SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period ended_________________________________________
Commission file number: 0-10990
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CASTLE ENERGY CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
Delaware 76-0035225
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(State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.)
One Radnor Corporate Center, Suite 250, 100 Matsonford Road, Radnor, Pennsylvania 19087
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (610) 995-9400
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(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check X whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days Yes _X_ No__ .
Indicate the number of shares outstanding of each of the issuer's
classes of common stock as of the latest practicable date: 2,601,029 shares of
Common Stock, $.50 par value outstanding as of April 30, 1999.
CASTLE ENERGY CORPORATION
INDEX
Page #
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Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheets - March 31, 1999 (Unaudited)
and September 30, 1998...............................................1
Consolidated Statements of Operations - Three Months
Ended March 31, 1999 and 1998 (Unaudited)............................2
Consolidated Statements of Operations - Six Months Ended
March 31, 1999 and 1998 (Unaudited)..................................3
Consolidated Statements of Cash Flows - Six Months Ended
March 31, 1999 and 1998 (Unaudited)..................................4
Consolidated Statements of Stockholders' Equity - Year
Ended September 30, 1998 and Six Months Ended March
31, 1999 (Unaudited).................................................5
Notes to the Consolidated Financial Statements (Unaudited)...........6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...........................................15
Item 3. Qualitative and Quantitative Disclosures About Market Risk............25
Part II. Other Information
Item 1. Legal Proceedings....................................................26
Item 6. Exhibits and Reports on Form 8-K.....................................26
Signature ..................................................................................27
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CASTLE ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
("000's" Omitted Except Share Amounts)
March 31, September 30,
1999 1998
----------- ----------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents................................................. $ 43,845 $ 36,600
Restricted cash........................................................... 924 613
Accounts receivable....................................................... 7,964 8,381
Marketable securities - Penn Octane Corporation........................... 575 471
Prepaid transportation, net............................................... 171 1,123
Prepaid expenses and other current assets................................. 204 293
Prepaid gas purchases..................................................... 852
Deferred income taxes..................................................... 2,765
Note receivable - Penn Octane Corporation................................. 100 1,000
Estimated realizable value of discontinued net refining assets............ 3,495 3,623
-------- --------
Total current assets.................................................... 57,278 55,721
Property, plant and equipment, net:
Natural gas transmission.................................................. 75 62
Furniture, fixtures and equipment......................................... 265 307
Oil and gas properties, net (full cost method)................................ 4,752 4,600
Gas contracts, net............................................................ 1,480 6,285
Investment in Penn Octane Corporation preferred stock......................... 477
Other assets.................................................................. 17 29
-------- --------
Total assets.............................................................. $ 64,344 $ 67,004
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Dividend payable.......................................................... $ 401
Accounts payable.......................................................... 6,051 $ 8,658
Accrued expenses.......................................................... 825 1,663
Net refining liabilities retained......................................... 5,900 5,129
-------- --------
Total current liabilities............................................... 13,177 15,450
Other long-term liabilities................................................... 1 1
-------- --------
Total liabilities....................................................... 13,178 15,451
-------- --------
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;
6,803,646 shares issued at March 31, 1999 and September 30, 1998........ 3,402 3,402
Additional paid-in capital................................................ 67,122 67,122
Retained earnings......................................................... 40,001 34,836
-------- --------
110,525 105,360
Treasury stock at cost - 4,202,617 shares at March 31, 1999 and
3,862,917 shares at September 30, 1998.................................. (59,359) (53,807)
-------- --------
Total stockholders' equity ............................................. 51,166 51,553
-------- --------
Total liabilities and stockholders' equity.............................. $64,344 $ 67,004
======== ========
The accompanying notes are an integral part of these financial statements.
-1-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("000's" Omitted Except Share Amounts)
(Unaudited)
Three Months Ended March 31,
-----------------------------------
1999 1998
------------ -----------
Revenues:
Natural gas marketing and transmission:
Gas sales.......................................................... $ 21,697 $ 17,885
------------ -----------
21,697 17,885
------------ -----------
Exploration and production:
Oil and gas sales ................................................. 581 562
Well operations ................................................... 87 57
------------ -----------
668 619
------------ -----------
22,365 18,504
------------ -----------
Expenses:
Natural gas marketing and transmission:
Gas purchases ..................................................... 13,318 11,113
Transportation .................................................... 494 400
Operating costs (recovery) ........................................ (16)
General and administrative ........................................ 67 12
Depreciation and amortization ..................................... 2,365 2,366
------------ -----------
16,244 13,875
------------ -----------
Exploration and production:
Oil and gas production ............................................ 287 183
General and administrative ........................................ 149 85
Depreciation, depletion and amortization .......................... 82 164
------------ -----------
518 432
------------ -----------
Corporate general and administrative expenses............................ 778 828
------------ -----------
17,540 15,135
------------ -----------
Operating income......................................................... 4,825 3,369
------------ -----------
Other income:
Interest income........................................................ 478 594
Other income........................................................... 33 8
------------ -----------
511 602
------------ -----------
Net income before provision for income taxes............................. 5,336 3,971
------------ -----------
Provision for income taxes:
State.................................................................. 39 40
Federal................................................................ 1,359 1,389
------------ -----------
1,398 1,429
------------ -----------
Net income............................................................... 3,938 2,542
Adjustments for comprehensive income.....................................
------------ ------------
Comprehensive income..................................................... $ 3,938 $ 2,542
============ ============
Net income per share:
Basic.................................................................. $ 1.39 $ .61
============ ============
Diluted................................................................ $ 1.37 $ .61
============ ============
Weightedaverage number of common and potential dilutive common shares
outstanding:
Basic.................................................................. 2,828,233 4,144,129
============ ============
Diluted................................................................ 2,871,967 4,181,244
============ ============
The accompanying notes are an integral part of these financial statements.
-2-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
("000's" Omitted Except Share Amounts)
(Unaudited)
Six Months Ended March 31,
---------------------------------
1999 1998
---------- -----------
Revenues:
Natural gas marketing and transmission:
Gas sales.......................................................... $ 42,152 $ 38,148
---------- -----------
42,152 38,148
---------- -----------
Exploration and production:
Oil and gas sales.................................................. 972 1,220
Well operations.................................................... 177 115
---------- -----------
1,149 1,335
---------- -----------
43,301 39,483
---------- -----------
Expenses:
Natural gas marketing and transmission:
Gas purchases...................................................... 26,264 24,199
Transportation..................................................... 953 860
Operating costs.................................................... (16)
General and administrative......................................... 156 38
Depreciation and amortization...................................... 4,731 4,731
---------- -----------
32,104 29,812
---------- -----------
Exploration and production:
Oil and gas production............................................. 481 348
General and administrative......................................... 396 307
Depreciation, depletion and amortization........................... 149 327
---------- -----------
1,026 982
---------- -----------
Corporate general and administrative expenses........................ 1,891 1,568
---------- -----------
35,021 32,362
---------- -----------
Operating income......................................................... 8,280 7,121
---------- -----------
Other income:
Interest income........................................................ 945 1,231
Other income........................................................... 34 29
---------- -----------
979 1,260
---------- -----------
Net income before provision for income taxes............................. 9,259 8,381
---------- -----------
Provision for income taxes:
State.................................................................. 78 84
Federal................................................................ 2,732 2,933
---------- -----------
2,810 3,017
---------- -----------
Net income............................................................... 6,449 5,364
Adjustment for comprehensive income......................................
---------- -----------
Comprehensive income..................................................... $ 6,449 $ 5,364
========== ===========
Net income per share:
Basic.................................................................. $ 2.24 $ 1.21
========== ===========
Diluted................................................................ $ 2.20 $ 1.20
========== ===========
Weighted average number of common and potential dilutive common shares
outstanding:
Basic.................................................................. 2,884,921 4,434,363
========== ===========
Diluted................................................................ 2,936,124 4,465,767
========== ===========
The accompanying notes are an integral part of these financial statements.
-3-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
("000's" Omitted)
(Unaudited)
Six Months Ended March 31,
------------------------------
1999 1998
------- -------
Net cash flow provided by operating activities........................... $13,994 $22,110
------- -------
Cash flows from investing activities:
Investment in pipelines.............................................. (15)
Investment in oil and gas properties................................. (301) (1,209)
Investment in note receivable - Penn Octane Corporation.............. (1,000)
------- -------
Net cash used in investing activities........................... (316) (2,209)
------- -------
Cash flows from financing activities:
Dividends paid to stockholders........................................ (881) (1,414)
Acquisition of treasury stock......................................... (5,552) (17,755)
Proceeds from exercise of stock options............................... 20
------- -------
Net cash provided by (used in) financing activities............. (6,433) (19,149)
------- -------
Net increase (decrease) in cash and cash equivalents..................... 7,245 752
Cash and cash equivalents - beginning of period.......................... 36,600 36,338
------- -------
Cash and cash equivalents - end of period................................ $43,845 $37,090
======= =======
The accompanying notes are an integral part of these financial statements.
-4-
CASTLE ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
("000's" Omitted Except Share Amounts)
Common Stock Additional Treasury Stock
--------------------- Paid-In Retained -----------------------
Shares Amount Capital Earnings Shares Amount Total
--------- ------ ---------- -------- --------- -------- ---------
Balance - October 1, 1997........ 6,798,646 $3,399 $67,061 $22,468 2,085,100 ($25,163) $67,765
Stock acquired................... 1,777,817 (28,644) (28,644)
Options exercised................ 5,000 3 61 64
Dividends........................ (1,688) (1,688)
Net income....................... 14,056 14,056
--------- ------ ------- ------- --------- ------- -------
Balance - September 30, 1998..... 6,803,646 3,402 67,122 34,836 3,862,917 (53,807) 51,553
Stock acquired................... 339,700 (5,552) (5,552)
Dividends........................ (1,284) (1,284)
Net income....................... 6,449 6,449
--------- ------ ------- ------- --------- ------- -------
Balance - March 31, 1999......... 6,803,646 $3,402 $67,122 $40,001 4,202,617 ($59,359) $51,166
========= ====== ======= ======= ========= ======= =======
The accompanying notes are an integral part of these financial statements.
-5-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Note 1 - Basis of Preparation
The unaudited consolidated financial statements of Castle Energy
Corporation (the "Company") included herein have been prepared pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
reclassifications have been made to make the periods presented comparable.
Although certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, the Company believes that the disclosures included herein are
adequate to make the information presented not misleading. Operating results for
the three month and the six month periods ended March 31, 1999 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 30, 1999 or for subsequent periods. These unaudited
consolidated financial statements should be read in conjunction with the
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended September 30, 1998.
In the opinion of the Company, the unaudited consolidated financial
statements contain all adjustments necessary for a fair statement of the results
of operations for the three and six month periods ended March 31, 1999 and 1998
and for a fair statement of financial position at March 31, 1999 and September
30, 1998.
Note 2 - September 30, 1998 Balance Sheet
The amounts presented in the balance sheet as of September 30, 1998
were derived from the Company's audited consolidated financial statements which
were included in its Annual Report on Form 10-K for the fiscal year ended
September 30, 1998.
Note 3 - Discontinued Operations
From August 1989 to September 30, 1995, several of the Company's
subsidiaries conducted refining operations. By December 12, 1995, the Company's
refining subsidiaries had sold all of their refining assets and the purchasers
had assumed all related liabilities, including contingent environmental
liabilities. In addition, Powerine Oil Company ("Powerine"), one of the
Company's refining subsidiaries, merged into a subsidiary of its purchaser and
is no longer a subsidiary of the Company. The Company's remaining refining
subsidiaries own no refining assets and are in the process of liquidation. As a
result, the Company has accounted for its refining operations as discontinued
operations. Such discontinued refining operations have not impacted the
Company's operations since September 30, 1995 although they may impact the
Company's future operations.
-6-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Note 4 - Contingencies/Litigation
Contingent Environmental Liabilities - Refining
Until September 30, 1995, the Company, through its subsidiaries,
operated in the refining segment of the petroleum business. As operators of
refineries, certain of the Company's subsidiaries were potentially liable for
environmental costs related to air emissions, ground and water contamination,
hazardous waste disposal and third party claims related to the foregoing.
Between September 29, 1995 and December 12, 1995 both of the refineries owned by
the Company's refining subsidiaries were sold to outside parties. In each case
the purchaser assumed all environmental liabilities. Furthermore, on January 16,
1996, Powerine, the subsidiary that previously owned the Powerine Refinery, was
effectively acquired by Energy Merchant Corp. ("EMC"), an unrelated party.
In July of 1996, the Company was named a defendant in a class action
lawsuit concerning emissions from the Powerine Refinery. Powerine previously
owned the Powerine Refinery, which is in Santa Fe Springs, California. In April
of 1997, the court granted the Company's motion to quash the plaintiff's
complaint based upon lack of jurisdiction and the Company is no longer involved
in the case.
During fiscal 1998, the Company was informed that the United States
Environmental Protection Agency ("EPA") was investigating offsite acid sludge
waste found near the Indian Refinery and was also investigating and remediating
surface contamination in the Indian Refinery property. The Indian Refinery,
located in Lawrenceville, Illinois, was previously operated by Indian Refinery I
Limited Partnership ("IRLP"), now an inactive subsidiary of the Company. Neither
the Company nor IRLP was named with respect to these two actions at this time.
In October 1998, the EPA named the Company and two of its subsidiaries,
including IRLP, as potentially responsible parties for the expected overall
clean-up of the Indian Refinery. In addition, eighteen other parties were named
including Texaco Refining and Marketing, Inc., the refinery operator for
approximately 50 years. The Company subsequently responded to the EPA indicating
that it was neither the owner nor operator of the Indian Refinery and thus not
responsible for its remediation. Estimated undiscounted clean-up costs for the
Indian Refinery are $80,000 to $150,000 according to third parties. Although the
Company does not believe it has any liabilities with respect to the
environmental liabilities of the refineries, a court of competent jurisdiction
may find otherwise. A decision by the U.S. Supreme Court in June 1998, however,
supports the Company's position.
As of April 30, 1999, neither of the refineries had restarted. The
Powerine Refinery has been sold to an unrelated party, which, the Company has
been informed, is seeking financing to restart that Refinery. The purchaser of
the Indian Refinery, American Western Refining Limited Partnership ("American
Western"), defaulted on its $5 million note to IRLP, filed a voluntary petition
for bankruptcy in the United States Bankruptcy Court in the District of Delaware
under Chapter 11 of
-7-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
the United States Bankruptcy Code and sold the Indian Refinery to another
unrelated party. The new owner is in the process of dismantling much of the
Indian Refinery.
Although the environmental liabilities related to the Indian Refinery
and Powerine Refinery have been transferred to others, there can be no assurance
that the parties assuming such liabilities will be able to pay them. American
Western, purchaser of the Indian Refinery, filed for bankruptcy and is in the
process of liquidation. The current owner is dismantling it. The current owner
of the Powerine Refinery is still seeking financing to restart that refinery.
Furthermore, the Company and two of its subsidiaries have been named as
potentially responsible parties for the remediation of the Indian Refinery by
the EPA.
If funds for environmental clean-up are not provided by these former
and/or present owners, it is possible that the Company and/or one or more of its
former refining subsidiaries could be named parties in additional legal actions
to recover remediation costs. In recent years, government and other plaintiffs
have often sought redress for environmental liabilities from the party most
capable of payment without regard to responsibility or fault. Whether or not the
Company ultimately prevails in such a circumstance, should litigation involving
the Company, IRLP or Powerine occur, the Company would probably incur
substantial legal fees and experience a diversion of management resources from
other operations.
Litigation
Powerine Arbitration
On October 14, 1997, MG paid the Company $8.7 million. The Company
believed that it was entitled to an additional $2,142. Subsequently, the Company
has recovered $900 in connection with the $2,142 sought.
Rex Nichols et al Lawsuit
In March of 1998, the Company, one of its subsidiaries and one of its
officers were sued by two outside interest owners owning interests in several
wells formerly operated by the Company's subsidiary until May 1997. The lawsuit
was filed in the Fourth Judicial District at Rusk County, Texas.
The lawsuit, as initially filed, sought unspecified net production
revenues resulting from reversionary interests on several wells operated by the
subsidiary. Management believes the Company's exposure on the matter, if any, is
less than $50.
Subsequently the plaintiffs expanded their petition claiming amounts
due in excess of $250 based upon their interpretation of other provisions in the
underlying oil and gas leases. The case is currently in discovery and no date
has been set for a trial. Management believes that the plaintiffs additional
claims are without merit and intends to vigorously defend its position.
-8-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
SWAP Agreement
In April of 1999, IRLP recovered $575 related to litigation against MG
Natural Gas Inc. ("MGNG"), a subsidiary of Metallgesellschaft Corp. ("MG"). The
book value of the recovery was $703. The difference between the book value and
the amount recovered has been recorded as a reduction in the value of
discontinued net refining assets since the recovery relates to IRLP's
discontinued refining operations.
Powerine/EMC/Litigation
In July 1998, the Company sued Powerine and EMC to recover $330 plus
interest. The amount sought represented amounts that Powerine or EMC were
required to pay to the Company under the January 1996 purchase and sale
agreement whereby Powerine merged into a subsidiary of EMC.
In April 1999, the Company recovered $355 from Powerine/EMC. The
recovery was recorded as a reduction in legal expense ($330) and interest income
($25) because the recovery represents reimbursement for Powerine's legal costs
which were paid by the Company in 1996, plus $25 interest.
Other
There have been no material litigation developments since those
reported in Item No. 4 of the Company's Form 10-Q for the period ended December
31, 1998 except as described above.
Note 5 - New Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130 ("SFAS 130") regarding
reporting comprehensive income, which establishes standards for reporting and
display of comprehensive income and its components. The components of
comprehensive income refer to revenues, expenses, gains and losses that are
excluded from net income under current accounting standards, including foreign
currency translation items, minimum pension liability adjustments and unrealized
gains and losses on certain investments in debt and equity securities. SFAS 130
requires that all items recognized under accounting standards as components of
comprehensive income be reported in a financial statement displayed in equal
prominence with the other financial statements. The total of other comprehensive
income for a period is required to be transferred to a component of equity that
is separately displayed in a statement of financial condition at the end of an
accounting period. SFAS 130 is effective for both interim and annual periods for
companies having fiscal years beginning after December 15, 1997.
Reclassification of financial statements for earlier periods provided for
comparative purposes is required. The Company adopted SFAS 130 effective October
1, 1998 but SFAS130 has not yet impacted the Company's financial disclosures.
-9-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
In June 1997, FASB issued Statement of Financial Accounting Standards
Board No. 131 ("SFAS 131") regarding disclosures about segments of an enterprise
and related information. SFAS 131 establishes standards for reporting
information about operating segments in annual financial statements and requires
the reporting of selected information about operating segments in interim
financial reports issued to stockholders. It also establishes standards for
related disclosures about products and services, geographic areas and major
customers. SFAS 131 is effective for companies having fiscal years beginning
after December 15, 1997. The Company adopted SFAS No.131 effective October 1,
1998. The provisions of SFAS have not materially changed the Company's
disclosures and reported financial information because the Company has presented
the required segment information in its consolidated statements of operations
for several years before SFAS131 was effective.
Statement of Financial Accounting Standards No. 133, Accounting for
Derivative Instruments and Hedging Activities ("SFAS 133"), was issued by the
Financial Accounting Standards Board in June 1998. SFAS 133 standardizes the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts. Under the standard, entities are required to carry
all derivative instruments in the statement of financial position at fair value.
The accounting for changes in the fair value (i.e., gains or losses) of a
derivative instrument depends on whether it has been designated and qualifies as
part of a hedging relationship and, if so, on the reason for holding it. If
certain conditions are met, entities may elect to designate a derivative
instrument as a hedge of exposures to changes in fair values, cash flows, or
foreign currencies. If the hedged exposure is a fair value exposure, the gain or
loss on the derivative instrument is recognized in earnings in the period of
change together with the offsetting loss or gain on the hedged item attributable
to the risk being hedged. If the hedged exposure is a cash flow exposure, the
effective portion of the gain or loss on the derivative instrument is reported
initially as a component of other comprehensive income (outside earnings) and
subsequently reclassified into earnings when the forecasted transaction affects
earnings. Any amounts excluded from the assessment of hedge effectiveness, as
well as the ineffective portion of the gain or loss, are reported in earnings
immediately. Accounting for foreign currency hedges is similar to the accounting
for fair value and cash flow hedges. If the derivative instrument is not
designated as a hedge, the gain or loss is recognized in earnings in the period
of change.
The Company expects to adopt SFAS 133 in fiscal 2000. To date all
hedging by the Company has been applicable to the Company's gas marketing
operations. Those operations are expected to end on May 31, 1999 when the
related gas contracts terminate. As a result, the Company believes SFAS 133 will
not affect existing operations and cannot make a determination as to whether it
will effect future operations until it engages in such operations.
-10-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Note 6 - Derivative Financial Instruments
The Company utilizes derivative financial instruments to reduce its
exposure to changes in the market price of natural gas. Commodity derivatives
utilized as hedges of natural gas are futures contracts. Natural gas basis swaps
are sometimes used to hedge the basis differential between the derivative
financial instrument index price and the natural gas field price. In order to
qualify as a hedge, price movements in the underlying commodity derivative must
be highly correlated with the hedged commodity.
Gains and losses on futures contracts that qualify as a hedge of firmly
committed or anticipated purchases and sales of natural gas are deferred on the
balance sheet and credited or debited to cost of gas purchased and recognized in
operations when the related hedged transaction occurs. Gains or losses on
derivative financial instruments that do not qualify as a hedge are recognized
in income currently.
As a result of hedging transactions, the cost of gas purchases
increased $721 and $340 for the six month periods ended March 31, 1999 and 1998,
respectively. For the quarters ended March 31, 1999 and 1998, the cost of gas
purchases increased $577 and $141, respectively.
Note 7 - Information Concerning Reportable Segments
During the six month periods ended March 31, 1999 and March 31, 1998,
the Company operated in two business segments: oil and gas exploration and
production and natural gas marketing. The Company does not allocate interest
income, interest expense or income tax expense to these segments. The operating
profit (loss) achieved by each of the Company's segments was as follows:
Six months ended March 31, 1999:
Operating
Segment Revenues Expenses Profit (Loss)
--------------------------------- -------- -------- -------------
1. Oil and gas exploration and
production $ 1,149 ($ 1,026) $ 123
2. Natural gas marketing 42,152 (32,104) 10,048
-------- ------- -------
$ 43,301 ($33,130) $10,171
======== ======= =======
-11-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Six months ended March 31, 1998:
Operating
Segment Revenues Expenses Profit
--------------------------------- -------- -------- -------------
1. Oil and gas exploration and
production $ 1,335 ($ 982) $ 353
2. Natural gas marketing 38,148 (29,812) 8,336
-------- ------- -------
$ 39,483 ($30,794) $ 8,689
======== ======= =======
Three months ended March 31, 1999:
Operating
Segment Revenues Expenses Profit (Loss)
--------------------------------- -------- -------- -------------
1. Oil and gas exploration and
production $ 668 ($ 518) $ 150
2. Natural gas marketing 21,697 (16,244) 5,453
--------- ------- --------
$ 22,365 ($16,762) $5,603
========= ======= ========
Three months ended March 31, 1998:
Operating
Segment Revenues Expenses Profit
--------------------------------- -------- -------- -------------
1. Oil and gas exploration and
production $ 619 ($ 432) $ 187
2. Natural gas marketing 17,885 (13,875) 4,010
--------- ------- -------
$ 18,504 ($14,307) $ 4,197
========= ======= =======
The individual components of revenue and expenses for each segment are
set forth in the attached "Consolidated Statements of Operations."
Note 7 - Penn Octane Investment
In October 1997, the Company invested $1,000 in a promissory note of
Penn Octane Corporation ("Penn Octane"), a public company. The note bears
interest at 10% payable quarterly and was due on June 30, 1998. At June 30,
1998, Penn Octane did not repay the note. In May of 1998, Penn Octane was
awarded a judgement against a bank and such judgement is in excess of the $1,000
owed to the Company by Penn Octane. In December 1998, Penn Octane assigned its
interest in the bank judgement to the extent of the Company's note to the
Company in return for an extension of the note until June 30, 1999. The Company
also received 225,000 warrants to purchase the common stock of Penn Octane for
one dollar and seventy-five cents per share as consideration for the extension.
The bank owing the judgement has appealed it to the Texas Supreme Court and such
appeal may not be resolved for a year or more.
-12-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
In March 1999, the Company agreed to convert $900 of its $1,000 note to
90,000 shares of preferred stock of Penn Octane. The preferred shares provide
dividends at 12% per annum which is to be paid semiannually. Interest is payable
in cash or common stock at Penn Octane's election. The preferred shares are
convertible into 360,000 common shares of Penn Octane. In addition, the Company
received 50,000 shares of Penn Octane's common stock as consideration for
entering into this transaction. The remaining $100 note continues to be due on
June 30, 1999.
At March 31, 1999, the Company recorded a $423 provision related to its
$900 preferred stock investment in Penn Octane.
At March 31, 1999, the Company owned 351,000 shares of Penn Octane
common stock, 90,000 shares of preferred stock of Penn Octane and a $100 note
from Penn Octane.
Note 8 - Subsequent Events
Acquisition of AmBrit Energy Corp Asset
On April 12, 1999, the Company entered into an agreement with AmBrit
Energy Corp. ("AmBrit") to acquire all of AmBrit's oil and gas properties. The
oil and gas assets purchased include producing properties in Alabama, Louisiana,
Mississippi, Montana, New Mexico, Oklahoma and Texas as well as undrilled
acreage in several of these states. The Company estimates the proved reserves
acquired to be approximately 27.5 billion feet of cubic gas equivalent. The
consideration to be paid is $22,000 of which ten percent was deposited upon
execution of the related purchase and sale agreement with the balance to be
funded at closing. The purchase price will be adjusted downwards to reflect
profits between the effective date, January 1, 1999 and the closing date. The
Company intends to fund the purchase using corporate cash. The purchase and sale
agreement contains several customary conditions to closing, including approval
by AmBrit's shareholders. The Company anticipates closing by June 1, 1999. There
can, however, be no assurance that the transaction will be consummated.
Investment in Drilling Joint Venture
In May 1999, the Company signed a letter of intent with another
exploration and production company to drill up to twelve exploratory wells in
South Texas. The Company's commitment to the joint venture is $5,300 although
most of this commitment will be released if initial drilling results are not as
estimated. The Company anticipates that these exploratory wells will be drilled
over the next year.
-13-
Castle Energy Corporation and Subsidiaries
Notes to Consolidated Financial Statements
(Dollars in thousands, except share amounts)
(Unaudited)
Investment in Romanian Concessions
In April 1999, the Company purchased an option to acquire three oil and
gas concessions granted to a subsidiary of Costilla Energy Corporation
("Costilla"), by the Romanian government. The Company paid Costilla $65 for the
option.
-14-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
RESULTS OF OPERATIONS
As noted previously, the Company had discontinued its refining
operations by September 30, 1995. As a result, management's discussion and
analysis focuses primarily on the Company's continuing operations -- natural gas
marketing and oil and gas exploration and production. All references herein to
dollars are in thousands.
The Company desires to take advantage of the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and has included a
discussion of risk factors related to Management's Discussion and Analysis of
Financial Condition and Results of Operations. The discussion and analysis below
include forward-looking data that are based upon management's estimates,
assumptions and projections. Important factors, such as the risk factors listed
below, could cause results to differ materially from those expected by
management.
NATURAL GAS MARKETING
Two of the Company's subsidiaries have entered into two long-term gas
contracts. The first contract is with Lone Star Gas Company ("Lone Star") and
requires one of the Company's subsidiaries to deliver to Lone Star 45,000,000
cubic feet of natural gas per day ("Lone Star Contract"). The second contract is
with MG Natural Gas Corp. ("MGNG") and requires another subsidiary of the
Company to deliver approximately 6,400,000 cubic feet of natural gas per day
("MGNG Contract"). Both contracts expire May 31, 1999.
Gross Margin
A comparison of the gross margins earned by the Company's natural gas
marketing segment is as follows:
Lone Star MGNG
Contract Contract Consolidated
--------- -------- ------------
Six Months Ended March 31, 1999
Gas Sales........................................... $39,707 $2,445 $42,152
Gas purchases....................................... (23,212) (3,052) (26,264)
------- ------ --------
Gross margin........................................ $16,495 ($ 607) $15,888
======= ======= =======
Six Months Ended March 31, 1998
Gas Sales........................................... $35,690 $2,458 $38,148
Gas purchases....................................... (20,886) (3,313) (24,199)
------- ------- -------
Gross margin........................................ $14,804 $ (855) $13,949
======= ======= =======
-15-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
Natural gas sales under the Lone Star Contract increased $4,017 or
11.3% from the first six months of fiscal 1998 to the first six months of fiscal
1999. Under the Lone Star Contract the price received for gas is essentially
fixed through May 31, 1999. The variance in gas sales, therefore, is almost
entirely attributable to the volumes of gas delivered. Although the volumes
delivered to Lone Star annually are essentially fixed (the Lone Star Contract
has a take-or-pay provision), the Lone Star Contract year is from February 1 to
January 31 whereas the Company's fiscal year is from October 1 to September 30.
Furthermore, although the volumes to be taken by Lone Star in a given contract
year are fixed, there is no provision requiring fixed monthly or daily volumes
and deliveries accordingly vary with Lone Star's seasonal and peak demands. Such
variances have been significant. As a result, Lone Star deliveries, although
fixed for a contract year, may be skewed and not proportional for the Company's
fiscal periods.
For the first six months of fiscal 1999 deliveries and sales to Lone
Star exceeded by approximately 25% those which would have resulted if daily
deliveries had been fixed and equal. The Company expects deliveries and sales to
Lone Star for the period April 1, 1999 to May 31, 1999, the termination date of
the Lone Star Contract, to be approximately 41% less than those which would
result if daily deliveries were fixed and equal.
Gas purchases for the Lone Star Contract increased $2,326 or 11.1% from
the first six months of fiscal 1998 to the first six months of fiscal 1999. For
each of the six month periods ended March 31, 1999 and 1998 gas purchases
comprised 58.5% of gas sales. From 1998 to 1999 the gross margin increased
$1,691 or 11.4%. For both periods being compared the gross margin percentage
((gas sales - gas purchases) as a percentage of gas sales) remained at 41.5%.
One of the Company's subsidiaries is a party to the MGNG Contract.
Pursuant to the terms of this contract, the subsidiary is required to sell to
MGNG 7,356,000 MMBtu's (British thermal units) of natural gas at a fixed price
ratably over the period from June 1, 1996 to May 31, 1999. The fixed price for
the gas sold to MGNG is significantly less than the fixed price of gas sold to
Lone Star. For the six months ended March 31, 1999, the Company realized a
negative gross margin of $607 on this contract versus a negative gross margin of
$855 for the six months ended March 31, 1998. The negative margins resulted
because the spot (market) prices paid by the Company for gas, plus hedging
adjustments where applicable, exceeded the fixed price received by the Company
from MGNG under the contract. The Company has hedged all of its remaining gas
purchase requirements for this contract. As a result, the Company expects to
realize a negative gross margin on this contract during its remaining term,
April 1, 1999 to May 31, 1999.
Both the Lone Star Contract and the MGNG contract expire May 31, 1999.
During the six months ended March 31, 1999, the operating income from these
contracts was $10,048 or 121.4% of consolidated operating income. For the six
months ended March 31, 1998, the operating income from these contracts was
$8,336 or approximately 117.1% of consolidated operating income for the period.
The Company does not anticipate replacing these contracts because it sold its
pipeline assets to a subsidiary of Union Pacific Resources Company ("UPRC") in
May 1997 and because it is unlikely that similar profitable long-term contracts
can be negotiated since most gas purchasers buy gas on the spot market. As a
result, once the two contracts end on May 31, 1999, the Company
-16-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
anticipates that its future revenues, operating income and net income will be
reduced. The Company intends to try to replace some or all of its operating
income contribution of these contracts with operating income from additional
exploration and production and other energy assets. In that respect, the Company
has entered into an agreement to acquire the oil and gas assets of AmBrit Energy
Corp., has entered into a drilling venture in South Texas and has an option to
acquire a drilling concession participation in Romania (see Note 8). There can,
however, be no assurance the Company will succeed in these efforts.
General and Administrative
General and administrative costs increased $118 from $38 for the six
months ended March 31, 1998 to $156 for the six months ended March 31, 1999. The
increase was attributable to increased legal costs and increased consulting fees
for on-going gas marketing operations.
Transportation
Transportation expense increased $93 or 10.8% from $860 for the six
months ended March 31, 1998 to $953 for the six months ended March 31, 1999.
Transportation expense is based upon and thus proportional to deliveries made to
Lone Star and represents the amortization of a $3,000 prepaid transportation
asset received by one of the Company's subsidiaries in the sale of the Castle
Pipeline to UPRC in May 1997. Deliveries to Lone Star were approximately 11%
greater during the six months ended March 31, 1999 than during the six months
ended March 31, 1998. Such expense will cease upon expiration of the Lone Star
Contract on May 31, 1999.
EXPLORATION AND PRODUCTION
Revenues
Oil and Gas Sales
Oil and gas sales decreased $248 or 20.3% from the first six months of
fiscal 1998 to the first six months of fiscal 1999. Approximately half of the
decrease is attributable to decreased production. The other half of the decrease
is primarily due to decreased prices received for oil and gas. Until February
1999 oil prices have been at or near record lows. Gas prices, although not as
low as oil prices, have been 20%-25% lower than in prior years.
Recently oil prices increased dramatically (in excess of $18.00 per
barrel) and gas prices also increased significantly. If such prices remain at
their current levels, the Company's revenue from oil and gas sales is expected
to increase despite depletion of oil and gas reserves. There can be no
assurance, however, that oil and gas prices will remain at their recent levels.
Well Operations
Revenue from well operations increased $62 or 53.9% from the first six
months of fiscal 1998 to the first six months of fiscal 1999. The increase was
primarily caused by the non-recurring recovery of operating fees in 1999 that
had been written off in prior years.
-17-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
Expenses
Oil and Gas Production
Oil and gas production expenses increased $133 or 38.2% from the first
six months of fiscal 1998 to the first six months of fiscal 1999. The increase
in oil and gas production expenses results from the general maturing of the
Company's oil and gas properties and the tendency for older, depleting
properties to carry a higher production expense burden than recently drilled
properties. Furthermore, oil and gas production expenses, especially repairs, do
not generally occur evenly throughout the year and are best compared on an
annual rather than on a quarterly basis. The Company expects that, although such
oil and gas production expense will increase as a result of its new drilling and
acquisition activities, such expenses will decline when compared to oil and gas
sales given the lower production costs typically associated with new production.
There can be no assurance, however, that such will be the case.
General and Administration
General and administrative costs increased $89 or 29% from the first
six months of fiscal 1998 to the first six months of fiscal 1999. The increase
was attributable to increased employee salaries, legal costs and consultant
fees.
Depreciation, Depletion and Amortization
Depreciation, depletion and amortization decreased $178 or 54.4% from
the first six months of fiscal 1998 to the first six months of fiscal 1999. The
decrease is attributable to decreased production.
As a result of the full cost accounting required to record the
Company's sale of 84% of its proved reserves to UPRC in May 1997, the Company's
cost per equivalent mcf produced thereafter is approximately $.37. Current
acquisition costs for natural gas on the open market are significantly higher
than this. As described in Note 8, the Company recently entered into an
agreement to acquire the oil and gas assets of AmBrit Energy Corp. The
anticipated closing date is June 1, 1999. The Company has also entered into a
drilling venture to drill twelve wells in South Texas and has acquired an option
to invest approximately $3,500 in a drilling concession in Romania. Accordingly,
the Company expects that its oil and gas revenues and expenses will increase to
the extent these planned transactions are consummated. Since the Company's
natural gas marketing contracts expire May 31, 1999, the Company anticipates
that all of its revenues and expenses thereafter will be derived from the
aforementioned oil and gas exploration and production acquisitions, and the
Company's own production. The Company may, however, decide to enter into another
segment of the energy business.
-18-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
CORPORATE GENERAL AND ADMINISTRATIVE EXPENSE
Corporate general and administrative expenses increased $323 or 20.6%
from the first six months of fiscal 1998 to the first six months of fiscal 1999.
Most of the increase was caused by increased consulting fees applicable to due
diligence on possible acquisitions. Additional factors causing the increase are
employee bonuses and increased legal costs.
OTHER INCOME (EXPENSE)
Interest Income
Interest income decreased $286 or 23.2% from the first six months of
fiscal 1998 to the first six months of fiscal 1999. The decrease is primarily
attributable to a decrease in the average balance of unrestricted cash
outstanding during the periods being compared. In addition, the interest rate
applicable to the Company's investment has decreased almost one-half of one
percent since March 31, 1998.
Other Income (Expense)
The composition of other income (expense) is as follows:
Six Months Ended March 31,
1999 1998
----------- ----------
Write downs of preferred stock investment in
Penn Octane........................................ ($423)
Market price adjustment - common stock of Penn
Octane............................................. 104
Litigation recovery - EMC............................. 355
Miscellaneous......................................... (2) $29
----- ---
$ 34 $29
===== ===
The write down of the Company's investment in Penn Octane stock is based
upon the Company's calculation of the loss that would be incurred if the Company
converted its shares of Penn Octane preferred stock and sold the resulting
common shares at a discount to the market price given the volume of shares that
would be sold (see Note 7).
The market price adjustment relates to the Company's investment in Penn
Octane common stock and is essentially a reversal of the market provision made
at September 30, 1998 when the market value of the stock was less than the
Company's cost.
-19-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
TAX PROVISION
The tax provision for the six months ended March 31, 1998 essentially
represents the amortization of the Company's deferred tax assets at an effective
rate of 36% of pre-tax income. The tax provision for the six months ended March
31, 1999 consists of three components:
a. The realization of the remaining $2,765 deferred tax assets at
an effective rate of 36% on $7,681 of pre-tax income.
b. A tax provision of 2% on all pre-tax income in excess of $7,681.
For the six months ended March 31, 1999, such excess pre-tax
income was $1,578. The 2% rate represents alternative minimum
Federal corporate taxes the Company must pay despite having tax
carryforwards available to offset regular Federal corporate tax.
c. Other tax adjustments of $13.
-20-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
LIQUIDITY AND CAPITAL RESOURCES
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, including without limitation in conjunction with the expected cash
receipts and expected cash obligations included below. All forward-looking
statements in this report are expressly qualified in their entirety by the
cautionary statements in this section.
During the six months ended March 31, 1999, the Company generated
$13,994 from operating activities. During the same period the Company invested
$301 in oil and gas drilling and paid $881 in stockholder dividends. At March
31, 1999, the Company had $43,845 of unrestricted cash, $44,101 of working
capital and no long-term debt.
At the present time the probable future cash expenditures of the
Company consist of the following:
a. Investments in Oil and Gas Properties and Energy Sector - in
addition to its drilling expectations for up to seventy
additional wells in Appalachia (approximately $5,250), twelve
exploratory wells in South Texas ($5,300), anticipated new
drilling on the properties to be acquired from AmBrit ($5,300)
and possibly several exploratory wells in Romania ($3,500), the
Company is currently pursuing several other possible material
investments in the energy sector. These possible investments
include drilling ventures, the acquisition of oil and gas
properties and oil and gas companies, as well as the acquisition
of pipelines and gas marketing transactions. Although most of
these possible investments involve domestic properties, some
involve investments overseas. Although the Company believes it
can conclude a transaction or several transactions on terms
favorable to the Company, there can be no assurance that such
will be the case. Oil and gas prices have recently increased
significantly and many potential sellers may decide not to sell
or may not be forced to sell by their lenders. In addition,
several large oil and gas companies have significantly more
resources than the Company and other parties may be willing to
pay more than the Company for a given acquisition.
b. Repurchase of Company Shares - as of April 30, 1999, the Company
had repurchased 4,202,617 of its shares of common stock at a
cost of $59,359. The Company's Board of Directors previously
authorized the repurchase of up to 4,250,000 shares to provide
an exit vehicle for investors who want to liquidate their
investment in the Company. The decision whether to repurchase
additional shares and/or to increase the repurchase
authorization above 4,250,000 shares will depend upon the market
price of the Company's stock, tax considerations, the number of
stockholders seeking to sell their shares and other factors.
-21-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
c. Recurring Dividends - the Company's Board of Directors adopted a
policy of paying a $.60 per share annual dividend ($.15 per
share quarterly) in June of 1997. The Company expects to
continue to pay such dividend until the Board of Directors, in
its sole discretion, changes such policy.
An estimate of the Company's expected cash resources and obligations
from April 1, 1999 to September 30, 1999, the fiscal year end during which the
Lone Star Contract expires, is as follows:
Expected Cash Resources: ("000's"
Omitted)
Cash on hand - April 1, 1999.......................................................... $43,845
Cash flow - remaining gas marketing and ongoing exploration and
production operations............................................................. 3,200
Cash flow - oil and gas operations to be acquired..................................... 2,400
Repayment of Penn Octane Corporation note............................................. 100
Proceeds from American Western note................................................... 800
Interest.............................................................................. 850
-------
51,195
-------
Expected Cash Obligations:
Acquisition of oil and gas properties of AmBrit....................................... 19,500
Drilling Ventures:
Appalachia........................................................................ 400
South Texas....................................................................... 2,000
Romania........................................................................... 500
AmBrit properties - new drilling...................................................... 500
Quarterly dividends................................................................... 780
Assumed IRLP payment of vendors and funding of
environmental reserves............................................................ 800
-------
24,480
-------
Excess of Expected Cash Resources Over Expected Cash Obligations......................... $26,715
=======
The foregoing estimates assume that the AmBrit Energy Corp. transaction
is consummated, that drilling operations commence in the South Texas drilling
venture and that the Romanian option is exercised and related concession
operations proceed as planned. Obviously, such may not be the case. Completion
of these transactions is dependent upon several risk factors, including those
listed below.
In addition to the foregoing, the Company anticipates additional
drilling expenditures of as much as $15,650 for the period from October 1, 1999
to September 30, 2002 assuming all planned transactions are consummated. Such
amounts are preliminary estimates only and the actual drilling costs spent
during this period may vary materially from those estimated. The Company has
also
-22-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
assumed certain energy prices for its production. Factors affecting energy
prices are beyond the control of the Company and actual prices will be different
than the prices assumed by the Company.
In the event that the Company decides to acquire additional energy
assets but does not have sufficient corporate cash to do so, the Company intends
to draw-down funds from its $30,000 line of credit with an energy bank. That
line of credit is unused.
The foregoing estimates assume that the Company's operations and
expected cash flow will not be affected by any of the risk factors listed below:
a. Contingent environmental liabilities
b. Vendor liabilities of the Company's inactive refining subsidiaries
c. Litigation
d. Credit risk - Lone Star
e. Supply risk - MGNG
f. Price risk - gas supply
g. Gas contract litigation - Lone Star and/or MGNG
h. Public market for Company's stock
i. Future of the Company
j. Foreign operation risks. Since the Company may spend approximately
$3,500 drilling a Romanian concession, the Company's interests are
subject to certain foreign country risks over which the Company
has no control - including political risk, the risk of additional
taxation and the possibility that foreign operating requirements
and procedures may reduce estimated profitability.
k. Other risks including general business risks, insurance claims
against the Company in excess of insurance recoveries, tax
liabilities resulting from tax audits, drilling risks and
litigation risk.
The Company has recently completed a study of the Year 2000 issue and
related risks. As a result of the study, the Company replaced its oil and gas
and general ledger software with new software which is Year 2000 compliant. The
Company expects the cost to approximate $100. At March 31, 1999, $90 had been
incurred. The Company commenced using the new software in the first quarter of
fiscal 1999. The Company has also made inquiries to outside parties who process
transactions of the Company, e.g., payroll, commercial banks, transfer agent,
reserve engineers, etc. While some outside parties have confirmed they are Year
2000 compliant, others have not done so to the Company's satisfaction. The
Company is continuing to pursue the vendors whose responses appear to provide
insufficient assurance.
-23-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
The most important systems operated by the Company are its revenue
distributions, joint interest billing and general ledger. The Company replaced
its software because the new systems are Year 2000 compliant. If a Year 2000
problem nevertheless occurred, the Company could process transactions for
several months manually or using small computers but only with increased
administrative costs. Nevertheless, in many cases, the Company is not the
operator of a given well or purchaser of oil and gas production. In those cases
the Company is dependent upon the operator and/or oil/gas purchaser for accurate
volumetric, cost and sales information and for payments. Although the Company
has made Year 2000 inquiries of such operators and purchasers and generally
received satisfactory responses, there can be no assurance that such operators
and purchasers will actually be Year 2000 compliant. If such is the case, the
Company could find a major portion of its production revenue held in escrow
until Year 2000 compliance was achieved or resulting litigation settled. The
related legal cost and resulting administrative confusion could be substantial.
The Company expects to make any necessary contingency plans in fiscal 1999 in
the event of non-compliance of its systems, customers or suppliers.
The Company and its subsidiaries are not aware of any material Year
2000 operational risks.
Readers should refer to the Management Discussion and Analysis of
Financial Condition and Results of Operations Section of the Company's Form 10-K
for the fiscal year ended September 30, 1998 for a description of the
aforementioned risk factors.
If any or several of these risks materialize, the Company's estimated
cash flow and results of operations will probably be adversely impacted and the
impact may be material. The estimated cash flow above assumes none of these
risks materializes. Given the number and variety of risks and the litigiousness
of today's corporate world, it is reasonably possible that one or more of these
risks may occur.
-24-
Castle Energy Corporation and Subsidiaries
(Dollars in thousands)
(Unaudited)
Item III. Qualitative and Quantitative Disclosures about Market Risk
One of the Company's subsidiaries has hedged all of the gas it must
purchase for the remaining term of the Lone Star Contract and the contract with
MGNG. The subsidiary used fixed price swaps to hedge such gas. The subsidiary
purchases gas on the open market and pays the trading party if the market price
is below the fixed price or is paid by the trading party if the market price
exceeds the fixed price. The result is that the Company's subsidiary has
essentially fixed the price of future gas purchases and is not subject to
commodity price risk related to its gas marketing activities. The Company's gas
marketing contracts expire May 31, 1999.
See Note 6 to the Consolidated Financial Statements.
-25-
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For information regarding lawsuits, reference is made to Item 3 of the
Company's Form 10-K (Annual Report) for the fiscal year ended September 30,
1998. Also see Note 4 to the March 31, 1999 financial statements included in
Part I.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits:
Exhibit 10.126 - Purchase and Sale Agreement by and
between AmBrit Energy Corp. and Castle
Exploration Company, Inc., effective
January 1, 1999
Exhibit 10.127 Agreement to Exchange $.9 Million
Secured Notes Into Senior Preferred
Stock of Penn Octane Corporation dated
March 3, 1999
Exhibit 11.1 - Statement re: Computation of Earnings
Per Share
Exhibit 27 - Financial Data Schedule
(B) Reports on Form 8-K: None
-26-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 17, 1999 CASTLE ENERGY CORPORATION
/s/Richard E. Staedtler
-----------------------
Richard E. Staedtler
Chief Financial Officer
Chief Accounting Officer
-27-