refinery.
In July of 1996, the Company was named a defendant in a class action
lawsuit concerning emissions from the Powerine Refinery. In April of 1997,
the court granted the Company's motion to quash the plaintiff's summons based
upon lack of jurisdiction and the Company is no longer involved in the case.
Although the environmental liabilities related to the Indian Refinery and
Powerine Refinery have been transferred to others, there can be no assurance
that the parties assuming such liabilities will be able to pay them. American
Western, owner of the Indian Refinery, filed for bankruptcy and is in the
process of liquidation. EMC, which assumed the environmental liabilities of
Powerine, sold the Powerine Refinery to an unrelated party, which we
understand is still seeking financing to restart that refinery. Furthermore,
as noted above, the EPA named the Company as a potentially responsible party
for remediation of the Indian Refinery and has requested and received relevant
information from the Company. Estimated gross undiscounted clean up costs for
this refinery are at least $80,000 - $150,000 according to third parties. If
the Company were found liable for the remediation of the Indian Refinery, it
could be required to pay a percentage of the clean-up costs. Since the
Company's subsidiary only operated the Indian Refinery five years, whereas
Texaco and others operated it over fifty years, the Company would expect that
its share of remediation liability would be proportional to its years of
operation, although such may not be the case. Furthermore, as noted above,
Texaco has claimed that the Company indemnified it for all environmental
liabilities related to the Indian Refinery. If Texaco were to sue the Company
on this theory and prevail in court, the Company could be held responsible for
the entire estimated clean up costs of $80,000-$150,000 or more. In such a
case, this cost would be far in excess of the Company's financial capability.
An opinion issued by the U.S. Supreme Court in June 1998 in the comparable
matter (of United States vs. Bestfoods, 52H O.S. 118 S.Q. 1076 (1998)) and a
recent decision by the U.S. Appeals Court for the Fifth Circuit (in Aviall
Services, Inc. vs. Cooper Industries, Inc. 213 F.3rd 134 (5th Cir. 2001)
varated and ret'g granted 278 F.3rd 446 (Dec. 19, 2001) support the Company's
positions. Nevertheless, if funds for environmental clean-up are not provided
Page 92
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
by these former and/or present owners, it is possible that the Company and/or
one of its former refining subsidiaries could be named parties in additional
legal actions to recover remediation costs. In recent years, government and
other plaintiffs have often sought redress for environmental liabilities from
the party most capable of payment without regard to responsibility or fault.
Whether or not the Company is ultimately held liable in such a circumstance,
should litigation involving the Company and/or IRLP occur, the Company would
probably incur substantial legal fees and experience a diversion of management
resources from other operations.
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 of these matters due
to inherent uncertainties.
NOTE 13 - COMMITMENTS, CONTINGENCIES AND LINE OF CREDIT
Operating Lease Commitments
The Company has the following noncancellable operating lease commitments
and noncancellable sublease rentals at September 30, 2001:
Lease Sublease
Year Ending September 30, Commitments Rentals
------------------------- ----------- --------
2002 $ 473 $ 65
2003 470 66
2004 240
2005 76
---------
2006 $ 1,259 $ 131
========= =======
Rent expense for the years ended September 30, 2001, 2000 and 1999 was
$456, $412 and $386, respectively.
Severance/Retention Obligations
The Company has severance agreements with substantially all of its
employees, including five of its officers, that provide for severance
compensation in the event substantially all of the Company's or its
subsidiaries' assets are sold and the employees are terminated as a result of
such sale. Such termination severance commitments aggregated $1,101 at
September 30, 2001. No severance obligations were owed to employees at
September 30, 2001.
Page 93
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Letters of Credit
At September 30, 2001, the Company had issued letters of credit of $209
for oil and gas drilling, operating and plugging bonds. The letters of credit
are renewed semi-annually or annually.
Line of Credit
See Note 21.
Legal Proceedings
Contingent Environmental Liabilities
See Note 12.
General
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were
defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case,
the Long Trusts, are non-operating working interest owners in wells previously
operated by Castle Texas Production Limited Partnership ("CTPLP"), an inactive
exploration and production subsidiary of the Company. The wells were among
those sold to Union Pacific Resources Corporation ("UPRC") in May 1997. The
Long Trusts claimed that CTPLP did not allow them to sell gas from March 1,
1996 to January 31, 1997 as required by applicable joint operating agreements,
and they sued CTPLP and the other defendants, claiming (among other things)
breach of contract, breach of fiduciary duty, conversion and conspiracy. The
plaintiffs sought actual damages, exemplary damages, pre-judgment and
post-judgment interest, attorney's fees and court costs. CTPLP counterclaimed
for approximately $150 of unpaid joint interests billings, interest,
attorneys' fees and court costs.
After a three-week trial, the District Court in Rusk County submitted
36 questions to the jury which covered all of the claims and counterclaims in
the lawsuit. Based upon the jury's answers, the District Court entered
judgement granting plaintiffs' claims against the Company and its
subsidiaries, as well as CTPLP's counterclaim against the plaintiffs. The
District Court issued an amended judgement on September 5, 2001, which became
final in December 2001. The net amount awarded to the plaintiffs was
approximately $2,700. The Company and its subsidiaries have filed a notice of
appeal with the Tyler Court of Appeals and will continue to vigorously contest
this matter.
Jenkins and Gilchrest, special counsel to the Company does not
consider an unfavorable outcome to this lawsuit probable. The Company's
management and special counsel believe that several of the plaintiffs' primary
Page 94
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
legal theories are contrary to established Texas law and that the Court's
charge to the jury was fatally defective. They further believe that any
judgment for plaintiffs based on those theories or on the jury's answers to
certain questions in the charge cannot stand and will be reversed on appeal.
As a result, the Company has not accrued any liability for this litigation.
Nevertheless, to pursue the appeal, the Company and its subsidiaries will be
required to post a bond to cover the net amount of damages awarded to the
plaintiffs and to maintain that bond until the resolution of the appeal (which
may take several years). The Company has included the letter of credit to
support the bond, estimated at approximately $3,000, in its line of credit
with a major energy bank.
See Note 21.
Larry Long Litigation
In May 1996, Larry Long, representing himself and allegedly "others
similarly situated," filed suit against the Company, three of the Company's
natural gas marketing and transmission and exploration and production
subsidiaries, Atlantic Richfield Company ("ARCO"), B&A Pipeline Company, a
former subsidiary of ARCO ("B&A"), and MGNG in the Fourth Judicial District
Court of Rusk County, Texas. The plaintiff originally claimed, among other
things, that the defendants underpaid non-operating working interest owners,
royalty interest owners and overriding royalty interest owners with respect to
gas sold to Lone Star pursuant to the Lone Star Contract. Although no amount
of actual damages was specified in the plaintiff's initial pleadings, it
appeared that, based upon the volumes of gas sold to Lone Star, the plaintiff
may have been seeking actual damages in excess of $40,000.
After some initial discovery, the plaintiff's pleadings were
significantly amended. Another purported class representative, Travis Crim,
was added as a plaintiff, and ARCO, B&A and MGNG were dropped as defendants.
Although it is not completely clear from the amended petition, the plaintiffs
apparently limited their proposed class of plaintiffs to royalty owners and
overriding royalty owners in leases owned by the Company's exploration and
production subsidiary limited partnership. In amending their pleadings, the
plaintiffs revised their basic claim to seeking royalties on certain operating
fees paid by Lone Star to the Company's natural gas marketing subsidiary
limited partnership.
In April 2000, Larry Long withdrew as a named plaintiff and in
September 2000, the Company and the remaining named plaintiff agreed to settle
the case for a payment of $250 by the Company. In July 2001, the Company
deposited $250 plus accrued interest of $9 in a litigation settlement account.
As of September 30, 2001, $106 had been disbursed from the account.
See Note 21.
Page 95
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
MGNG Litigation
On May 4, 1998, CTPLP, a subsidiary of the Company, filed a lawsuit
against MGNG and MG Gathering Company ("MGC"), two subsidiaries of MG, in the
district court of Harris County, Texas. One of the Company's exploration and
production subsidiaries sought to recover gas measurement and transportation
expenses charged by the defendants in breach of a certain gas purchase
contract. Improper charges exceeded $750 before interest. In October of
1998, MGNG and MGC filed a suit in Harris County, Texas. This suit sought
indemnification from two of the Company's subsidiaries in the event CTPLP won
its lawsuit against MGNG and MGC. The MG entities cited no basis for their
claim of indemnification. The management of the Company and special counsel
retained by the Company believe that the Company's subsidiary is entitled to
at least $750 plus interest and that the Company's two subsidiaries have no
indemnification obligations to MGNG or MGC. The parties participated in
mediation but were not able to resolve the issue.
In October 1999, MGNG filed a second lawsuit against the Company and
three of its subsidiaries claiming $772 was owed to MGNG under a gas supply
contract between one of the Company's subsidiaries and MGNG. The suit was
filed in the district court of Harris County, Texas. The Company and its
subsidiaries believed that they do not owe $772 and were entitled to legally
offset some or all of the $772 claimed against amounts owed to CTPLP by MGNG
for improper gas measurement and transportation deductions. The Castle
entities answered this suit denying MGNG's claims based partially on the right
of offset.
In September 2000, the parties agreed to settle all lawsuits. Under
the terms of the settlement the amount claimed by MGNG under a gas supply
contract was reduced by $325 and the net amount payable to MGNG was set at
$400 and the parties signed mutual releases.
See Note 21.
Pilgreen Litigation
As part of the AmBrit purchase, Castle Exploration Company, Inc.
("CECI") acquired a 10.65% overriding royalty interest ("ORRI") in the
Pilgreen #2ST gas well in Texas. Because of title disputes, AmBrit and other
interest owners had previously filed claims against the operator of the
Pilgreen well, and CECI acquired post January 1, 1999 rights in that
litigation. Although revenue attributed to the ORRI has been suspended by the
operator since first production, because of recent related appellate decisions
and settlement negotiations, the Company believes that revenue attributable to
the ORR should be released to CECI in the near future. As of September 30,
2001, approximately $415 attributable to CECI's share of the ORRI revenue was
suspended. The Company's policy is to recognize the suspended revenue only
when and if it is received.
Page 96
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
GAMXX
On February 27, 1998, the Company entered into an agreement with
Alexander Allen, Inc. ("AA") concerning amounts owed to the Company by AA and
its subsidiary, GAMXX Energy, Inc. ("GAMXX"). The Company had made loans to
GAMXX through 1991 in the aggregate amount of approximately $8,000. When
GAMXX was unable to obtain financing, the Company recorded a one hundred
percent loss provision on its loans to GAMXX in 1991 and 1992 while still
retaining its lender's lien against GAMXX.
Pursuant to the terms of the GAMXX Agreement, the Company was to
receive $1,000 cash in settlement for its loans when GAMXX closed on its
financing. GAMXX expected such closing not later than May 31, 1998 but failed
to do so. As a result, the Company elected to terminate the GAMXX Agreement.
Pursuant to the Agreement, GAMXX agreed to assist the Company in selling
GAMXX's assets or the Company's investment in GAMXX. The Company is currently
seeking to dispose of its lender's interest in GAMXX and recover some of the
loan to GAMXX.
The Company has carried its loans to GAMXX at zero for the last eight
years. The Company will record any proceeds as "other income" if and when it
collects such amount.
Hedging Activities
Until June 1, 1999, the Company's natural gas marketing subsidiary
utilized natural gas swaps to reduce its exposure to changes in the market
price of natural gas. Effective May 31, 1999 all natural gas marketing
contracts terminated by their own terms. As a result of these hedging
transactions, the cost of gas purchases increased $609 for the year ended
September 30, 1999.
On June 1, 1999, the Company acquired all of the oil and gas assets of
AmBrit (see Note 4) and thereafter commenced hedging sales of the related oil
and gas production. As of September 30, 1999, the Company had hedged
approximately 54% of its anticipated consolidated crude oil production and
approximately 39% of its anticipated consolidated natural gas production for
the period from October 1, 1999 to September 30, 2000. The Company used
futures contracts to hedge such production. The average hedged prices for
crude oil and natural gas, which are based upon futures price on the New York
Mercantile Exchange, were $19.85 per barrel of crude oil and $2.66 per mcf of
gas. The Company accounted for these futures contracts as hedges and the
differences between the hedged price and the exchange price increased or
decreased the oil and gas revenues resulting from the sale of production by
the Company. Oil and gas production was not hedged after July 2000
production. As a result of these hedging transactions, oil and gas sales
decreased $1,528 and $150 for the fiscal years ended September 30, 2000 and
1999, respectively.
Page 97
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
At September 30, 2001 and December 14, 2001, the Company had not hedged
its anticipated future oil and gas production.
NOTE 14 - EMPLOYEE BENEFIT PLAN
401(K)plan
On October 1, 1995, the Company adopted a 401(k) plan (the "Plan") for its
employees and those of its subsidiaries. All employees are eligible to
participate. Employees participating in the Plan can authorize the Company to
contribute up to 15% of their gross compensation to the Plan. The Company
matches such voluntary employee contributions up to 3% of employee gross
compensation. Employees' contributions to the Plan cannot exceed thresholds
set by the Secretary of the Treasury. Vesting of Company contributions is
immediate. During the years ended September 30, 2001, 2000 and 1999, the
Company's contributions to the Plan aggregated $50, $46 and $37, respectively.
Post-Retirement Benefits
Neither the Company nor its subsidiaries provide any other post-retirement
plans for employees.
NOTE 15 - STOCKHOLDERS' EQUITY
On December 29, 1999, the Company's Board of Directors declared a stock
split in the form of a 200% stock dividend applicable to all stockholders of
record on January 12, 2000. The additional shares were paid on January 31,
2000 and the Company's shares first traded at post-split prices on February 1,
2000. The stock split applied only to the Company's outstanding shares on
January 12, 2000 (2,337,629 shares) and did not apply to treasury shares
(4,491,017 shares) on that date. As a result of the stock split, 4,675,258
additional shares were issued and the Company's common stock book value was
increased $2,338 to reflect additional par value applicable to the additional
shares issued to effect the stock split. All share changes, including those
affecting the recorded book value of common stock, have been recorded
retroactively.
From November 1996 until September 30, 2001, the Company's Board of
Directors authorized the Company to purchase up to 5,267,966 of its
outstanding shares of common stock on the open market. As of September 30,
2001, 4,871,020
shares (13,973,054 shares before taking into account the 200% stock dividend
effective January 31, 2000) had been repurchased at a cost of $66,506. The
repurchased shares are held in treasury
On June 30, 1997, the Company's Board of Directors approved a dividend
policy of $.20 per share per year, payable quarterly. The dividend policy
remains in effect until rescinded or changed by the Board of Directors.
Quarterly dividends of $.05 per share have subsequently been paid.
See Note 21
Page 98
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 16 - STOCK OPTIONS AND WARRANTS
Option and warrant activities during each of the three years ended
September 30, 2001 are as follows (in whole units):
Incentive
Plan
Options Options Total
--------- ------- ---------
Outstanding at October 1, 1998 195,000 20,000 215,000
Issued 15,000 15,000
Exercised (25,000) (25,000)
Repurchased (10,000) (10,000)
--------- ------- ---------
Outstanding at September 30, 1999 175,000 20,000 195,000
Effect of 200% stock dividend (see Note 15) 350,000 40,000 390,000
Issued 105,000 105,000
--------- ------- ---------
Outstanding at September 30, 2000 630,000 60,000 690,000
Issued 60,000 60,000
--------- ------- ---------
Outstanding at September 30, 2001 690,000 60,000 750,000
Exercisable at September 30, 2001 690,000 60,000 750,000
========= ======= =========
Reserved at September 30, 2001 1,687,500 60,000 1,747,500
========= ======= =========
Reserved at September 30, 2000 1,687,500 60,000 1,747,500
========= ======= =========
Reserved at September 30, 1999 1,687,500 60,000 1,747,500
========= ======= =========
Exercise prices at:
September 30, 2001 $3.42- $3.79
$8.58
September 30, 2000 $3.42- $3.79
$8.58
September 30, 1999 $3.42- $3.79
$5.75
Exercise Termination Dates 5/17/2003- 4/23/2007 5/17/2003-
1/02/2011 1/02/2011
In fiscal 1993, the Company adopted the 1992 Executive Equity Incentive
Plan (the "Incentive Plan"). The purpose of the Incentive Plan is to increase
the ownership of common stock of the Company by those non-union key employees
(including officers and directors who are officers) and outside directors who
contribute to the continued growth, development and financial success of the
Company and its subsidiaries, and to attract and retain key employees and
reward them for the Company's profitable performance.
Page 99
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
The Incentive Plan provides that an aggregate of 1,687,500 shares (after
taking into account the 200% stock dividend effective January 31, 2000) of
common stock of the Company will be available for awards in the form of stock
options, including incentive stock options and non-qualified stock options
generally at prices at or in excess of market prices at the date of grant.
The Incentive Plan also provides that each outside director of the
Company will annually be granted an option to purchase 15,000 shares of common
stock at fair market value on the date of grant.
The Company applies Accounting Principles Board Opinion Number 25 in
accounting for options and warrants and accordingly recognizes no compensation
cost for its stock options and warrants for grants with an exercise price
equal to the current fair market value. The following reflect the Company's
pro-forma net income and net income per share had the Company determined
compensation costs based upon fair market values of options and warrants at
the grant date pursuant to SFAS 123 as well as the related disclosures
required by SFAS 123.
A summary of the Company's stock option and warrant activity from October
1, 1998 to September 30, 2001 is as follows:
Weighted
Average
Options Price
------- ------
Outstanding - October 1, 1998 215,000 $12.96
Issued 15,000 17.25
Exercised (25,000) 10.25
Repurchased (10,000) 10.75
------- ------
Balance - September 30, 1999 195,000 13.75
Effect of 200% stock dividend (see Note 15) 390,000 (9.17)
Issued 105,000 7.89
------- ------
Outstanding - September 30, 2000 690,000 5.09
Issued 60,000 7.00
------- ------
Outstanding - September 30, 2001 750,000 $5.24
======= ======
At September 30, 2001, exercise prices for outstanding options ranged
from $3.42 to $8.58. The weighted average remaining contractual life of such
options was 5.6 years.
Page 100
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
The per share weighted average fair values of stock options issued during
fiscal 2001, 2000 and fiscal 1999 were $2.41, $3.29 and $4.56, respectively,
on the dates of issuance using the Black-Scholes option pricing model with the
following weighted average assumptions: average expected dividend yield - 3.0%
in 2001, 3.0% in 2000 and 3.5% in 1999; risk free interest rate - 3.50% in
2001, 5.54% in 2000 and 6.32% in 1999; expected life of 10 years in 2001, 2000
and 1999 and volatility factor of .38 in 2001, .44 in 2000, and .22 in 1999.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
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:
Year Ending September 30,
---------------------------
2001 2000 1999
------ ------ ------
Net income as reported $1,716 $5,069 $8,266
Adjustment required by SFAS 123 (145) (346) (152)
------ ------ ------
Pro-forma net income $1,571 $4,723 $8,114
====== ====== ======
Pro-forma net income per share:
Basic $ 0.24 $ .68 $ .99
------ ------ ------
Diluted $ 0.23 $ .66 $ .97
------ ------ ------
Page 101
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
NOTE 17 - INCOME TAXES
Provisions for (benefit of) income taxes consist of:
September 30,
-------------
2001 2000 1999
----- ----- -----
Provision for (benefit of) income taxes:
Current:
Federal $ 4 ($ 35) $ 193
State (2)
Deferred:
Federal 786 922 2,209
State 22 26 68
Adjustment to the valuation allowance for deferred taxes:
Federal (419) (3,115) 475
State (12) (89 13
----- ------ ------
$ 381 ($2,291) $2,956
===== ------ ======
Deferred tax assets (liabilities) are comprised of the following at
September 30, 2001 and 2000:
September 30,
-------------
2001 2000
------ ------
Operating losses and tax credit carryforwards $4,715 $4,993
Statutory depletion carryovers 3,903 3,689
Depletion accounting (5,341) (3,602)
Discontinued net refining operations 866 866
Losses in foreign subsidiaries 1,295 300
------ ------
5,438 6,246
Valuation allowance (3,559) (3,990)
------ ------
$1,879 $2,256
====== ======
Deferred tax assets - current $1,879 $2,256
------ ------
$1,879 $2,256
====== ======
Page 102
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
At September 30, 2001, the Company determined that a portion of the
deferred tax asset would more likely than not be realized based upon estimates
of future taxable income and upon the projected taxable income resulting from
the anticipated sale of its oil and gas assets to Delta and accordingly
decreased the valuation allowance by $431 to $3,559.
If recent decreases in oil and gas prices continue and if the sale of the
Company's oil and gas assets to Delta is not consummated, the Company may be
required to increase its valuation allowance.
See Note 21.
At September 30, 2000, the Company determined that it was more likely
than not that a portion of the deferred tax assets would be realized, based on
current projections of taxable income due to higher commodity prices at
September 30, 2000, and the valuation allowance was decreased by $3,204 to a
total valuation allowance of $3,990.
The income tax provision (benefit) differs from the amount computed by
applying the statutory federal income tax rate to income before income taxes
as follows:
Year Ended September 30,
------------------------
2001 2000 1999
----- ------ ------
Tax at statutory rate $734 $ 972 $3,928
State taxes, net of federal benefit 7 (42) 51
Revision of tax estimates and contingencies 50 (151)
Statutory depletion (1,330)
Increase (decrease) in valuation allowance (431) (3,204) 489
Other 21 (17) (31)
----- ------ ------
$ 381 ($2,291) $2,956
===== ====== ======
At September 30, 2001, the Company had the following tax carryforwards
available:
Federal Tax
-----------
Alternative
Minimum
Regular Tax
-------- -----------
Net operating loss $ 2,674 $24,021
Alternative minimum tax credits $ 3,752 N/A
Statutory depletion $ 10,841 $ 440
Page 103
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
The net operating loss carryforwards expire from 2001 through 2010.
On September 9, 1994, the Company experienced a change of ownership for
tax purposes. As a result of such change of ownership, the Company's net
operating loss carryforward became subject to an annual limitation of $7,845.
At September 30, 2001 all net operating loss carryforwards of the Company were
no longer subject to the annual limitation.
The Company also has approximately $58,688 in individual state tax loss
carryforwards available at September 30, 2001. Approximately $47,287 of such
carryforwards are primarily available to offset taxable income apportioned to
certain states in which the Company has no operations and currently has no
plans for future operations. As a result, it is probable most of such state
tax carryforwards will expire unused.
NOTE 18 - RELATED PARTIES
In June 1999, the Company repurchased 24,700 (74,100 after stock split)
shares of the Company's common stock from an officer of the Company. Such
shares were repurchased at the closing stock price on the date of sale less
$.125, resulting in a payment of $434 to the officer. The shares were
repurchased pursuant to the Company's share repurchase program.
Another officer of the Company is a 10% shareholder in an unaffiliated
company that is entitled to receive 12.5% of the Company's share of net cash
flow from its Romanian joint venture after the Company has recovered its
investment in Romania.
NOTE 19 - BUSINESS SEGMENTS
As of September 30, 1995, the Company had disposed of its refining
segment of the energy business (see Note 3) and operated in only two business
segments - natural gas marketing and transmission and exploration and
production. In May 1997, the Company sold its pipeline (natural gas
transmission) to a subsidiary of UPRC (see Note 4). As a result, the Company
was no longer in the natural gas transmission segment but continued to operate
in the natural gas marketing and exploration and production segments. On May
31, 1999, the Company's long-term gas sales and gas supply contracts expired
by their own terms and the Company exited the natural gas marketing business.
The Company does not allocate interest income, interest expense or income
tax expense to these segments.
Page 104
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
Year Ended September 30, 2001
----------------------------------------------------------------------
Natural Gas Oil & Gas Eliminations
Marketing Exploration and
and and Refining Corporate
Transmission Production (Discontinued) Items Consolidated
------------ ---------- -------------- ------------ ------------
Revenues $ 21,144 $ 21,144
Operating income (loss) $ 5,682 ($ 4,169) $ 1,513
Identifiable assets $67,702* $ 105,238 ($113,822) $ 59,118
Capital expenditures $ 15,531 $ 15,531
Depreciation, depletion
and amortization $ 3,468 $ 2 $ 3,470
Year Ended September 30, 2000
----------------------------------------------------------------------
Natural Gas Oil & Gas Eliminations
Marketing Exploration and
and and Refining Corporate
Transmission Production (Discontinued) Items Consolidated
------------ ---------- -------------- ------------ ------------
Revenues $ 17,959 $ 17,959
Operating income (loss) $ 5,686 ($ 3,717) $ 1,969
Identifiable assets $67,727* $ 92,229 ($ 96,661) $ 63,295
Capital expenditures $ 11,399 $ 11,399
Depreciation, depletion
and amortization $ 3,207 $ 2 $ 3,209
Year Ended September 30, 1999
----------------------------------------------------------------------
Natural Gas Oil & Gas Eliminations
Marketing Exploration and
and and Refining Corporate
Transmission Production (Discontinued) Items Consolidated
------------ ---------- -------------- ------------ ------------
Revenues $50,067 $ 7,190 $ 57,257
Operating income (loss) $11,563 $ 1,718 ($ 4,112) $ 9,169
Identifiable assets $79,026* $ 67,720 ($ 87,208) $ 59,538
Capital expenditures $ 24,065 $ 24,065
Depreciation, depletion
and amortization $6,284 $ 2,046 $ 8,330
*Consists primarily of intracompany receivables.
Page 105
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
For the year ended September 30, 1999, sales by the Company's natural gas
marketing subsidiary to Lone Star Gas Company under the Lone Star Contract
aggregated $46,802. These amounts constituted approximately 82% of
consolidated revenues for the year ended September 30, 1999. The Lone Star
contract terminated in May 1999.
At the present time, the Company's consolidated revenues consist entirely
of oil and gas sales. Three purchasers of the Company's oil and gas
production currently account for approximately 43% of consolidated production.
Sales derived from these three purchasers for the year ended September 30,
2001 aggregated $2,871, $2,611 and $2,603.
NOTE 20 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and Cash Equivalents -- the carrying amount is a reasonable estimate
of fair value.
Marketable securities are related solely to the Company's investment in
Penn Octane, Delta and Chevron/Texaco common stock and options to buy Penn
Octane stock and are recorded at fair market value. Market value for common
stock is computed to equal the closing share price at year end times the
number of shares held by the Company. Fair market value for options is
computed using the Black - Scholes option valuation model.
Other Current Assets and Current Liabilities - the Company believes that
the book values of other current assets and current liabilities approximate
the market values.
NOTE 21 - SUBSEQUENT EVENTS
Subsequent to September 30, 2001, the Company disbursed the remaining
$153 from the Larry Long Litigation settlement account (see Note 13).
Subsequent to September 30, 2001, the Company paid MGNG $400 in
settlement of the MGNG Litigation (see Note 13).
In November 2001, the Company entered into an agreement for a line of
credit of up to $40,000 with an energy bank. Pursuant to the related
agreement the energy bank agreed to make available to the Company loans and
letters of credit not to exceed a borrowing base determined by the value of
the Company's oil and gas reserves using parameters set by the bank. Such
borrowing based will be determined no less than semi-annually. The loans and
letters of credit will be secured by the Company's oil and gas properties to
the extent the amount outstanding under the facility exceeds $10,000.
Interest under the facility will accrue at the bank's prime rate or at a LIBOR
rate - the choice of rates being determined by the Company. Letters of credit
issued under the facility will accrue interest at 2.25% annually. Loans
outstanding under the facility will be repaid pursuant to a schedule set by
the bank but redetermined at each borrowing base determination date. In
Page 106
Castle Energy Corporation
Notes to Consolidated Financial Statements
("$000's" Omitted Except Per Share Amounts)
addition, the Company is subject to typical financial covenants including
minimum tangible net worth, debt service coverage, interest coverage and
current ratio limitations, limitations on annual and quarterly dividends the
Company may pay to shareholders and other limitations governing capital
expenditures. The facility is scheduled to terminate November 30, 2003. The
facility also includes a provision to provide letters of credit of up to
$3,000 as may be required for the Long Trusts Lawsuit litigation (see Note
13).
On December 11, 2001, the Company entered into a letter of intent to sell
all of its domestic oil and gas assets to Delta for $20,000 and 9,566,000
shares of commons stock of Delta. The effective date of the proposed sale is
October 1, 2001 and the expected closing date is April 30, 2002 or later. The
sale is subject to execution of a definitive purchase and sale agreement by
both parties, approval of the transaction by both Delta's and the Company's
directors and approval of the issuance of the shares to Castle by Delta's
shareholders.
If the sale to Delta is not consummated, the Company could continue to
operate as it does currently or pursue other alternative strategies.
NOTE 22 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
(December 31) (March 31) (June 30) (September 30)
------------- ---------- --------- --------------
Year Ended September 30, 2001:
Revenues $5,394 $6,316 $5,347 $4,087
Operating income (loss) $1,533 $2,174 $ 511 ($2,705)
Net income (loss) $1,110 $1,531 $ 397 ($1,322)
Net income per share (diluted) $ .16 $ .22 $ .06 ($ .20)
First Second Third Fourth
Quarter Quarter Quarter Quarter
(December 31) (March 31) (June 30) (September 30)
------------- ---------- --------- --------------
Year Ended September 30, 2000:
Revenues $4,085 $3,318 $4,945 $5,611
Operating income (loss) $ 32 ($ 387) $ 835 $1,489
Net income (loss) $ 259 ($ 277) $1,024 $4,063
Net income (loss) per share (diluted) $ .04 ($ .04) $ .15 $ .58
For the year ended September 30, 2000 revenues from well operations have
been retroactively reclassified as reductions of oil and gas production costs.
The sums of the quarterly per share amounts differ from the annual per
share amounts primarily because the stock purchases made by the Company were
not made in equal amounts and at corresponding times each quarter.
Page 107
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("$000's" Omitted Except Share Amounts)
December 31, September 30,
2001 2001
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 3,989 $ 5,844
Restricted cash 217 370
Accounts receivable 2,426 2,787
Marketable securities 6,599 6,722
Prepaid expenses and other current assets 342 277
Estimated realizable value of discontinued net refining assets 612 612
Deferred income taxes 2,025 1,879
-------- --------
Total current assets 16,210 18,491
Property, plant and equipment, net:
Natural gas transmission 50 51
Furniture, fixtures and equipment 196 222
Oil and gas properties, net (full cost method):
Proved properties 38,864 39,843
Unproved properties not being amortized 233 110
Investment in Networked Energy LLC 367 401
-------- --------
Total assets $ 55,920 $ 59,118
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable $ 331 $ 331
Accounts payable 1,146 3,543
Accrued expenses 221 292
Accrued taxes on appreciation of marketable securities 856 900
Net refining liabilities retained 3,016 3,016
-------- --------
Total current liabilities 5,570 8,082
Long-term liabilities 9 9
-------- --------
Total liabilities 5,579 8,091
-------- --------
Commitments and contingencies
Stockholders' equity:
Series B participating preferred stock;
par value - $1.00; 10,000,000 shares
authorized; no shares issued
Common stock; par value - $0.50; 25,000,000
shares authorized; 11,503,904 shares issued
at December 31, 2001 and September 30, 2001 5,752 5,752
Additional paid-in capital 67,365 67,365
Accumulated other comprehensive income -
unrealized gains on marketable securities,
net of taxes 1,521 1,600
Retained earnings 42,209 42,816
-------- --------
116,847 117,533
Treasury stock at cost - 4,871,020 shares at
December 31, 2001 and September 30, 2001 (66,506) (66,506)
-------- --------
Total stockholders' equity 50,341 51,027
-------- --------
Total liabilities and stockholders' equity $ 55,920 $ 59,118
======== ========
The accompanying notes are an integral part of these financial statements.
Page 108
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("$000's" Omitted Except Share Amounts)
(Unaudited)
Three Months Ended December 31,
2001 2000
-------------------------------
Revenues:
Oil and gas sales $ 3,441 $ 5,394
---------- ---------
Expenses:
Oil and gas production 1,254 1,404
General and administrative 1,371 1,758
Depreciation, depletion and amortization 1,242 699
---------- ---------
3,867 3,861
---------- ---------
Operating income (loss) (426) 1,533
---------- ---------
Other income (expense):
Interest income 33 212
Other income 1 6
Equity in loss of Networked Energy LLC (34) (16)
---------- ---------
0 202
---------- ---------
Income (loss) before provision for income taxes (426) 1,735
---------- ---------
Provision for (benefit of) income taxes:
State (4) 17
Federal (150) 608
---------- ---------
(154) 625
---------- ---------
Net income (loss) ($ 272) $ 1,110
========== =========
Net income (loss) per share:
Basic ($ .04) $ .17
========== =========
Diluted ($ .04) $ .16
========== =========
Weighted average number of common and
potential dilutive common shares outstanding:
Basic 6,632,884 6,680,404
========== =========
Diluted 6,753,630 6,899,633
========== =========
The accompanying notes are an integral part of these financial statements.
Page 109
CASTLE ENERGY CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
("$000's" Omitted Except Share Amounts)
(Unaudited)
Three Months Ended December 31,
-------------------------------
2001 2000
------ -------
Net cash flow provided by (used in)
operating activities ($1,165) $ 1,809
------ -------
Cash flows from investing activities:
Sale of oil and gas properties 40
Investment in oil and gas properties (358) (1,144)
Investment in furniture, fixtures and equipment (1)
------ -------
Net cash (used in) investing activities (359) (1,104)
------ -------
Cash flows from financing activities:
Dividends paid to stockholders (331) (333)
Acquisition of treasury stock (300)
------ -------
Net cash (used in) financing activities (331) (633)
------ -------
Net increase (decrease) in cash and cash equivalents (1,855) 72
Cash and cash equivalents - beginning of period 5,844 11,525
------ -------
Cash and cash equivalents - end of period $3,989 $11,597
====== =======
The accompanying notes are an integral part of these financial statements.
Page 110
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND
OTHER COMPREHENSIVE INCOME
("$000's" Omitted Except Share Amounts)
Year Ended September 30, 2001 and Three Months Ended December 31,2001 (Unaudited)
--------------------------------------------------------------------------------------
Accumu-
lated
Other
Common Stock Additional Compre- Compre- Retained Treasury Stock
----------------- Paid-In hensive hensive Earnings ------------------
Shares Amount Capital Income Income (Deficit) Shares Amount Total
--------- ------ ---------- ------- ------- --------- -------- ------- ------
Balance-October 1, 2000 11,503,904 $5,752 $67,365 $ 4,671 $42,422 4,791,020 ($65,934) $54,276
Stock acquired 80,000 (572) (572)
Dividends declared
($.05 per share) (1,322) (1,322)
Comprehensive income:
Net income $ 1,716 1,716 1,716
Other comprehensive income:
Unrealized (loss) on marketable
securities, net of tax (3,071) (3,071) (3,071)
-------
($1,355)
=======
---------- ------ ------- ------- ------- --------- -------- --------
Balance-September 30,
2001 11,503,904 5,752 67,365 1,600 42,816 4,871,020 (66,506) 51,027
Dividends declared
($.05 per share) (331) (331)
Dividend adjustment (4) (4)
Comprehensive income (loss):
Net income (loss) ($ 272) (272) (272)
Other comprehensive income (loss):
Unrealized (loss) on marketable
securities, net of tax (79) (79) (79)
-------
($ 351)
=======
---------- ------ ------- ------- ------- --------- -------- --------
Balance - December 31,
2001 11,503,904 $5,752 $67,365 $1,521 $42,209 4,871,020 ($66,506) $50,341
The accompanying notes are an integral part of these financial
statements.
Page 111
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. 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,
2001 are not necessarily indicative of the results that may be expected for
the fiscal year ending September 30, 2002 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, 2001.
In the opinion of the Company, the unaudited consolidated financial
statements contain all adjustments necessary for a fair statement of the
results of operations for the three-month periods ended December 31, 2001 and
2000 and for a fair statement of financial position at December 31, 2001.
Note 2 - September 30, 2001 Balance Sheet
- -----------------------------------------
The amounts presented in the balance sheet as of September 30, 2001 were
derived from the Company's audited consolidated financial statements which
were included in its Annual Report on Form 10-K for the fiscal year ended
September 30, 2001.
Note 3 - Discontinued Operations
- --------------------------------
From August 1989 to September 30, 1995, several of the Company's
subsidiaries conducted refining operations. By December 12, 1995, the
Company's refining subsidiaries had sold all of their refining assets and the
purchasers had assumed all related liabilities, including contingent
environmental liabilities. In addition, in 1996, Powerine Oil Company
("Powerine"), one of the Company's former refining subsidiaries, merged into a
subsidiary of the purchaser of the refining assets sold by Powerine and is no
longer a subsidiary of the Company. The Company's remaining refining
subsidiaries own no refining assets, have been inactive for over six years and
are inactive and in the process of liquidation. As a result, the Company has
accounted for its refining operations as discontinued operations. Such
discontinued refining operations have not impacted the Company's operations
since September 30, 1995, although they may impact the Company's future
operations.
Page 112
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Note 4 - Contingencies/Litigation
- ---------------------------------
Contingent Environmental Liabilities
In December 1995, Indian Refining I Limited Partnership ("IRLP"), an
inactive subsidiary of the Company, sold its refinery, the Indian Refinery, to
American Western Refining L.P. ("American Western"), an unaffiliated party.
As part of the related purchase and sale agreement, American Western assumed
all environmental liabilities and indemnified IRLP with respect thereto.
Subsequently, American Western filed for bankruptcy and sold the Indian
Refinery to an outside party pursuant to a bankruptcy proceeding. The outside
party has substantially dismantled the Indian Refinery. American Western
recently filed a Plan of Liquidation. American Western anticipated that the
Plan of Liquidation would be confirmed in January 2002 but confirmation has
been delayed because of legal challenges by Chevron/Texaco, the parent of
Texaco Refining and Marketing ("Texaco"), the operator of the Indian Refinery
for over 50 years.
During fiscal 1998, the Company was informed that the United States
Environmental Protection Agency ("EPA") had investigated offsite acid sludge
waste found near the Indian Refinery and had investigated and remediated
surface contamination on the Indian Refinery property. Neither the Company
nor IRLP was initially named with respect to these two actions.
In October 1998, the EPA named the Company and two of its inactive
refining subsidiaries as potentially responsible parties for the expected
clean-up of the Indian Refinery. In addition, eighteen other parties were
named including Texaco. A subsidiary of Texaco had owned the refinery until
December of 1988. The Company subsequently responded to the EPA indicating
that it was neither the owner nor the operator of the Indian Refinery and thus
not responsible for its remediation.
In November 1999, the Company received a request for information from the
EPA concerning the Company's involvement in the ownership and operation of the
Indian Refinery. The Company responded to the EPA information request in
January 2000.
On August 7, 2000, the Company received notice of a claim against it and
two of its inactive refining subsidiaries from Texaco and its parent. Texaco
had made no previous claims against the Company although the Company's
subsidiaries had owned the refinery from August 1989 until December 1995. In
its claim, Texaco demanded that the Company and its former subsidiaries
indemnify Texaco for all liability resulting from environmental contamination
at and around the Indian Refinery. In addition, Texaco demanded that the
Company assume Texaco's defense in all matters relating to environmental
contamination at and around the Indian Refinery, including lawsuits, claims
and administrative actions initiated by the EPA and indemnify Texaco for costs
Page 113
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
that Texaco has already incurred addressing environmental contamination at the
Indian Refinery. Finally, Texaco also claimed that the Company and two of its
inactive subsidiaries are liable to Texaco under the Federal Comprehensive
Environmental Response Compensation and Liability Act as owners and operators
of the Indian Refinery. The Company responded to Texaco disputing the factual
and theoretical basis for Texaco's claims against the Company. The Company's
management and special counsel subsequently met with representatives of Texaco
but the parties disagreed concerning Texaco's claims.
The Company and its special counsel believe that Texaco's claims are
utterly without merit and the Company intends to vigorously defend itself
against Texaco's claims and any lawsuits that may follow. In addition to the
numerous defenses that the Company has against Texaco's contractual claim for
indemnity, the Company and its special counsel believe that by the express
language of the agreement which Texaco construes to create an indemnity,
Texaco has irrevocably elected to forgo all rights of contractual
indemnification it might otherwise have had against any person, including the
Company.
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. In August 1998, EMC sold the
Powerine Refinery to a third party, which, we are informed, is seeking to sell
the Powerine Refinery plant.
In July of 1996, the Company was named a defendant in a class action
lawsuit concerning emissions from the Powerine Refinery. In April of 1997,
the court granted the Company's motion to quash the plaintiff's summons based
upon lack of jurisdiction and the Company is no longer involved in the case.
Although any environmental liabilities related to the Indian Refinery and
Powerine Refinery have been transferred to others, there can be no assurance
that the parties assuming such liabilities will be able to pay them. American
Western, owner of the Indian Refinery, filed for bankruptcy and is in the
process of liquidation. EMC, which assumed the environmental liabilities of
Powerine, sold the Powerine Refinery to an unrelated party, which we
understand is still seeking financing to restart that refinery. Furthermore,
as noted above, the EPA named the Company as a potentially responsible party
for remediation of the Indian Refinery and has requested and received relevant
information from the Company. Estimated gross undiscounted clean-up costs for
this refinery are at least $80,000- $150,000 according to third parties. If
the Company were found liable for the remediation of the Indian Refinery, it
could be required to pay a percentage of the clean-up costs. Since the
Company's subsidiary only operated the Indian Refinery five years, whereas
Texaco and others operated it over fifty years, the Company would expect that
its share of remediation liability would be proportional to its years of
Page 114
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
operation, although such may not be the case. Furthermore, as noted above,
Texaco has claimed that the Company indemnified it for all environmental
liabilities related to the Indian Refinery. If Texaco were to sue the Company
on this theory and prevail in court, the Company could be held responsible for
the entire estimated clean up costs of $80,000-$150,000 or more. In such a
case, this cost would be far in excess of the Company's financial capability.
An opinion issued by the U.S. Supreme Court in June 1998 in a comparable
matter and a recent opinion by the U.S. Appeals Court for the Fifth Circuit
support the Company's positions. Nevertheless, if funds for environmental
clean-up are not provided by these former and/or present owners, it is
possible that the Company and/or one of its former refining subsidiaries could
be named parties in additional legal actions to recover remediation costs. In
recent years, government and other plaintiffs have often sought redress for
environmental liabilities from the party most capable of payment without
regard to responsibility or fault. Whether or not the Company is ultimately
held liable in such a circumstance, should litigation involving the Company
and/or IRLP occur, the Company would probably incur substantial legal fees and
experience a diversion of management resources from other operations.
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 of these matters due
to inherent uncertainties.
Litigation
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were
defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case,
the Long Trusts, are non-operating working interest owners in wells previously
operated by Castle Texas Production Limited Partnership ("CTPLP"), an inactive
exploration and production subsidiary of the Company. The wells were among
those sold to Union Pacific Resources Corporation ("PRC") in May 1997. The
Long Trusts claimed that CTPLP did not allow them to sell gas from March 1,
1996 to January 31, 1997 as required by applicable joint operating agreements,
and they sued CTPLP and the other defendants, claiming (among other things)
breach of contract, breach of fiduciary duty, conversion and conspiracy. The
plaintiffs sought actual damages, exemplary damages, pre-judgment and
post-judgment interest, attorney's fees and court costs. CTPLP counterclaimed
for approximately $150 of unpaid joint interests billings plus interest,
attorneys' fees and court costs.
After a three-week trial, the District Court in Rusk County
submitted 36 questions to the jury which covered all of the claims and
counterclaims in the lawsuit. Based upon the jury's answers, the District
Page 115
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Court entered judgement granting plaintiffs' claims against the Company and
its subsidiaries, as well as CTPLP's counterclaim against the plaintiffs. The
District Court issued an amended judgement on September 5, 2001 which became
final December 19, 2001. The net amount awarded to the plaintiffs was
approximately $2,700. The Company and its subsidiaries have filed a notice of
appeal with the Tyler Court of Appeals and will continue to vigorously contest
this matter.
Special counsel to the Company does not consider an unfavorable
outcome to this lawsuit probable. The Company's management and special
counsel believe that several of the plaintiffs' primary legal theories are
contrary to established Texas law and that the Court's charge to the jury was
fatally defective. They further believe that any judgment for plaintiffs
based on those theories or on the jury's answers to certain questions in the
charge cannot stand and will be reversed on appeal. As a result, the Company
has not accrued any liability for this litigation. Nevertheless, to pursue
the appeal, the Company and its subsidiaries were required to post a bond to
cover the gross amount of damages awarded to the plaintiffs and to maintain
that bond until the resolution of the appeal which may take several years.
Originally, the Company and its subsidiaries anticipated posting a bond of
approximately $3,000 based upon the net amount of damages but the Company and
its subsidiaries later decided to post a bond of $3,886 based upon the gross
damages in order to avoid on-going legal expenses and to expeditiously move
the case to the Tyler Court of Appeals. The letter of credit supporting this
bond was provided by the Company's lender pursuant to the Company's $40,000
line of credit with that lender.
Pilgreen Litigation
As part of the oil and gas properties acquired from AmBrit Energy
Corp. ("AmBrit") in June 1999, Castle Exploration Company, Inc., a
wholly-owned subsidiary of the Company ("CECI") acquired a 10.65% overriding
royalty interest ("ORRI") in the Pilgreen #2ST gas well. Because of title
disputes, AmBrit and other interest owners had previously filed claims against
the operator of the Pilgreen well, and CECI acquired post January 1, 1999
rights in that litigation. Although revenue attributed to the ORRI has been
suspended by the operator since first production, because of recent related
appellate decisions and settlement negotiations, the Company believes that
revenue attributable to CECI's ORRI should be released to CECI in the near
future, although another working interest owner has recently raised a question
as to the manner in which the ORRI should be calculated. As of December 31,
2001, approximately $466 attributable to CECI's share of the ORRI revenue in
the Pilgreen #25T well and related leasehold was suspended, including revenue
attributable to an additional well drilled on the lease. The Company's policy
is to recognize the suspended revenue only when and if it is received.
Page 116
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
Note 5 - New Accounting Pronouncements
- --------------------------------------
Statement of Financial Accounting Standards No. 133, as amended,
"Accounting for Derivative Instruments and Hedging Activities" (ASFAS No.
133"), was issued by the Financial Accounting Standards Board in June 1998.
Subsequently, SFAS No. 138 "Accounting for Certain Derivative Instruments"
(ASFAS No. 138"), an amendment of SFAS No. 133, was issued. SFAS 133 and SFAS
138 standardize the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts. Under the standard,
entities are required to carry all derivative instruments in the statement of
financial position at fair value. The accounting for changes in the fair
value (i.e., gains or losses) of a derivative instrument depends on whether
such instrument has been designated and qualifies as part of a hedging
relationship and, if so, depends on the reason for holding it. If certain
conditions are met, entities may elect to designate a derivative instrument as
a hedge of exposures to changes in fair values, cash flows, or foreign
currencies. If the hedged exposure is a fair value exposure, the gain or loss
on the derivative instrument is recognized in earnings in the period of change
together with the offsetting loss or gain on the hedged item attributable to
the risk being hedged. If the hedged exposure is a cash flow exposure, the
effective portion of the gain or loss on the derivative instrument is reported
initially as a component of other comprehensive income (not included in
earnings) and subsequently reclassified into earnings when the forecasted
transaction affects earnings. Any amounts excluded from the assessment of
hedge effectiveness, as well as the ineffective portion of the gain or loss,
is reported in earnings immediately. Accounting for foreign currency hedges
is similar to the accounting for fair value and cash flow hedges. If the
derivative instrument is not designated as a hedge, the gain or loss is
recognized in earnings in the period of change. The Company adopted SFAS No.
133 and SFAS No. 138 effective October 1, 2000. The Company ceased hedging
its oil and gas production in July 2000. At December 31, 2001 and September
30, 2001, the Company had no freestanding derivative instruments in place and
had no embedded derivative instruments. As a result, the Company's adoption
of SFAS No. 133 and SFAS No. 138 had no impact on its results of operations or
financial condition.
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" (ASFAS 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 will adopt SFAS No. 142 in the first quarter of fiscal 2003. The
Company does not believe that its future adoption of SFAS No. 142 will have a
material effect on its results of operations.
Page 117
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
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 will adopt SFAS 143 effective October 1, 2002. At this time, the
Company cannot reasonably estimate the effect of the adoption of this
statement on either its financial position or results of operations.
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 will adopt SFAS No. 144
effective October 1, 2002. At this time the Company is unable to determine
what the future impact of adopting this statement will have on its financial
position or results of operations.
Note 6 - Information Concerning Reportable Segments
- ---------------------------------------------------
For the periods ended December 31, 2001 and 2000, the Company operated in
only one segment of the energy industry, oil and gas exploration and
production. Until May 31, 1999, the Company also operated in the natural gas
marketing segment of the energy industry.
Note 7 - Sale of Domestic Exploration and Production Assets
- -----------------------------------------------------------
On January 15, 2002, the Company entered into an agreement to sell its
domestic oil and gas properties to Delta Petroleum Company, a public
exploration and production company headquartered in Denver, Colorado
("Delta"). The purchase price is $20,000 plus 9,566,000 shares of Delta's
common stock, which would result in the Company owning approximately 43% of
Delta. The effective date of the sale is October 1, 2001 and closing is
expected by April 30, 2002. It is possible that closing could be postponed
Page 118
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
("$000's" Omitted Except Share Amounts)
(Unaudited)
because closing is subject to approval of Delta's shareholders, a process
requiring regulatory approval. Pursuant to the terms of the purchase and sale
agreement, the cash portion of the purchase price will be reduced by the cash
flow from the properties between the effective date and the closing date.
Each party is subject to penalties for failure to close the transaction. In
addition, Delta may repurchase up to 3,188,667 of its shares from Castle for
$4.50 per share for a period of one year after closing and Delta agreed to
nominate three directors selected by the Company to Delta's Board of Directors
which is currently comprised of four directors. The agreement also includes a
provision whereby Delta may pay a portion of the cash purchase price with a
270 day note bearing interest of 8% if Delta is unable to fund the entire cash
portion of the purchase price. The note plus accrued interest is payable in
cash or Delta's common stock (at $3.00/share) at Delta's option. Although the
Company anticipates that Delta will be deemed the acquirer for accounting
purposes, there is a remote possibility that the Company could be construed as
the acquirer if sufficient additional shares of Delta's common stock were
issued to the Company. If this occurs, the Company will account for the
transaction as an acquisition of Delta using the purchase method and will
include the financial results of Delta in its consolidated financial
statements.
The Company currently expects that the proceeds on the sale will exceed
the current carrying value of the oil and gas properties to be sold. Any
resultant gain recorded by the Company upon sale will be dependent to a large
extent upon the market price of Delta's common stock at the time the
transaction closes and the nature of the proceeds received. Given the
volatility of oil and gas prices and other factors, there can be no assurance
that the transaction will close as planned or that the Company will recognize
a gain on the transaction in its financial statements. Portions of any gain
recorded will be deferred due to the Company's indirect retention of interest
in the properties sold as a result of its ownership interest in Delta after
the sale. After the sale the Company expects to hold 43% of Delta's
outstanding stock which will be recorded on the equity method. Under this
method the Company records its share of Delta's income or loss with an
offsetting entry to the carrying value of the Company's investment. Cash
distributions, if any, are recorded as a reduction in the carrying value of
the Company's investment. If at any time prior to the completion of the sale
the Company estimates that it would record a loss on disposition, the loss
would be recorded when estimated in accordance with SFAS No. 121.
Page 119
Information Concerning Castle Litigation
- ----------------------------------------
AmBrit Energy Corp. and Castle Exploration Company, Inc. vs. United Oil &
Minerals, Inc., Cause No. 99-04-18405-CV; pending in the 25th Judicial
District Court of Lavaca County, Texas.
The amount of money attributable to Castle's interest in the
Pilgreen well, as paid into the registry of the District Court of
Lavaca County pending resolution of this case, has increased by several
months of additional production revenue. The operator, United Oil &
Minerals, Inc. ("United"), has agreed that Castle Texas Oil and Gas
Limited Partnership ("CTOGLP"), a subsidiary of Castle, is entitled to
an overriding royalty interest in production from the Pilgreen well.
Because of a claim by Dominion Oklahoma Texas Exploration and
Production, Inc. ("Dominion"), a working interest owner, that the
overriding royalty interest held by CTOGLP in the lease in question
should be deemed to be burdened by certain other overriding royalty
interests, United now contends that there is a title dispute as to
approximately 33% of the Pilgreen production proceeds paid into the
registry of the court attributable to the 3.55% of CTOGLP interest that
is disputed. United has agreed to release funds attributable to CTOGLP's
7.10% interest in Pilgreen production from the registry of the Court.
Castle has instructed its trial counsel in this matter to amend its
petition to add Dominion as a defendant and to seek a declaratory
judgement that Castle is entitled to a 10.65% overriding royalty
interest in the Pilgreen. Castle 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. Castle intends to contest this matter vigorously.
Castle has also been informed that production proceeds from an
additional well on this lease in which CTOGLP has a 5.325% overriding
royalty interest may also have been paid into the registry of the court
because of the assertion of a title dispute as to the CTOGLP interest.
Dominion Oklahoma Texas Exploration and Production, Inc. Vs. Castle Texas Oil
and Gas Limited Partnership, Cause No. 02-03-19170-CV; pending in the 25th
Judicial District Court of Lavaca County, Texas
On March 18, 2002, Dominion, operator of the Mitchell and
Migl-Mitchell wells in the Southwest Speaks field, filed suit in Texas
against CTOGLP, a subsidiary of Castle, seeking declaratory judgement in
a title action that the overriding royalty interest held by CTOGLP in
these wells should be deemed to be burdened by certain other overriding
royalty interests and 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.
Dominion has threatened to suspend all revenue payable to Castle from the
Mitchell and Migl-Mitchell to offset their claim. Castle 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. Castle intends to contest this matter
vigorously.
Castle preliminarily estimates that the amount in controversy with
respect to both of the matters discussed above is approximately
$1,180,000, but believes that both of Dominion's claims are without
merit.
Page 120
Information Concerning Delta
- ----------------------------
Delta is a Colorado corporation organized on December 21, 1984. Delta
maintains its principal executive offices at Suite 3310, 555 Seventeenth
Street, Denver, Colorado 80202, and its telephone number is (303) 293-9133.
Delta is engaged in the acquisition, exploration, development and production
of oil and gas properties.
As of June 30, 2001, Delta had varying interests in 138 gross (22.86 net)
productive wells located in seven states. Delta has undeveloped properties in
five states, and interests in five federal units and one lease offshore
California near Santa Barbara. Delta operates 25 of the wells and the
remaining wells are operated by independent operators.
Enclosed with this Proxy Statement is a copy of our Annual Report on Form
10-K, as amended, for the fiscal year ended June 30, 2001, and our Quarterly
Report on Form 10-Q for the quarter ended December 31, 2001.
Recent Material Changes in Delta's Business
- -------------------------------------------
On February 19, 2002, Delta completed the acquisition of Piper Petroleum
Company ("Piper"), a privately owned oil and gas company headquartered in Fort
Worth, Texas. Delta issued 1,374,240 shares of restricted common stock for
100% of the shares of Piper. The 1,374,240 shares of restricted common stock
was valued at approximately $5,244,000 based on the five-day average closing
price surrounding the announcement of the merger. In addition, Delta issued
51,000 shares for the cancellation of certain debt of Piper. As a result of
the acquisition, we acquired Piper's working and royalty interests in over 300
properties which are primarily located in Texas, Oklahoma and Louisiana along
with a 5% working interest in the Comet Ridge coal bed methane gas project in
Queensland, Australia.
On December 27, 2001, Delta also announced that on November 15, 2001, it
purchased certain producing properties from three unaffiliated parties in
exchange for $412,427 in cash and 137,476 restricted shares of Common Stock.
The properties are located in six fields in the Edwards Reef Trend in Lavaca,
DeWitt, Karnee, Live Oak and McMullen counties in the State of Texas and
consist of non-operated minority interests in 34 gas wells and associated
undeveloped acreage. This transaction has been previously disclosed in a Form
8-K filing with the Securities and Exchange Commission dated December 20,
2001.
Delta and several other companies owning interests in forty undeveloped
federal Outer Continental Shelf leases located several miles off the coast of
California filed a lawsuit on January 9, 2002 alleging that the U.S.
Government has materially breached their leases. The Complaint, filed in the
U.S. Court of Federal Claims in Washington, D.C., is based on the premise that
post-leasing amendments to a federal statute governing offshore activities
have now been interpreted to alter significantly the companies' rights and
ability to move forward with further exploration and development activities.
In addition, the suit alleges that the Government has failed to carry out its
own obligations under the leases, resulting in substantial delays and
interference in the companies' exploration and development efforts. The forty
undeveloped leases are located in the Offshore Santa Maria Basin off the coast
of Santa Barbara and San Luis Obispo counties, and in the Santa Barbara
Channel off Santa Barbara and Ventura counties.
Page 121
The suit seeks compensation for the lease bonuses and rentals paid to the
Federal Government, exploration costs and related expenses. The total amount
claimed by all lessees for bonuses and rentals exceeds $1.2 billion, with
additional amounts for exploration costs and related expenses. Delta's claim
(including the claim of its subsidiary Amber Resources Company) for lease
bonuses and rentals paid by Delta and its predecessors is in excess of
$152,000,000. In addition, its claim for exploration costs and related
expenses will also be substantial.
On March 1, 2002, Delta completed the sale of 21 producing wells and
acreage located primarily in the Eland and Stadium fields of Stark County,
North Dakota, to Sovereign Holdings, LLC, a privately-held Colorado limited
liability company, for cash consideration of $2,750,000 pursuant to a purchase
and sale agreement February 1, 2002 and effective January 1, 2002. These
properties accounted for approximately 9.45% of our total assets as of June
30, 2001 and also accounted for approximately 22.6% of our total revenues and
approximately 11.9% of our total operating expenses during our past fiscal
year.
Information Incorporated by Reference
- -------------------------------------
The following documents that Delta has filed with the Securities and
Exchange Commission are incorporated herein:
1. Annual Report on Form 10-KSB (for fiscal year ended June 30, 2001)
filed October 15, 2001, Exchange Act reporting number 0-16203.
2. Amendment No. 1 to Annual Report on Form 10-KSB/A (for fiscal year
ended June 30, 2001) filed October 26, 2001, Exchange Act reporting
number 0-16203.
3. Amendment No. 2 to Annual Report on Form 10-K/A (for fiscal year
ended June 30, 2001) filed December 31, 2001, Exchange Act reporting
number 0-16203.
4. Quarterly Report on Form 10-Q (for quarter ended September 30, 2001)
filed November 13, 2001, Exchange Act reporting number 0-16203.
5. Quarterly Report on Form 10-Q (for quarter ended December 31, 2001)
filed February 14, 2002, Exchange Act reporting number 0-16203.
6. Current Report on Form 8-K dated October 25, 2001, filed December 20,
2001, Exchange Act reporting number 0-16203.
7. Current Report on Form 8-K dated January 15, 2002, filed January 22,
2002, Exchange Act reporting number 0-16203.
8. Current Report on Form 8-K dated March 1, 2002, filed March 18, 2002,
Exchange Act reporting number 0-16203.
Any statement contained in a document incorporated by reference herein shall
be deemed to be modified or superseded for all purposes to the extent that a
statement contained in this document or in any other subsequently filed
document which is also incorporated herein by reference modifies or replaces
such statement.
Page 122
Shareholders and investors may read and copy any materials filed with the
SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington,
D.C. 20549. Information on the operations of the Public Reference Room may be
obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains an
Internet site that contains reports, prox and information statements and other
information concerning Delta at www.sec.gov.
SHAREHOLDER PROPOSALS
Any shareholder proposals to be included in the Board of Directors'
solicitation of proxies for the 2002 Annual Meeting of Shareholders must be
received by Aleron H. Larson, Jr., Secretary, at 475 17th Street, Suite 1400,
Denver, Colorado 80202, a reasonable amount of time prior to the mailing of
the proxy materials for that meeting.
GENERAL AND OTHER MATTERS
The Board of Directors knows of no matter, other than those referred to
in this Proxy Statement, which will be represented at the Annual Meeting.
However, if any other matters are properly brought before the Meeting or any
of its adjournments, the person or persons voting the proxies will vote them
in accordance with their judgment on such matters.
The cost of preparing, assembling, and mailing this Proxy Statement, the
enclosed proxy card and the Notice of the Annual Meeting will be paid by us.
Additional solicitation by mail, telephone, telegraph or personal solicitation
may be done by our directors, officers and regular employees. Such persons
will receive no additional compensation for such services. Brokerage houses,
banks and other nominees, fiduciaries and custodians nominally holding shares
of Common Stock of record will be requested to forward proxy soliciting
material to the beneficial owners of such shares, and will be reimbursed by us
for their reasonable expenses.
AVAILABLE INFORMATION. Upon request of any shareholder, our Annual
Report for the year ended June 30, 2001 filed with the SEC on Form 10-KSB,
including financial statements, will be sent to the shareholder without charge
by first class mail within one business day of receipt of such request. All
requests should be addressed to our Secretary at 475 17th Street, Suite 1400,
Denver, Colorado 80202 or by telephone (303) 293-9133.
You are urged to complete, sign, date and return your proxy promptly.
You may revoke your proxy at any time before it is voted. If you attend the
Annual Meeting, as we hope you will, you may vote your shares in person.
By Order of the Board of Directors
Aleron H. Larson, Jr.
Chairman/Secretary
_______ __, 2002
Page 123
EXHIBIT A
DELTA PETROLEUM CORPORATION
2002 INCENTIVE PLAN
1. Purpose of the Plan
The purpose of this Delta Petroleum Corporation 2002 Incentive Plan
("Plan") is to create shareholder value. To do so, the Plan provides
incentives to selected employees and directors of the Company and its
Subsidiaries, and selected non-employee consultants and advisors to the
Company and its Subsidiaries, who contribute, and are expected to contribute,
materially to its success. The Plan also provides a means of rewarding
outstanding performance and enhances the interest of such persons in the
Company's success and development by providing them a proprietary interest in
the Company. Further, the Plan is designed to enhance the Company's ability to
maintain a competitive position in attracting and retaining qualified
personnel necessary for the success and development of the Company.
2. Definitions
As used in the Plan, the following definitions apply to the terms
indicated below:
(a) "Board of Directors" shall mean the Board of Directors of Delta
Petroleum Corporation.
(b) "Cause," when used in connection with the termination of a
Participant's employment with the Company, for purposes of the Plan, shall
mean the termination of the Participant's employment by the Company on account
of (i) the willful and continued failure by the Participant substantially to
perform his duties and obligations (other than any such failure resulting from
his incapacity due to physical or mental illness) or (ii) the willful engaging
by the Participant in an act or acts which could reasonably be expected to
cause injury to the Company. For purposes of this Section 2(b), no act, or
failure to act, on a Participant's part shall be considered "willful" unless
done, or omitted to be done, by the Participant in bad faith and without
reasonable belief that his action or omission was in the best interests of the
Company.
(c) "Cash Bonus" shall mean an award of a bonus payable in cash
pursuant to Section 13 hereof.
(d) "Change in Control" shall mean:
(i) the acquisition at any time by a"person" or "group" (as that
term is used in Sections 13(d)and 14(d)(2) of the Exchange
Act) (excluding, for this purpose, the Company or any
Subsidiary or any employee benefit plan of the Company or
any Subsidiary) of beneficial ownership (as defined in Rule
13d-3 under the Exchange Act) directly or indirectly, of
securities representing 20% or more of the combined voting
power in the election of directors of the then-outstanding
securities of the Company or any successor of the Company;
(ii) the termination of service as directors, for any reason
other than death, disability or retirement from the Board of
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Directors, during any period of two consecutive years or
less, of individuals who at the beginning of such period
constituted a majority of the Board of Directors, unless the
election of or nomination for election of each new director
during such period was approved by a vote of at least
two-thirds of the directors still in office who were
directors at the beginning of the period;
(iii) approval by the shareholders of the Company of any merger
or consolidation or statutory share exchange as a result of
which the Common Shares shall be changed, converted or
exchanged (other than a merger or share exchange with a
wholly-owned Subsidiary of the Company), or liquidation of
the Company, or any sale or disposition of 50% or more of
the assets or earning power of the Company;
(iv) approval by the shareholders of the Company of any merger,
consolidation or statutory share exchange to which the
Company is a party as a result of which the persons who were
shareholders of the Company immediately prior to the
effective date of the merger, consolidation or statutory
share exchange shall have beneficial ownership of less than
50% of the combined voting power in the election of
directors of the surviving corporation following the
effective date of such merger, consolidation or statutory
share exchange; or
(v) a determination by the Board of Directors, in its sole and
absolute discretion, that a change in control has occurred.
(e) "Code" shall mean the Internal Revenue Code of 1986, as amended
from time to time.
(f) "Committee" shall mean the committee appointed by the Board of
Directors from time to time to administer the Plan.
(g) "Common Shares" shall mean Delta Petroleum Corporation common
shares, no par value per share.
(h) "Company" shall mean Delta Petroleum Corporation, a Colorado
corporation, and each of its Subsidiaries.
(i) "Disability" shall mean a Participant's inability to engage in
any substantial gainful activity by reason of any medically determinable
physical or mental impairment which can be expected to result in death or
which has lasted or can be expected to last for a continuous period of not
less than twelve (12) months.
(j) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
(k) The "Fair Market Value" of Common Shares with respect to any day
shall be (i) the closing sales price on the immediately preceding business day
of Common Shares as reported on the principal securities exchange on which
Common Shares are then listed or admitted to trading, or (ii) if not so
reported, the average of the closing bid and ask prices on the immediately
preceding business day as reported on the National Association of Securities
Dealers Automated Quotation System, or (iii) if not so reported, as furnished
by any member of the National Association of
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Securities Dealers, Inc. selected by the Committee. In the event
that the price of Common Shares shall not be so reported, the Fair Market
Value of Common Shares shall be determined by the Committee in its absolute
discretion.
(l) "Incentive Award" shall mean an Option, LSAR, Tandem SAR,
Stand-Alone SAR, share of Phantom Stock, Stock Bonus or Cash Bonus granted
pursuant to the terms of the Plan.
(m) "Incentive Stock Option" shall mean an Option which is an
"incentive stock option" within the meaning of Section 422 of the Code and
which is identified as an Incentive Stock Option in the agreement by which it
is evidenced.
(n) "Issue Date" shall mean the date established by the Committee on
which certificates representing shares of Restricted Stock shall be issued by
Delta Petroleum Corporation pursuant to the terms of Section 10(d) hereof.
(o) "LSAR" shall mean a limited stock appreciation right which is
granted pursuant to the provisions of Section 7 hereof and which relates to an
Option. Each LSAR shall be exercisable only upon the occurrence of a Change in
Control and only in the alternative to the exercise of its related Option.
(p) "Non-Employee Participant" shall mean a Participant who is not an
employee of the Company.
(q) "Non-Qualified Stock Option" shall mean an Option which is not an
Incentive Stock Option and which is identified as a Non-Qualified Stock Option
in the agreement by which it is evidenced.
(r) "Option" shall mean an option to purchase Common Shares of Delta
Petroleum Corporation granted pursuant to Section 6 hereof. Each Option shall
be identified as either an Incentive Stock Option or a Non-Qualified Stock
Option in the agreement by which it is evidenced.
(s) "Participant" shall mean a person who is eligible to participate
in the Plan and to whom an Incentive Award is granted pursuant to the Plan,
and, upon his death, his successors, heirs, executors and administrators, as
the case may be.
(t) "Person" shall mean a "person," as such term is used in Sections
13(d) and 14(d) of the Exchange Act.
(u) "Phantom Stock" shall mean the right to receive in cash the
Fair Market Value of Common Shares of Delta Petroleum Corporation, which right
is granted pursuant to Section 11 hereof and subject to the terms and
conditions contained therein.
(v) "Plan" shall mean the Delta Petroleum Corporation 2002 Incentive
Plan, as it may be amended from time to time.
(w) "Restricted Stock" shall mean a Common Share which is granted
pursuant to the terms of Section 10 hereof and which is subject to the
restrictions set forth in Section 10(c) hereof for so long as such
restrictions continue to apply to such share.
(x) "Securities Act" shall mean the Securities Act of 1933, as
amended.
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(y) "Stand-Alone SAR" shall mean a stock appreciation right granted
pursuant to Section 9 hereof which is not related to any Option.
(z) "Stock Bonus" shall mean a grant of a bonus payable in Common
Shares pursuant to Section 12 hereof.
(aa) "Subsidiary" shall mean any corporation in which at the time of
reference Delta Petroleum Corporation owns, directly or indirectly, stock
comprising more than fifty percent of the total combined voting power of all
classes of stock of such corporation.
(bb) "Tandem SAR" shall mean a stock appreciation right granted
pursuant to Section 8 hereof which is related to an Option. Each Tandem SAR
shall be exercisable only to the extent its related Option is exercisable and
only in the alternative to the exercise of its related Option.
(cc) "Vesting Date" shall mean the date established by the Committee
on which a share of Restricted Stock or Phantom Stock may vest.
(dd) "Delta Petroleum Corporation" shall mean Delta Petroleum
Corporation, a Colorado corporation, and its successors.
3. Stock Subject to the Plan
Under the Plan, the Committee may grant to Participants (i) Options, (ii)
LSARs, (iii) Tandem SARs, (iv) Stand-Alone SARs, (v) shares of Restricted
Stock, (vi) shares of Phantom Stock, (vii) Stock Bonuses and (viii) Cash
Bonuses; provided, however, that grants under the Plan to non-employee
directors of the Company shall be made by the Board of Directors. When
referring to grants under the Plan to non-employee directors of the Company,
any reference in this Plan to the Committee shall be deemed to refer to the
Board of Directors.
Subject to adjustment as provided in Section 14 hereof, the Committee may
grant Options, Stand-Alone SARs, shares of Restricted Stock, shares of Phantom
Stock and Stock Bonuses under the Plan with respect to a number of Common
Shares that in the aggregate does not exceed 2,000,000 shares. The grant of
an LSAR, Tandem SAR or Cash Bonus shall not reduce the number of Common Shares
with respect to which Options, Stand-Alone SARs, shares of Restricted Stock,
shares of Phantom Stock or Stock Bonuses may be granted pursuant to the Plan.
In the event that any outstanding Option or Stand-Alone SAR expires,
terminates or is canceled for any reason (other than pursuant to Paragraphs
7(b)(2) or 8(b)(3) hereof), the Common Shares subject to the unexercised
portion of such Option or Stand-Alone SAR shall again be available for grants
under the Plan. In the event that an outstanding Option is canceled pursuant
to Paragraphs 7(b)(2) or 8(b)(3) hereof by reason of the exercise of an LSAR
or a Tandem SAR, the Common Shares subject to the canceled portion of such
Option shall not again be available for grants under the Plan. In the event
that any shares of Restricted Stock or Phantom Stock, or any Common Shares
granted in a Stock Bonus are forfeited or canceled for any reason, such shares
shall again be available for grants under the Plan.
Common Shares issued under the Plan may be either newly issued shares or
treasury shares, at the discretion of the Committee, and Delta Petroleum
Corporation hereby reserves 2,000,000 Common Shares for issuance pursuant to
the Plan.
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4. Administration of the Plan
The Plan shall be administered by a Committee of the Board of Directors
consisting of two or more persons, each of whom shall be a "non-employee
director" within the meaning of Rule 16b-3(b)(3) promulgated under Section 16
of the Exchange Act. The Committee shall from time to time designate the
persons who shall be granted Incentive Awards and the amount and type of such
Incentive Awards, provided, however that any Incentive Awards granted to
non-employee directors of the Company shall be granted by the Board and not by
the Committee. When referring to grants under the Plan to non-employee
directors of the Company, any reference in this Plan to the Committee shall be
deemed to refer to the Board of Directors.
The Committee shall have full authority to administer the Plan,
including authority to interpret and construe any provision of the Plan and
the terms of any Incentive Award issued under it and to adopt such rules and
regulations for administering the Plan as it may deem necessary. Decisions of
the Committee shall be final and binding on all parties.
The Committee may, in its absolute discretion (i) accelerate the date on
which any Option or Stand-Alone SAR granted under the Plan becomes
exercisable, (ii) accelerate the Vesting Date or Issue Date, or waive any
condition imposed pursuant to Section 10(b) hereof, with respect to any share
of Restricted Stock granted under the Plan and (iii) accelerate the Vesting
Date or waive any condition imposed pursuant to Section 11 hereof, with
respect to any share of Phantom Stock granted under the Plan.
In addition, the Committee may, in its absolute discretion, grant
Incentive Awards to Participants on the condition that such Participants
surrender to the Committee for cancellation such other Incentive Awards
(including, without limitation, Incentive Awards with higher exercise prices)
as the Committee specifies. Notwithstanding Section 3 herein, prior to the
surrender of such other Incentive Awards, Incentive Awards granted pursuant to
the preceding sentence of this Section 4 shall not count against the limits
set forth in such Section 3.
Whether an authorized leave of absence, or absence in military or
government service, shall constitute termination of employment shall be
determined by the Committee.
No member of the Committee shall be liable for any action, omission, or
determination relating to the Plan, and Delta Petroleum Corporation shall
indemnify and hold harmless each member of the Committee and each other
director or employee of the Company to whom any duty or power relating to the
administration or interpretation of the Plan has been delegated against any
cost or expense (including counsel fees) or liability (including any sum paid
in settlement of a claim with the approval of the Committee) arising out of
any action, omission or determination relating to the Plan, unless, in either
case, such action, omission or determination was taken or made by such member,
director or employee in bad faith and without reasonable belief that it was in
the best interests of the Company.
5. Eligibility
The persons who shall be eligible to receive Incentive Awards pursuant to
the Plan shall be such persons, including employees, officers, and directors
of the Company and non-employee consultants and advisors to the Company, as
the Committee shall select from time to time. Non-employee Directors of the
Company may only participate in the Plan pursuant to Paragraph 25 hereof.
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6. Options
Subject to the provisions of the Plan, the Committee may grant Options,
which Options shall be evidenced by agreements in such form as the Committee
shall from time to time approve. Options shall comply with and be subject to
the following terms and conditions:
(a) Identification of Options
All Options granted under the Plan that are Incentive Stock Options
shall be clearly identified in the agreement evidencing such Options as
Incentive Stock Options. Any Options not so identified shall be deemed to be
Non-Qualified Stock Options.
(b) Exercise Price
The exercise price of any Non-Qualified Stock Option granted under
the Plan shall be such price as the Committee shall determine on the date on
which such Non-Qualified Stock Option is granted; provided, that such price
may not be less than the minimum price required by applicable law. The
exercise price of any Incentive Stock Option granted under the Plan shall be
not less than 100% of the Fair Market Value of Common Shares on the date on
which such Incentive Stock Option is granted.
(c) Term and Exercise of Option
(1) Each Option shall be exercisable on such date or dates,
during such period and for such number of Common Shares as shall be determined
by the Committee on the day on which such Option is granted and set forth in
the Option agreement with respect to such Option; provided, however, that no
Option shall be exercisable after the expiration of ten years from the date
such Option was granted; and, provided, further, that each Option shall be
subject to earlier termination, expiration or cancellation as provided in the
Plan.
(2) Each Option shall be exercisable in whole or in part;
provided, that no partial exercise of an Option shall be for an aggregate
exercise price of less than $1,000, unless such partial exercise is for the
last remaining unexercised portion of such Option. The partial exercise of an
Option shall not cause the expiration, termination or cancellation of the
remaining portion thereof. Upon the partial exercise of an Option, the
agreements evidencing such Option and any related LSARs and Tandem SARs shall
be returned to the Participant exercising such Option together with the
delivery of the certificates described in Section 6(c)(5) hereof.
(3) An Option shall be exercised by delivering notice to Delta
Petroleum Corporation's principal office, to the attention of its Secretary,
no less than one business day in advance of the effective date of the proposed
exercise. Such notice shall be accompanied by the agreements evidencing the
Option and any related LSARs and Tandem SARs, shall specify the number of
Common Shares with respect to which the Option is being exercised and the
effective date of the proposed exercise and shall be signed by the
Participant. The
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Participant may withdraw such notice at any time prior to the close
of business on the business day immediately preceding the effective date of
the proposed exercise, in which case such agreements shall be returned to him.
Payment for Common Shares purchased upon the exercise of an Option shall be
made on the effective date of such exercise either (i) in cash, by certified
check, bank cashier's check or wire transfer or (ii) subject to the approval
of the Committee, in Common Shares owned by the Participant and valued at
their Fair Market Value on the effective date of such exercise, or partly in
Common Shares with the balance in cash, by certified check, bank cashier's
check or wire transfer. Any payment in Common Shares shall be effected by the
delivery of such shares to the Secretary of Delta Petroleum Corporation, duly
endorsed in blank or accompanied by stock powers duly executed in blank,
together with any other documents and evidences as the Secretary of Delta
Petroleum Corporation shall require from time to time. In addition, at the
time of grant the Committee may provide that an Option may be exercised in a
"cashless" transaction in which the holder may surrender all or a portion of
the Option and receive the number of shares of Common Shares equal in value to
the Fair Market Value per share at the date of surrender less the exercise
price per share of the Option, multiplied by the number of shares which may be
purchased under the Option, or portion thereof, being surrendered.
(4) Any Option granted under the Plan may be exercised by a
broker-dealer acting on behalf of a Participant if (i) the broker-dealer has
received from the Participant or the Company a fully-and-duly-endorsed
agreement evidencing such Option and instructions signed by the Participant
requesting Delta Petroleum Corporation to deliver the Common Shares subject to
such Option to the broker-dealer on behalf of the Participant and specifying
the account into which such shares should be deposited, (ii) adequate
provision has been made with respect to the payment of any withholding taxes
due upon such exercise and (iii) the broker-dealer and the Participant have
otherwise complied with Section 220.3(e)(4) of Regulation T, 12 CFR Part 220.
(5) Certificates for Common Shares purchased upon the exercise
of an Option shall be issued in the name of the Participant, or such
Participant's written designee, and delivered to the Participant or designee
as soon as practicable following the effective date on which the Option is
exercised.
(6) Except as specifically set forth in the agreement evidencing
Options granted under the Plan, Options shall be assignable and transferable
provided, however, that the Company shall not be under an obligation as
provided in Paragraph 6(c)(7) below to include the shares underlying such
transferred or assigned options in any registration statement except upon
death or pursuant to a qualified domestic relations order.
(7) The Company, at the Company's expense, shall file and
maintain a registration statement on the appropriate form with the Securities
and Exchange Commission covering shares underlying all options granted
hereunder except as set forth in Paragraph 6(c)(6) above. The expiration date
of any option expiring prior to 90 days before the effective date of a
registration statement covering said option shall be extended until a date
ninety (90) days following the effective date of said registration statement.
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(d) Limitations on Grant of Incentive Stock Options
(1) The aggregate Fair Market Value of Common Shares with
respect to which "incentive stock options" (within the meaning of Section 422
of the Code) are exercisable for the first time by a Participant during any
calendar year under the Plan and any other stock option plan of the Company
(or any "subsidiary" of Delta Petroleum Corporation as such term is defined in
Section 425 of the Code) shall not exceed $100,000. Such Fair Market Value
shall be determined as of the date on which each such incentive stock option
is granted. In the event that the aggregate Fair Market Value of Common Shares
with respect to such incentive stock options exceeds $100,000, then Incentive
Stock Options granted hereunder to such Participant shall, to the extent and
in the order required by Regulations promulgated under the Code (or any other
authority having the force of Regulations), automatically be deemed to be
Non-Qualified Stock Options, but all other terms and provisions of such
Incentive Stock Options shall remain unchanged. In the absence of such
Regulations (and authority), or in the event such Regulations (or authority)
require or permit a designation of the options which shall cease to constitute
incentive stock options, Incentive Stock Options shall, to the extent of such
excess and in the order in which they were granted, automatically be deemed to
be Non-Qualified Stock Options, but all other terms and provisions of such
Incentive Stock Options shall remain unchanged.
(2) No Incentive Stock Option may be granted to an individual
if, at the time of the proposed grant, such individual owns stock possessing
more than ten percent of the total combined voting power of all classes of
stock of Delta Petroleum Corporation or any of its "subsidiaries" (within the
meaning of Section 425 of the Code), unless (i) the exercise price of such
Incentive Stock Option is at least one hundred and ten percent of the Fair
Market Value of a Common Share at the time such Incentive Stock Option is
granted and (ii) such Incentive Stock Option is not exercisable after the
expiration of five years from the date such Incentive Stock Option is granted.
(e) Effect of Termination of Employment
(1) Except as may be specifically set forth in the agreement
evidencing an Option, in the event that the employment of a Participant with
the Company shall terminate for any reason Options granted to such
Participant, to the extent that they were exercisable at the time of such
termination, shall remain exercisable in accordance with their terms.
(2) In the event that a Non-Employee Participant ceases to
provide services to the Company, all Options granted to such Non-Employee
Participant shall remain exercisable in accordance with their terms.
(f) Acceleration of Exercise Date Upon Change in Control
Upon the occurrence of a Change in Control, each Option granted
under the Plan and outstanding at such time shall become fully and immediately
exercisable and shall remain exercisable until its expiration, termination or
cancellation pursuant to the terms of the Plan.
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7. Limited Stock Appreciation Rights
The Committee may grant in connection with any Option granted hereunder
one or more LSARs relating to a number of Common Shares equal to or less than
the number of Common Shares subject to the related Option. An LSAR may be
granted at the same time as, or subsequent to the time that, its related
Option is granted. Each LSAR shall be evidenced by an agreement in such form
as the Committee shall from time to time approve. Each LSAR granted hereunder
shall be subject to the following terms and conditions:
(a) Benefit Upon Exercise
(1) The exercise of an LSAR relating to a Non-Qualified Stock
Option with respect to any number of Common Shares shall entitle the
Participant to a cash payment, for each such share, equal to the excess of (i)
the greater of (A) the highest price per Common Share paid in the Change in
Control in connection with which such LSAR became exercisable and (B) the Fair
Market Value of a Common Share on the date of such Change in Control over (ii)
the exercise price of the related Option. Such payment shall be paid as soon
as practical, but in no event later than the expiration of five business days,
after the effective date of such exercise.
(2) The exercise of an LSAR relating to an Incentive Stock
Option with respect to any number of Common Shares shall entitle the
Participant to a cash payment, for each such share, equal to the excess of (i)
the Fair Market Value of a Common Share on the effective date of such exercise
over (ii) the exercise price of the related Option. Such payment shall be paid
as soon as practical, but in no event later than the expiration of five
business days, after the effective date of such exercise.
(b) Term and Exercise of LSARs
(1) An LSAR shall be exercisable only during the period
commencing on the first day following the occurrence of a Change in Control
and terminating on the expiration of sixty days after such date.
Notwithstanding the preceding sentence of this Section 7(b), in the event that
an LSAR held by any Participant who is or may be subject to the provisions of
Section 16(b) of the Exchange Act becomes exercisable prior to the expiration
of six months following the date on which it is granted, then the LSAR shall
also be exercisable during the period commencing on the first day immediately
following the expiration of such six month period and terminating on the
expiration of sixty days following such date. Notwithstanding anything else
herein, an LSAR relating to an Incentive Stock Option may be exercised with
respect to a Common Share only if the Fair Market Value of such share on the
effective date of such exercise exceeds the exercise price relating to such
share. Notwithstanding anything else herein, an LSAR may be exercised only if
and to the extent that the Option to which it relates is exercisable.
(2) The exercise of an LSAR with respect to a number of Common
Shares shall cause the immediate and automatic cancellation of the Option to
which it relates with respect to an equal number of shares. The exercise of an
Option, or the
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cancellation, termination or expiration of an Option (other
than pursuant to this Paragraph (2)), with respect to a number of Common
Shares, shall cause the cancellation of the LSAR related to it with respect to
an equal number of shares.
(3) Each LSAR shall be exercisable in whole or in part;
provided, that no partial exercise of an LSAR shall be for an aggregate
exercise price of less than $1,000, unless such partial exercise is for the
last remaining unexercised portion of such LSAR. The partial exercise of an
LSAR shall not cause the expiration, termination or cancellation of the
remaining portion thereof. Upon the partial exercise of an LSAR, the
agreements evidencing the LSAR, the related Option and any Tandem SARs related
to such Option shall be returned to the Participant exercising such LSAR
together with the payment described in Paragraph 7(a)(1) or (2) hereof, as
applicable.
(4) Except as specifically set forth in the agreements relating
thereto, each LSAR and any related Options shall be assignable and
transferable.
(5) An LSAR shall be exercised by delivering notice to Delta
Petroleum Corporation's principal office, to the attention of its Secretary,
no less than one business day in advance of the effective date of the proposed
exercise. Such notice shall be accompanied by the applicable agreements
evidencing the LSAR, the related Option and any Tandem SARs relating to such
Option, shall specify the number of Common Shares with respect to which the
LSAR is being exercised and the effective date of the proposed exercise and
shall be signed by the Participant. The Participant may withdraw such notice
at any time prior to the close of business on the business day immediately
preceding the effective date of the proposed exercise, in which case such
agreements shall be returned to him.
8. Tandem Stock Appreciation Rights
The Committee may grant in connection with any Option granted hereunder
one or more Tandem SARs relating to a number of Common Shares equal to or less
than the number of Common Shares subject to the related Option. A Tandem SAR
may be granted at the same time as, or subsequent to the time that, its
related Option is granted. Each Tandem SAR shall be evidenced by an agreement
in such form as the Committee shall from time to time approve. Tandem SARs
shall comply with and be subject to the following terms and conditions:
(a) Benefit Upon Exercise
The exercise of a Tandem SAR with respect to any number of Common
Shares shall entitle a Participant to a cash payment, for each such share,
equal to the excess of (i) the Fair Market Value of a Common Share on the
effective date of such exercise over (ii) the exercise price of the related
Option. Such payment shall be paid as soon as practical, but in no event later
than the expiration of five business days, after the effective date of such
exercise.
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(b) Term and Exercise of Tandem SAR
(1) A Tandem SAR shall be exercisable at the same time and to
the same extent (on a proportional basis, with any fractional amount being
rounded down to the immediately preceding whole number) as its related Option.
Notwithstanding the first sentence of this Paragraph 8(b)(1), (i) a Tandem SAR
shall not be exercisable at any time that an LSAR related to the Option to
which the Tandem SAR is related is exercisable and (ii) a Tandem SAR relating
to an Incentive Stock Option may be exercised with respect to a Common Share
only if the Fair Market Value of such share on the effective date of such
exercise exceeds the exercise price relating to such share.
(2) Notwithstanding the first sentence of Paragraph 8(b)(1)
hereof, the Committee may, in its absolute discretion, grant one or more
Tandem SARs which shall not become exercisable unless and until the
Participant to whom such Tandem SAR is granted is, in the determination of the
Committee, subject to Section 16(b) of the Exchange Act and which shall cease
to be exercisable if and at the time that the Participant ceases, in the
determination of the Committee, to be subject to such Section 16(b).
(3) The exercise of a Tandem SAR with respect to a number of
Common Shares shall cause the immediate and automatic cancellation of its
related Option with respect to an equal number of shares. The exercise of an
Option, or the cancellation, termination or expiration of an Option (other
than pursuant to this Paragraph (3)), with respect to a number of Common
Shares shall cause the automatic and immediate cancellation of its related
Tandem SARs to the extent that the number of Common Shares subject to such
Option after such exercise, cancellation, termination or expiration is less
than the number of shares subject to such Tandem SARs. Such Tandem SARs shall
be canceled in the order in which they became exercisable.
(4) Each Tandem SAR shall be exercisable in whole or in part;
provided, that no partial exercise of a Tandem SAR shall be for an aggregate
exercise price of less than $1,000, unless such partial exercise is for the
last remaining unexercised portion of such Tandem SAR. The partial exercise of
a Tandem SAR shall not cause the expiration, termination or cancellation of
the remaining portion thereof. Upon the partial exercise of a Tandem SAR, the
agreements evidencing such Tandem SAR, its related Option and LSARs relating
to such Option shall be returned to the Participant exercising such Tandem SAR
together with the payment described in Section 8(a) hereof.
(5) Except as specifically set forth in the agreements relating
thereto, each Tandem SAR and the related Option shall be assignable and
transferable.
(6) A Tandem SAR shall be exercised by delivering notice to
Delta Petroleum Corporation's principal office, to the attention of its
Secretary, no less than one business day in
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advance of the effective date of the proposed exercise. Such
notice shall be accompanied by the applicable agreements evidencing the Tandem
SAR, its related Option and any LSARs related to such Option, shall specify
the number of Common Shares with respect to which the Tandem SAR is being
exercised and the effective date of the proposed exercise and shall be signed
by the Participant. The Participant may withdraw such notice at any time prior
to the close of business on the business day immediately preceding the
effective date of the proposed exercise, in which case such agreements shall
be returned to him.
9. Stand-Alone Stock Appreciation Rights
Subject to the provisions of the Plan, the Committee may grant
Stand-Alone SARs, which Stand-Alone SARs shall be evidenced by agreements in
such form as the Committee shall from time to time approve. Stand-Alone SARs
shall comply with and be subject to the following terms and conditions:
(a) Exercise Price
The exercise price of any Stand-Alone SAR granted under the Plan
shall be determined by the Committee at the time of the grant of such
Stand-Alone SAR.
(b) Benefit Upon Exercise
The exercise of a Stand-Alone SAR with respect to any number of
Common Shares prior to the occurrence of a Change in Control shall entitle a
Participant to a cash payment, for each such share, equal to the excess of (i)
the Fair Market Value of a Common Share on the exercise date over (ii) the
exercise price of the Stand-Alone SAR. The exercise of a Stand-Alone SAR with
respect to any number of Common Shares upon or after the occurrence of a
Change in Control shall entitle a Participant to a cash payment, for each such
share, equal to the excess of (i) the greater of (A) the highest price per
Common Share paid in connection with such Change in Control and (B) the Fair
Market Value of a Common Share on the date of such Change in Control over (ii)
the exercise price of the Stand-Alone SAR. Such payments shall be paid as soon
as practical, but in no event later than five business days, after the
effective date of the exercise.
(c) Term and Exercise of Stand-Alone SARs
(1) Each Stand-Alone SAR shall be exercisable on such date or
dates, during such period and for such number of Common Shares as shall be
determined by the Committee and set forth in the Stand-Alone SAR agreement
with respect to such Stand-Alone SAR; provided, however, that no Stand-Alone
SAR shall be exercisable after the expiration of ten years from the date such
Stand-Alone SAR was granted; and, provided, further, that each Stand-Alone SAR
shall be subject to earlier termination, expiration or cancellation as
provided in the Plan.
(2) Each Stand-Alone SAR may be exercised in whole or in part;
provided, that no partial exercise of a Stand-Alone SAR shall be for an
aggregate exercise price of less than
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$1,000, unless such partial exercise is for the last remaining
unexercised portion of such Stand-Alone SAR. The partial exercise of a
Stand-Alone SAR shall not cause the expiration, termination or cancellation of
the remaining portion thereof. Upon the partial exercise of a Stand-Alone SAR,
the agreement evidencing such Stand-Alone SAR shall be returned to the
Participant exercising such Stand-Alone SAR together with the payment
described in Section 9(b) hereof.
(3) A Stand-Alone SAR shall be exercised by delivering notice to
Delta Petroleum Corporation's principal office, to the attention of its
Secretary, no less than one business day in advance of the effective date of
the proposed exercise. Such notice shall be accompanied by the applicable
agreement evidencing the Stand-Alone SAR, shall specify the number of Common
Shares with respect to which the Stand-Alone SAR is being exercised and the
effective date of the proposed exercise and shall be signed by the
Participant. The Participant may withdraw such notice at any time prior to the
close of business on the business day immediately preceding the effective date
of the proposed exercise, in which case the agreement evidencing the
Stand-Alone SAR shall be returned to him.
(4) Except as specifically set forth in the agreements relating
thereto, each Stand-Alone SAR shall be assignable and transferable.
(d) Effect of Termination of Employment
(1) In the event that the employment of a Participant with the
Company shall terminate for any reason Stand-Alone SARs granted to such
Participant, to the extent that they were exercisable at the time of such
termination, shall remain exercisable in accordance with their terms.
(2) In the event that a Non-Employee Participant ceases to
provide services to the Company, all Stand-Alone SARs granted to such
Non-Employee Participant shall remain exercisable in accordance with their
terms.
(e) Acceleration of Exercise Date Upon Change in Control
Upon the occurrence of a Change in Control, each Stand-Alone SAR
granted under the Plan and outstanding at such time shall become fully and
immediately exercisable and shall remain exercisable until its expiration,
termination or cancellation pursuant to the terms of the Plan.
10. Restricted Stock
Subject to the provisions of the Plan, the Committee may grant shares of
Restricted Stock. Each grant of shares of Restricted Stock shall be evidenced
by an agreement in such form as the Committee shall from time to time approve.
Each grant of shares of Restricted Stock shall comply with and be subject to
the following terms and conditions:
(a) Issue Date and Vesting Date
At the time of the grant of shares of Restricted Stock, the
Committee shall establish an Issue Date or Issue Dates and a
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Vesting Date or Vesting Dates with respect to such shares. The
Committee may divide such shares into classes and assign a different Issue
Date and/or Vesting Date for each class. Except as provided in Sections 10(c)
and 10(f) hereof, upon the occurrence of the Issue Date with respect to a
share of Restricted Stock, a share of Restricted Stock shall be issued in
accordance with the provisions of Section 10(d) hereof. Provided that all
conditions to the vesting of a share of Restricted Stock imposed pursuant to
Section 10(b) hereof are satisfied, and except as provided in Sections 10(c)
and 10(f) hereof, upon the occurrence of the Vesting Date with respect to a
share of Restricted Stock, such share shall vest and the restrictions of
Section 10(c) hereof shall cease to apply to such share.
(b) Conditions to Vesting
At the time of the grant of shares of Restricted Stock, the
Committee may impose such restrictions or conditions, not inconsistent with
the provisions hereof, to the vesting of such shares as it, in its absolute
discretion, deems appropriate. By way of example and not by way of limitation,
the Committee may require, as a condition to the vesting of any class or
classes of shares of Restricted Stock, that the Participant or the Company
achieve certain performance criteria, such criteria to be specified by the
Committee at the time of the grant of such shares.
(c) Restrictions on Transfer Prior to Vesting
Prior to the vesting of a share of Restricted Stock, no transfer of
a Participant's rights with respect to such shares, whether voluntary or
involuntary, by operation of law or otherwise, shall vest the transferee with
any interest or right in or with respect to such share, but immediately upon
any attempt to transfer such rights, such share, and all of the rights related
thereto, shall be forfeited by the Participant and the transfer shall be of no
force or effect.
(d) Issuance of Certificates
(1) Except as provided in Sections 10(c) or 10(f) hereof,
reasonably promptly after the Issue Date with respect to shares of Restricted
Stock, Delta Petroleum Corporation shall cause to be issued a stock
certificate, registered in the name of the Participant to whom such shares
were granted, evidencing such shares; provided, that Delta Petroleum
Corporation shall not cause to be issued such a stock certificate unless it
has received a stock power duly endorsed in blank with respect to such shares.
Each such stock certificate shall bear the following legend:
"The transferability of this certificate and the shares of
stock represented hereby is subject to the restrictions, terms and conditions
(including forfeiture and restrictions against transfer) contained in the
Delta Petroleum Corporation 2002 Incentive Plan and an Agreement entered into
between the registered owner of such shares and Delta Petroleum Corporation.
A copy of the Plan and Agreement is on file in the office of the Secretary of
Delta Petroleum Corporation Such legend shall not be removed from the
certificate evidencing such shares until such shares vest pursuant to the
terms hereof."
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(2) Each certificate issued pursuant to Paragraph 10(d)(1)
hereof, together with the stock powers relating to the shares of Restricted
Stock evidenced by such certificate, shall be deposited by the Company with a
custodian designated by the Company. The Company shall cause such custodian to
issue to the Participant a receipt evidencing the certificates held by it
which are registered in the name of the Participant.
(e) Consequences Upon Vesting
Upon the vesting of a share of Restricted Stock pursuant to the
terms hereof, the restrictions of Section 10(c) hereof shall cease to apply to
such share. Reasonably promptly after a share of Restricted Stock vests
pursuant to the terms hereof, Delta Petroleum Corporation shall cause to be
issued and delivered to the Participant to whom such shares were granted, a
certificate evidencing such share, free of the legend set forth in Paragraph
10(d)(1) hereof, together with any other property of the Participant held by
the custodian pursuant to Section 14(b) hereof.
(f) Effect of Termination of Employment
(1) In the event that the employment of a Participant with the
Company shall terminate for any reason other than Cause prior to the vesting
of shares of Restricted Stock granted to such Participant, a proportion of
such shares (up to 100%), to the extent not forfeited or canceled on or prior
to such termination pursuant to any provision hereof, shall vest on the date
of such termination. The proportion referred to in the preceding sentence
shall be determined by the Committee at the time of the grant of such shares
of Restricted Stock and may be based on the achievement of any conditions
imposed by the Committee with respect to such shares pursuant to Section
10(b). Such proportion may be equal to zero.
(2) In the event of the termination of a Participant's
employment for Cause, all shares of Restricted Stock granted to such
Participant which have not vested as of the date of such termination shall
immediately be forfeited.
(3) In the event that a Non-Employee Participant ceases to
provide services to the Company, all shares of Restricted Stock granted to
such Non-Employee Participant shall vest in accordance with the terms of the
grant.
(g) Effect of Change in Control
Upon the occurrence of a Change in Control, all shares of Restricted
Stock which have not theretofore vested (including those with respect to which
the Issue Date has not yet occurred), or been canceled or forfeited pursuant
to any provision hereof, shall immediately vest.
(h) Registration of Restricted Stock
The Company, at the Company's expense, shall file and maintain a
registration statement on the appropriate form with the Securities and
Exchange Commission covering the restricted stock granted hereunder after it
has vested.
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11. Phantom Stock
Subject to the provisions of the Plan, the Committee may grant shares of
Phantom Stock. Each grant of shares of Phantom Stock shall be evidenced by an
agreement in such form as the Committee shall from time to time approve. Each
grant of shares of Phantom Stock shall comply with and be subject to the
following terms and conditions:
(a) Vesting Date
At the time of the grant of shares of Phantom Stock, the Committee
shall establish a Vesting Date or Vesting Dates with respect to such shares.
The Committee may divide such shares into classes and assign a different
Vesting Date for each class. Provided that all conditions to the vesting of a
share of Phantom Stock imposed pursuant to Section 11(c) hereof are satisfied,
and except as provided in Section 11(d) hereof, upon the occurrence of the
Vesting Date with respect to a share of Phantom Stock, such share shall vest.
(b) Benefit Upon Vesting
Upon the vesting of a share of Phantom Stock, a Participant shall be
entitled to receive in cash, within 30 days of the date on which such share
vests, an amount in cash in a lump sum equal to the sum of (i) the Fair Market
Value of a Common Share of the Company on the date on which such share of
Phantom Stock vests and (ii) the aggregate amount of cash dividends paid with
respect to a Common Share of the Company during the period commencing on the
date on which the share of Phantom Stock was granted and terminating on the
date on which such share vests.
(c) Conditions to Vesting
At the time of the grant of shares of Phantom Stock, the Committee
may impose such restrictions or conditions, not inconsistent with the
provisions hereof, to the vesting of such shares as it, in its absolute
discretion, deems appropriate. By way of example and not by way of limitation,
the Committee may require, as a condition to the vesting of any class or
classes of shares of Phantom Stock, that the Participant or the Company
achieve certain performance criteria, such criteria to be specified by the
Committee at the time of the grant of such shares.
(d) Effect of Termination of Employment
(1) In the event that the employment of a Participant with the
Company shall terminate for any reason other than Cause prior to the vesting
of shares of Phantom Stock granted to such Participant, a proportion of such
shares (up to 100%), to the extent not forfeited or canceled on or prior to
such termination pursuant to any provision hereof, shall vest on the date of
such termination. The proportion referred to in the preceding sentence shall
be determined by the Committee at the time of the grant of such shares of
Phantom Stock and may be based on the achievement of any conditions imposed by
the Committee with respect to such shares pursuant to Section 11(c). Such
proportion may be equal to zero.
(2) In the event of the termination of a Participant's
employment for Cause, all shares of Phantom Stock granted to such Participant
which have not vested as of the date of such termination shall immediately be
forfeited.
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(3) In the event that a Non-Employee Participant ceases to
provide services to the Company, all shares of Phantom Stock granted to such
Non-Employee Participant shall vest in accordance with the terms of the grant.
(e) Effect of Change in Control
Upon the occurrence of a Change in Control, all shares of Phantom
Stock which have not theretofore vested, or been canceled or forfeited
pursuant to any provision hereof, shall immediately vest.
12. Stock Bonuses
Subject to the provisions of the Plan, the Committee may grant Stock
Bonuses in such amounts as it shall determine from time to time. A Stock Bonus
shall be paid at such time and subject to such conditions as the Committee
shall determine at the time of the grant of such Stock Bonus. Certificates for
Common Shares granted as a Stock Bonus shall be issued in the name of the
Participant to whom such grant was made and delivered to such Participant as
soon as practicable after the date on which such Stock Bonus is required to be
paid.
13. Cash Bonuses
Subject to the provisions of the Plan, the Committee may grant, in
connection with any grant of Restricted Stock or Stock Bonus or at any time
thereafter, a cash bonus, payable promptly after the date on which the
Participant is required to recognize income for federal income tax purposes in
connection with such Restricted Stock or Stock Bonus, in such amounts as the
Committee shall determine from time to time; provided however, that in no
event shall the amount of a Cash Bonus exceed 50% of the Fair Market Value of
the related shares of Restricted Stock or Stock Bonus on such date. A Cash
Bonus shall be subject to such conditions as the Committee shall determine at
the time of the grant of such Cash Bonus.
14. Adjustment Upon Changes in Common Shares
(a) Shares Available for Grants
In the event of any change in the number of Common Shares
outstanding by reason of any stock dividend or split, recapitalization,
merger, consolidation, combination or exchange of shares or similar corporate
change, the maximum aggregate number of Common Shares with respect to which
the Committee may grant Options, Stand-Alone SARs, shares of Restricted Stock,
shares of Phantom Stock and Stock Bonuses shall be appropriately adjusted by
the Committee. In the event of any change in the number of Common Shares
outstanding by reason of any other event or transaction, the Committee may,
but need not, make such adjustments in the number and class of Common Shares
with respect to which Options, Stand-Alone SARs, shares of Restricted Stock,
shares of Phantom Stock and Stock Bonuses may be granted as the Committee may
deem appropriate.
(b) Outstanding Restricted Stock and Phantom Stock
Unless the Committee in its absolute discretion otherwise
determines, any securities or other property (including dividends paid in
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cash) received by a Participant with respect to a share of Restricted Stock,
the Issue Date with respect to which occurs prior to such event, but which has
not vested as of the date of such event, as the result of any dividend, stock
split, recapitalization, merger, consolidation, combination, exchange of
shares or otherwise, will not vest until such share of Restricted Stock vests,
and shall be promptly deposited with the custodian designated pursuant to
Paragraph 10(d)(2) hereof.
The Committee may, in its absolute discretion, adjust any grant of
shares of Restricted Stock, the Issue Date with respect to which has not
occurred as of the date of the occurrence of any of the following events, or
any grant of shares of Phantom Stock, to reflect any dividend, stock split,
recapitalization, merger, consolidation, combination, exchange of shares or
similar corporate change as the Committee may deem appropriate to prevent the
enlargement or dilution of rights of Participants under the grant.
(c) Outstanding Options, LSARs, Tandem SARs and Stand-Alone
SARs--Certain Increases or Decreases in Issued Shares Without Consideration
Subject to any required action by the shareholders of Delta
Petroleum Corporation, in the event of any increase or decrease in the number
of issued Common Shares resulting from a subdivision or consolidation of
Common Shares or the payment of a stock dividend (but only on the Common
Shares), the Committee shall proportionally adjust the number of Common Shares
subject to each outstanding Option, LSAR, Tandem SAR and Stand-Alone SAR, and
the exercise price per Common Share of each such Option, LSAR, Tandem SAR and
Stand-Alone SAR.
(d) Outstanding Options, LSARs, Tandem SARs and Stand-Alone
SARs--Certain Mergers
Subject to any required action by the shareholders of Delta
Petroleum Corporation, in the event that Delta Petroleum Corporation shall be
the surviving corporation in any merger or consolidation (except a merger or
consolidation as a result of which the holders of Common Shares receive
securities of another corporation), each Option, LSAR, Tandem SAR and
Stand-Alone SAR outstanding on the date of such merger or consolidation shall
pertain to and apply to the securities which a holder of the number of Common
Shares subject to such Option, LSAR, Tandem SAR or Stand-Alone SAR would have
received in such merger or consolidation.
(e) Outstanding Options, LSARs, Tandem SARs and Stand-Alone
SARs--Certain Other Transactions
Delta Petroleum Corporation shall not, at any time while there are
issued and outstanding pursuant to this Plan any unexpired options (including
any related LSARs or Tandem SARs), Stand-Alone SARs or other rights to acquire
securities of Delta Petroleum Corporation (whether or not then exercisable),
effect a merger, consolidation, exchange of shares, recapitalization,
reorganization, or other similar event, as a result of which shares of Common
Stock of Delta Petroleum Corporation shall be changed into the same or a
different number of shares of the same or another class or classes of stock or
securities or other assets of Delta Petroleum Corporation or another entity,
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or enter into any agreement to effect a sale of all or substantially all of
Delta Petroleum Corporation's assets (a "Corporate Change"), unless the
resulting successor or acquiring entity (the "Resulting Entity") assumes by
written instrument all of Delta Petroleum Corporation's obligations pursuant
to any options then outstanding under this Plan (including any related LSARs
or Tandem SARs), Stand-Alone SARs or other rights under this Plan to acquire
securities of Delta Petroleum Corporation (whether or not then exercisable),
which shall include, but not limited be to, an agreement in such written
instrument that any and all options then outstanding under this Plan
(including any related LSARs or Tandem SARs), Stand-Alone SARs or other rights
to acquire securities of Delta Petroleum Corporation (whether or not then
exercisable) or other rights shall be exercisable into such class, amount and
type of securities or other assets (or stock appreciation rights with respect
to, as appropriate) of the Resulting Entity as the holder would have received
had the holder exercised its options (including any related LSARs or Tandem
SARs), Stand-Alone SARs or other rights to acquire securities of Delta
Petroleum Corporation (whether or not then exercisable) issued pursuant to
this Plan immediately prior to such Corporate Change, and the Exercise Price
of such options or other rights shall be proportionately increased (if such
options or other rights shall be changed into or become exchangeable for an
option, warrant or other right to purchase a smaller number of shares of
Common Stock of the Resulting Entity) or shall be proportionately decreased
(if such options or other rights shall be changed or become exchangeable for
an option, warrant or other right to purchase a larger number of shares of
Common Stock of the Resulting Entity); provided, however, that Delta Petroleum
Corporation shall not affect any Corporate Change unless it first shall have
given thirty (30) days notice of any Corporate Change to each holder of issued
and outstanding unexpired options or other rights to acquire securities of
Delta Petroleum Corporation pursuant to this Plan at such holder's last known
address as reflected on the books and records of Delta Petroleum Corporation.
(f) Outstanding Options, LSARs, Tandem SARs and Stand-Alone
SARs--Other Changes
In the event of any change in the capitalization of Delta Petroleum
Corporation or corporate change other than those specifically referred to in
Section 14(c), (d) or (e) hereof, the Committee shall make such adjustments in
the number and class of shares subject to Options, LSARs, Tandem SARs or
Stand-Alone SARs outstanding on the date on which such change occurs and in
the per share exercise price of each such Option, LSAR, Tandem SAR and
Stand-Alone SAR to prevent dilution or enlargement of rights.
(g) No Other Rights
Except as expressly provided in the Plan, no Participant shall have
any rights by reason of any subdivision or consolidation of shares of stock of
any class, the payment of any dividend, any increase or decrease in the number
of shares of stock of any class or any dissolution, liquidation, merger or
consolidation of Delta Petroleum Corporation or any other corporation. Except
as expressly provided in the Plan, no issuance by Delta Petroleum Corporation
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of shares of stock of any class, or securities convertible into shares of
stock of any class, shall affect, and no adjustment by reason thereof shall be
made with respect to the number of Common Shares subject to an Incentive Award
or the exercise price of any Option, LSAR, Tandem SAR or Stand-Alone SAR.
15. Rights as a Shareholder
No person shall have any rights as a shareholder with respect to any
Common Shares covered by or relating to any Incentive Award granted pursuant
to this Plan until the date of the issuance of a stock certificate with
respect to such shares. Except as otherwise expressly provided in Section 14
hereof, no adjustment to any Incentive Award shall be made for dividends or
other rights for which the record date occurs prior to the date such stock
certificate is issued.
16. No Special Employment Rights; No Right to Incentive Award
Nothing contained in the Plan or any Incentive Award shall confer upon
any Participant any right with respect to the continuation of his employment
by the Company or interfere in any way with the right of the Company, subject
to the terms of any separate employment agreement to the contrary, at any time
to terminate such employment or to increase or decrease the compensation of
the Participant from the rate in existence at the time of the grant of an
Incentive Award.
No person shall have any claim or right to receive an Incentive Award
hereunder. The Committee's granting of an Incentive Award to a Participant at
any time shall neither require the Committee to grant an Incentive Award to
such Participant or any other Participant or other person at any time nor
preclude the Committee from making subsequent grants to such Participant or
any other Participant or other person.
17. Securities Matters
(a) Notwithstanding anything herein to the contrary, the Company
shall not be obligated to cause to be issued or delivered any certificates
evidencing Common Shares pursuant to the Plan unless and until the Company is
advised by its counsel that the issuance and delivery of such certificates is
in compliance with all applicable laws, regulations of governmental authority
and the requirements of any securities exchange on which Common Shares are
traded. The Committee may require, as a condition of the issuance and delivery
of certificates evidencing Common Shares pursuant to the terms hereof, that
the recipient of such shares make such covenants, agreements and
representations, and that such certificates bear such legends, as the
Committee, in its sole discretion, deems necessary or desirable.
(b) The exercise of any Option granted hereunder shall only be
effective at such time as counsel to the Company shall have determined that
the issuance and delivery of Common Shares pursuant to such exercise is in
compliance with all applicable laws, regulations of governmental authority and
the requirements of any securities exchange on which Common Shares are traded.
The Company may, in its sole discretion, defer the effectiveness of any
exercise of an Option granted hereunder in order to allow the issuance of
shares of Common Stock pursuant thereto to be made pursuant to registration or
an exemption from the registration or other methods for compliance available
under federal or state securities laws. The Company shall inform the
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Participant in writing of its decision to defer the effectiveness of the
exercise of an Option granted hereunder. During the period that the
effectiveness of the exercise of an Option has been deferred, the Participant
may, by written notice, withdraw such exercise and obtain the refund of any
amount paid with respect thereto.
(c) With respect to persons subject to Section 16 of the Securities
Exchange Act of 1934, transactions under this Plan are intended to comply with
all applicable conditions of Rule 16b-3 or its successors under the Exchange
Act. To the extent any provision of the Plan, the grant of an Incentive Award,
or action by the Committee fails to so comply, it shall be deemed null and
void, to the extent permitted by law and deemed advisable by the Committee.
18. Withholding Taxes
(a) Cash Remittance
Whenever Common Shares are to be issued upon the exercise of an
Option, the occurrence of the Issue Date or Vesting Date with respect to a
share of Restricted Stock or the payment of a Stock Bonus, the Company shall
have the right to require the Participant to remit to the Company in cash an
amount sufficient to satisfy federal, state and local withholding tax
requirements, if any, attributable to such exercise, occurrence or payment
prior to the delivery of any certificate or certificates for such shares. In
addition, upon the exercise of an LSAR, Tandem SAR or Stand-Alone SAR, the
grant of a Cash Bonus or the making of a payment with respect to a share of
Phantom Stock, the Company shall have the right to withhold from any cash
payment required to be made pursuant thereto an amount sufficient to satisfy
the federal, state and local withholding tax requirements.
(b) Stock Remittance
At the election of the Participant, subject to the approval of the
Committee, when Common Shares are to be issued upon the exercise of an Option,
the occurrence of the Issue Date or the Vesting Date with respect to a share
of Restricted Stock or the grant of a Stock Bonus, in lieu of the remittance
required by Section 18(a) hereof, the Participant may tender to the Company a
number of Common Shares determined by such Participant, the Fair Market Value
of which at the tender date the Committee determines to be sufficient to
satisfy the federal, state and local withholding tax requirements, if any,
attributable to such exercise, occurrence or grant and not greater than the
Participant's estimated total federal, state and local tax obligations
associated with such exercise, occurrence or grant.
(c) Stock Withholding
At the election of the Participant, subject to the approval of the
Committee, when Common Shares are to be issued upon the exercise of an Option,
the occurrence of the Issue Date or the Vesting Date with respect to a share
of Restricted Stock or the grant of a Stock Bonus, in lieu of the remittance
required by Section 18(a) hereof, the Company shall withhold a number of such
shares determined by such Participant, the Fair Market Value of which at the
exercise date the Committee determines to be sufficient to satisfy the
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federal, state and local withholding tax requirements, if any, attributable to
such exercise, occurrence or grant and is not greater than the Participant's
estimated total federal, state and local tax obligations associated with such
exercise, occurrence or grant.
19. Amendment of the Plan
The Plan will have no fixed termination date, but may be terminated at
any time by the Board of Directors. Incentive Awards outstanding as of the
date of any such termination will not be affected or impaired by the
termination of the Plan. The Board of Directors may amend, alter, or
discontinue the Plan, but no amendment, alteration or discontinuation shall be
made which would (i) impair the rights of a Participant without the
Participant's consent, except such an amendment which is necessary to cause
any Incentive Award or transaction under the Plan to qualify, or to continue
to qualify, for the exemption provided by Rule 16b-3, or (ii) disqualify any
Incentive Award or transaction under the Plan from the exemption provided by
Rule 16b-3. In addition, no such amendment may be made without the approval of
the Company's shareholders to the extent such approval is required by law or
agreement.
20. No Obligation to Exercise
The grant to a Participant of an Option, LSAR, Tandem SAR or Stand-Alone
SAR shall impose no obligation upon such Participant to exercise such Option,
LSAR, Tandem SAR or Stand-Alone SAR.
21. Expenses and Receipts
The expenses of the Plan shall be paid by the Company. Any proceeds
received by the Company in connection with any Incentive Award will be used
for general corporate purposes.
22. Suspension or Termination of Incentive Award
In addition to the remedies of the Company elsewhere provided for
herein, failure by a Participant to comply with any of the terms and
conditions of the Plan or the agreement executed by such Participant
evidencing an Incentive Award, unless such failure is remedied by such
Participant within ten days after having been notified of such failure by the
Committee, shall be grounds for the cancellation and forfeiture of such
Incentive Award, in whole or in part, as the Committee may determine.
23. Code Section 162(m).
The Committee, in its sole discretion, may require that one or more
Incentive Awards contain provisions which provide that, in the event Section
162(m) of the Code, or any successor provision relating to excessive employee
remuneration, would operate to disallow a deduction by the Company for all or
part of any Incentive Award under the Plan, a Participant's receipt of the
portion of such Incentive Award that would not be deductible by the Company
shall be deferred until the next succeeding year or years in which the
Participant's remuneration does not exceed the limit set forth in such
provision of the Code.
24. Effective Date of Plan
The Plan shall be effective as of November 1, 2001, subject to approval
by the Company's Shareholders at their next Annual or Special Meeting.
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25. Participation in the Plan by Nonemployee Directors
(a) The Plan will be administered as to Nonemployee Directors by the
Board of Directors.
(b) All Nonemployee Directors shall participate in the Plan, subject to
the conditions and limitations of the Plan, so long as they remain
eligible to participate in the Plan.
(c) No Nonemployee Director shall be eligible for an Incentive Award if,
at the time said Incentive Award would otherwise be granted, such
Nonemployee Director (i) is directly or indirectly the beneficial
owner of five percent or more of any class of equity security of the
Company which is registered pursuant to Section 12 of the Exchange
Act or of any security convertible into or exercisable for such
class of equity security (excluding shares covered by the Plan); or
(ii) is an officer, director, 10% or greater shareholder, employee
or agent of a person or entity which is directly or indirectly the
beneficial owner of more than five percent of any class of equity
security of the Company which is registered pursuant to Section 12
of the Exchange Act or of any security convertible into or
exercisable for such class of equity security (excluding shares
covered by the Plan). Incentive Award grants, if any, to any such
non-eligible Nonemployee Directors shall be determined by the Board.
(d) Unless the Board of Directors shall otherwise direct, Options or
Restricted Common Stock shall automatically be granted to
Nonemployee Directors according to the following formula:
(i) Stock and Options shall be determined for all eligible
Nonemployee Directors of the Company in each calendar year
during the term of the Plan as of December 31. No Stock or
Option may be changed after it has been so determined,
except pursuant to the Plan. No Nonemployee Director shall
be entitled to receive more than one grant of Stock or
Options per year pursuant to the Plan even if such
Nonemployee Director serves as a director for more than one
Participating Company. The Stock or Options shall be
granted to each Participant by the Company or, if the
Participant is not a Nonemployee Director of the Company, by
the Participating Company for which a Nonemployee Director
serves as a director.
(ii) Stock or Options shall be granted pursuant to the Plan to
eligible Participant as follows:
Annually each Participant who has served for any position of
the year shall be granted either: (1) an option for 20,000 shares of Common
Stock, or (2) at the election of the participating Nonemployee Director, shall
be granted, in lieu of an option, 10,000 shares of Restricted Common Stock.
The exercise price of the Stock Options to be granted to
Nonemployee Directors pursuant to the Plan shall be 50% of the Market Price as
determined at the date of grant. The "Market Price" of a share of Common
Stock under the Plan shall be the average of the "Fair Market Value" of the
Common Stock for all trading days during the twelve months preceding the date
on which the stock option is determined. The "Fair Market Value" of a share
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of Common Stock with respect to any day shall be (i) the closing sales price
of a share of Common Stock as reported on the principal securities exchange on
which shares of Common Stock are then listed or admitted to trading; or (ii)
if not so reported, the last sales price as reported by the NASDAQ Stock
Market; or (iii) if not so reported, the average of the closing bid and ask
prices as reported on the NASDAQ Stock Market; or (iv) if not so reported, as
furnished by any member of the National Association of Securities Dealers,
Inc. selected by the Committee. Each Stock Option shall be exercisable for a
ten year period commencing on the date of grant and shall expire ten years
after the date of grant. Certificates evidencing the Stock Options shall be
registered in the respective names of the Participants and shall be issued to
each Participant as soon as practicable following the date of grant.
A-24
PRELIMINARY COPY
DELTA PETROLEUM CORPORATION
PROXY
THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS
The undersigned hereby constitutes and appoints Aleron H. Larson, Jr. and
Roger A. Parker, or each of them, lawful attorneys and proxies of the
undersigned, with full power of substitution, for and in the name, place and
stead of the undersigned, to attend the Annual Meeting of Shareholders of
Delta Petroleum Corporation, to be held at Delta's corporate offices at 555
17th Street, Suite 3310, Denver, Colorado 80202 on _______ ______ __, 2002, at
10:00 a.m. (local time), and any adjournment(s) thereof, with all powers the
undersigned would possess if personally present and to vote thereat, as
provided below, the number of shares the undersigned would be entitled to vote
if personally present.
(Check One)
For Against Abstain
Proposal 1: To approve the four nominees to the
Board of Directors:
Aleron H. Larson, Jr. [ ] [ ] [ ]
Roger A. Parker [ ] [ ] [ ]
Jerrie F. Eckelberger [ ] [ ] [ ]
James B. Wallace [ ] [ ] [ ]
Proposal 2: To approve Delta's 2002 [ ] [ ] [ ]
Incentive Plan
Proposal 3: To approve the proposed
issuance of shares and warrants
pursuant to an Investment Agreement
with Swartz Private Equity, LLC [ ] [ ] [ ]
Proposal 4: To ratify the appointment of [ ] [ ] [ ]
KPMG LLP as independent auditors
Proposal 5: To approve an amendment to Delta's
Articles of Incorporation to reduce
the quorum and voting requirements
for meetings of shareholders [ ] [ ] [ ]
Proposal 6: To approve the proposed issuance
of shares pursuant to a Purchase
and Sale Agreement with Castle
Energy Corporation [ ] [ ] [ ]
In accordance with their discretion, said attorneys and proxies are authorized
to vote upon such other business as may properly come before the meeting or
any adjournment(s) thereof. Every properly signed proxy will be voted in
accordance with the specifications made thereon. IF NOT OTHERWISE SPECIFIED,
THIS PROXY WILL BE VOTED FOR PROPOSALS 1, 2,3, 4, 5 and 6. All prior proxies
are revoked. This proxy will also be voted in accordance with the discretion
of the proxy or proxies on any other business. Receipt is hereby acknowledged
of the Notice of Annual Meeting and Proxy Statement.
__________________________________________________________________________
Signature Signature (if jointly held)
_________________________________ ____________________________________
Print Name Print Name
_________________________________ ____________________________________
Dated Dated
(Please sign exactly as name appears hereon. When signing as attorney,
executor, administrator, trustee, guardian, etc., give full title as such.
For joint accounts, each joint owner should sign.)
PLEASE MARK, DATE, SIGN AND RETURN THE PROXY FORM PROMPTLY USING THE
ENCLOSED ENVELOPE.