SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from _______________ to _________________
COMMISSION FILE NUMBER: 0-10990
CASTLE ENERGY CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 76-0035225
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
357 South Gulph Road, Suite 260
King of Prussia, Pennsylvania 19406
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER: (610) 992-9900
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK -- $.50 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ].
Indicate by check mark whether Registrant is an accelerated filer as
defined in Rule 12b-2 of the Act. Yes ___ No _X_.
As of November 25, 2005, there were 7,305,360 shares of the registrant's
Common Stock ($.50 par value) outstanding. The aggregate market value of voting
stock held by non-affiliates of the registrant as of such date was $131,326,128
(6,893,760 shares at $19.05 per share).
DOCUMENTS INCORPORATED BY REFERENCE:
CASTLE ENERGY CORPORATION
2005 FORM 10-K
TABLE OF CONTENTS
ITEM PAGE
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PART I
1. and 2. Business and Properties.............................................................................................. 1
3. Legal Proceedings.................................................................................................... 6
4. Submission of Matters to a Vote of Security 10 Holders............................................................... 10
PART II
5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities......... 11
6. Selected Financial Data.............................................................................................. 12
7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................ 14
8. Financial Statements and Supplementary Data.......................................................................... 23
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................. 60
9A. Controls and Procedures.............................................................................................. 60
PART III
10. Directors and Executive Officers of the Registrant................................................................... 61
11. Executive Compensation............................................................................................... 64
12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters....................... 66
13. Certain Relationships and Related Transactions....................................................................... 68
14. Principal Accountant Fees and Services............................................................................... 68
PART IV
15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................................... 69
PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
INTRODUCTION
All statements other than statements of historical fact contained in this
report are forward-looking statements. Forward-looking statements in this report
generally are accompanied by words such as "anticipate," "believe," "estimate,"
or "expect" or similar statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, no
assurance can be given that such expectations will prove correct. Factors that
could cause the Company's results to differ materially from the results
discussed in such forward-looking statements are disclosed in this report. All
forward-looking statements in this Form 10-K are expressly qualified in their
entirety by the cautionary statements in this paragraph.
References to "the Company" mean Castle Energy Corporation, the parent,
and/or one or more of its subsidiaries. Such references are for convenience only
and are not intended to describe legal relationships.
From inception (February 1981) until September 2002, the Company operated
in the exploration and production segment of the energy business. During this
period the Company owned interests in oil and gas wells in fourteen states in
the United States and participated in the drilling of five wildcat wells in
Romania. For the periods from inception until August 1989 and from June 1999 to
September 6, 2002, the exploration and production segment of the energy business
was the only business in which the Company operated. On May 31, 2002, the
Company sold all of its domestic oil and gas properties to Delta Petroleum
Corporation, another public company engaged in oil and gas exploration and
production ("Delta"). On September 6, 2002, the Company sold all of its
interests in Romania to the operator of its Romanian concession. Prior to these
sales the Company owned interests in approximately 525 oil and gas wells in the
United States and a fifty percent interest in several drilling concessions in
Romania. As a result of these sales, the Company did not directly own any
operating assets from September of 2002 until March 30, 2004. On March 30 and
31, 2004, the Company acquired interests in 166 gas wells in western
Pennsylvania from Delta, another outside party and from several limited
partnerships. The Company operates approximately 130 of the wells.
During the period from August of 1989 through September 30, 1995, the
Company, through certain subsidiaries, was primarily engaged in petroleum
refining. Indian Refining I Limited Partnership (formerly Indian Refining
Limited Partnership) ("IRLP"), an indirect wholly-owned subsidiary of the
Company, owned the former Texaco Indian Refinery, an 86,000 barrel per day (B/D)
refinery located in Lawrenceville, Illinois ("Indian Refinery"). In addition,
Powerine Oil Company ("Powerine"), a former indirect wholly-owned subsidiary of
the Company, owned and operated a 49,500 B/D refinery located in Santa Fe
Springs, California ("Powerine Refinery"). By September 30, 1995, the Company's
refining subsidiaries had terminated and discontinued all of their refining
operations.
During the period from December 31, 1992 to May 31, 1999, the Company,
through two of its subsidiaries, was also engaged in natural gas marketing and
transmission operations. During this period one of the Company's subsidiaries
sold natural gas to Lone Star Gas Company ("Lone Star") under a long-term gas
sales contract. The subsidiaries also entered into two long-term gas sales
contracts and one long-term gas supply contract with MG Natural Gas Corp.
("MGNG"), a subsidiary of MG Corp. ("MG"), whose parent was Metallgesellschaft
A.G. ("MGAG"), a large German conglomerate. All of the subsidiaries' gas
contracts terminated on May 31, 1999. The Company has not replaced these
contracts because it sold its pipeline assets to a subsidiary of Union Pacific
Resources Corporation ("UPRC") in May 1997 and because it was unable to
negotiate similar profitable long-term contracts since most gas purchasers then
bought gas on the spot market.
In August 2000, the Company purchased thirty-five percent (35%) of the
membership interests of Networked Energy LLC ("Network") for $500,000. Network
is a private company engaged in the planning, installation and operation of
natural gas fueled energy generating facilities that supply power, heating and
cooling services directly to retail customers with significant energy
consumption to reduce their energy costs - especially during peak usage periods.
In March 2002, the Company invested an additional $150,000 in Network,
increasing its membership interest to 45%. The Company also made a loan to
Network of $125,000 at that time. Network is a start up company which earned its
first revenues during the quarter ended September 30, 2004.
-1-
In October 1996, the Company commenced a program to repurchase shares of
its common stock at stock prices beneficial to the Company. As of November 25,
2005, 4,911,044 shares had been repurchased or surrendered and the Company's
Board of Directors has authorized the purchase of up to 356,946 additional
shares.
As of September 30, 2005, the Company's primary assets were as follows:
a. $27,759,000 of unrestricted cash.
b. 6,700,000 common shares of Delta, representing approximately 14%
of Delta's outstanding common shares. Such shares had a market
value of approximately $139,360,000 based upon the closing price
of Delta's common stock on September 30, 2005.
c. Oil and gas properties with an estimated market value of
$14,000,000 to $17,000,000.
d. A 45% membership interest in Network. Network's book value was
$5,000 at September 30, 2005.
e. A loan secured by a mortgage on a vacant refinery site in
Theodore, Alabama formerly owned by GAMXX Energy Inc. ("GAMXX"),
which the Company has agreed to sell for $3,500,000. The book
value of the loan at September 30, 2005 was zero.
In addition, the Company is involved in two significant lawsuits - see
Item 3 - "Legal Proceedings."
On November 8, 2005, the Company entered into a merger agreement (the
"Merger Agreement") with Delta. Delta Petroleum Corporation, a newly-formed
Delaware corporation and a wholly-owned subsidiary of Delta ("Delta-Delaware"
and collectively, with Delta "Delta") and DPCA LLC, a Delaware limited liability
company and a newly formed wholly-owned subsidiary of Delta ("DPCA").
Pursuant to the merger agreement, the Company will merge with and into
DPCA with DPCA as the surviving company and the Company's stockholders will
receive approximately 1.164 shares of Delta's common stock for each of their
shares of the Company's common stock (or a total of 8,500,000 shares of Delta
common stock in the aggregate) (the "Merger"). In the Merger, the 6,700,000
shares of Delta common stock currently owned by the Company will be cancelled.
The Merger is designed to be a tax-free exchange for stockholders of both Delta
and the Company. The boards of directors of the Company and Delta have approved
the Merger.
The closing of the merger is subject to approval of the Merger
Agreement by the holders of a majority of the shares of the Company's
outstanding common stock, review of the related prospectus by regulatory
agencies, receipt of legal opinions and other customary closing conditions set
forth in the Merger Agreement.
The Merger Agreement contains certain termination rights for both Delta
and the Company, and further provides that, upon termination of the Merger
Agreement under specified circumstances, either party may be required to pay the
other a termination fee of $5,000,000 or reimburse the other party up to
$1,000,000 in fees and expenses actually incurred relating to the transaction
contemplated by the Merger Agreement.
Concurrently with the execution of the Merger Agreement and in order to
induce Delta to enter into the Merger Agreement, certain of the Company's
officers and all of its directors and the estate and family of the Company's
founder and former Chief Executive Officer, Joseph L. Castle II, have entered
into voting agreements with Delta pursuant to which they agreed, among other
things, to vote all shares of the Company's common stock held by them in favor
of the adoption of the Merger Agreement and the other transactions contemplated
by the Merger Agreement.
The foregoing description of the Merger Agreement and the voting
agreements does not purport to be complete and is qualified in its entirety by
reference to the Merger Agreement and voting agreements.
The Company will file a preliminary proxy statement and a definitive
proxy statement in connection with the proposed Merger with the Securities and
Exchange Commission (the "SEC"). The proxy statement will be mailed to the
stockholders of the Company. STOCKHOLDERS OF THE COMPANY ARE URGED TO READ THE
PROXY STATEMENT AND OTHER RELEVANT MATERIALS WHEN THEY BECOME AVAILABLE BECAUSE
THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT THE MERGER AND THE COMPANY.
Investors and security holders may obtain free copies of these documents (when
they are available) and other documents filed with the SEC at the SEC's web site
at www.sec.gov.
-2-
OIL AND GAS EXPLORATION AND PRODUCTION
GENERAL
The Company's significant activities during the five years ended
September 30, 2005 are as follows:
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, a public oil and gas exploration and production
company ("Costilla"), by the Romanian government. The Company paid Costilla
$65,000 for the option. In May 1999, the Company exercised the option. By
September 30, 2001, the Company had participated in the drilling of five wildcat
wells in Romania. Four of those wells resulted in dry holes. Although the fifth
well produced some volumes of natural gas when tested, the Company was not able
to obtain a sufficiently high gas price to justify future production. The
Company subsequently agreed to participate in the drilling of a sixth well in
the Black Sea in the spring or early summer of 2002. The drilling of the Black
Sea well was postponed several times because of the lack of suitable drilling
rigs. On September 6, 2002, the Company's subsidiary, which owned a 50% interest
in the Romanian drilling concessions, sold all of its interests in Romania to
the operator of the concessions for $1. As a result, the Company did not
participate in the drilling of the wildcat well in the Black Sea, which, the
Company was informed, resulted in a dry hole.
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
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. The Company used its own
internally generated funds to make the purchase.
On May 31, 2002, the Company consummated the sale of all of its
domestic oil and gas properties to Delta. The sale was pursuant to a purchase
and sale agreement dated January 15, 2002. At closing, the Company received
$18,236,000 cash plus 9,566,000 shares of Delta's common stock. The $18,236,000
cash represented a $20,000,000 purchase price cash component as of October 1,
2001, the effective date of the sale, less $1,764,000 of net cash flow received
by the Company applicable to production from the properties subsequent to the
effective date. In September 2002, the Company paid Delta $194,000 as a final
purchase price adjustment, effectively reducing the cash portion of the sale to
$18,042,000. Pursuant to the purchase and sale agreement the Company granted
Delta an option to repurchase up to 3,188,667 of Delta's shares owned by the
Company at $4.50/share through May 31, 2003. Delta's option expired unexercised
on May 31, 2003.
The Company owned no oil and gas properties from September 6, 2002
until March 30, 2004.
On March 31, 2004, the Company acquired interests in 138 western
Pennsylvania gas wells from Delta. The Company previously owned most of these
properties through May 31, 2002 when it sold all of its United States oil and
gas properties to Delta. The effective date of the purchase was January 1, 2004.
The purchase price was $8,000,000. At the same time the Company also purchased
another owner's interests in the same gas properties for $334,000. The other
owner's interests in the properties were approximately four percent of Delta's
interests in the same properties. On March 30, 2004, the Company acquired
interests in 28 western Pennsylvania gas wells for $1,100,000 from five limited
partnerships.
The final purchase price for all three gas property acquisitions was
approximately $8,985,000 after giving effect to all purchase price adjustments
and excluding $222,000 of related asset retirement obligations.
The Company's petroleum reservoir engineer has estimated the proved
reserves applicable to the three purchases to be approximately eight billion
cubic feet of natural gas at date of purchase, of which approximately 87%
represents proved producing reserves, while the remaining 13% represents behind
pipe and undeveloped reserves. Approximately 130 of 166 wells in which the
Company acquired interests are operated by the Company.
-3-
PROPERTIES
Proved Oil and Gas Reserves
The following is a summary of the Company's oil and gas reserves as of
September 30, 2005. All estimates of reserves are based upon engineering
evaluations prepared by the Company's independent petroleum reservoir engineers,
Ralph E. Davis Associates, Inc., in accordance with the requirements of the SEC.
Such estimates include only proved reserves. The Company reports its reserves
annually to the Department of Energy. The Company's estimated reserves were as
follows:
SEPTEMBER 30,
-------------------------
NET MCF OF GAS: 2005 2004
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Proved developed ....................................................... 7,792,341 8,081,000
Proved undeveloped ..................................................... 623,576 804,000
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Total .................................................................. 8,415,917 8,885,000
========= =========
Since the Company sold all of its oil and gas properties by September
30, 2002 and did not reacquire any gas properties until March 30, 2004, the
Company did not directly own any oil and gas reserves at September 30, 2003.
In addition, proven oil and gas revenues were indirectly attributed to
the Company by virtue of the Company's ownership of Delta, which was 17.8% at
September 30, 2004. Such reserves are included in the unaudited reserve
disclosures in Note 13 to the consolidated financial statement included in Item
8 of this Form 10-K.
Oil and Gas Production
The following table summarizes the net quantities of oil and gas
production of the Company for each of the three fiscal years in the period ended
September 30, 2005, including production from acquired properties since the date
of acquisition.
FISCAL YEAR ENDED SEPTEMBER 30,
-------------------------------------
2005 2004 2003
------- ------- ---------
Oil -- Bbls (barrels).................................................. 0 0 0
Gas -- MCF (thousand cubic feet)....................................... 384,950 156,000 0
Production for the year ended September 30, 2004 only includes
production from March 30, 2004 to September 30, 2004 since the Company owned no
oil and gas properties from October 1, 2003 to March 29, 2004.
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 the Company 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. The Company did not hedge its production
during these periods.
FISCAL YEAR ENDED SEPTEMBER 30,
--------------------------------
2005 2004 2003
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Average Sales Price per Barrel of Oil................................... N/A N/A N/A
Average Sales Price per MCF of Gas...................................... $6.65 $6.96 N/A
Average Production Cost per Equivalent MCF(1)........................... $1.52 $2.02 N/A
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(1) For purposes of equivalency of units, a barrel of oil is assumed equal
to six MCF of gas, based upon relative energy content.
-4-
No sale price or production cost data are included in the above data
for the period October 1, 2002 to March 30, 2004 because the Company sold all of
its producing oil and gas properties to Delta on May 31, 2002 and did not
acquire gas properties until March 30, 2004.
Production Wells and Acreage
The following table presents the oil and gas properties in which the
Company held an interest as of September 30, 2005 and 2004. The wells and
acreage owned by a subsidiary of the Company are located in Pennsylvania.
AS OF AS OF
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
------------------------ ----------------------
Productive Wells:(1) GROSS(2) NET(3) GROSS(2) NET (3)
--------- --------- -------- ---------
Gas Wells............................................. 166 127 166 127
Oil Wells............................................. 0 0 0 0
ACREAGE:
Developed Acreage..................................... 5,680 3,644 5,680 3,644
Undeveloped Acreage................................... 1,002 800 1,002 800
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(1) A "productive well" is a producing well or a well capable of production.
(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.
The Company owned no wells or acreage at September 30, 2003.
Drilling Activity
The Company has not participated in the drilling of any wells since it
sold all of its domestic oil and gas properties to Delta in May 2002.
REGULATIONS
The oil and gas exploration and production operations of the Company are
subject to a number of local, state and federal environmental laws and
regulations. Compliance with such regulations has not resulted in material
expenditures.
Most states in which the Company historically conducted and currently
conducts oil and gas exploration and production activities have laws regulating
the production and sale of oil and gas. Such laws and regulations generally are
intended to prevent waste of oil and gas and to protect correlative rights and
opportunities to produce oil and gas between owners of interests in a common
reservoir. Most states also have regulations requiring permits for the drilling
of wells and regulations governing the method of drilling, casing and operating
wells, the surface use and restoration of properties upon which wells are
drilled and the plugging and abandonment of wells. In recent years there has
been a significant increase in the amount of state regulation, including
increased bonding, plugging and operational requirements. Such increased state
regulation resulted in increased legal and compliance costs to the Company.
The Company is subject to various local, state and Federal laws
regarding environmental and ecological matters because it acquired and now
operates gas properties. To alleviate the environmental risk, the Company
carries $5,000,000 of liability insurance. The costs of such liability insurance
have increased significantly recently. Although the Company believes that the
insurance it carries is adequate, such may not be the case given increased
litigiousness generally.
-5-
EMPLOYEES AND OFFICE FACILITIES
As of November 25, 2005, the Company and one of its subsidiaries
employed nine personnel.
The Company leases certain offices as follows:
OFFICE LOCATION FUNCTION
--------------- --------
King of Prussia, PA Corporate Headquarters
Blue Bell, PA Accounting and Administration
Oklahoma City, Oklahoma Legal
The leases governing the Company's offices include standard provisions
for fixed rentals plus reimbursement of allocated shares of utility costs and
the right to sublease subject to landlord approval. The last office lease
expires in December 2010. The lease commitments of the Company are set forth in
Note 15 to the Consolidated Financial Statements in Item 8 to this Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
ENVIRONMENTAL LIABILITIES/LITIGATION
Chevron Litigation
On September 20, 2005, the Company settled its long-standing litigation
with Texaco Inc. and other subsidiaries of Chevron Corporation (collectively "
Chevron"). In exchange for a payment of $5,750,000 by the Company, the Company
negotiated a settlement agreement which provided mutual releases and a complete
and comprehensive indemnification by Texaco Inc. of the Company, related
entities and persons against losses or liabilities arising out of or related to
the now dismantled Indian Refinery and related properties.
Chevron had filed the lawsuit against the Company and two of its
inactive subsidiaries in August 2002, seeking damages and declaratory relief
under contractual and statutory claims arising from environmental contamination
at the Indian Refinery. A now inactive subsidiary of the Company had operated
that refinery for approximately five years subsequent to approximately
seventy-five years of operation by Chevron. The lawsuit claimed that the Company
was contractually obligated to indemnify and defend Chevron against all
liability and costs, including lawsuits, claims and administrative actions
initiated by the United States Environmental Protection Agency ("EPA") and
others that Chevron had incurred or might incur as a result of environmental
contamination at and around the Indian Refinery, even if that environmental
contamination had been caused by Chevron. The suit also sought costs, damages
and declaratory relief against the Company under the Federal Comprehensive
Environmental Response Compensation Liability Act ("CERCLA"), the Oil Pollution
Act of 1990 ("OPA") and the Solid Waste Disposal Act, as amended, ("RCRA").
Chevron had also tendered to the Company the defense of certain third party
claims against Chevron in Illinois state court. The Company disputed and
contested the claims made by Chevron and denied all liability.
All claims in this litigation, as well as any other claims tendered by
Chevron, have been resolved by the settlement and the litigation was dismissed
with prejudice on October 12, 2005. At September 30, 2005, the Company accrued
the $5,750,000 settlement which it paid on October 26, 2005.
OTHER LITIGATION
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were
defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case,
the Long Trusts, are non-operating working interest owners in certain wells
previously operated by Castle Texas Production Limited Partnership ("CTPLP"), an
inactive exploration and production subsidiary of the Company. The wells were
among those sold to UPRC in May 1997. The Long Trusts claimed that CTPLP did not
allow them to sell gas from March 1, 1996 to January 31, 1997 as required by
applicable joint operating agreements, and they sued CTPLP and the Company's
other subsidiaries, claiming (among other things) breach of contract, breach of
fiduciary duty, conversion and conspiracy. The Long Trusts sought actual
damages, exemplary damages, prejudgment and post-judgment interest, attorney's
fees and court costs. CTPLP counterclaimed for approximately $150,000 of unpaid
joint interest billings plus interest, attorney's fees and court costs.
-6-
After a three-week trial, the District Court in Rusk County submitted 36
questions to the jury which covered the claims and counterclaim in the lawsuit.
Based upon the jury's answers, the District Court entered judgment on some of
the Long Trusts' claims against the Company and its subsidiaries, as well as
CTPLP's counterclaim against the Long Trusts. The District Court issued an
amended judgment on September 5, 2001 which became final December 19, 2001. The
net amount awarded to the plaintiffs was approximately $2,700,000.
The Company and its subsidiaries and the Long Trusts subsequently filed
notices of appeal, submitted legal briefs in April 2002, reply briefs in June
and July 2002, and ultimately argued the case before the 12th Court of Appeals
in Tyler, Texas in October 2002. On July 31, 2003, that court reversed and
remanded in part the trial court's judgment against the Company and its
subsidiaries while affirming the judgment against the Long Trusts which had
awarded damages on the counterclaim asserted by CTPLP. In its decision, the
appellate court held that the trial court had submitted erroneous theories to
the jury, expressly rejecting the Long Trusts' claims for breach of fiduciary
duty, conversion, implied covenants and exemplary damages. It also remanded the
Long Trusts' claims for breach of contract to the district court for retrial.
The appellate court upheld the trial court's award to CTPLP on its counterclaim
for approximately $150,000 of unpaid joint interests billings, $450,000 in
attorneys' fees, plus interest and court costs. Both the Company and its
subsidiaries and the Long Trusts thereafter submitted motions for a rehearing on
certain rulings to the 12th Court of Appeals. That court denied both motions for
a rehearing.
The Long Trusts subsequently filed a petition for review with the
Supreme Court of Texas. On March 26, 2004, the Texas Supreme Court denied the
Long Trusts petition for review and the Long Trusts filed a petition for
rehearing with that court two weeks later. That petition was also subsequently
denied, whereupon the Court of Appeals issued its mandate on June 9, 2004,
completing the appellate process. The supersedeas bond posted by the Company was
released, along with a $4,110,000 letter of credit, including accrued interest,
that secured the bond. Certain breach of contract claims by the Long Trusts
which were reversed and remanded by the appellate court may be retried by the
plaintiffs. Based on the evidence at the initial trial coupled with the guidance
to the trial court given in the appellate decision, the Company believes that it
will be able to prove that there was no breach of contract and that Long Trusts
suffered no damages, and that any such breach of contract claims, even if
decided adversely to the Company, will not result in a material loss to the
Company.
Pursuant to the mandate of the Texas Court of Appeals, the Company moved
to sever CTPLP's claims against the Long Trusts from any retrial of the Long
Trust's contract claims against the Company and to collect on CTPLP's judgment
against the Long Trusts which is secured by a letter of credit posted by the
Long Trusts with the trial court. On September 17, 2004, the Long Trusts filed a
Motion for Clarification with the Court of Appeals which in essence sought to
reverse that court's severance of CTPLP's claims from the retrial of the Long
Trusts' breach of contract claims. The Company filed a Petition for Writ of
Mandamus with the Court of Appeals on December 3, 2004, requesting that the
trial court be stayed from proceeding further, and be ordered to comply with the
June mandate of the Court of Appeals. On January 31, 2005, the Court of Appeals
stayed the trial court from proceeding and subsequently denied the Motion for
Clarification on March 3, 2005 and the Petition for Writ of Mandamus on March
16, 2005. On May 2, 2005, the trial court from the bench announced that CTPLP's
severed claim would be assigned a new case number, but took all other requests
for action from the parties under advisement. In August 2005, the Company filed
a second Petition for Writ of Mandamus with the Court of Appeals requesting that
the calculation of interest due from the Long Trusts be made without a new trial
and that Long Trusts be ordered to pay the judgment against it plus interest
without delay.
The Company estimates the judgment to be $1,046,000, including accrued
interest, as of September 30, 2005. The Company has not accrued any recoveries
for this litigation as of September 30, 2005, but will record recoveries if and
when they are ultimately realized (collected).
-7-
Pilgreen Litigation
As part of the oil and gas properties acquired from AmBrit Energy
Corporation ("AmBrit") in June 1999, Castle Exploration Company, Inc., a
wholly-owned subsidiary of the Company ("CECI") acquired a 10.65% overriding
royalty interest ("ORRI") in the Simpson lease in south Texas, including the
Pilgreen #2ST gas well. CECI subsequently transferred that interest to Castle
Texas Oil and Gas Limited Partnership ("CTOGLP"), an indirect wholly-owned
subsidiary. Because the operator suspended revenue attributable to the ORRI from
first production due to title disputes, AmBrit, the previous owner, filed claims
against the operator of the Pilgreen well, and CTOGLP acquired rights in that
litigation with respect to the period after January 1, 1999. In August 2002,
$282,000 was released to the Company of which $249,000 was recorded as income by
the Company and the remaining $33,000 paid to Delta. Because of a claim by
Dominion Oklahoma Texas Exploration and Production, Inc. ("Dominion") (see
below), a working interest owner in the same well, that CTOGLP's ORRI in the
Simpson lease should be deemed burdened by 3.55% overriding royalty interest,
there is still a title dispute as to approximately $120,000 of suspended CTOGLP
Pilgreen #2ST production proceeds for the Company's account. (The Company sold
all of its oil and gas assets, including the Pilgreen #2ST well, to Delta on May
31, 2002 but effective as of October 1, 2001.) The Company has named Dominion as
a defendant in a legal action seeking a declaratory judgment that the Company is
entitled to its full 10.65% overriding royalty interest in the Pilgreen well.
The Company believes that Dominion's title exception to CTOGLP's overriding
royalty interest is erroneous and notes that several previous title opinions
have confirmed the validity of CTOGLP's interest. The litigation is related to
the Dominion litigation (see below). The Company and its counsel are currently
reviewing the effect of the Court of Appeals' opinion issued in the Dominion
litigation on the Company's claims in this litigation. Since the Company has not
recorded any revenue related to the $120,000 of suspended revenue, it expects to
record $120,000 of revenue if and when such revenue is realized (collected), but
no expense if it fails in this litigation.
Christiansen Litigation
CTOGLP, along with several unrelated parties, has also filed suit to
collect production proceeds from an additional well on the Simpson lease in
which CTOLGP had a 5.325% ORRI suspended by the operator because of title
disputes. The Company intends to contest this matter vigorously. At the present
time, the amount held in escrow applicable to the additional well attributable
to the Company's interest is approximately $66,000 although approximately
$22,000 of that amount would be subject to Dominion's claims in the Pilgreen
Litigation. The Company has not recorded any of the net $44,000 of suspended
revenue as income, but will record it as income when and if it is realized
(collected). There is no claim or contingent liability against the Company or
its subsidiaries in this matter, just a contingent gain if CTOGLP were to
prevail.
Dominion Litigation
On March 18, 2002, Dominion, operator of the Mitchell and Migl-Mitchell
wells in the Southwest Speaks field in south Texas and a working interest owner
in the Pilgreen #2ST well, filed suit in Texas against CTOGLP seeking
declaratory judgment in a title action that the ORRI held by CTOGLP in these
wells should be deemed to be burdened by certain other ORRI's aggregating 3.55%
and should therefore be reduced from 10.65% to 7.10%. Dominion is also seeking
an accounting and refund of payments for overriding royalty to CTOGLP in excess
of the 7.10% since April 2000. The Company currently estimates the amount in
controversy to be approximately $783,000. Dominion threatened to suspend all
revenue payable to the Company from the Mitchell and Migl-Mitchell to offset its
claim. The Company and Dominion subsequently examined the land and lease
documents concerning the ORRI's. The Company believes that Dominion's title
exception to CTOGLP's ORRI is erroneous and notes that several previous title
opinions have confirmed the validity of CTOGLP's interest.
In July 2003, Dominion filed a motion for partial summary judgment
concerning the Company's claim that it had assumed the liabilities of its
predecessor in interest and CTOGLP filed its response to Dominion's motion as
well as its own cross motion for partial summary judgment. In September 2003,
the District Court of Lavaca County granted Dominion's partial motion for
partial summary judgment. In January 2004, Dominion filed a motion for final
summary judgment on this matter to which CTOGLP and the other defendants filed a
response. In May 2004, the District Court of Lavaca County granted Dominion's
motion for final summary judgment, following which the Company appealed both of
the District Court's summary judgments to the Court of Appeals in Corpus
Christi.
By agreement with Dominion, CTOGLP executed a promissory note for
$783,000 guaranteed by the Company and deposited this amount in a separate
restricted cash account of CTOGLP to support the note and to avoid the cost of a
supersedeas bond. On July 28, 2005, the Court of Appeals issued a Memorandum
Opinion that affirmed Dominion's claims to reduce the ORRI, but only to take
effect at a date after CTOGLP had sold the ORRI. The Court of Appeals overturned
that portion of the judgment that required CTOGLP to refund any money received
by it. The Company does not at this time know if Dominion intends to petition
the Supreme Court of Texas for review of this decision. The promissory note
issued by CTOGLP will be cancelled and the restricted cash account of CTOGLP
released when and if this judgment becomes final and non-appealable.
-8-
In fiscal 2004, the Company recorded an $825,000 loss provision related
to the Dominion litigation - primarily as a result of the District Court's
granting of Dominion's motion for summary judgment in May 2004. The Company has
reversed that provision plus $20,000 of accrued interest on the contingent note
during fiscal 2005 primarily because the Court of Appeals reversed that District
Court judgment against the Company. Nevertheless, Company's contingent note
payable to Dominion and CTOGLP's restricted cash account are required to remain
in place until the Appeals Court judgment becomes non-appealable. Dominion filed
a petition for appeal to the Texas Supreme Court of the appellate court's
decision. If the Supreme Court reverses the Appeals Court decision, the Company
would then become liable for the contingent note to Dominion plus interest or
some portion thereof. In such case, the Company would again record a loss
provision.
-9-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not hold a meeting of stockholders or otherwise submit
any matter to a vote of stockholders during the fourth quarter of fiscal 2005.
-10-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
PRINCIPAL MARKET
The Company's Common Stock is quoted on the Nasdaq National Market
("NNM") under the trading symbol "CECX."
STOCK PRICE AND DIVIDEND INFORMATION
Stock Price:
The table below presents the high and low sales prices of the Company's
Common Stock as reported by the NNM for each of the quarters during the two
fiscal years ended September 30, 2005.
2005 2004
------------------ -------------------
HIGH LOW HIGH LOW
------ ------ ------ -----
First Quarter (December 31)..................................... $13.35 $10.56 $ 7.50 $5.22
Second Quarter (March 31)....................................... $12.80 $10.36 $10.50 $7.25
Third Quarter (June 30)......................................... $13.22 $ 9.01 $14.00 $9.04
Fourth Quarter (September 30)................................... $22.00 $12.40 $15.40 $9.81
The final sale of the Company's Common Stock as reported by the NNM on
November 25, 2005 was at $19.05.
Dividends:
On June 30, 1997, the Company's Board of Directors adopted a policy of
paying regular quarterly cash dividends of $.05 per share on the Company's
common stock. Commencing July 15, 1997, dividends have been paid quarterly
except for the quarter ended June 30, 2002. As with any company, the declaration
and payment of future dividends are subject to the discretion of the Company's
Board of Directors and will depend on various factors.
In addition, the Company's Board of Directors approved a special
dividend of $1.00 per share which was paid in June 2005.
APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK
As of November 25, 2005, the Company's Common Stock was held by
approximately 3,000 stockholders.
-11-
EQUITY COMPENSATION PLANS OF THE COMPANY
Information with respect to outstanding options to acquire the Company's
stock pursuant to equity compensation plans of the Company as of September 30,
2005 is as follows:
NUMBER OF WEIGHTED NUMBER OF
SECURITIES AVERAGE SECURITIES
TO BE ISSUED EXERCISE REMAINING
UPON EXERCISE PRICE OF AVAILABLE
OF OUTSTANDING OUTSTANDING FOR
OPTIONS, OPTIONS, ISSUANCE
WARRANTS WARRANTS UNDER
AND RIGHTS AND RIGHTS EQUITY PLAN (1)
--------------- ------------ ---------------
Equity compensation plans approved by security holders........ 75,000 $6.36 1,612,500
Equity compensation plans not approved by security
holders............................................... 15,000 $3.79
------ ---------
Total................................................. 90,000 $5.93 1,612,500
====== =========
(1) Excludes shares subject to outstanding options, warrants and rights.
The Company's 1992 Equity Incentive Plan was approved by stockholders
and adopted by the Company in 1993. The other options issued were not pursuant
to any plan. (See Note 18 to the consolidated financial statements included in
Item 8 of this Form 10-K.)
Subsequent to September 30, 2005, the 90,000 options outstanding at
September 30, 2005 were exercised.
ITEM 6. SELECTED FINANCIAL DATA
During the five fiscal years ended September 30, 2005 the Company
consummated a number of transactions affecting the comparability of the
financial information set forth below. See Note 4 to the Company's Consolidated
Financial Statements included in Item 8 of this Form 10-K.
The following selected financial data have been derived from the
Consolidated Financial Statements of the Company for each of the five years
ended September 30, 2005. The information should be read in conjunction with the
Consolidated Financial Statements and notes thereto included in Item 8 of this
Form 10-K.
-12-
FOR THE FISCAL YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------------
2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales:
Exploration and production ........................... $2,561 $ 1,087 $9,445 $21,144
Gross Margin:
Exploration and production (oil and gas sales,
less production expenses)........................... $1,977 $ 772 $6,178 $13,745
Income (loss) from continuing operations, net of tax $1,801 $13,620 ($2,001) ($1,844) $ 1,716
Income (loss) from discontinued operations, net of
tax................................................. ($3,392)
Net income (loss)...................................... ($1,591) $13,620 ($2,001) ($1,844) $ 1,716
Income (loss) per common share:
Continuing operations:
Basic.............................................. $ .26 $ 2.04 ($ .30) ($ .28) $ .26
Diluted............................................ $ .26 $ 1.96 ($ .30) ($ .28) $ .25
Discontinued operations:
Basic.............................................. ($ .49)
Diluted............................................ ($ .49)
Net income (loss)
Basic.............................................. ($ .23) $ 2.04 ($ .30) ($ .28) $ .26
Diluted............................................ ($ .23) $ 1.96 ($ .30) ($ .28) $ .25
Dividends declared per share of common stock
outstanding ......................................... $ 1.20 $ .20 $ .20 $ .15 $ .20
SEPTEMBER 30,
------------------------------------------------------------------
2005 2004 2003 2002 2001
---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Total assets........................................... $177,723 $83,826 $49,808 $51,941 $59,118
Long-term obligations.................................. $ 275 $ 246
Redeemable preferred stock.............................
Capital leases.........................................
-13-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
("$000'S OMITTED EXCEPT SHARE AND PER UNIT AMOUNTS)
GENERAL
All statements other than statements of historical fact contained in
this report are forward-looking statements. Forward-looking statements in this
report generally are accompanied by words such as "anticipate," "believe,"
"estimate," or "expect" or similar statements. Although the Company believes
that the expectations reflected in such forward-looking statements are
reasonable, no assurance can be given that such expectations will prove correct.
Factors that could cause the Company's results to differ materially from the
results discussed in such forward-looking statements are discussed below. All
forward-looking statements in this Form 10-K are expressly qualified in their
entirety by the cautionary statements in this paragraph.
During the period from August 1989 to September 30, 1995, two of the
Company's subsidiaries conducted refining operations. By December 12, 1995, the
Company's refining subsidiaries had sold all of their refining assets. In
addition, Powerine merged into another company and was no longer a subsidiary of
the Company. The Company's other refining subsidiaries own no refining assets
and are in the process of liquidation. As a result, the Company accounted for
its refining operations as discontinued operations in the Company's consolidated
financial statements as of September 30, 1995 and retroactively. In September
2005, the Company settled the Chevron litigation for $5,750 and recorded a loss
from discontinued operations of $3,392, net of $1,505 tax.
Since November 1996, the Company has reacquired 4,911,044 shares or
approximately 69% of its previously outstanding common stock (after taking into
account a three-for-one stock split in January 2000). As a result of these share
acquisitions, earnings and losses per outstanding share have been higher than
would have been the case if no shares had been repurchased.
FISCAL 2005 VERSUS FISCAL 2004
Gas sales increased $1,474 from 2004 to 2005 as a result of the
Company's acquisition of 166 Appalachian gas properties on March 30 and 31, 2004
(see Note 4 to the consolidated financial statements included in this Form
10-K). The Company owned no oil and gas properties from October 1, 2003 to March
30, 2004.
Production expenses increased $269 from 2004 to 2005 as a result of the
Company's acquisition of 166 Appalachian gas properties on March 30, and 31,
2004 (see Note 4 to the consolidated financial statements included in this Form
10-Q). The Company owned no oil and gas properties from October 1, 2003 to March
30, 2004.
Depreciation, depletion and amortization increased $256 from 2004 to
2005. The increase was entirely attributable to the gas properties acquired by
the Company in March 2004. The Company owned no oil and gas properties from
October 1, 2003 to March 30, 2004.
General and administrative costs increased $499 or 11.3% from 2004 to
2005. The increase was primarily attributable to increased compensation costs.
The $845 litigation recovery in 2005 results from the Appeal Court
decision in the Dominion Litigation. This amount represents the reversal of an
$825 litigation provision related to the same Dominion litigation recorded in
2004 plus $20 of interest. See Item 3 to this Form 10-K.
-14-
The Company's equity in Delta's net income increased $338 or 25% from
2004 to 2005. The increase was caused by Delta's increased net income,
notwithstanding that the Company's percentage ownership of Delta decreased from
approximately 18% at October 1, 2004 to approximately 16% at March 31, 2005 and
the fact that the Company recorded no Delta equity income after March 31, 2005
(see Notes 6 and 10 to the consolidated financial statements and "Critical
Accounting Policies").
Interest income increased $439 from 2004 to 2005 primarily because of
increased interest rates.
The gain on the sale of the Company's investment in Delta decreased
$15,145 from 2004 to 2005. In 2004, the Company sold 2,948,289 shares of Delta
versus only 300,000 shares in 2005.
The $3,392 loss from discontinued operations in 2005 resulted from the
settlement of the Chevron litigation (see Item 3 to this Form 10-K). The loss
consists of the following:
Chevron litigation settlement......................................................... $5,750
Less: amount accrued for estimated environmental liabilities at settlement date....... (853)
------
Net provision for Chevron litigation.................................................. 4,897
Less: tax benefit..................................................................... (1,505)
------
$3,392
======
The tax benefit of $493 for 2005 consists of a $1,012 tax provision
allocated to continuous operations and a $1,505 tax benefit allocated to
discontinued operations. The net tax benefit overall results from the tax assets
created by the Company's tax losses and the probability that the Company will
use such tax assets to offset the unrealized gain on the Company's 6,700,000
shares of Delta's stock.
For 2004, the Company recorded a tax provision of $2,385, or 14.9% of
pre-tax book income, for the period. This provision was significantly less than
that which would be obtained using the Company's blended tax rate (Federal and
state taxes combined) of 36% because the Company was able to utilize its tax
carryforwards and was thus able to release its valuation allowance.
FISCAL 2004 VERSUS FISCAL 2003
Gas sales increased $1,087 as a result of the Company's acquisition of
166 Appalachian gas properties on March 30 and 31, 2004 (see Note 4 to the
consolidated financial statements included in Item 8 of this 10-K). The Company
owned no oil and gas properties from September 2002 to March 30, 2004.
Production expenses increased $315 as a result of the Company's
acquisition of 166 Appalachian gas properties on March 30 and 31, 2004 (see Note
4). The Company owned no oil and gas properties from September 2002 to March 30,
2004.
Depreciation, depletion and amortization increased $195 from fiscal 2003
to fiscal 2004. The increase was entirely attributable to depletion of the gas
properties acquired by the Company in March 2004. In fiscal 2003, the Company
owned no oil or gas properties.
General and administrative expenses increased $867 or 24.3% from the
year ended September 30, 2003 to the year ended September 30, 2004. The increase
resulted primarily from increased legal costs related to the Chevron lawsuit. In
addition, the Company recorded a bad debt provision of $86 for the year ended
September 30, 2004 because of delays and uncertainties in the collection of
estimated accounts receivable that were then over eighteen months old. No
similar bad debt provision was recorded for the year ended September 30, 2003.
-15-
The Company recorded no gain or loss in the value of the option it
granted to Delta for the year ended September 30, 2004 because that option
expired unexercised on May 31, 2003. For the year ended September 30, 2003, the
Company recorded a $432 gain in the value of that option. The Company had
granted Delta an option to repurchase 3,188,667 of the Delta shares held by the
Company at $4.50/share until May 31, 2003 as part of the sale of its domestic
oil and gas properties to Delta on May 31, 2002. The Company owned 17.8% of
Delta on September 30, 2004.
The Company recorded no portion of the loss of Network for the year
ended September 30, 2004 because the Company had recorded a $354 impairment
provision on its equity investment in Network and a $126 allowance for doubtful
accounts on its note receivable from Network at March 31, 2003, reducing both
amounts to zero. The Company has no obligation to fund Network's future losses.
For the year ended September 30, 2004, Network's loss was $4. The Company owns
45% of Network.
For the year ended September 30, 2003, the Company recorded $20 as its
portion of Network's loss.
The Company's equity in Delta's net income increased $285 or 26.7% from
the year ended September 30, 2003 to the year ended September 30, 2004. The
increase was caused by Delta's increased net income, excluding the $1,782 gain
recorded by Delta on its sale of its Appalachian properties to the Company,
notwithstanding that the Company's percentage ownership of Delta decreased from
approximately 39% at September 30, 2003 to 17.8% at September 30, 2004. The
Company did not record any portion of Delta's gain on the Appalachian property
sale because intercompany profits are eliminated under the equity method (see
Notes 4 and 10).
During the year ended September 30, 2004, the Company sold all of its
holdings in Penn Octane Corporation ("Penn Octane"), constituting 1,343,600
shares of common stock of Penn Octane, for $2,809, resulting in a gain on the
sale of $538. As a result of the sale, the Company's only remaining marketable
securities consist of 354 shares of Chevron, which had a market value of $19 at
September 30, 2004. In addition, during the year ended September 30, 2004, the
Company sold 2,948,289 shares of Delta for $29,339, resulting in a gain of
$18,211 (see Note 10). There were no such sales during the year ended September
30, 2003.
For the year ended September 30, 2004, the Company recorded a tax
provision of $2,385 or 14.9% of pre-tax book income for the period. This
provision was significantly less than that which would be obtained using the
Company's blended tax rate (Federal and state taxes combined) of 36% because the
Company was able to utilize its tax carryforwards and was thus able to release
its valuation allowance.
The $349 tax benefit for the year ended September 30, 2003 resulted
primarily because of changes in the Company's expectations concerning future
taxable income.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended September 30, 2005, $4,035 was used in operating
activities. During the same period the Company paid $8,612 for dividends to
stockholders. During the same period the Company received $4,800 in proceeds
from the sale of part of its investment in Delta and $1,985 from the exercise of
stock options. At September 30, 2005, the Company had $27,759 of unrestricted
cash, $22,349 of working capital and no long-term debt.
-16-
At September 30, 2005, the Company's contractual obligations were as
follows:
PAYMENTS DUE BY PERIODS STARTING OCTOBER 1, 2005
------------------------------------------------
LESS
THAN 2-3 4-5 AFTER 5
1 YEAR YEARS YEARS YEARS TOTAL
------- ----- ----- ------- ------
Operating leases................. $184 $357 $213 $ 14 $ 768
Asset retirement obligations..... 3 6 6 242 257
---- ---- ---- ---- -----
$187 $363 $219 $256 $1025
==== ==== ==== ==== =====
As noted in Item 1 to this Form 10-K, the Company entered into the
Merger Agreement on November 8, 2005. Pursuant to that agreement, the Company is
to merge into a subsidiary of Delta. Closing is expected by February 28, 2006,
but that date could be delayed or accelerated by regulatory approvals and other
factors beyond the Company's control. If the Company or Delta terminates the
planned merger, it is likely that the Company will liquidate although it may
continue to operate. Accordingly, the discussion below addresses all three
alternatives: completion of the merger into Delta, liquidation and continuing to
operate.
Merger into Delta
Pursuant to the Merger Agreement (see Item 1 to this Form 10-K), the
Company would merge into a subsidiary of Delta, all of the Company's outstanding
shares of common stock would be cancelled and the Company's stockholders would
receive 8,500,000 shares of Delta or approximately 1.164 shares of Delta for
each share of the Company's outstanding common stock. As part of the merger,
Delta would also reacquire the 6,700,000 shares of Delta's stock the Company
currently owns, resulting in a net issuance of 1,800,000 shares by Delta.
The risks that the merger will not be consummated include but are not
limited to the following:
a. The stockholders of the Company do not approve the merger
(approval of Delta's stockholders is not required).
b. Regulatory reviews or other factors will delay the merger past
April 1, 2006, in which case either party can terminate the
merger without penalty or prevent the merger from being
consummated.
c. The requisite legal opinions and regulatory approvals will not
be received.
d. Either the Company or Delta unintentionally or intentionally
does not consummate the merger despite penalty provisions of up
$1,000 and $5,000, respectively, in such cases.
Although the Company will consider termination if Delta's stock price
were to decline precipitously before closing despite the $5,000 penalty, the
Company may nevertheless decide to complete the transaction under such
circumstances for two primary reasons. First, approximately 75%-80% of the
Company's current value is in the 6,700,000 shares of Delta stock that the
Company already holds and thus the Company is already an investor in Delta to
the extent of those 6,700,000 shares. Furthermore, pursuant to the Merger
Agreement (see Item 1 to this Form 10-K), the Company has agreed not to dispose
of these shares before the merger is consummated. Second, by effecting the
merger, the Company will avoid income taxes on the unrealized gain on its
6,700,000 Delta shares. At September 30, 2005, such gain was approximately
$120,900 and the related income taxes approximately $42,300 (before offset by
tax carryforwards). Nevertheless, if the Company's directors believe that
Delta's stock price will decline significantly in the future and remain
depressed, they may elect to terminate the merger, pay the required penalty and
sell or distribute Delta's stock to the Company's stockholders after paying the
related income taxes on such sale or distribution.
-17-
Even if the Company intends to complete the merger, it is possible that
Delta may elect to terminate the merger despite the penalty provisions. Whether
the merger is terminated by the Company or Delta, the Company would have to
decide whether to liquidate or continue to operate if such were the case.
If the merger is completed, the future risk factors applicable to the
Company's stockholders become primarily those concerning Delta - not those
concerning the Company, whose separate corporate existence would cease upon
merging into a subsidiary of Delta. The risk factors concerning Delta's
operations and stock are described in Delta's Form 10-K for the year ended June
30, 2005. Such factors include but are not limited to changes in oil and gas
prices, drilling and exploration and production risks, Delta's ability to
finance its planned drilling activities, Delta's compliance with its debt
covenants, severe weather threats to Delta's production in the Gulf Coast region
of the United States, Delta's policy of paying no dividends on its common stock
and other factors. These risk factors will be discussed in greater detail in the
proxy statement/prospectus that will be sent to the Company's stockholders in
connection with their consideration of the proposed merger.
If the merger is completed as anticipated, the Company's stockholders
will own stock in a company whose assets and liabilities consist of Delta's
assets and liabilities and the Company's assets and liabilities excluding the
6,700,000 Delta shares owned by the Company prior to the merger. As a result,
the price of the Delta shares to be owned by the Company's stockholders will
depend to a large degree upon the subsequent operations of Delta and the factors
noted above concerning Delta. Since the Company's non-cash assets, which Delta
will receive under the merger agreement, are immaterial compared to Delta's
assets, the performance and value of the Company's non-cash asset (oil and gas
properties, investment in GAMXX, investment in Network) are not expected to have
a material effect on Delta's performance after the merger. If Delta's
post-merger stock price declines, such decline will affect the value received by
the Company's stockholders. Although Delta's average trading volume is currently
in excess of 400,000 shares daily versus only approximately 15,000 average
shares daily for the Company's stock, Delta's stock price could decline after
the merger if a large number of the Company's stockholders or Delta stockholders
attempt to sell their shares shortly after the merger thus depressing the demand
for the stock.
Liquidation
If the merger is not completed as planned it is probable that the
Company would liquidate given its small market capitalization, limited operating
assets, the cost to acquire additional operating assets in the current
environment and the ever-increasing regulatory and other costs of remaining a
public company.
If a decision is made to liquidate, the Company anticipates that it
would distribute some cash and/or Delta shares to its stockholders in complete
liquidation of their stock as soon as possible while retaining sufficient assets
to reasonably provide for existing and anticipated future liabilities, including
those related to the current litigation. Such provision would include sufficient
assets to provide a reasonable reserve for the Company's current litigation in
the event the Company were to receive an adverse judgment. If any net assets
remain after the Company pays or provides for such remaining liabilities, the
net proceeds of such assets would then be distributed to stockholders as a final
distribution. The Company would probably also file a no action letter with the
SEC seeking relief from continuing SEC reporting requirements during the winding
down of its business. Such a plan of liquidation or any other plan of
liquidation would be subject to prior approval by the Company's stockholders.
The primary risks and costs associated with such a liquidation scenario are as
follows:
a. Litigation - As noted above, the Company remains a defendant in
two unsettled lawsuits. Although the Company does not believe it
has any material liabilities with respect to either of these
lawsuits and expects to receive a recovery in the Long Trusts'
litigation (see Item 3 to this Form 10-K), any or several of the
plaintiffs in these lawsuits could undertake legal actions to
delay such litigation or to prevent the Company from making
liquidating distributions to its stockholders and/or delay
resolution of related litigation. Any resulting litigation could
not only cause the Company to incur significant legal costs but
could also delay any distributions to stockholders for years
and/or reduce such distributions. In addition, even if the
Company's stockholders approve any future plan of liquidation,
dissident stockholders of the Company could conceivably also
take legal actions to prevent the Company from implementing any
liquidation plan.
b. Tax Risks - The Company currently owns 6,700,000 shares of
Delta. The Company's tax basis in such Delta shares is
approximately $18,500. Such Delta shares constitute the
Company's largest asset. If the Company sells its Delta stock or
distributes the Delta stock to its stockholders in liquidation
or as a special dividend, the Company will incur a tax liability
equal to approximately 35% of the difference between the
Company's tax basis and the fair market value of the 6,700,000
Delta shares on the date of distribution. If the Company
distributes Delta stock to its stockholders, the tax treatment
would be the same as if the Company had sold its Delta shares
for their fair market value and then distributed the proceeds to
it stockholders.
-18-
At September 30, 2005, the Company's unrealized appreciation on
its Delta stock was approximately $120,900 and the related tax
liability approximately $42,300 (before offset by approximately
$4,100 of tax carryforwards). Any such tax income tax liability
would significantly reduce distributions available to
stockholders. Furthermore, if Delta's stock price increases,
income taxes payable by the Company upon distribution of Delta
stock would also increase.
c. Continuing Public Company Administrative Burden - If the
Company's directors decide to liquidate, the Company will
probably seek relief from most of its public company reporting
requirements. If such a request is denied by the SEC, the
Company would continue incurring the costs of being a public
company while having fewer or no operating revenues to absorb
such costs. Such costs are significant and probably will
increase in the future given the myriad of post-Enron regulatory
requirements that are currently being mandated. The result would
be a diminution of assets available for distribution to
stockholders. For example, commencing October 1, 2006, the
Company would face internal control attestation requirements and
the costs to comply with such requirements could easily exceed
$500 initially.
d. Lack of Liquidity - If the Company's directors decide to
liquidate and the related plan of liquidation is approved by the
Company's stockholders, it is likely that the Company's stock
would cease to trade in the Nasdaq National Market after the
plan of liquidation is approved. In such case, stockholders
would not be able to trade their stock. Stockholders who have
used their Company stock as collateral for margin loans would
probably be required to provide other collateral to support such
loans. Even if the Company is able to distribute Delta stock as
part of its initial distribution to stockholders without any
legal challenges or other delays, there could be a delay between
the date the Company's stock is delisted and the date when the
Company' stockholders receive Delta shares that could be
substituted as collateral for a margin loan. Stockholders would
presumably have to provide other collateral in the interim.
Suspension of trading would probably also cause suspension of
SEC reporting.
e. Liquidation of Assets - The Company's primary remaining assets
consist of cash and cash equivalents and the Company's
investment in Delta (6,700,000 shares). The Company also owns an
investment in Network and a lender's interest in GAMXX. Although
the value of the Company's gas properties has recently increased
as the price of natural gas increased, the value of such
properties could decline before the Company is able to sell such
properties. Although natural gas prices are currently at
historic highs, such prices have fluctuated significantly
recently often increasing or decreasing in a short period.
Network is a private development stage limited liability company
with no public market for its membership units. Network only
recently generated its first revenue producing contracts and has
only recently been marginally profitable. As noted above,
Delta's stock has been highly volatile fluctuating from
$8.99/share to over $21.00 per share during the last year. The
amount realized on any sale of the Company's Delta stock would
be largely determined by the price of Delta's stock at the time
of any sale. Increases or decreases in the price of Delta's
stock at the time of sale or distribution to stockholders would,
however, be partially offset by increases or decreases in any
resulting income tax liability to the Company.
f. Legal Uncertainties in Litigation - There is little case law and
precedent under applicable Delaware statutes concerning
liquidation of a profitable public company such as the Company.
Several years may be required to liquidate and application of
governing laws may be uncertain.
-19-
Continuing to Operate
If the Company does not merge with Delta or liquidate but instead
continues to operate, it would be subject to oil and gas price risks, drilling
risks, production risks, litigation risks, insurance coverage risks and other
general risks inherent in the oil and gas business. In addition, the Company
would continue to be exposed to the continuing public company administrative and
regulatory burden. At the present time, the Company estimates its annual public
company administrative costs to be $600-$800. When the Company becomes subject
to internal control attestation requirements (currently expected to be October
1, 2006), such annual public company costs are expected to increase
significantly. In addition, the Company faces risks related to its experienced
employees. If one or more of its key employees departs, the Company believes it
would be extremely difficult to replace such employees since most experienced
oil and gas employees reside in areas where the oil and gas industry is
concentrated - not in the Philadelphia area where the Company has most of its
offices. Finally, the Company's existing gas operations are minuscule compared
to those of its competitors yet the Company incurs substantial fixed costs to
provide the requisite legal, accounting and production systems to operate and
account for its production and to comply with public company reporting
requirements. If the Company continues to operate, it would be faced with the
prospect of acquiring more oil and gas assets to justify its fixed overhead at a
time when the prices being paid for oil and gas properties are high, making such
investment more risky than previously. Under such circumstances the Company may
find it impossible to make the economically justifiable acquisitions it needs to
rationalize its fixed operating and public company costs. In addition to the
foregoing, if the Company continued to operate it would face risks related to
the lack of liquidity for its stockholders (see above discussion under
"Liquidation").
At the present time, the Company's anticipated future cash expenditures
are primarily recurring general and administrative costs, including legal costs
(see Item 3 this Form 10-K), recurring dividends and lease operating costs
related to the Appalachian gas properties acquired by the Company (see Note 4 to
the consolidated financial statements included in Item 8 to this Form 10-K). In
addition, the Company would review possible future acquisitions of oil and gas
properties and, if the Company is successful in such pursuits, additional
expenditures would be required. To the extent that such anticipated expenditures
cannot be funded from cash flow from the Company's oil and gas operations, the
Company could fund such expenditures using its available cash. If the Company
were to make another substantial acquisition at a price in excess of its current
cash and other excess liquid working capital, the Company believes it could fund
such acquisitions by selling additional shares of Delta or by renewing its
previous oil and gas borrowing arrangements with an energy bank and using the
related loan proceeds for the acquisition.
The Company's future operations would be subject to the following risks:
a. Litigation - As noted above, the Company is still a defendant in
two significant unsettled lawsuits. Although the Company does
not believe it has any material liabilities with respect to any
of these lawsuits, the Company could incur significant
liabilities if it ultimately is judged to be liable in these
lawsuits. This litigation could cause the Company to incur
significant legal costs.
b. Exploration and Production Price Risk - The Company has not
hedged any of its anticipated future gas production because the
cost to do so appears excessive when compared to the risk
involved. As a result, the Company remains exposed to future gas
price changes with respect to all of its anticipated future gas
production. Such exposure could be significant given the
volatility of gas prices. For example, natural gas prices have
increased over 50% from 2002 to 2005 and could either increase
or decrease a similar percentage in the future. When the Company
acquired its gas properties in March 2004, the prices being
received for natural gas were $5.00 to $6.00 per mcf sold. The
Company paid for its gas reserve acquisitions using such
pricing. If natural gas prices decrease in the future, the
decrease will directly impact the Company's gas sales, operating
income and net income. In addition, if gas prices are low at the
end of the Company's quarterly and annual reporting periods, the
value of the Company's gas reserves may decrease such that the
Company would be forced to record an impairment provision. See
"Critical Accounting Policies" below.
c. Exploration and Production Operating Risk - All of the Company's
current gas properties are onshore properties with relatively
low operating risk. Nevertheless, the Company faces the risks
encountered from operating approximately 130 gas wells -
including the risk of gas leaks, resulting environmental damage,
third party liability claims related to operations, including
those in excess of the Company's liability insurance coverage
and including claims by landowners where the operated wells are
located, as well as other general operating risks.
-20-
d. Public Market for the Company's Stock - Although there presently
exists a market for the Company's stock, such market is volatile
and the Company's stock is thinly traded. This volatility may
adversely affect the market price and liquidity of the Company's
common stock.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
On March 30 and 31, 2004, the Company acquired interests in
Pennsylvania gas wells (see Note 4 to the consolidated financial statements
included in Item 8 to this form 10-K). The Company has not hedged its share of
the expected natural gas production from these wells. As a result, the Company
remains at risk with respect to such unhedged expected production. If market
prices increase, gas sales applicable to the unhedged production will increase.
If market prices decrease, gas sales related to such unhedged production will
decrease.
At September 30, 2005, the Company owned 6,700,000 shares of Delta.
The stock price of Delta has fluctuated significantly in the last three years
and thus the market value of the Company's investment in Delta remains subject
to changes in the market price of Delta stock. The Company has not hedged its
market risk with respect to its Delta stock.
INFLATION AND CHANGING PRICES
Gas sales prices are determined by markets locally and worldwide and
often move inversely to inflation. In the last three years gas prices have
increased over 50%. At September 30, 2005, such prices reached historic highs.
In prior periods such prices have decreased significantly - often over a very
short period of time. Since the Company has not hedged its future gas
production, gas revenues, operating income (loss) and net income (loss) are
subject to changes in gas prices. Inflation has not had and is not expected to
have a material effect on the Company's results of operations.
NEW ACCOUNTING PRONOUNCEMENTS
On September 28, 2004, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 106 ("SAB No. 106"). SAB No. 106 applies to
companies using the full cost method of accounting for oil and gas properties
and equipment costs, such as the Company. SAB No. 106 affects the way in which
the Company calculates its full cost ceiling limitation (the Company now
excludes future cash outflows associated with settling asset retirement
obligations that are accrued on the balance sheet related to proved developed
properties in the calculation of the ceiling) and the way the Company calculates
depletion on its proved undeveloped gas properties. The Company adopted SAB No.
106 on October 1, 2004. The effects of adoption of SAB No. 106 to date have been
immaterial.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)").
SFAS No. 123(R) requires an entity to recognize the grant-date fair value of
stock options and other equity-based compensation issued to employees in the
income statement. Pursuant to a delay in the implementation date by the SEC,
SFAS No. 123(R) will be effective for the Company beginning October 1, 2005. The
Company does not expect SFAS No. 123(R) to have any impact on its results of
operations. The Company has not issued any stock options since January 2002 and
all stock options issued were vested by July 31, 2002.
In May 2005, the FASB issued SFAS No. 154 Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3
("SFAS 154"). SFAS 154 requires retrospective application to prior periods'
financial statements for changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. SFAS 154 also requires that a change in depreciation,
amortization, or depletion method for long-lived, non-financial assets be
accounted for as a change in accounting estimate affected by a change in
accounting principle. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The implementation of FAS 154 is not expected to have a material impact on the
Company's consolidated results of operations, financial position or cash flows.
-21-
In March 2005, the FASB issued FASB Interpretation 47 ("FIN 47 "), an
interpretation of SFAS No. 143, "Accounting for Asset Retirement Obligations"
("SFAS No. 143 "). FIN 47 clarifies the term "conditional asset retirement
obligation" as it is used in SFAS No. 143. The Company expects to apply the
guidance of FIN 47 commencing October 1, 2005 and expects no impact on its
financial statements.
CRITICAL ACCOUNTING POLICIES:
The accounting policies critical to the Company are as follows:
FULL COST METHOD OF ACCOUNTING FOR OIL AND GAS PROPERTIES
The Company follows the full-cost method of accounting for oil and gas
properties and equipment costs. Under this method of accounting, net capitalized
costs, less related deferred income taxes, in excess of the present value of net
future cash inflows (oil and gas sales less production expenses) from proved
reserves, tax effected and discounted at 10%, and the cost of properties not
being amortized, if any, are charged to expense (full cost ceiling test). If at
a future reporting date oil and gas prices decline, it is possible that the
Company's book value will exceed the allowable full cost ceiling and the Company
would have to write down its oil and gas properties. Even if oil and gas prices
subsequently increase, the write down would not be restored under the full cost
method of accounting. Although the Company recorded no full cost ceiling
provision through September 30, 2005, it could be required to record such a
provision in the future - especially if there were a significant decrease in gas
prices by the end of a quarterly or annual financial reporting period.
METHOD OF ACCOUNTING FOR INVESTMENT IN DELTA
The Company currently owns 6,700,000 shares of Delta. Through March 31,
2005, the Company accounted for its investment in Delta using the equity method
of accounting. Under this method the Company increased its investment by its
share of Delta's income and decreased its investment by its share of Delta's
losses and distributions. The Company also increased its investment for
increases in its share of Delta's equity as a result of Delta's issuances of
additional Delta equity at prices in excess of the Company's book value.
Effective April 1, 2005, the Company commenced accounting for its
investment in Delta as a marketable available-for-sale security (see Notes 6 and
10 to the consolidated financial statements). As a result, commencing April 1,
2005, pursuant to Statement of Financial Accounting Standards No. 115 ("SFAS
115"), the Company measures its investment in Delta's stock at fair market value
(closing prices per the stock exchange) with unrealized gains or losses, net of
taxes, recorded in other comprehensive income until the stock is sold or
otherwise disposed of. At such time gain or loss will be included in earnings. A
decline in the market value of any available for sale security below cost that
is deemed to be other than temporary will result in a reduction in the carrying
amount to fair value. The impairment will be charged to earnings and a new cost
basis for the security will result. Accordingly, the future effect of any change
in the market value of Delta stock will affect the Company's equity but will not
be recorded in operations until the stock is actually sold or disposed of.
-22-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Statements of Operations for the Years Ended September 30, 2005, 2004 and 2003................. 24
Consolidated Balance Sheets as of September 30, 2005 and 2004............................................... 25
Consolidated Statements of Cash Flows for the Years Ended September 30, 2005, 2004 and 2003................. 26
Consolidated Statements of Stockholders' Equity and Other Comprehensive Income for the Years
Ended September 30, 2005, 2004 and 2003................................................................... 28
Notes to the Consolidated Financial Statements.............................................................. 29
Report of Independent Registered Public Accounting Firm..................................................... 58
Report of Independent Registered Public Accounting Firm..................................................... 59
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes thereto.
-23-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30,
-----------------------------------------
2005 2004 2003
---------- ----------- -----------
Revenues:
Gas sales ............................................................... $ 2,561 $ 1,087
----------- -----------
2,561 1,087
----------- -----------
Expenses:
Gas production .......................................................... 584 315
General and administrative .............................................. 4,931 4,432 $ 3,565
Depreciation, depletion and amortization ................................ 507 251 56
Litigation provision (recovery) ......................................... (845) 825
----------- ----------- -----------
5,177 5,823 3,621
----------- ----------- -----------
Operating income (loss) ................................................... (2,616) (4,736) (3,621)
----------- ----------- -----------
Other income (expense):
Gain on sale of marketable securities ................................... 538
Gain on sale of Delta Petroleum Corporation investment .................. 3,066 18,211
Interest income ......................................................... 647 208 255
Other income ............................................................ 21 432 17
Impairment provision - investment in Networked Energy
LLC ................................................................... (480)
Decrease in fair value of option granted to Delta
Petroleum Corporation ................................................. 432
Equity in income (loss) of Networked Energy LLC ......................... 5 (20)
Equity in income (loss) of Delta Petroleum Corporation
1,690 1,352 1,067
----------- ----------- -----------
5,429 20,741 1,271
----------- ----------- -----------
Income (loss) from continuing operations before provision for
(benefit of) income taxes ............................................... 2,813 16,005 (2,350)
----------- ----------- -----------
Provision for (benefit of) income taxes:
State ................................................................... 29 63 (10)
Federal ................................................................. 983 2,322 (339)
----------- ----------- -----------
1,012 2,385 (349)
----------- ----------- -----------
Net income (loss) from continuing operations .............................. 1,801 13,620 (2,001)
Income (loss) from discontinued refining operations, less
applicable income tax benefit of $1,505 ................................. (3,392)
----------- ----------- -----------
Net income (loss) ......................................................... ($ 1,591) $ 13,620 ($ 2,001)
=========== =========== ===========
Net income (loss) per share:-
Continuing operations:
Basic ................................................................. $ .26 $ 2.04 ($ .30)
=========== =========== ===========
Diluted ............................................................... $ .26 $ 1.96 ($ .30)
=========== =========== ===========
Discontinued operations:
Basic ................................................................. ($ .49)
===========
Diluted ............................................................... ($ .49)
===========
Net income (loss)
Basic ................................................................. ($ .23) $ 2.04 ($ .30)
=========== =========== ===========
Diluted ............................................................... ($ .23) $ 1.96 ($ .30)
=========== =========== ===========
Weighted average number of common and potential dilutive common shares
outstanding:
Basic ................................................................. 7,052,693 6,675,538 6,592,884
=========== =========== ===========
Diluted ............................................................... 7,052,693 6,933,982 6,592,884
=========== =========== ===========
Dividends declared per share .............................................. $ 1.20 $ .20 $ .20
=========== =========== ===========
The accompanying notes are an integral part of these
consolidated financial statements
-24-
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
SEPTEMBER 30,
----------------------------
2005 2004
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents......................................................... $ 27,759 $ 33,742
Restricted cash................................................................... 898 120
Accounts receivable............................................................... 674 582
Account receivable - Delta Petroleum Corporation.................................. 339
Marketable securities............................................................. 23 19
Prepaid expenses and other current assets......................................... 252 203
Note receivable - Networked Energy LLC, net of allowance for doubtful account
of $126 ........................................................................
---------- ----------
Total current assets............................................................ 29,606 35,005
Property, plant and equipment, net:
Furniture, fixtures, equipment and vehicles....................................... 188 111
Oil and gas properties, net (full cost method):
Proved properties............................................................... 8,564 9,012
Marketable securities................................................................ 139,360
Investment in Networked Energy LLC, net of impairment reserve of $354................ 5
Investment in Delta Petroleum Corporation (equity method)............................ 39,698
---------- ----------
Total assets..................................................................... $ 177,723 $ 83,826
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable.................................................................. $ 361 $ 343
Accounts payable.................................................................. 667 749
Accrued expenses.................................................................. 476 906
Litigation settlement payable on discontinued refining operations................. 5,750
Asset retirement obligations 3 3
---------- ----------
Total current liabilities...................................................... 7,257 2,001
Net refining liabilities (assets) retained........................................... 2,404
Asset retirement obligations......................................................... 254 227
Deferred income taxes................................................................ 39,422 5,171
Other liabilities.................................................................... 21 19
---------- ----------
Total liabilities.............................................................. 46,954 9,822
---------- ----------
Commitments and contingencies........................................................
Stockholders' equity:
Series B participating preferred stock; par value - $1.00; 10,000,000 shares
authorized; no shares issued
Common stock; par value - $0.50; 25,000,000 shares authorized;
12,126,404 shares issued at September 30, 2005 and 11,781,404 shares issued at
September 30, 2004............................................................. 6,064 5,891
Additional paid-in capital 88,500 85,691
Accumulated other comprehensive income, net of taxes.............................. 64,172 170
Retained earnings................................................................. 38,700 48,919
---------- ----------
197,436 140,671
Treasury stock at cost - 4,911,044 shares at September 30, 2005 and 4,911,020
shares at September 30, 2004..................................................... (66,667) (66,667)
---------- ----------
Total stockholders' equity..................................................... 130,769 74,004
---------- ----------
Total liabilities and stockholders' equity..................................... $ 177,723 $ 83,826
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements
-25-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30,
-------------------------------------
2005 2004 2003
-------- ------- -------
Cash flows from operating activities:
Net income (loss)............................................................. ($ 1,591) $13,620 ($2,001)
-------- ------- -------
Adjustments to reconcile net income (loss) to cash provided by (used in)
operating activities:
Accretion of discount - asset retirement obligations...................... 17
Provision for bad debts................................................... 86
Depreciation, depletion and amortization.................................. 507 251 56
Write offs - property, plant and equipment................................ 32
Decrease in fair value of option granted to Delta Petroleum Corporation... (432)
Gain on sale of marketable securities..................................... (538)
Gain on sale of investment in Delta Petroleum Corporation................. (3,066) (18,211)
Deferred income tax expense (benefit) (463) 2,047 (349)
Impairment of investment in Networked Energy LLC.......................... 480
Equity in (income) loss of Networked Energy LLC........................... (5) 20
Equity in (income) loss of Delta Petroleum Corporation.................... (1,690) (1,352) (1,067)
Changes in assets and liabilities:
(Increase) decrease in restricted cash.................................. (778) 4,165 (55)
(Increase) decrease in accounts receivable.............................. 247 (499) (44)
(Increase) decrease in prepaid expenses and other current assets........ (49) (81) 85
Increase (decrease) in accounts payable................................. (82) 208 128
Increase (decrease) in accrued expenses................................. (430) 665 (322)
Increase (decrease) in other long-term liabilities...................... 2 19 (11)
Increase (decrease) in litigation settlement payable.................... 5,750
Increase (decrease) in net refining liabilities (assets) retained....... (2,404)
-------- ------- -------
Total adjustments..................................................... (2,444) (13,240) (1,479)
-------- ------- -------
Net cash flow provided by (used in) operating activities.............. (4,035) 380 (3,480)
-------- ------- -------
Cash flows from investing activities:
Proceeds from sale of marketable securities................................... 2,809
Proceeds from sale of investment in Delta Petroleum Corporation............... 4,800 29,339
Investment in gas properties.................................................. (9,341)
Investment in Networked Energy LLC............................................ (125)
Purchase of furniture, fixtures and equipment................................. (128) (102)
Other......................................................................... 7 2 2
-------- ------- -------
Net cash provided by (used in) investing activities................... 4,679 22,707 (123)
-------- ------- -------
(continued on next page)
The accompanying notes are an integral part of these
consolidated financial statements
-26-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
("$000'S" OMITTED)
(continued from previous page)
YEAR ENDED SEPTEMBER 30,
---------------------------------------
2005 2004 2003
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from exercise of stock options....................................... 1,985 1,371
Dividends paid to stockholders ............................................... (8,612) (1,331) (1,321)
-------- -------- --------
Net cash provided by (used in) financing activities......................... (6,627) 40 (1,321)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents............................ (5,983) 23,127 (4,924)
Cash and cash equivalents - beginning of period................................. 33,742 10,615 15,539
-------- -------- --------
Cash and cash equivalents - end of period....................................... $ 27,759 $ 33,742 $ 10,615
======== ======== ========
Supplemental disclosures of cash flow information are as follows:
Cash paid during the period:
Income taxes................................................................ $ 350 $ 13
======== ======== ========
Accrued dividends ............................................................ $ 361 $ 343 $ 330
======== ======== ========
Unrealized gain (loss) on investment in available-for-sale marketable
securities, net of $35,811 taxes in 2005.................................... $ 64,172 $ 666
======== ========
Issuance of additional equity by Delta Petroleum Corporation and option
expense credited directly to paid-in-capital by Delta, net of $180, $4,595
and $0 of income taxes in 2005, 2004 and 2003, respectively................. $ 320 $ 15,459 $ 1,167
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements
-27-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND OTHER COMPREHENSIVE INCOME (LOSS)
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
YEARS ENDED SEPTEMBER 30, 2005, 2004 AND 2003
---------------------------------------------------------------------------------------------
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TREASURY STOCK
------------------- PAID-IN COMPREHENSIVE COMPREHENSIVE RETAINED ------------------
SHARES AMOUNT CAPITAL INCOME (LOSS) INCOME (LOSS) EARNINGS SHARES AMOUNT TOTAL
---------- ------ --------- ------------- ------------- -------- --------- -------- -------
Balance - October 1, 2002............ 11,503,904 $5,752 $67,365 $ 487 $ 39,965 4,911,020 ($66,667)$46,902
Issuance of additional stock by Delta
Petroleum Corporation 1,167 1,167
Dividends declared ($.20 per share).. (1,321) (1,321)
Comprehensive income (loss):
Net income (loss).................. ($ 2,001) (2,001) (2,001)
Other comprehensive income (loss):
Unrealized gain (loss) on
marketable securities, net of
$375 of income taxes............. 666 666 666
Equity in other comprehensive
income (loss) of Delta
Petroleum Corporation, net of
$129 tax benefit............... 230 230 230
Total comprehensive income (loss).... -------
($1,105)
---------- ------ ------- ======= ----- -------- --------- -------- -------
Balance - September 30, 2003......... 11,503,904 5,752 68,532 1,383 36,643 4,911,020 (66,667) 45,643
Options exercised.................... 277,500 139 1,232 1,371
Tax benefit of options exercised..... 468 468
Issuance of additional stock by
Delta Petroleum Corporation,
net of $4,595 tax.................. 15,459 15,459
Dividends declared ($.20 per share).. (1,344) (1,344)
Comprehensive income (loss):
Net income (loss)................... $13,620 13,620 13,620
Other comprehensive income (loss):
Reclassification adjustment,
net of $649 tax................. (1,153) (1,153) (1,153)
Equity in other comprehensive
income (loss) of Delta
Petroleum Corporation, net of
$32 tax benefit.
(60) (60) (60)
---------- ------ ------- ------- ----- -------- --------- -------- -------
Total comprehensive income (loss)... $12,407
=======
Balance - September 30, 2004........ 11,781,404 5,891 85,691 170 48,919 4,911,020 (66,667) 74,004
Treasury stock surrendered.......... 24
Options exercised................... 345,000 173 1,812 1,985
Tax benefit of options exercised.... 677 677
Issuance of additional stock by
Delta Petroleum Corporation,
net of $180 tax................... 320 320
Dividends declared ($1.20 per share) (8,628) (8,628)
Comprehensive income (loss):
Net income (loss)................. ($ 1,591) (1,591) (1,591)
Other comprehensive income (loss):
Equity in other comprehensive
income (loss) of Delta
Petroleum Corporation, net
of $600 tax benefit........... (1,067) (1,067) (1,067)
Reversal of cumulative equity in
comprehensive income (loss)
of Delta as of April 1, 2005,
net of $506 tax............... 900 900 900
Unrealized gain on marketable
securities, net of $35,811
tax........................... 64,169 64,169 64,169
---------- ------ ------- ------- ------- ------- --------- -------- --------
Total comprehensive income (loss)... $62,411
=======
Balance - September 30, 2005........ 12,126,404 $6,064 $88,500 $64,172 $38,700 4,911,044 ($66,667) $130,769
========== ====== ======= ======= ======= ========= ======== ========
The accompanying notes are an integral part of these
consolidated financial statements
-28-
CASTLE ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
NOTE 1 - BUSINESS AND ORGANIZATION
BUSINESS
References to Company mean Castle Energy Corporation, the parent, and/or
one or more of its subsidiaries. Such references are for convenience only and
are not intended to describe legal relationships.
Castle Energy Corporation (the "Company") is a public company
incorporated in Delaware. Mrs. Joseph L. Castle wife of the deceased past
Chairman of the Board and Chief Executive Officer, Joseph L. Castle II, and the
estate of Mr. Castle owned 20.7% of the Company's outstanding common stock at
September 30, 2005. Mr. Castle passed away on August 15, 2005.
MERGER INTO DELTA
On November 8, 2005, the Company entered into a merger agreement (the
"Merger Agreement") with Delta. Delta Petroleum Corporation, a newly-formed
Delaware corporation and a wholly-owned subsidiary of Delta ("Delta-Delaware"
and collectively, with Delta "Delta") and DPCA LLC, a Delaware limited liability
company and a newly formed wholly-owned subsidiary of Delta ("DPCA").
Pursuant to the merger agreement, the Company will merge with and into
DPCA with DPCA as the surviving company and the Company's stockholders will
receive approximately 1.164 shares of Delta's common stock for each of their
shares of the Company's common stock, (or a total of 8,500,000 shares of Delta
common stock in the aggregate) (the "Merger"). In the merger, the 6,700,000
shares of Delta common stock currently owned by the Company will be cancelled.
The Merger is designed to be a tax-free exchange for stockholders of both Delta
and the Company. The boards of directors of the Company and Delta have approved
the Merger.
The closing of the merger is subject to approval of the Merger
Agreement by the holders of a majority of the shares of the Company's
outstanding common stock, review by regulatory agencies, receipt of legal
opinions and other customary closing conditions set forth in the Merger
Agreement.
The Merger Agreement contains certain termination rights for both Delta
and the Company, and further provides that, upon termination of the Merger
Agreement under specified circumstances, either party may be required to pay the
other a termination fee of $5,000 or reimburse the other party up to $1,000 in
fees and expenses actually incurred relating to the transaction contemplated by
the Merger Agreement.
Concurrently with the execution of the Merger Agreement and in order to
induce Delta to enter into the Merger Agreement, certain of the Company's
officers and all of its directors and the estate and family of the Company's
founder and former Chief Executive Officer, Joseph L. Castle II, entered into
voting agreements with Delta pursuant to which they agree, among other things,
to vote all shares of the Company's common stock held by them in favor of the
adoption of the Merger Agreement and the other transactions contemplated by the
Merger Agreement.
EXPLORATION AND PRODUCTION
From inception until May 31, 2002, the Company was engaged in the
exploration and production segment of the energy business. On May 31, 2002, the
Company sold all of its domestic oil and gas properties to Delta Petroleum
Corporation, another public exploration and production company ("Delta"). On
September 6, 2002, a subsidiary of the Company sold all of its interests in oil
and gas concessions in Romania to the operator of the Romanian concessions. From
September 2002 until March 30, 2004, the Company owned no oil and gas properties
or other operating assets. On March 30 and March 31, 2004, the Company acquired
interests in 166 gas wells in western Pennsylvania (see Note 4.)
-29-
CASTLE ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
NATURAL GAS MARKETING
In December 1992, the Company acquired a long-term natural gas sales
contract with Lone Star Gas Company ("Lone Star Contract") and a gas pipeline.
The Company also entered into two long-term gas sales contracts and one
long-term 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 natural gas pipeline to a subsidiary of Union Pacific Resources
Corporation ("UPRC") and thus exited the gas transmission business while still
conducting gas marketing operations. Effective May 31, 1999, the aforementioned
gas sales and gas purchase contracts expired by their own terms and were not
replaced by other third party gas marketing business. With the exception of the
Long Trusts Lawsuit (see Note 15), the Company and its subsidiaries are not
involved with any matters related to their former natural 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. In April 2003, American Western's Plan of Liquidation was confirmed
by the bankruptcy court and IRLP subsequently received $599 which it distributed
to its creditors.
In August 2002, Texaco Inc. and certain other subsidiaries of Chevron
Corporation (collectively "Chevron") sued the Company and two of its inactive
subsidiaries, including IRLP, concerning environmental liabilities related to
the Indian Refinery. In September 2005, the Company and its subsidiaries settled
the lawsuit for $5,750 (see Note 3).
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. In March 2002, the
Company invested an additional $150 in Network's equity, increasing its interest
to 45%, and made a $125 loan to Network. In March 2003, the Company recorded a
$480 impairment reserve with respect to its investment in and loan to Network,
reducing the value of same to zero. Network recorded its first revenues and
first profit for the quarter ended September 30, 2004 (see Note 9).
FUTURE OF THE COMPANY
After the sale of all of the Company's domestic oil and gas properties
to Delta in 2002, the Company's management and Board of Directors considered
liquidation of the Company and distribution of the Company's assets to its
stockholders. Consideration of liquidation was suspended as a result of the
lawsuit filed against the Company by Chevron (see Note 3). As a result of this
lawsuit and management's decision not to liquidate, the Company sought
acquisitions in the energy industry and acquired interests in 166 western
Pennsylvania gas wells in March of 2004. In September 2005, the Company settled
the Chevron litigation. (See Note 3) On November 8, 2005, the Company entered
into the Merger Agreement. If the merger is not consummated, the Company's
directors anticipate that the Company will probably liquidate although it may
continue to operate.
-30-
CASTLE ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
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, 2005, 2004 and 2003. During those periods, the
Company operated in the exploration and production segment of the energy
business. As a result of the Chevron litigation settlement in September 2005,
the Company also recorded a loss from discontinued refining operations during
the fiscal year ended September 30, 2005. (See Note 3 to the consolidated
financial statements.)
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
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. (See Note 5)
MARKETABLE SECURITIES
The Company currently classifies its investment securities, including
its investment in Delta, as available-for-sale securities. Pursuant to Statement
of Financial Accounting Standards No. 115 "Accounting for Certain Investments in
Debt and Equity Securities," ("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. A
decline in the market value of any available-for-sale security below cost that
is deemed to be other than temporary results in a reduction in the carrying
amount to fair value. The impairment is charged to earnings and a new cost basis
for the security results. Until April 1, 2005, the Company accounted for its
investment in Delta on the equity method (see below). The Company accounts for
its investment in Network on the equity method.
FURNITURE, FIXTURES AND EQUIPMENT
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 three years. Such periods are the estimated useful
lives of such furniture, fixtures and equipment.
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. 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 plus the lower
of cost or market of unevaluated properties, tax-effected and discounted at 10%,
and the cost of properties not being amortized, if any, are charged to current
expense.
-31-
CASTLE ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
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.
Contingent environmental liabilities are recorded at their estimated
settlement values, including estimated legal costs to contest such liabilities.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets other than oil and gas
properties for impairment whenever events or changes in circumstances indicated
that the carrying amount of an asset might 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 are less than the carrying amount of the asset, an
impairment loss is recognized. Measurement of an impairment loss is 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."
HEDGING ACTIVITIES
The Company has not used hedges during the periods reported.
GAS BALANCING
The Company follows the "sales method" of accounting for its natural gas
and crude oil revenue, so that the Company recognizes sales revenue on all
natural gas or crude oil sold to its purchasers, regardless of whether the sales
are proportionate to the Company's ownership in the property. A receivable or
liability is recognized only to the extent that the Company has an imbalance on
a specific property greater than the expected remaining proved reserves. Gas
balancing activities have been immaterial during the periods reported.
ASSET RETIREMENT OBLIGATIONS
The Company follows the provisions of Statement of Financial Accounting
Standards 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 costs 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. The Company recorded an asset retirement obligation of $222 in
conjunction with its acquisition of interests in gas wells on March 31, 2004
(see Note 4). At September 30, 2005, the asset retirement obligation was $257
with the change from the initial amount recorded resulting primarily from
accretion expense. (See Note 8)
-32-
CASTLE ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
INVESTMENTS IN NETWORK AND DELTA
The Company's investment in Network (the Company owned 45% of Network at
September 30, 2005) is recorded using the equity method. Under this method, the
Company records its share of Network's income or loss and other comprehensive
income (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. If Network issues additional equity
at prices different than that of the Company's investment, the Company would
record such difference, net of tax, as a charge or credit to the Company's
investment with the offsetting entry to "Paid-In-Capital."
At March 31, 2003, the Company recorded a $480 impairment provision
related to its investment in Network, reducing the book value of such investment
to zero. (See Note 9)
Through March 31, 2005, the Company also accounted for its investment in
Delta using the equity method. Initially, in May 2002, the Company had owned 44%
of Delta and three of the Company's directors constituted three of seven Delta
directors. By April 1, 2005, the Company's ownership of Delta had decreased to
16% (approximately 15% fully diluted) and the Company's directors only comprised
two of nine Delta directors. As a result of these developments, the Company
believed it no longer had significant influence on Delta's management and thus,
effective April 1, 2005, the Company commenced accounting for its investment in
Delta as a marketable available-for-sale security (see above). As a result of
the change in accounting method, the book value of the Company's investment in
Delta and the Company's cumulative equity in Delta's comprehensive income (loss)
at April 1, 2005, under the equity method of accounting, $39,892, became the
Company's value of the Delta stock as a marketable security on April 1, 2005.
At September 30, 2005, the Company owned approximately 14% of Delta and
one of the Company's directors was also a director of Delta, whose board of
directors currently consists of nine directors.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) 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 No. 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.
Proforma net income and earnings per share had the Company accounted for
its options under the fair value method of SFAS 123 would not change from the
net income and earnings per share amounts presented as the Company has not
issued any stock options since January 2002 and all options were vested by July
31, 2002.
INCOME TAXES
The Company follows Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes" ("SFAS No. 109"). SFAS No. 109 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 No. 109
generally considers all expected future events other than anticipated enactments
of changes in the tax law or tax rates. SFAS No.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 19)
-33-
CASTLE ENERGY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
RECLASSIFICATIONS
Certain reclassifications have been made to make the periods presented
comparable.
USE OF ESTIMATES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America 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.
NEW ACCOUNTING PRONOUNCEMENTS
On September 28, 2004, the Securities and Exchange Commission issued
Staff Accounting Bulletin No. 106 ("SAB No. 106"). SAB No. 106 applies to
companies using the full cost method of accounting for oil and gas properties
and equipment costs, such as the Company. SAB No. 106 affects the way in which
the Company calculates its full cost ceiling limitation (the Company now
excludes future cash outflows associated with settling asset retirement
obligations that are accrued on the balance sheet related to proved developed
properties in the calculation of the ceiling) and the way the Company calculates
depletion on its proved undeveloped gas properties. The Company adopted SAB No.
106 on October 1, 2004. The effects of adoption of SAB No. 106 to date have been
immaterial.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)").
SFAS No. 123(R) requires an entity to recognize the grant-date fair value of
stock options and other equity-based compensation issued to employees in the
income statement. Pursuant to a delay in the implementation date by the SEC,
SFAS No. 123(R) will be effective for the Company beginning October 1, 2005. The
Company does not expect SFAS No. 123(R) to have any impact on its results of
operations. The Company has not issued any stock options since January 2002 and
all stock options issued were vested by July 31, 2002.
In May 2005, the FASB issued SFAS No. 154 Accounting Changes and Error
Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3
("SFAS 154 "). SFAS 154 requires retrospective application to prior periods'
financial statements for changes in accounting principle, unless it is
impracticable to determine either the period-specific effects or the cumulative
effect of the change. SFAS 154 also requires that a change in depreciation,
amortization, or depletion method for long-lived, non-financial assets be
accounted for as a change in accounting estimate affected by a change in
accounting principle. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The implementation of FAS 154 is not expected to have a material impact on the
Company's consolidated results of operations, financial position or cash flows.
In March 2005, the FASB issued FASB Interpretation 47 ("FIN 47 "), an
interpretation of SFAS No. 143, "Accounting for Asset Retirement Obligations"
("SFAS No. 143 "). FIN 47 clarifies the term "conditional asset retirement
obligation" as it is used in SFAS No. 143. The Company expects to apply the
guidance of FIN 47 commencing October 1, 2005 and expects no impact on its
financial statements.
-34-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
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, 2002 to September 30, 2005 is as follows:
NET REFINING
LIABILITIES
(ASSETS) RETAINED
-----------------
Balance - October 1, 2002.................................. $3,016
Adjustment of liabilities.................................. (151)
Cash transactions.......................................... (461)
------
Balance - September 30, 2003 and 2004...................... 2,404
Cash transactions.......................................... (1,551)
Chevron settlement......................................... 4,897
------
Balance - September 30, 2005............................... $5,750
======
As of September 30, 2005, the estimated value of net refining
liabilities (assets) retained consisted of a litigation settlement payable of
$5,750. The litigation settlement was paid by the Company on October 26, 2005.
Most of the cash transfers involve the payment of legal and other expenses
related to the Chevron litigation.
"Net refining liabilities (assets) retained is based on the transactions
consummated by the Company with American Western and transactions consummated by
American Western and IRLP subsequently with others and the Company's litigation
with Chevron (see below).
Chevron Litigation
On September 20, 2005, the Company settled its long-standing litigation
with Chevron. In exchange for a payment by the Company of $5,750, the Company
negotiated a settlement agreement which provided mutual releases and a complete
and comprehensive indemnification by Texaco Inc. of the Company, related
entities and persons against losses or liabilities arising out of or related to
the now dismantled Indian Refinery and related properties.
Chevron had filed the lawsuit against the Company and two of its
inactive subsidiaries in August 2002, seeking damages and declaratory relief
under contractual and statutory claims arising from environmental contamination
at the Indian Refinery. A now inactive subsidiary of the Company had operated
that refinery for approximately five years subsequent to approximately 75 years
of operation by Chevron. The lawsuit claimed that the Company was contractually
obligated to indemnify and defend Chevron against all liability and costs,
including lawsuits, claims and administrative actions initiated by the United
States Environmental Protection Agency ("EPA") and others that Chevron had
incurred or might incur as a result of environmental contamination at and around
the Indian Refinery, even if that environmental contamination had been caused by
Chevron. The suit also sought costs, damages and declaratory relief against the
Company under the Federal Comprehensive Environmental Response Compensation
Liability Act ("CERCLA"), the Oil Pollution Act of 1990 ("OPA") and the Solid
Waste Disposal Act, as amended, ("RCRA"). Chevron had also tendered to the
Company the defense of certain third party claims against Chevron in Illinois
state court. The Company disputed and contested the claims made by Chevron and
denied all liability.
-35-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
All claims in this litigation, as well as any other claims tendered by
Chevron, have been resolved by the settlement and the litigation was dismissed
with prejudice on October 12, 2005. The Company accrued the $5,750 settlement at
September 30, 2005 which it paid on October 26, 2005.
NOTE 4 - ACQUISITIONS AND DISPOSITIONS
Acquisitions
On March 31, 2004, the Company acquired interests in 138 western
Pennsylvania gas wells from Delta. The Company previously owned most of these
properties through May 31, 2002 when it sold all of its United States oil and
gas properties to Delta. The purchase price paid by the Company was $8,000. The
effective date of the purchase was January 1, 2004. For accounting purposes the
Company allocated $43 of the purchase price to trucks and the remainder to gas
properties.
The Company owned approximately 25% of Delta (see Note 10) at the time of
purchase and three of the Company's directors were also directors of Delta.
Prior to approving the purchase, the Company appointed a committee of
independent directors to evaluate and make a recommendation to the Board of
Directors with respect to the proposed transaction. The Committee engaged an
outside consultant to evaluate the fairness of the proposed purchase. Based upon
that consultant's recommendation that the purchase price was reasonable and fair
and the favorable recommendation of the committee, the full Board of Directors
of the Company unanimously approved the transaction.
At the same time the Company also purchased another owner's interests in
the same gas properties for $334 subject to similar final closing adjustments.
The other owner's interests in the properties were approximately four percent of
Delta's interests in the same properties.
On March 30, 2004, the Company acquired interests in 28 western
Pennsylvania gas wells for $1,100 from five limited partnerships. That
transaction closed March 30, 2004. The President of the general partner of the
five selling limited partnerships was and still is an officer and director of
the Company. As a result, the Company appointed a committee of independent
directors to evaluate and make recommendations to the Board with respect to the
proposed transaction. That committee engaged an outside consultant to evaluate
the fairness of the proposed purchase. Based upon that consultant's opinion that
the proposed purchase price was reasonable and fair and the favorable
recommendation of the committee, the full Board of Directors of the Company
unanimously approved the transaction.
The final adjusted purchase price for all of the gas properties acquired
in March 2004 was $8,985.
The Company's petroleum reservoir engineer estimated the proved reserves
applicable to the three Pennsylvania purchases to be approximately eight billion
cubic feet of natural gas, of which approximately 87% represents proved
producing reserves, while the remaining 13% represents behind pipe and
undeveloped reserves. Approximately 130 of 166 wells in which the Company
acquired interests are operated by the Company. The Company also entered into an
operations management agreement with Delta whereby Delta agreed to perform
certain well operations functions for the Company on a transitional basis for up
to six months commencing April 1, 2004. That agreement terminated September 30,
2004 and the Company commenced and is now performing the well operations
functions previously performed by Delta.
-36-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
NOTE 5 - RESTRICTED CASH
Restricted cash consists of the following:
SEPTEMBER 30,
----------------------
2005 2004
---- ----
Certificates of deposit supporting operating bonds ..................... $110 $120
Deposit securing contingent promissory note in Dominion
litigation, plus accrued interest..................................... 788
---- ----
$898 $120
==== ====
The certificates of deposit support letters of credit for operating and
drilling bonds provided to state or county regulatory agencies.
The deposit securing the contingent promissory note in the Dominion
litigation is payable only if there is a final judgment against the Company.
(See Note 15)
NOTE 6 - MARKETABLE SECURITIES
The Company's investment in marketable securities was as follows:
SEPTEMBER 30, 2005
-------------------------
DELTA SEPTEMBER 30, 2004
PETROLEUM -------------------
CHEVRON CORPORATION CHEVRON TOTAL
------- ----------- ------- -----
Common shares owned.................................. 354 6,700,000 354 354
=== ========= === ===
Cost................................................. $15 $ 39,892 $15 $15
Unrealized gain (loss)............................... 8 99,468 4 4
--- --------- --- ---
Book (market) value.................................. $23 $ 139,360 $19 $19
=== ========= === ===
Through March 31, 2005, the Company accounted for its investment in
Delta using the equity method. Commencing April 1, 2005, the Company accounted
for its investment in Delta as available-for-sale marketable securities (see
Notes 2 and 10).
-37-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
NOTE 7 - ACCOUNTS RECEIVABLE
Accounts receivable consists of the following:
SEPTEMBER 30,
-------------------------
2005 2004
---------- ----------
Gas production revenues................................................................ $506 $495
Purchase price adjustments............................................................. 17
Other.................................................................................. 168 70
---- ----
$674 $582
==== ====
Account receivable - Delta Petroleum Corporation....................................... $339
====
Account receivable - Delta Petroleum Corporation consisted of the final
purchase price adjustment related to the Company's acquisition of Appalachian
gas properties from Delta (see Notes 4 and 10). Delta paid this amount
subsequent to September 30, 2004.
NOTE 8 - ASSET RETIREMENT OBLIGATIONS
Changes in the Company's asset retirement obligations are as follows:
YEAR ENDED SEPTEMBER 30,
------------------------
2005 2004
---- ----
Balance - beginning of period...................................................... $230
Acquisitions....................................................................... $222
Adjustments........................................................................ 10 8
Accretion of discount.............................................................. 17
---- ----
Balance - end of period............................................................ $257 $230
==== ====
Current portion.................................................................... $ 3 $ 3
Long-term portion.................................................................. 254 227
---- ----
$257 $230
==== ====
NOTE 9 - INVESTMENT IN NETWORKED ENERGY LLC AND NOTE RECEIVABLE DUE FROM
NETWORKED ENERGY LLC
The Company accounts for its investment in Network using the equity
method of accounting (see Note 2). In fiscal 2002 the Company invested an
additional $150 in Network increasing its ownership from 35% to 45%. In
addition, the Company loaned Network $125 in fiscal 2003. The Company recorded a
$354 impairment provision on its investment in Network's equity and a $126
allowance for doubtful accounts on its note receivable from Network at March 31,
2003 because Network had not obtained any contracts for the services its offers.
These impairment provisions reduced the book value of the Company's investment
in Network to zero and the Company no longer recorded any portion of Network's
losses after March 31, 2003. For the period from April 1, 2003 to September 30,
2003, Network recorded a loss of $13, no portion of which was recorded by the
Company. For the period from October 1, 2003 to September 30, 2004, Network
recorded a loss of $4, no portion of which was recorded by the Company. For the
period from October 1, 2004 - September 30, 2005, Network recorded income of
$29. As a result, the Company recorded 45% of Network's cumulative net income
since April 1, 2003, which aggregated $12. The Company's investment in Network
as of September 30, 2005 and 2004 was as follows:
-38-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
NOTE
INVESTMENT RECEIVABLE
---------- ----------
Investment in Network's equity........................................................ $650
Note receivable - Network............................................................. $125
Accumulated amortization of goodwill.................................................. (23)
Accumulated share of Network's losses................................................. (273)
Impairment provision.................................................................. (354)
Accrued interest receivable........................................................... 1
Allowance for doubtful account........................................................ (126)
---- ----
Balance - September 30, 2004.......................................................... - -
Share of Network's cumulative income(loss) since April 1, 2003........................ 5
---- ----
Balance - September 30, 2005.......................................................... $ 5 -
==== ====
Network's membership units are held by the Company and one other member
who owns 55% of Network. The membership interests are not publicly traded.
See Notes 1 and 2.
NOTE 10 - INVESTMENT IN DELTA PETROLEUM CORPORATION (EQUITY METHOD)
Changes in the Company's investment in Delta were as follows:
Investment - October 1, 2003...................................................................... $29,477
Share of Delta's income (losses).................................................................. 1,352
Share of Delta's other comprehensive income (loss)................................................ (92)
Tax effect on share of Delta's other comprehensive income (loss).................................. 32
Issuance of additional Delta shares to outsiders at a price different than the Company's book
value.......................................................................................... 20,054
Sale of Delta shares to outsiders................................................................. (11,128)
Other............................................................................................. 3
-------
Investment - September 30, 2004................................................................... 39,698
Share of Delta's income (losses), October 1, 2004 to March 31, 2005............................... 1,690
Share of Delta's other comprehensive income (loss) and sale of additional Delta shares
to outsiders October 1, 2004 to March 31, 2005................................................. 238
Sale of 300,000 Delta shares to third party in March 2005........................................ (1,734)
Reclassification to marketable securities, March 31, 2005......................................... (39,892)
-------
Investment - April 1, 2005 and September 30, 2005................................................. 0
=======
Through March 31, 2005, the Company accounted for its investment in
Delta using the equity method. Initially, in May 2002, the Company had owned 44%
of Delta and three of the Company's directors constituted three of seven Delta
directors. By March 31, 2005, the Company's ownership of Delta had decreased to
16% (approximately 15% fully diluted) and the Company's directors only comprised
two of nine Delta directors. As a result of these developments, the Company
believed it no longer had significant influence on Delta's management and thus,
effective April 1, 2005, the Company commenced accounting for its investment in
Delta as a marketable available-for-sale security. As a result of this change in
accounting method, the book value of the Company's investment in Delta and the
Company's cumulative equity in Delta's comprehensive income (loss) at April 1,
2005, under the equity method of accounting, $39,892, became the Company's value
of the Delta stock as a marketable security on April 1, 2005.
-39-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
The difference between the Company's investment in Delta and its
proportional share of Delta's equity was approximately $4,000 at September 30,
2004. The Company has allocated the excess to Delta's ownership interests in
offshore California leases and the related potential legal recovery from Delta's
offshore California oil and gas leases.
In March 2005, the Company sold 300,000 shares of Delta for net proceeds
of $4,800 and recognized a gain of $3,066 on the sale. The book value of the
shares sold was based upon the book value per share of the Company's investment
in Delta, computed using the equity method, on the day of the sale. In March and
May 2004, the Company sold 2,948,289 shares of Delta for net proceeds of $29,339
and recognized a gain on the sale of $18,211. The book values of the shares sold
was based upon the book value per share of the Company's investment in Delta on
the day of the sale.
At September 30, 2005, the Company owned approximately 14% of Delta and
one of the Company's directors was also a director of Delta, which currently has
nine directors.
See Notes 2 and 6.
Condensed financial information concerning Delta is as follows:
SEPTEMBER 30,
2004
-------------
CONDENSED BALANCE SHEETS
Assets
Current assets .................................................................................. $ 15,896
Property and equipment, net...................................................................... 261,907
Other assets..................................................................................... 1,330
---------
$ 279,133
=========
Liabilities and Stockholders' Equity
Current liabilities, including current portion of long-term debt................................. $ 15,177
Long-term liabilities and minority interests..................................................... 63,445
Shareholder's equity............................................................................. 200,511
---------
$ 279,133
=========
-40-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
SEPTEMBER 30,
----------------------------
2004 2003
------------- ------------
(Unaudited)
CONDENSED STATEMENTS OF OPERATIONS
Revenue:
Oil and gas sales............................................................... $49,387 $27,850
Other........................................................................... (428) (2,074)
------- -------
48,959 25,776
------- -------
Expense:
Lease operating expenses........................................................ 11,865 9,579
General and administrative...................................................... 9,514 5,368
Depreciation, depletion and amortization........................................ 13,344 5,797
Other........................................................................... 7,920 800
------- -------
42,643 21,544
------- -------
Other income (loss)............................................................... (1,849) (1,728)
------- -------
Income (loss) before taxes........................................................ 4,467 2,504
Income taxes......................................................................
Discontinued operations, net of tax............................................... 3,169
------- -------
Net income (loss)................................................................. $ 7,636 $ 2,504
======= =======
The above condensed financial information has been compiled using
Delta's audited financial statements for the years ended June 30, 2004 and 2003
and its unaudited quarterly financial statements for the quarters ended
September 30, 2002, 2003 and 2004.
NOTE 11 - FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are as follows:
SEPTEMBER 30,
---------------------------
2005 2004
---------- ----------
Cost:
Furniture and fixtures and software............................................ $ 705 $ 690
Automobiles and trucks ........................................................ 461 349
------- -------
1,166 1,039
Accumulated depreciation......................................................... (978) (928)
------- -------
$ 188 $ 111
======= =======
NOTE 12 - OIL AND GAS PROPERTIES (UNAUDITED)
Oil and gas properties consist of the following:
SEPTEMBER 30,
---------------------------
2005 2004
---------- ----------
Proved properties..................................................................... $9,217 $9,207
Less: accumulated depreciation, depletion and amortization............................ (653) (195)
------ ------
$8,564 $9,012
====== ======
-41-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
As required by SFAS No. 69 "Disclosure About Oil and Gas Producing
Activities," the Company has also presented information concerning its interest
in Delta's oil and gas operations.
The Company's 17.8% interest in Delta's net capitalized costs at
September 30, 2004 was $46,619 (unaudited).
Capital costs incurred by the Company in oil and gas activities are as
follows:
YEAR ENDED SEPTEMBER 30,
------------------------
2005 2004
------ ------
UNITED UNITED
STATES STATES
------ ------
Acquisition of properties:
Proved properties......................................................... $8,985
Unproved properties
Exploration...................................................................
Development...................................................................
------- ------
$8,985
======= ======
No capital costs were incurred by the Company in oil and gas activities
for the year ended September 30, 2003.
The Company's interest in Delta's costs of property acquisition,
exploration and development are as follows:
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
ONSHORE OFFSHORE TOTAL ONSHORE OFFSHORE TOTAL
-------- -------- ------- ------- -------- ------
Acquisition of properties:
Proved properties .............. $22,888 $22,888 $4,421 $4,421
Unproved properties ............ 6,626 $121 6,747 285 $181 466
Exploration........................ 428 428 58 58
Development........................ 4,410 190 4,600 2,112 404 2,516
------- ---- ------- ------ ---- ------
$34,352 $311 $34,663 $6,876 $585 $7,461
======= ==== ======= ====== ==== ======
Company's interest in Delta........ 17.8% 41%
==== ==
All of Delta's offshore properties are located in offshore California.
The Company's interest in Delta's property acquisition, exploration and
development costs incurred in oil and gas activities is presented for annual
periods ending June 30 because this is Delta's fiscal year end.
-42-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT 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,
------------------------
2005 2004
---------- -----------
Revenues:
Crude oil, condensate, natural gas liquids and natural gas sales.................... $2,561 $1,087
------ ------
Costs and expenses:
Production costs.................................................................. $ 584 $ 315
Depreciation, depletion and amortization.......................................... 457 195
------ ------
Total costs and expenses.......................................................... 1,041 510
------ ------
Income tax provision (benefit)...................................................... 547 99
------ ------
Income (loss) from oil and gas producing activities................................. $ 973 $ 478
====== ======
The income tax provisions were computed at the effective tax rate for
continuous operations for the related fiscal year.
The Company had no oil and gas producing activities for the year ended
September 30, 2003.
The Company's 17.8% interest in Delta's historical results of
operations, excluding corporate overhead and interest expense, from oil and gas
producing activities are as follows:
YEAR ENDED JUNE 30,
---------------------
2004 2003
--------- ----------
Income (loss) from oil and gas producing activities, including $982 of
income from discontinued operations and gains from properties sold in 2004.......... $3,339 $4,241
====== ======
The Company's interest in Delta........................................................ 17.8% 41%
====== ======
The Company's interest in Delta's historical results of operations is
presented for annual periods ended June 30 because this is Delta's fiscal year
end.
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,
--------------------------
2005 2004
---------- ----------
Depletion rate per equivalent MCF of natural gas....................................... $1.19 $1.25
===== =====
No depletion expense was incurred for the fiscal year ended September
30, 2003 because the Company did not directly own any oil and gas properties in
fiscal 2003.
Under the full cost method of accounting, the net book value of oil and
gas properties less related deferred income taxes (the "costs to be recovered")
may not exceed a calculated "full cost ceiling." The ceiling limitation is the
discounted estimated after-tax future net revenues from oil and gas properties.
The ceiling is imposed separately by country. In calculating future net
revenues, current prices and costs are generally held constant indefinitely. The
costs to be recovered are compared to the ceiling on a quarterly basis. If the
costs to be recovered exceed the ceiling, the excess is written off as an
expense, except as discussed in the following paragraph.
-43-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
If, subsequent to the end of the reporting period, but prior to the
applicable financial statements being published, prices increase to levels such
that the ceiling would exceed the costs to be recovered, a write-down otherwise
indicated at the end of the reporting period is not required to be reported. A
write-down indicated at the end of a reporting period is also not required if
the value of additional reserves proved up on properties after the end of the
reporting period, but prior to the publishing of the financial statements, would
result in the ceiling exceeding the costs to be recovered, as long as the
properties were owned at the end of the reporting period.
An expense recorded in one period may not be reversed in a subsequent
period even though higher oil and gas prices may have increased the ceiling
applicable to the subsequent period.
At September 30, 2005 and 2004, based upon natural gas prices at
September 30, 2005 and 2004, the ceiling value of the Company's reserves
exceeded the Company's costs to be recovered and no full cost ceiling write-down
was required.
NOTE 13 - PROVED OIL AND GAS RESERVES AND RESERVE VALUATION (UNAUDITED)
Reserve estimates are based upon subjective engineering judgments made by
the Company's independent petroleum reservoir engineers, 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:
("000'S" OMITTED)
--------------------------------------
OIL (BBLS) NATURAL GAS (MCF)
---------- -----------------
Proved developed and undeveloped reserves:
As of October 1, 2002 and 2003................................
Acquisitions.............................................. 9,041
Production................................................ (156)
------
As of September 30, 2004...................................... 8,885
Production................................................ (385)
Revision of previous estimates............................ (84)
------
As of September 30, 2005 8,416
======
Proved developed reserves:
September 30, 2002 and 2003...................................
======
September 30, 2004............................................ 8,081
======
September 30, 2005............................................ 7,792
======
Company's 17.8% interest in reserves of Delta (proved developed and
undeveloped reserves):
June 30, 2004............................................... 2,350 15,749
===== ======
The Company did not own any oil and gas properties at September 30, 2002
or September 30, 2003.
-44-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
Delta's fiscal year is June 30th and reserve information with respect to
the Company's share of Delta's reserves is therefore presented as of that date.
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 SFAS 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:
SEPTEMBER 30,
-------------------------
2005 2004
---------- ----------
Future cash inflows ................................................................ $129,204 $53,961
Future production costs ............................................................ (27,260) (12,116)
Future development costs ........................................................... (1,379) (1,479)
Future income tax expense .......................................................... (28,535) (10,563)
-------- -------
Future net cash flows .............................................................. 72,030 29,803
Discount factor of 10% for estimated timing of future cash flows ................... (38,845) (16,660)
-------- -------
Standardized measure of discounted future cash flows ............................... $ 33,185 $13,143
======== =======
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 were computed
at the blended rate (Federal and state combined) of 36%, taking into account the
Company's tax carryforwards. (See Note 19)
No standardized measure of discounted future cash flows existed at
September 30, 2003 because the Company owned no oil and gas properties directly
on this date.
The following were the sources of changes in the standardized measure of
discounted future net cash flows:
SEPTEMBER 30,
----------------------------
2005 2004
---------- ----------
Standardized measure, beginning of year ............................................ $13,143
Sale of oil and gas, net of production costs ....................................... (1,977) ($ 772)
Net changes in prices .............................................................. 26,221
Decrease in development costs ...................................................... (33)
Purchase of reserves in place ...................................................... 17,802
Net changes in income taxes......................................................... (6,081) (3,887)
Accretion of discount............................................................... 1,314
Other............................................................................... 598
------- -------
Standardized measure, end of year................................................... $33,185 $13,143
======= =======
No presentation of changes in the standardized measure of discounted
future net cash flows was prepared for the year ended September 30, 2003 because
the Company had disposed of all of its oil and gas properties by May of 2002 and
did not reacquire oil and gas properties until March of 2004.
-45-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
The Company's interests in Delta's standardized measure of discounted
future cash flows are as follows:
JUNE 30,
-----------------------
2004 2003
---------- ----------
$51,271 $43,957
======= =======
Company's ownership interest........................................................... 17.8% 41%
==== ==
The Company's share of Delta's standardized measure of discounted future
cash flow was computed as of June 30 because this is Delta's fiscal year end.
NOTE 14 - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share.
YEAR ENDED SEPTEMBER 30,
-------------------------------------------
2005 2004 2003
---------- ---------- ----------
Numerator:
Numerator for basic and diluted earnings per share - net income
(loss) available to common stockholders............................. ($ 1,591) $ 13,620 ($ 2,001)
========== ========== ==========
Denominator:
Denominator for basic earnings per share-weighted average shares
outstanding......................................................... 7,052,693 6,675,538 6,592,884
Effective of dilutive stock options.................................... 258,444
---------- --------- ----------
Denominator for diluted earnings per common share...................... 7,052,693 6,933,982 6,592,884
---------- --------- ----------
Basic net income (loss) per common share............................... ($ .23) $ 2.04 ($ .30)
========== ========= ==========
Diluted net income (loss) per common share............................. ($ .23) $ 1.96 ($ .30)
========== ========= ==========
The following options that could be potentially dilutive were not
included in the computation of diluted net income (loss) per share because the
effect would have been anti-dilutive for the periods indicated:
YEAR ENDED SEPTEMBER 30,
---------------------------------------------
2005 2004 2003
------------ ------------ ------------
Number of options........................................................ 90,000 712,500
Price range of options................................................... $3.79-$8.58 $3.71-$8.58
NOTE 15 - 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, 2005:
-46-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
LEASE SUBLEASE NET LEASE
YEAR ENDING SEPTEMBER 30, COMMITMENTS COMMITMENTS COMMITMENTS
------------------------- ----------- ----------- -----------
2006.................................... $184 ($21) $163
2007.................................... 180 (21) 159
2008.................................... 177 (21) 156
2009.................................... 120 (21) 99
2110.................................... 93 (21) 72
2111.................................... 14 (3) 11
---- ----- ----
Total................................... $768 ($108) $660
==== ===== ====
Rent expense for the years ended September 30, 2005, 2004 and 2003 was
$311, $339 and $449, respectively.
SEVERANCE/RETENTION OBLIGATIONS
At September 30, 2005, the Company had severance agreements with one
officer and four employees. The severance agreements provide severance payments
if the Company sells its assets, the officer/employee is terminated and the new
purchaser does not offer the officer/employee employment at a compensation level
of at least 80% of the officer's/employee's current compensation level.
Severance obligations at September 30, 2005 were as follows:
Officer............................................. $ 73
Employees........................................... 118
-----
$ 191
=====
LEGAL PROCEEDINGS
CONTINGENT ENVIRONMENTAL LIABILITIES
See Note 3.
OTHER LITIGATION
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were
defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case,
the Long Trusts, are non-operating working interest owners in certain wells
previously operated by Castle Texas Production Limited Partnership ("CTPLP"), an
inactive exploration and production subsidiary of the Company. The wells were
among those sold to UPRC in May 1997. The Long Trusts claimed that CTPLP did not
allow them to sell gas from March 1, 1996 to January 31, 1997 as required by
applicable joint operating agreements, and they sued CTPLP and the Company's
other subsidiaries, claiming (among other things) breach of contract, breach of
fiduciary duty, conversion and conspiracy. The Long Trusts sought actual
damages, exemplary damages, prejudgment and post-judgment interest, attorney's
fees and court costs. CTPLP counterclaimed for approximately $150 of unpaid
joint interest billings plus interest, attorney's fees and court costs.
After a three-week trial, the District Court in Rusk County submitted 36
questions to the jury which covered the claims and counterclaim in the lawsuit.
Based upon the jury's answers, the District Court entered judgment on some of
the Long Trusts' claims against the Company and its subsidiaries, as well as
CTPLP's counterclaim against the Long Trusts. The District Court issued an
amended judgment on September 5, 2001 which became final December 19, 2001. The
net amount awarded to the plaintiffs was approximately $2,700.
-47-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
The Company and its subsidiaries and the Long Trusts subsequently filed
notices of appeal, submitted legal briefs in April 2002, reply briefs in June
and July 2002, and ultimately argued the case before the 12th Court of Appeals
in Tyler, Texas in October 2002. On July 31, 2003, that court reversed and
remanded in part the trial court's judgment against the Company and its
subsidiaries while affirming the judgment against the Long Trusts which had
awarded damages on the counterclaim asserted by CTPLP. In its decision, the
appellate court held that the trial court had submitted erroneous theories to
the jury, expressly rejecting the Long Trusts' claims for breach of fiduciary
duty, conversion, implied covenants and exemplary damages. It also remanded the
Long Trusts' claims for breach of contract to the district court for retrial.
The appellate court upheld the trial court's award to CTPLP on its counterclaim
for approximately $150 of unpaid joint interests billings, $450 in attorneys'
fees, plus interest and court costs. Both the Company and its subsidiaries and
the Long Trusts thereafter submitted motions for a rehearing on certain rulings
to the 12th Court of Appeals. That court denied both motions for a rehearing.
The Long Trusts subsequently filed a petition for review with the
Supreme Court of Texas. On March 26, 2004, the Texas Supreme Court denied the
Long Trusts petition for review and the Long Trusts filed a petition for
rehearing with that court two weeks later. That petition was also subsequently
denied, whereupon the Court of Appeals issued its mandate on June 9, 2004
completing the appellate process. The supersedeas bond posted by the Company was
released, along with a $4,110 letter of credit, including accrued interest, that
secured the bond. Certain breach of contract claims by the Long Trusts which
were reversed and remanded by the appellate court may be retried by the
plaintiffs. Based on the evidence at the initial trial coupled with the guidance
to the trial court given in the appellate decision, the Company believes that it
will be able to prove that there was no breach of contract and that Long Trusts
suffered no damages, and that any such breach of contract claims, even if
decided adversely to the Company, will not result in a material loss to the
Company.
Pursuant to the mandate of the Texas Court of Appeals, the Company moved
to sever CTPLP's claims against the Long Trusts from any retrial of the Long
Trust's contract claims against the Company and to collect on CTPLP's judgment
against the Long Trusts which is secured by a letter of credit posted by the
Long Trusts with the trial court. On September 17, 2004, the Long Trusts filed a
Motion for Clarification with the Court of Appeals which in essence sought to
reverse that court's severance of CTPLP's claims from the retrial of the Long
Trusts' breach of contract claims. The Company filed a Petition for Writ of
Mandamus with the Court of Appeals on December 3, 2004, requesting that the
trial court be stayed from proceeding further, and be ordered to comply with the
June mandate of the Court of Appeals. On January 31, 2005, the Court of Appeals
stayed the trial court from proceeding and subsequently denied the Motion for
Clarification on March 3, 2005 and the Petition for Writ of Mandamus on March
16, 2005. On May 2, 2005, the trial court from the bench announced that CTPLP's
severed claim would be assigned a new case number, but took all other requests
for action from the parties under advisement. In August 2005, the Company filed
a second Petition for Writ of Mandamus with the Court of Appeals requesting that
the calculation of interest due from the Long Trusts be made without a new trial
and that Long Trusts be ordered to pay the judgment against it plus interest
without delay.
The Company estimates the judgment to be $1,046, including accrued
interest, as of September 30, 2005. The Company has not accrued any recoveries
for this litigation as of September 30, 2005, but will record recoveries if and
when they are ultimately realized (collected).
-48-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
Pilgreen Litigation
As part of the oil and gas properties acquired from AmBrit Energy
Corporation ("AmBrit") in June 1999, Castle Exploration Company, Inc., a
wholly-owned subsidiary of the Company ("CECI") acquired a 10.65% overriding
royalty interest ("ORRI") in the Simpson lease in south Texas, including the
Pilgreen #2ST gas well. CECI subsequently transferred that interest to Castle
Texas Oil and Gas Limited Partnership ("CTOGLP"), an indirect wholly-owned
subsidiary. Because the operator suspended revenue attributable to the ORRI from
first production due to title disputes, AmBrit, the previous owner, filed claims
against the operator of the Pilgreen well, and CTOGLP acquired rights in that
litigation with respect to the period after January 1, 1999. In August 2002,
$282 was released to the Company of which $249 was recorded as income by the
Company and the remaining $33 paid to Delta. Because of a claim by Dominion
Oklahoma Texas Exploration and Production, Inc. ("Dominion") (see below), a
working interest owner in the same well, that CTOGLP's ORRI in the Simpson lease
should be deemed burdened by 3.55% overriding royalty interest, there is still a
title dispute as to approximately $120 of suspended CTOGLP Pilgreen #2ST
production proceeds for the Company's account. (The Company sold all of its oil
and gas assets, including the Pilgreen #2ST well, to Delta on May 31, 2002 but
effective as of October 1, 2001.) The Company has named Dominion as a defendant
in a legal action seeking a declaratory judgment that the Company is entitled to
its full 10.65% overriding royalty interest in the Pilgreen well. The Company
believes that Dominion's title exception to CTOGLP's overriding royalty interest
is erroneous and notes that several previous title opinions have confirmed the
validity of CTOGLP's interest. The litigation is related to the Dominion
litigation (see below). The Company and its counsel are currently reviewing the
effect of the Court of Appeals' opinion issued in the Dominion litigation on the
Company's claims in this litigation. Since the Company has not recorded any
revenue related to the $120 of suspended revenue, it expects to record $120 of
revenue if and when such revenue is realized (collected), but no expense if it
fails in this litigation.
Christiansen Litigation
CTOGLP, along with several unrelated parties, has also filed suit to
collect production proceeds from an additional well on the Simpson lease in
which CTOLGP had a 5.325% ORRI suspended by the operator because of title
disputes. The Company intends to contest this matter vigorously. At the present
time, the amount held in escrow applicable to the additional well attributable
to the Company's interest is approximately $66 although approximately $22 of
that amount would be subject to Dominion's claims in the Pilgreen Litigation.
The Company has not recorded any of the net $44 of suspended revenue as income,
but will record it as income when and if it is realized (collected). There is no
claim or contingent liability against the Company or its subsidiaries in this
matter, just a contingent gain if CTOGLP were to prevail.
Dominion Litigation
On March 18, 2002, Dominion, operator of the Mitchell and Migl-Mitchell
wells in the Southwest Speaks field in south Texas and a working interest owner
in the Pilgreen #2ST well, filed suit in Texas against CTOGLP seeking
declaratory judgment in a title action that the ORRI held by CTOGLP in these
wells should be deemed to be burdened by certain other ORRI's aggregating 3.55%
and should therefore be reduced from 10.65% to 7.10%. Dominion is also seeking
an accounting and refund of payments for overriding royalty to CTOGLP in excess
of the 7.10% since April 2000. The Company currently estimates the amount in
controversy to be approximately $783. Dominion threatened to suspend all revenue
payable to the Company from the Mitchell and Migl-Mitchell to offset its claim.
The Company and Dominion subsequently examined the land and lease documents
concerning the ORRI's. The Company believes that Dominion's title exception to
CTOGLP's ORRI is erroneous and notes that several previous title opinions have
confirmed the validity of CTOGLP's interest.
In July 2003, Dominion filed a motion for partial summary judgment
concerning the Company's claim that it had assumed the liabilities of its
predecessor in interest and CTOGLP filed its response to Dominion's motion as
well as its own cross motion for partial summary judgment. In September 2003,
the District Court of Lavaca County granted Dominion's partial motion for
partial summary judgment. In January 2004, Dominion filed a motion for final
summary judgment on this matter to which CTOGLP and the other defendants filed a
response. In May 2004, the District Court of Lavaca County granted Dominion's
motion for final summary judgment following which the Company's appealed both of
the District Court's summary judgments to the Court of Appeals in Corpus
Christi.
-49-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
By agreement with Dominion, CTOGLP executed a promissory note for $783
guaranteed by the Company and deposited this amount in a separate restricted
cash account of CTOGLP to support the note and to avoid the cost of a
supersedeas bond. On July 28, 2005, the Court of Appeals issued a Memorandum
Opinion that affirmed Dominion's claims to reduce the ORRI, but only to take
effect at a date after CTOGLP had sold the ORRI. The Court of Appeals overturned
that portion of the judgment that required CTOGLP to refund any money received
by it. The Company does not at this time know if Dominion intends to petition
the Supreme Court of Texas for review of this decision. The promissory note
issued by CTOGLP will be cancelled and the restricted cash account of CTOGLP
released when and if this judgment becomes final and non-appealable.
In fiscal 2004, the Company recorded an $825 loss provision related to
the Dominion litigation - primarily as a result of the District Court's granting
of Dominion's motion for summary judgment in May 2004. The Company has reversed
that provision plus $20 of accrued interest on the contingent note during fiscal
2005 primarily because the Court of Appeals reversed that District Court
judgment against the Company. Nevertheless, Company's contingent note payable to
Dominion and CTOGLP's restricted cash account are required to remain in place
until the Appeals Court judgment becomes non-appealable. Dominion filed a
petition for appeal to the Texas Supreme Court of the appellate court's
decision. If the Supreme Court reverses the Appeals Court decision, the Company
would then become liable for the contingent note to Dominion plus interest or
some portion thereof. In such case, the Company would again record a loss
provision.
CONTINGENT GAIN
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 and received
a $24,000 mortgage on the GAMXX property, an idle refining plant in Theodore,
Alabama. 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. The Company subsequently filed
and currently maintains a $10,000 lien on the GAMXX properties.
In September 2005, the Company entered into an agreement to sell its
lender's interest in GAMXX to an outside party for $3,500 in January 2006. The
agreement provides that the purchaser is responsible for unpaid property taxes
(approximately $1000 at September 30, 2005) on the property as well as for any
environmental remediation that is required. The purchaser made a non-refundable
deposit of $10 upon executing the agreement. If the purchaser completes the
purchase of the Company's interest in GAMXX, the Company expects that it will
receive net proceeds of approximately $3,200 after allowance for broker
commissions and legal fees. If the purchaser does not ultimately purchase the
Company's interest, the Company will simply retain the $10 deposit.
In September 2005, another third party purchased the tax lien on the
property by paying the unpaid property taxes of $1,000. As a result, the Company
or any purchaser of its interest has a year from the date of the purchase of the
tax lien to redeem the tax lien by paying the tax lien purchaser $1,000 plus
interest. If the tax lien is not redeemed in that one-year period, the property
will be owned by the purchaser of the tax lien and the Company's mortgage and
lien on the property will be terminated.
The Company has carried its loans to GAMXX at zero for the last ten
years. The Company will record any proceeds as "other income" if and when it
collects such amount.
-50-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
NOTE 16 - 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, 2005, 2004 and 2003, the Company's
contributions to the Plan aggregated $23, $13, and $18, respectively.
POST-RETIREMENT BENEFITS
Neither the Company nor its subsidiaries provide any other
post-retirement plans for employees.
NOTE 17 - STOCKHOLDERS' EQUITY
From November 1996 until September 30, 2003, 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, 2005, 4,911,044
shares had been repurchased or surrendered to the Company at a cost of $66,667.
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 for all
quarters except for the quarter ending June 30, 2002. In addition, the Company
paid a special dividend of $1.00 per share during the quarter ended June 30,
2005.
NOTE 18 - STOCK OPTIONS AND WARRANTS
Option and warrant activities during each of the three years ended
September 30, 2005 are as follows (in whole units):
INCENTIVE WEIGHTED
PLAN OTHER AVERAGE
OPTIONS OPTIONS TOTAL PRICE
--------- ------- ----- --------
Outstanding at October 1, 2002....................... 750,000 60,000 810,000 $5.29
Expired.............................................. (97,500) (97,500) 4.08
--------- ------- --------- -----
Outstanding at September 30, 2003.................... 652,500 60,000 712,500 5.46
Exercised............................................ (277,500) (277,500) 4.94
--------- ------- --------- -----
Outstanding at September 30, 2004.................... 375,000 60,000 435,000 5.79
Exercised............................................ (300,000) (45,000) (345,000) 5.75
--------- ------- --------- -----
Outstanding - September 30, 2005..................... 75,000 15,000 90,000 $5.93
========= ======= ========= =====
Exercisable at September 30, 2005.................... 75,000 15,000 90,000
========= ======= =========
Reserved at September 30, 2005....................... 1,687,500 15,000 1,702,500
========= ======= =========
Reserved at September 30, 2004....................... 1,687,500 60,000 1,747,500
========= ======= =========
Reserved at September 30, 2003....................... 1,687,500 60,000 1,747,500
========= ======= =========
Reserved at September 30, 2002....................... 1,687,500 60,000 1,747,500
========= ======= =========
-51-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
INCENTIVE WEIGHTED
PLAN OTHER AVERAGE
OPTIONS OPTIONS TOTAL PRICE
--------- ------- ----- --------
Exercise prices at:
September 30, 2005...................... $3.71-$8.58 $3.79
September 30, 2004...................... $3.71-$8.58 $3.79
September 30, 2003...................... $3.42-$8.58 $3.79
Exercise Termination Dates.............. 01/02/2008- 4/23/2007 04/23/2007-
01/02/2012 01/02/2012
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.
The Incentive Plan provided that an aggregate of 1,687,500 shares 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 provided that each outside director of the
Company would annually be granted an option to purchase 15,000 shares of common
stock at fair market value on the date of grant. Effective October 1, 2002, the
Company's Compensation Committee terminated the annual option grants to outside
directors. No options have been granted since January 2002.
The Company applies APB 25 in accounting for options and accordingly
recognizes no compensation cost for its stock options for grants with an
exercise price equal to the current fair market value.
At September 30, 2005, exercise prices for outstanding options ranged
from $3.71 to $8.58. The weighted average remaining contractual life of such
options was 3.9 years.
No stock options were issued in fiscal 2003, 2004 or 2005.
See Note 24.
-52-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
NOTE 19 - INCOME TAXES
Provisions for (benefit of) income taxes consist of:
YEAR ENDED SEPTEMBER 30,
-----------------------------
2005 2004 2003
---- ---- ----
Provision for (benefit of) income taxes:
Current:
Federal....................................................... ($ 1) $ 337
State......................................................... (29)
Deferred:
Federal....................................................... (13) 5,389 ($1,809)
State......................................................... (450) 164 (52)
Adjustment to the valuation allowance for deferred taxes:
Federal....................................................... (3,404) 1,470
State......................................................... (101) 42
----- ------ -------
($493) $2,385 ($ 349)
===== ====== =======
The tax provision (benefit) has been allocated as follows:
YEAR ENDED SEPTEMBER 30,
-----------------------------
2005 2004 2003
---- ---- ----
Continuing operations:
State.............................................................. $ 29 $ 63 ($ 10)
Federal............................................................ 983 2,322 (339)
Discontinued operations:
State.............................................................. (42)
Federal............................................................ (1,463)
------ ------ -----
($ 493) $2,385 ($349)
====== ====== =====
Deferred tax assets (liabilities) are comprised of the following:
2005 2004
---- ----
Litigation provision...................................................... $ 297
Investment in Delta Petroleum Corporation................................. ($43,535) (7,119)
Operating losses and tax credit carryforwards............................. 4,219 757
Basis of gas properties................................................... (130)
Discontinued net refining operations...................................... 866
Investment in Network..................................................... 24 28
-------- -------
(39,422) (5,171)
Valuation allowance.......................................................
-------- -------
($39,422) ($5,171)
======== =======
Deferred tax assets (liability) - current.................................
Deferred tax assets - (liability) - long-term............................. ($39,422) ($5,171)
======== =======
($39,422) ($5,171)
======== =======
-53-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
At September 30, 2004, the Company decreased its valuation allowance by
$6,416 based upon its assessment of the amount of gross deferred tax asset that
would more likely than not be realized based on an estimate of future taxable
income. Approximately $3,500 of the decrease in the valuation allowance was
recorded as a reduction in income tax expense.
The income tax provision (benefit) differs from the amount computed by
applying the statutory federal income tax rate to income (loss) from continuing
operations before income taxes as follows:
YEAR ENDED SEPTEMBER 30,
-------------------------------
2005 2004 2003
---- ---- ----
Tax expense (benefit) at statutory rate........................... $ 983 $5,602 ($823)
State taxes, net of federal benefit............................... 29 160 (15)
Revision of tax estimates related to oil and gas tax credits...... (427)
Revision of tax estimates related to statutory depletion.......... (130)
Revision of other tax estimates................................... 128 (466)
Increase (decrease) in valuation allowance........................ (6,416) 1,512
Tax exempt interest...............................................
Change in valuation allowance credited to Paid-in Capital......... 2,911
------ ------ -----
$1,012 $2,385 ($349)
====== ====== =====
At September 30, 2005, the Company had the following tax carryforwards
available:
FEDERAL TAX
---------------------
ALTERNATIVE
MINIMUM
REGULAR TAX
------- -----------
Net operating loss.................................. $8,453 $14,014
Alternative minimum tax credits..................... $1,176 0
The regular net operating loss carryforwards expire through 2025. The
alternative minimum tax net operating loss carryforwards expire from 2007 to
2025.
The Company also estimates that it has approximately $67,700 in
individual state tax loss carryforwards available at September 30, 2005. Most of
such carryforwards are primarily available to offset taxable income apportioned
to certain states in which the Company no longer has operations. As a result, it
is probable at the present time that most of such state tax carryforwards will
expire unused.
-54-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
NOTE 20 - RELATED PARTIES
During the years ended September 30, 2004 and 2003, Delta paid two
officers of the Company $315 and $420, respectively, for consulting compensation
for the period October 1, 2002 to May 31, 2004. As a result of the Company's
sale of all of its domestic oil and gas properties to Delta on May 31, 2002, the
Company had reduced the salaries of the two officers by approximately 65%.
The Company paid Delta $172 for services provided in conjunction with
operation of the Company's gas properties from March 30, 2004 to September 30,
2004. (See Note 4)
In March 2004, the Company purchased gas properties from Delta and five
limited partnerships, whose general partner was a company owned by an officer of
the Company. (See Note 4)
NOTE 21 - BUSINESS SEGMENTS
As of September 30, 1995, the Company had disposed of its refining
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. 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. During 2002, the equity method losses incurred as a result
of the Company's investment in Network exceeded a threshold for identifying and
reporting Network as an additional segment. Network is engaged in the planning,
installation and operation of natural gas fueled energy generating facilities.
This segment is referred to as the Power Business.
The Company does not allocate interest income, interest expense or
income tax expense to these segments.
YEAR ENDED SEPTEMBER 30, 2005
-------------------------------------------------------------------------------------------
NATURAL GAS OIL & GAS ELIMINATIONS
MARKETING EXPLORATION AND
AND AND REFINING POWER CORPORATE
TRANSMISSION PRODUCTION (DISCONTINUED) BUSINESS ITEMS CONSOLIDATED
------------ ------------- -------------- ---------- ------------ --------------
Revenues ........................ $ 2,561 $ 2,561
Equity in net income (loss) of
equity method investees........ $ 1,690 $5 $ 1,695
Operating income (loss) ......... ($ 817) ($ 1,799) ($ 2,616)
Identifiable assets ............. $66,973 $76,085 $34,665 $ 177,723
Investment in equity method
investees..................... $5 $ 5
Capital expenditures ............ $ 27 $ 101 $ 128
Depreciation, depletion and
amortization .................. $ 457 $ 50 $ 507
-55-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30, 2004
-------------------------------------------------------------------------------------------
NATURAL GAS OIL & GAS ELIMINATIONS
MARKETING EXPLORATION AND
AND AND REFINING POWER CORPORATE
TRANSMISSION PRODUCTION (DISCONTINUED) BUSINESS ITEMS CONSOLIDATED
------------ ------------- -------------- ---------- ------------ --------------
Revenues ....................... $ 1,087 $ 1,087
Equity in net income (loss)
of equity method investees... $ 1,352 $ 1,352
Operating income (loss) ........ 59 ($ 4,795) ($ 4,736)
Identifiable assets ............ $66,973 $ 74,857 ($ 58,004) $ 83,826
Investment in equity method
investees.................... $ 39,698 $ 39,698
Capital expenditures ........... $ 9,421 $ 22 $ 9,443
Depreciation, depletion and
amortization ................ $ 195 $ 56 $ 251
YEAR ENDED SEPTEMBER 30, 2003
-------------------------------------------------------------------------------------------
NATURAL GAS OIL & GAS ELIMINATIONS
MARKETING EXPLORATION AND
AND AND REFINING POWER CORPORATE
TRANSMISSION PRODUCTION (DISCONTINUED) BUSINESS ITEMS CONSOLIDATED
------------ ------------- -------------- ---------- ------------ --------------
Revenues .......................
Equity in net income (loss) of
equity method investees....... $ 1,067 ($20) $ 1,047
Operating income (loss) ........ ($ 3,621) ($ 3,621)
Identifiable assets ............ $66,971 $ 78,486 ($ 95,649) $ 49,808
Investment in equity method
investees..................... $ 29,477 $ 29,477
Capital expenditures ...........
Depreciation, depletion and
amortization ................. $ 56 $ 56
For the year ended September 30, 2004, four purchasers of the Company's
gas production accounted for 34%, 18%, 17% and 10%, respectively, of the
Company's gas sales. For the year ended September 30, 2005, four purchasers
accounted for 35%, 14%, 14% and 10% of the Company's gas sales. The Company had
no oil or gas sales for the year ended September 30, 2003.
NOTE 22 - 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 primarily to the Company's investment
in Delta's common stock at September 30, 2005 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.
-56-
CASTLE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
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 23 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
(DECEMBER 31) (MARCH 31) (JUNE 30) (SEPTEMBER 30)
------------- ----------- ----------- --------------
Year Ended September 30, 2005:
Revenues ................................ $699 $ 812 $456 $ 594
Operating income (loss).................. ($468) ($ 740) ($ 45) ($1,363)
Net income (loss) ....................... $343 $2,880 ($496) ($4,318)
Net income (loss) per share (diluted) ... $.05 $ .40 ($.07) ($ .61)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
(DECEMBER 31) (MARCH 31) (JUNE 30) (SEPTEMBER 30)
------------- ----------- ----------- --------------
Year Ended September 30, 2004:
Revenues ................................ $ 491 $ 596
Operating income (loss).................. ($1,251) ($ 1,198) ($1,601) ($ 686)
Net income (loss) ....................... ($1,248) $12,168 $2,713 ($ 13)
Net income (loss) per share (diluted) ... ($ .19) $ 1.77 $ .39 ($ .00)
The Company recorded a loss from discontinued operations of $3,392,
net of a $1,505 tax benefit, in the fourth quarter of the year ended September
30, 2005. See Note 3.
NOTE 24 - SUBSEQUENT EVENTS
On November 8, 2005, the Company entered into an agreement to merge into
Delta (see Note 1).
Subsequent to September 30, 2005, a director of the Company exercised
90,000 options. Proceeds to the Company were $533. After the exercise of these
options, no options remained outstanding.
-57-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Castle Energy Corporation:
We have audited the accompanying consolidated balance sheet of Castle Energy
Corporation and subsidiaries as of September 30, 2005, and the related
consolidated statements of operations, stockholders' equity and other
comprehensive income (loss), and cash flows for the year ended September 30,
2005. 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 audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides 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, 2005, and the results of their
operations and their cash flows for the year ended September 30, 2005, in
conformity with accounting principles generally accepted in the United States of
America.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
November 18, 2005
-58-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Castle Energy Corporation:
We have audited the accompanying consolidated balance sheet of Castle Energy
Corporation and subsidiaries as of September 30, 2004, and the related
consolidated statements of operations, stockholders' equity and other
comprehensive income, and cash flows for each of the years in the two-year
period ended September 30, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2004, and the results of their
operations and their cash flows for each of the years in the two-year period
ended September 30, 2004 in conformity with U.S. generally accepted accounting
principles.
KPMG LLP
Houston, Texas
December 14, 2004
-59-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A. CONTROLS AND PROCEDURES
The conclusions of the Company's Chief Executive Officer and Chief Financial
Officer concerning the effectiveness of the Company's disclosure controls and
procedures and changes in internal controls as of September 30, 2005 are as
follows:
a) They have concluded that the Company's disclosure controls and
procedures are effective in ensuring that information required
to be disclosed by the Company in the reports it files or
submits under the Securities Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC.
b) There were no changes in the Company's internal controls during
the quarter ended September 30, 2005 that have materially
affected or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
See Exhibits 31.1 and 31.2 to this Form 10-K.
-60-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below is certain information concerning the directors and
executive officers of the Company as of December 7, 2005:
NAMED DIRECTORS AND EXECUTIVE
OFFICERS OF THE COMPANY AGE POSITION(S)
- ----------------------------- --- -----------
Sidney F. Wentz .............. 73 Chairman of the Board (1)
Richard E. Staedtler.......... 61 Director, President and Chief Executive Officer of the Company (2)
Martin R. Hoffmann............ 73 Director (3)
John P. Keller................ 66 Director (2)
Russell S. Lewis.............. 50 Director (3)
Mary A. Cade.................. 42 Chief Financial Officer and Chief Accounting Officer
William C. Liedtke III........ 54 Vice President and General Counsel
- -------------------
(1) Term expires at 2007 annual meeting of shareholders
(2) Term expires at 2006 annual meeting of shareholders
(3) Term expires at 2008 annual meeting of shareholders
A description of the business experience of each of the directors and
executive officers of the Company is as follows:
SIDNEY F. WENTZ has been a director of the Company since June 1995 and
became Chairman of the Board of Directors of the Company on August 15, 2005,
following the death of Joseph L. Castle, founder of the Company. Previously, Mr.
Wentz was Chairman of the Board of The Robert Wood Johnson Foundation, the
nation's largest health care philanthropy from June 1989 until his retirement in
1999. Commencing in 1967, he held several positions with Crum and Forster, an
insurance holding company, retiring as Chairman and Chief Executive Officer in
1988. He also was practiced law as an attorney with the law firm of White & Case
and then Corporate Attorney for Western Electric Company/AT&T. Mr. Wentz is a
director of Somerset Hills Bancorp and a trustee of Drew University.
RICHARD E. STAEDTLER was elected President and Chief Executive Officer
of the Company on August 15, 2005 and has been a director of the Company since
May 1997. Between November 1994 and August 2005, he served as Senior Vice
President and Chief Financial Officer of the Company. Mr. Staedtler also served
as a director of the Company from 1986 through September 1992, and as Chief
Financial Officer of the Company from 1984 through June 1993. Mr. Staedtler is a
certified public accountant. Mr. Staedtler also serves as a director of Premium
and Specialities, Inc., a private company which manufactures personalized
specialty items, and is the President, sole director and sole stockholder of
Terrapin Resources, Inc., a private oil and gas production company.
MARTIN R. HOFFMANN has been a director of the Company since June 1995.
Mr. Hoffmann was previously of counsel to the Washington, D.C. office of the law
firm of Skadden, Arps, Slate, Meagher & Flom LLP. He was a Senior Visiting
Fellow at the Center for Technology, Policy and Industrial Development of the
Massachusetts Institute of Technology from May 1993 to May 1995 and a private
business consultant since 1993. From 1989 to 1993, Mr. Hoffmann served as Vice
President and General Counsel of Digital Equipment Corporation. Mr. Hoffmann
also served in various capacities at the United States Department of Defense,
including General Counsel from 1974 to 1975 and Secretary of the Army from 1975
to 1977 and currently serves as a consultant to the United States Department of
Defense. He is a Director of Seachange International, Inc. of Maynard,
Massachusetts as well as a trustee of CIME Endeavor Foundation.
-61-
JOHN P. KELLER has been a director of the Company since April 1997.
Since 1972, Mr. Keller has served as the President of Keller Group, Inc., a
privately-held corporation engaged in steel forging and coal mining in the
midwestern United States. In 1993 and 1994, Mr. Keller also served as the
Chairman of American Appraisal Associates, an appraisal company. Mr. Keller was
previously a director of Delta Petroleum Corporation.
RUSSELL S. LEWIS has been a director of the Company since April 2000.
From 1994 to 1999, Mr. Lewis was the Chief Executive Officer of TransCore, Inc.,
a company which sells and installs electronic toll collection systems. Since
1999, Mr. Lewis has been the owner and President of Lewis Capital Group, a
company investing in and providing consulting services to growth-oriented
companies. Since March of 2000, Mr. Lewis has served in various capacities at
Verisign, including General Manager of Verisign's Global Registry and his
current position as Senior Vice President of Corporate Development. Mr. Lewis is
also a director of Delta Petroleum Corporation.
MARY A. CADE was appointed Chief Financial Officer of the Company on
August 15, 2005 and Chief Accounting Officer on August 24, 2005, having served
as Treasurer and Controller of the Company since 1994. Ms. Cade has an MBA in
Finance from Philadelphia University.
WILLIAM C. LIEDTKE III has been Vice President and General Counsel of
the Company since February 2000. Prior to becoming an officer and employee of
the Company, from April 1999 to January 2000, Mr. Liedtke was President of WCL
III, Inc., a corporation wholly owned by Mr. Liedtke, in which capacity he
provided services on a consulting basis to the Company with respect to the
Company's investment in the concessions in Romania, as well as miscellaneous
matters regarding domestic oil and gas properties of the Company. Upon the
employment of Mr. Liedtke by the Company in February 2000, WCL III, Inc. ceased
doing business with the Company and has been inactive thereafter. He served as
Chief Executive Officer of Redeco Energy Inc. from October 1997 to March 1999,
having previously served as its Vice President and Chief Operating Officer since
February 1995. Mr. Liedtke served as an Independent General Partner of Merrill
Lynch Oklahoma Venture Partners LP from August 1999 to December 2000, when the
partnership wound up.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's officers, directors and owners of more
than 10% of any class of the Company's securities registered pursuant to Section
12 of the Exchange Act to file reports of ownership and changes in ownership
with the Commission. The Commission's rules also require such persons to furnish
the Company with a copy of all Section 16(a) reports that they file. Based
solely upon a review of the copies of the reports and written representations
furnished to the Company, all such reporting persons complied with such
reporting obligations during the fiscal year ended September 30, 2005.
AUDIT COMMITTEE
The Company has established an Audit Committee in accordance with
Section 3(a)(58)(A) of the Securities Exchange Act of 1934.
The Audit Committee consists of Mr. Hoffmann (Chairman), Mr. Keller and
Mr. Lewis. All three Audit Committee members are outside directors. The
functions of the Audit Committee are to: (a) appoint the Company's independent
public accountants; (b) review the financial reports of the Company; (c) monitor
the effectiveness of the independent audit; (d) assure that the scope and
implementation of the independent audit is not restricted or the independence of
the independent accountants compromised; (e) review the independent accountants'
reports to management on internal controls and recommend such actions as may be
appropriate; (f) review and approve any related party transactions and (g)
review and approve any proposed engagement of all services performed by the
Company's independent accountants. The Audit Committees has and will continue to
have at least three members, all of whom meet, and will continue to meet, the
requirements of Rule 4350(d)(2)(A) of the Nasdaq Stock Market's listing
standards, including the definition of independence in Nasdaq Stock Market Rule
4200(a)(15) and Rule 10A-3(b)(1) under the Securities Exchange Act of 1934. The
Audit Committee charter provides for meetings to be held at least quarterly.
-62-
The Nominating Committee consists of Mr. Lewis (Chairman), Mr. Hoffmann
and Mr. Keller. All three Nominating Committee members are outside directors.
The Nominating Committee at least annually assesses the appropriate skills and
characteristics required of Board members in the context of the current make-up
of the Board of Directors and the needs of the Company, and considers principles
to be applied in filling vacancies and planning for Board succession. It assists
the Board in the identification of individuals qualified to become Board
members, considers and recommends director nominees to the Board of Directors
prior to each annual meeting of stockholders and recommends nominees for
committees of the Board.
The Compensation Committee consists of Mr. Keller (Chairman), Mr.
Hoffmann and Mr. Lewis, none of whom have ever been employees or officers of the
Company or had any relationship requiring disclosure under Item 404 of
Regulation S-K promulgated by the Securities and Exchange Commission.. All three
Compensation Committee members are outside directors. The Compensation Committee
establishes overall compensation programs and policies for the Company. The
Compensation Committee monitors the selection and performance as well as reviews
and approves the compensation of key executives, and administers the Incentive
Plan.
All members of the Audit, Nominating and Compensation Committees are
independent within the meaning of Rule 4200(a)(15) of the Nasdaq Stock Market's
listing standards.
DISCLOSURE OF AUDIT COMMITTEE FINANCIAL EXPERT
The Board of Directors of the Company has determined that Mr. Russell
Lewis is an audit committee financial expert. Mr. Lewis is independent within
the meaning of Nasdaq Stock Market Rule 4200(a)(15) and Rule 10A-3(b)(1) under
the Securities Exchange Act of 1934.
CODE OF ETHICS FOR SENOR FINANCIAL OFFICERS
In August 2003, the Company's Board of Directors adopted a Code of
Ethics that applies to all of the Company's officers and directors, including
its chief executive officer, chief financial officer, general counsel and
controller. The requirements of that code provide for honest and ethical
conduct; avoidance or ethical handling of conflicts of interest; full, fair and
accurate and timely and transparent public disclosure; compliance with
applicable governmental and self regulatory laws and rules; prompt internal
reporting of code violations and accountability for compliance with the Code of
Ethics. The Company is committed to and without charge will provide a copy of
its Code of Ethics to any person upon written request addressed to the Secretary
of the Company at its offices.
-63-
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION
The following table summarizes all compensation earned by the Company's
Chief Executive Officer and each of the other executive officers (collectively
with the Chief Executive Officer, the "Named Executive Officers") whose total
annual salary and bonus exceeded $100,000 for the fiscal year ended September
30, 2005.
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS
------------
SECURITIES
FISCAL YEAR ANNUAL COMPENSATION UNDERLYING ALL OTHER
ENDED ---------------------- OPTIONS/ COMPENSATION (1)
NAME AND PRINCIPAL POSITION SEPTEMBER 30, SALARY ($) BONUS ($) SARS (#) ($)
- --------------------------- ------------- ---------------------- ------------ ----------------
Joseph L. Castle II (2)................ 2005 $218,750 $50,000
Formerly Chairman of the Board, 2004 $125,000
Chief Executive Officer and 2003 $125,000 $50,000 $2,877
Director of the Company
Richard E. Staedtler (3)............... 2005 $185,428 $50,000 $7,625
President, Chief Executive 2004 $133,332 $5,333
Officer and Director of the Company 2003 $100,000 $5,983
Mary A. Cade (4)....................... 2005 $133,750 $20,000 $4,613
Chief Financial Officer and 2004
Chief Accounting Officer 2003
William C. Liedtke III................. 2005 $161,250 $15,000 $5,288
Vice President and 2004 $157,332 $10,000 $5,020
General Counsel 2003 $156,000 $10,000 $4,680
- -------------------
(1) Represents Company matching contributions under the Company's 401(k)
Plan.
(2) Mr. Castle, founder of the Company, served as Chairman of the Board,
Chief Executive Officer and Director of the Company until his death on
August 15, 2005.
(3) Mr. Staedtler, a Director of the Company, served as Chief Financial
Officer and Chief Accounting Officer until August 15, 2005, at which
time he was appointed President and Chief Executive Officer.
(4) Ms. Cade served as Treasurer and Controller until August 15, 2005, at
which time she was appointed Chief Financial Officer and on August 24,
2005, she was also appointed Chief Accounting Officer. Prior to 2005,
she was not a Named Executive Officers and her compensation did not
exceed $100,000.
OPTION GRANTS IN LAST FISCAL YEAR
No options were granted to the Named Executive Officers during the
fiscal year ended September 30, 2005.
-64-
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES
The following table shows certain information regarding the exercise of stock
options during the fiscal year ended September 30, 2005 and the total number of
unexercised options held at September 30, 2005 by the Named Executive Officers.
There were no unexercised options held by any of the Named Executive Officers as
of September 30, 2005.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR-END FISCAL YEAR-END
SHARES VALUE (#) ($)
ACQUIRED ON REALIZED EXERCISABLE/ EXERCISABLE/
NAME EXERCISE (#) $ UNEXERCISABLE UNEXERCISABLE
- ---- ------------ --------- --------------- ---------------
Joseph L. Castle II............ -/- -/- -/- -/-
Richard E. Staedtler........... -/- -/- -/- -/-
William C. Liedtke, III........ 45,000 $131,400 -/- -/-
Mary A. Cade................... -/- -/- -/- -/-
SEVERANCE/RETENTION AGREEMENTS
Upon his employment by the Company, Mr. Liedtke received a severance agreement
which provides for one month of severance compensation for each full year of
employment by the Company, with a minimum compensation of three months' base
salary, in the event substantially all of the Company's assets are sold and Mr.
Liedtke is terminated as a result of such sale.
COMPENSATION OF DIRECTORS
Each outside directors receives an annual director fee of $20,000. In addition,
all outside directors receive a fee of $1,500 for each meeting of the board of
directors attended. Committee members also receive a $500 fee for attending each
committee meeting.
-65-
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL HOLDERS OF VOTING SECURITIES
The following table sets forth, as of November 25, 2005, the names of all
persons who were known by the Company to be the beneficial owners [as defined in
the rules of the Securities and Exchange Commission (the "Commission")], of more
than five percent of the shares of Common Stock of the Company:
AMOUNT AND NATURE OF
BENEFICIAL PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER OWNERSHIP(1) CLASS(1)
- ------------------------------------ -------------------- ------------
Sally W. Castle and the Estate of Joseph L. Castle II 1,490,624(2) 20.40%
357 South Gulph Road
Suite 260
King of Prussia, Pennsylvania 19406
1,167,000(3) 15.97%
FMR Corp.
82 Devonshire Street
Boston, Massachusetts 02109
777,550 (4) 10.64%
Kestrel Investment Management
411 Borel Avenue, Suite 403
San Mateo, California 94402
Dimensional Fund Advisors, Inc. 521,150 (5) 7.13%
1299 Ocean Avenue
11th Floor
Santa Monica, CA 90401-1038
- -------------------
(1) Based on a total of 7,305,360 shares of Common Stock issued and
outstanding as of November 25, 2005. Information in the above table and
footnotes is based upon the most recent respective statement on Form 4,
Schedule 13D or 13G or amendment thereto filed by such persons with the
SEC, except as otherwise known to the Company.
(2) Sally W. Castle is the executor of the Estate of Joseph L. Castle, II
(the "Estate"). She is deemed to beneficially own 1,490,624 shares of
Common Stock which consists of 1,434,699 shares of Common Stock owned by
the Estate and 55,925 shares of Common Stock directly owned by Mrs.
Castle.
(3) According to the Schedule 13G filed February 14, 2001 by FMR Corp.,
Fidelity Management & Research Company ("Fidelity"), a wholly-owned
subsidiary of FMR Corp. and an investment adviser registered under
Section 203 of the Investment Advisers Act of 1940, is the beneficial
owner of 1,167,000 shares of the common stock outstanding of the Company
as a result of acting as investment adviser to various investment
companies registered under Section 8 of the Investment Company Act of
1940. The ownership of one investment company, Fidelity Low Priced Stock
Fund, amounted to 1,167,000 shares of the common stock outstanding.
Edward C. Johnson 3d, FMR Corp., through its control of Fidelity, and
the funds each has sole power to dispose of the 1,167,000 shares owned
by the Funds. Neither FMR Corp. nor Edward C. Johnson 3d, Chairman of
FMR Corp., has the sole power to vote or direct the voting of the shares
owned directly by the Fidelity Funds, which power resides with the
Funds' Boards of Trustees. Members of the Edward C. Johnson 3d family
are the predominant owners of Class B shares of common stock of FMR
Corp., representing approximately 49% of the voting power of FMR Corp.
Mr. Johnson 3d owns 12.0% and Abigail Johnson owns 24.5% of the
aggregate outstanding voting stock of FMR Corp. Mr. Johnson 3d is
Chairman of FMR Corp. and Abigail P. Johnson is a Director of FMR Corp.
The Johnson family group and all other Class B shareholders have entered
into a shareholders' voting agreement under which all Class B shares
will be voted in accordance with the majority vote of Class B shares.
Accordingly, through their ownership of voting common stock and the
execution of the shareholders' voting agreement, members of the Johnson
family may be deemed, under the Investment Company Act of 1940, to form
a controlling group with respect to FMR Corp.
-66-
(4) According to the Schedule 13G filed February 14, 2005 by Kestrel
Investment Management, Kestrel is deemed to be the beneficial owner of
the 777,550 shares of the common stock of the Company pursuant to
separate arrangements whereby it acts as investment adviser to certain
persons in which it also holds an ownership interest. Each person for
whom Kestrel acts as investment adviser has the right to receive or the
power to direct the receipt of dividends from, or the proceeds from the
sale of, the common stock purchased or held pursuant to such
arrangements. David J. Steirman and Abbott J. Keller are deemed to be
the beneficial owners of the shares of the common stock of the Company
pursuant to their ownership interests in Kestrel Investment Management
Corporation.
(5) According to the Schedule 13G filed February 9, 2005 by Dimensional Fund
Advisors Inc., Dimensional is an investment advisor registered under
Section 203 of the Investment Advisors Act of 1940, which furnishes
investment advice to four investment companies registered under the
Investment Company Act of 1940, and serves as investment manager to
certain other commingled group trusts and separate accounts. These
investment companies, trusts and accounts are the "Funds". In its role
as investment advisor or manager, Dimensional possesses voting and/or
investment power over the common stock of the Company owned by the
Funds, and may be deemed to be the beneficial owner of the common stock
of the Company held by the Funds. However, all of such shares are owned
by the Funds, no one advisory client of which, to the knowledge of
Dimensional, owns more than 5% of the class. Dimensional disclaims
beneficial ownership of the shares.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth, as of November 25, 2005, the shares of
Common Stock beneficially owned by each executive officer named in the Summary
of Compensation Table below (the "Named Executives"), by each director of the
Company and by the directors and executive officers of the Company as a group,
with sole voting and investment power unless otherwise indicated:
AMOUNT AND NATURE OF PERCENT OF
NAME OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP (1) CLASS (1) (2)
- ------------------------ ------------------------ -------------
Richard E. Staedtler........................................... 74,650 1.02%
Martin R. Hoffmann............................................. 86,000(3) 1.18%
Sidney F. Wentz................................................ 78,000 1.07%
John P. Keller................................................. 111,000 1.52%
Russell S. Lewis............................................... 62,000 -
Mary A. Cade................................................... - -
William C. Liedtke, III........................................ - -
All directors and executive officers as a group
(7 persons)................................................. 411,650 5.63%
- -------------------
(1) Based 7,305,360 shares of Common Stock issued and outstanding as of
November 25, 2005.
(2) Percentages of less than one percent are omitted.
(3) Includes 6,000 shares of Common Stock owned by an individual retirement
account for the benefit of Mr. Hoffmann.
-67-
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - NONE
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees billed to the Company by the Company's independent accountants,
Grant Thornton LLP and KPMG LLP, for work applicable to the periods indicated,
were as follows:
YEAR ENDED SEPTEMBER 30,
------------------------------
2005 2004
---------- ----------
Audit fees............................................................. $129,384 $125,651
Audit - related fees...................................................
Tax fees...............................................................
All other fees.........................................................
-------- --------
$129,384 $125,651
======== ========
Independent accountant................................................. Grant Thornton KPMG LLP
The policy of the Audit Committee of the Company is to pre-approve all
material professional services performed by the Company's independent
accountant.
-68-
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Financial statements and schedules filed as part of this Report on Form
10-K are listed in Item 8 of this Form 10-K.
(b) Exhibits
The Exhibits required by Item 601 of Regulation S-K and filed herewith
or incorporated by reference herein are listed in the Exhibit Index below.
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT
-------------- -----------------------
3.1 Restated Certificate of Incorporation(15)
3.2 Bylaws(10)
4.1 Specimen Stock Certificate representing Common Stock(8)
4.2 Rights Agreement between Castle Energy Corporation and American Stock Transfer and Trust Company as
Rights Agent, dated as of April 21, 1994(10)
10.33 Castle Energy Corporation 1992 Executive Equity Incentive Plan(8)
10.34 First Amendment to Castle Energy Corporation 1992 Executive Equity Incentive Plan, effective May 11,
1993(8)
10.124 Asset Purchase Agreement dated February 27, 1998 by and between Castle Energy Corporation and Alexander
Allen, Inc. (21)
10.132 Castle Energy Corporation Severance Benefit Plan (26)
10.140 Agreement to Transfer a Membership Interest In Networked Energy LLC to CEC, Inc., dated August 31, 2000
(31)
10.142 Purchase and Sale Agreement, dated April 1, 2001, between Strand Energy LC and Castle Exploration
Company, Inc. (30)
10.143 Credit Agreement as of November 26, 2001 among Castle Exploration Company, Inc. and Castle Energy
Corporation and Bank of Texas National Association (37)
10.144 Purchase and Sale Agreement between Castle Energy Corporation and Delta Petroleum Corporation, executed
January 15, 2002 (32)
10.145 Amendment Number One to Purchase and Sale Agreement between Castle Energy Corporation and Delta Petroleum
Corporation, March 2002 (33)
10.146 Purchase and Sale Agreement between Redeco Petroleum Company Limited and Hemco Romania Limited, dated
September 6, 2002 (35)
10.147 Amendment of Rights Agreements between Castle Energy Corporation and American Stock Transfer Company as
Rights Agent, dated December 31, 2002 (36)
10.148 Purchase and Sale Agreement between Delta Petroleum Corporation and Castle Exploration Company, Inc.,
dated March 30, 2004 (37)
10.149 Settlement Agreement and Mutual Release, dated September 19, 2005, between Chevron Environmental
Management Company, Chevron Environmental Service Company and Texaco Inc. and Castle Energy Corporation,
Indian Refining I Limited Partnership, Indian Refining & Marketing I Inc. and William S. Sudhaus (38)
10.150 Agreement and Plan of Merger, dated as of November 8, 2005, among Delta Petroleum Corporation, a Colorado
corporation; Delta Petroleum Corporation, a Delaware corporation; DPCA LLC, a Delaware limited liability
company and Castle Energy Corporation (39)
-69-
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT
-------------- -----------------------
10.151 Voting Agreement, dated as of November 3, 2005, among
Delta Petroleum Corporation, a Colorado corporation;
Delta Petroleum Corporation, a Delaware corporation;
DPCA LLC, a Delaware limited liability company and
Certain Stockholders of Castle Energy Corporation
10.152 First Amendment to Voting Agreement and Irrevocable
Proxy, dated as of November 28, 2005, among Delta
Petroleum Corporation, a Colorado corporation; Delta
Petroleum Corporation, a Delaware corporation; DPCA
LLC, a Delaware limited liability company and Certain
Stockholders of Castle Energy Corporation
11.1 Statement re: Computation of Earnings Per Share
21 List of subsidiaries of Registrant
21.1 Separate financial statements of Delta Petroleum Corporation - Year Ended June 30, 2005
23.3 Consent of Ralph Davis & Co.
31.1 Certificate of Chief Executive Officer (Section 302 of Sarbanes-Oxley Act)
31.2 Certificate of Chief Financial Officer (Section 302 of Sarbanes-Oxley Act)
32.1 Certificate of Chief Executive Officer (Section 906 of Sarbanes-Oxley Act)
32.2 Certificate of Chief Financial Officer (Section 906 of Sarbanes-Oxley Act)
(8) Incorporated by reference to the Registrant's Form S-1 (Registration
Statement), dated September 29, 1993 (File 33-69626)
(10) Incorporated by reference to the Registrant's Form 10-Q for the second
quarter ended March 31, 1994 (File 0-10990)
(15) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended September 30, 1994 (File 0-10990)
(23) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended March 31, 1998 (File 0-10990)
(26) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended September 30, 1999 (File 0-10990)
(30) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended March 31, 2001 (File 0-10990)
(31) Incorporated by reference to the Registrant's Form 10-K for year ended
September 30, 2000 (File 0-10990)
(32) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended December 31, 2001 (File 0-10990)
(33) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended March 31, 2002 (File 0-10990)
(35) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended September 30, 2002 (File 0-10990)
(36) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended December 31, 2002 (File 0-10990)
(37) Incorporated by reference to the Registrant's Form 10-Q for quarter
ended March 31, 2004 (File 0-10990)
(38) Incorporated by reference to the Registrant's Form 8-K, dated September
23, 2005 (File 0-10990)
(39) Incorporated by reference to the Registrant's Amendment #3 to Schedule
13D, dated December 1, 2005 (File 0-10990)
-70-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
CASTLE ENERGY CORPORATION
Date: December 1, 2005 By: /S/RICHARD E. STAEDTLER
----------------------------
Richard E. Staedtler
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the registrant
and in the capacities and on the dates indicated.
/s/ RICHARD E. STAEDTLER Chief Executive Officer December 1, 2005
- -------------------------- Director
Richard E. Staedtler
/s/ MARY A. CADE Chief Financial Officer December 1, 2005
- -------------------------- Chief Accounting Officer
Mary A. Cade
/s/ MARTIN R. HOFFMANN Director December 1, 2005
- --------------------------
Martin R. Hoffmann
/s/ JOHN P. KELLER Director December 1, 2005
- --------------------------
John P. Keller
/S/ RUSSELL S. LEWIS Director December 1, 2005
- --------------------------
Russell S. Lewis
/s/ SIDNEY F. WENTZ Chairman December 1, 2005
- --------------------------
Sidney F. Wentz
-71-
DIRECTORS, OFFICERS, BOARD OF DIRECTORS AND
PROFESSIONALS
(DECEMBER 1, 2005)
RICHARD E. STAEDTLER SIDNEY F. WENTZ
President and Chief Executive Officer Chairman
Former Chairman of The Robert
Wood Johnson Foundation
MARTIN R. HOFFMANN RUSSELL S. LEWIS
Former Secretary of the Army President, Lewis
Capital Group
JOHN P. KELLER
President, Keller Group, Inc.
OPERATING OFFICERS
RICHARD E. STAEDTLER WILLIAM C. LIEDTKE III
President and Chief Executive Officer Vice President and General Counsel
MARY A. CADE
Chief Financial Officer
Chief Accounting Officer
PRINCIPAL OFFICES
357 South Gulph Road 512 Township Line Road
Suite 260 Three Valley Square, Suite 100
King of Prussia, PA 19406 Blue Bell, PA 19422
5623 North Western Avenue, Suite A
Oklahoma City, OK 73118
PROFESSIONALS
COUNSEL REGISTRAR AND TRANSFER AGENT
Duane Morris LLP American Stock Transfer & Trust
30 South 17th Street 40 Wall Street, 46th Floor
Philadelphia, PA 19103 New York, New York 10005
INDEPENDENT ACCOUNTANTS
Grant Thornton LLP
One Leadership Square
211 N. Robinson, Suite 1200
Oklahoma City, OK 73102