ITEM 3. LEGAL PROCEEDINGS
Contingent Environmental Liabilities
In December 1995, IRLP, an inactive subsidiary of the Company, sold its refinery, the Indian Refinery, to American Western Refining L.P. ("American Western"), an unaffiliated party. As part of the related purchase and sale agreement, American Western assumed all environmental liabilities and indemnified IRLP with respect thereto. Subsequently, American Western filed for bankruptcy and sold the Indian Refinery to an outside party pursuant to a bankruptcy proceeding. The outside party has substantially dismantled the Indian Refinery. American Western recently filed a Plan of Liquidation. American Western anticipates that the Plan of Liquidation expects to be confirmed in January 2002.
During fiscal 1998, the Company was informed that the United States Environmental Protection Agency ("EPA") had investigated offsite acid sludge waste found near the Indian Refinery and had investigated and remediated surface contamination on the Indian Refinery property. Neither the Company nor IRLP was initially named with respect to these two actions.
In October 1998, the EPA named the Company and two of its inactive refining subsidiaries as potentially responsible parties for the expected clean-up of the Indian Refinery. In addition, eighteen other parties were named including Texaco Refining and Marketing, Inc. ("Texaco"), the refinery operator for over 50 years. A subsidiary of Texaco had owned the refinery until December of 1988. The Company subsequently responded to the EPA indicating that it was neither the owner nor the operator of the Indian Refinery and thus not responsible for its remediation.
In November 1999, the Company received a request for information from the EPA concerning the Company's involvement in the ownership and operation of the Indian Refinery. The Company responded to the EPA information request in January 2000.
On August 7, 2000, the Company received notice of a claim against it and two of its inactive refining subsidiaries from Texaco and its parent. Texaco had made no previous claims against the Company although the Company's subsidiaries had owned the refinery from August 1989 until December 1995. In its claim, Texaco demanded that the Company and its former subsidiaries indemnify Texaco for all liability resulting from environmental contamination at and around the Indian Refinery. In addition, Texaco demanded that the Company assume Texaco's defense in all matters relating to environmental contamination at and around the Indian Refinery, including lawsuits, claims and administrative actions initiated by the EPA and indemnify Texaco for costs that Texaco has already incurred addressing environmental contamination at the Indian Refinery. Finally, Texaco also claimed that the Company and two of its inactive subsidiaries are liable to Texaco under the Federal Comprehensive Environmental Response Compensation and Liability Act as owners and operators of the Indian Refinery. The Company responded to Texaco disputing the factual and theoretical basis for Texaco's claims against the Company. The Company's management and special counsel subsequently met with representatives of Texaco but the parties disagreed concerning Texaco's claims.
The Company and its special counsel believe that Texaco's claims are utterly without merit and the Company intends to vigorously defend itself against Texaco's claims and any lawsuits that may follow. In addition to the numerous defenses that the Company has against Texaco's contractual claim for indemnity, the Company and its special counsel believe that by the express language of the agreement which Texaco construes to create an indemnity, Texaco has irrevocably elected to forgo all rights of contractual indemnification it might otherwise have had against any person, including the Company.
In September 1995, Powerine sold the Powerine Refinery to Kenyen Resources ("Kenyen"), an unaffiliated party. In January 1996, Powerine merged into a subsidiary of Energy Merchant Corp. ("EMC"), an unaffiliated party, and EMC assumed all environmental liabilities. In August 1998, EMC sold the Powerine Refinery to a third party, which, we are informed, continues to seek financing to restart the Powerine Refinery.
In July of 1996, the Company was named a defendant in a class action lawsuit concerning emissions from the Powerine Refinery. In April of 1997, the court granted the Company's motion to quash the plaintiff's summons based upon lack of jurisdiction and the Company is no longer involved in the case.
Although the environmental liabilities related to the Indian Refinery and Powerine Refinery have been transferred to others, there can be no assurance that the parties assuming such liabilities will be able to pay them. American Western, owner of the Indian Refinery, filed for bankruptcy and is in the process of liquidation. EMC, which assumed the environmental liabilities of Powerine, sold the Powerine Refinery to an unrelated party, which we understand is still seeking financing to restart that refinery. Furthermore, as noted above, the EPA named the Company as a potentially responsible party for remediation of the Indian Refinery and has requested and received relevant information from the Company. Estimated gross undiscounted clean-up costs for this refinery are at least $80,000,000 - $150,000,000 according to third parties. If the Company were found liable for the remediation of the Indian Refinery, it could be required to pay a percentage of the clean-up costs. Since the Company's subsidiary only operated the Indian Refinery five years, whereas Texaco and others operated it over fifty years, the Company would expect that its share of remediation liability would be proportional to its years of operation, although such may not be the case. Furthermore, as noted above, Texaco has claimed that the Company indemnified it for all environmental liabilities related to the Indian Refinery. If Texaco were to sue the Company on this theory and prevail in court, the Company could be held responsible for the entire estimated clean up costs of $80,000,000-$150,000,000 or more. In such a case, this cost would be far in excess of the Company's financial capability.
An opinion issued by the U.S. Supreme Court in June 1998 in a comparable matter and a recent opinion by the U.S. Appeals Court for the Fifth Circuit support the Company's positions. Nevertheless, if funds for environmental clean-up are not provided by these former and/or present owners, it is possible that the Company and/or one of its former refining subsidiaries could be named parties in additional legal actions to recover remediation costs. In recent years, government and other plaintiffs have often sought redress for environmental liabilities from the party most capable of payment without regard to responsibility or fault. Whether or not the Company is ultimately held liable in such a circumstance, should litigation involving the Company and/or IRLP occur, the Company would probably incur substantial legal fees and experience a diversion of management resources from other operations.
Although the Company does not believe it is liable for any of its subsidiaries' clean-up costs and intends to vigorously defend itself in such regard, the Company cannot predict the ultimate outcome of these matters due to inherent uncertainties.
General
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case, the Long Trusts, are non-operating working interest owners in wells previously operated by Castle Texas Production Limited Partnership ("CTPLP"), an inactive exploration and production subsidiary of the Company. The wells were among those sold to UPRC in May 1997. The Long Trusts claimed that CTPLP did not allow them to sell gas from March 1, 1996 to January 31, 1997 as required by applicable joint operating agreements, and they sued CTPLP and the other defendants, claiming (among other things) breach of contract, breach of fiduciary duty, conversion and conspiracy. The plaintiffs sought actual damages, exemplary damages, pre-judgment and post-judgment interest, attorney's fees and court costs. CTPLP counterclaimed for approximately $150,000 of unpaid joint interests billings, interest, attorneys' fees and court costs.
After a three-week trial, the District Court in Rusk County submitted 36 questions to the jury which covered all of the claims and counterclaims in the lawsuit. Based upon the jury's answers, the District Court entered judgement granting plaintiffs' claims against the Company and its subsidiaries, as well as CTPLP's counterclaim against the plaintiffs. The District Court issued an amended judgement on September 5, 2001 which became final December 19, 2001. The net amount awarded to the plaintiffs was approximately $2,700,000. The Company and its subsidiaries have filed a notice of appeal with the Tyler Court of Appeals and will continue to vigorously contest this matter.
Special counsel to the Company does not consider an unfavorable outcome to this lawsuit probable. The Company's management and special counsel believe that several of the plaintiffs' primary legal theories are contrary to established Texas law and that the Court's charge to the jury was fatally defective. They further believe that any judgment for plaintiffs based on those theories or on the jury's answers to certain questions in the charge cannot stand and will be reversed on appeal. As a result, the Company has not accrued any liability for this litigation. Nevertheless, to pursue the appeal, the Company and its subsidiaries will be required to post a bond to cover the net amount of damages awarded to the plaintiffs and to maintain that bond until the resolution of the appeal (which may take several years). The Company has included the letter of credit to support the bond, estimated at approximately $3,000,000, in its line of credit with a major energy bank. See Note 21 to the consolidated financial statements which are included in Item 8 to this Form 10-K.
Larry Long Litigation
In May 1996, Larry Long, representing himself and allegedly "others similarly situated," filed suit against the Company, three of the Company's natural gas marketing and transmission and exploration and production subsidiaries, Atlantic Richfield Company ("ARCO"), B&A Pipeline Company, a former subsidiary of ARCO ("B&A"), and MGNG in the Fourth Judicial District Court of Rusk County, Texas. The plaintiff originally claimed, among other things, that the defendants underpaid non- operating working interest owners, royalty interest owners and overriding royalty interest owners with respect to gas sold to Lone Star pursuant to the Lone Star Contract. Although no amount of actual damages was specified in the plaintiff's initial pleadings, it appeared that, based upon the volumes of gas sold to Lone Star, the plaintiff may have been seeking actual damages in excess of $40,000,000.
After some initial discovery, the plaintiff's pleadings were significantly amended. Another purported class representative, Travis Crim, was added as a plaintiff, and ARCO, B&A and MGNG were dropped as defendants. Although it is not completely clear from the amended petition, the plaintiffs apparently limited their proposed class of plaintiffs to royalty owners and overriding royalty owners in leases owned by the Company's exploration and production subsidiary limited partnership. In amending their pleadings, the plaintiffs revised their basic claim to seeking royalties on certain operating fees paid by Lone Star to the Company's natural gas marketing subsidiary limited partnership.
In April 2000, Larry Long withdrew as a named plaintiff and in September 2000, the Company and the remaining named plaintiff agreed to settle the case for a payment of $250,000 by the Company. As of December 27, 2001, the Company had paid $259,000, representing the $250,000 settlement amount plus $ 9,000 of interest, to the plaintiffs and their lawyers.
MGNG Litigation
On May 4, 1998, CTPLP, a subsidiary of the Company, filed a lawsuit against MGNG and MG Gathering Company ("MGC"), two subsidiaries of MG, in the district court of Harris County, Texas. One of the Company's exploration and production subsidiaries sought to recover gas measurement and transportation expenses charged by the defendants in breach of a certain gas purchase contract. Improper charges exceeded $750,000 before interest. In October of 1998, MGNG and MGC filed a suit in Harris County, Texas. This suit sought indemnification from two of the Company's subsidiaries in the event CTPLP won its lawsuit against MGNG and MGC. The MG entities cited no basis for their claim of indemnification. The management of the Company and special counsel retained by the Company believe that the Company's subsidiary is entitled to at least $750,000 plus interest and that the Company's two subsidiaries have no indemnification obligations to MGNG or MGC. The parties participated in mediation but were not able to resolve the issue.
In October 1999, MGNG filed a second lawsuit against the Company and three of its subsidiaries claiming $772,000 was owed to MGNG under a gas supply contract between one of the Company's subsidiaries and MGNG. The suit was filed in the district court of Harris County, Texas. The Company and its subsidiaries believed that they do not owe $772,000 and were entitled to legally offset some or all of the $772,000 claimed against amounts owed to CTPLP by MGNG for improper gas measurement and transportation deductions. The Castle entities answered this suit denying MGNG's claims based partially on the right of offset.
In September 2000, the parties agreed to settle all lawsuits. Under the terms of the settlement the amount claimed by MGNG under a gas supply contract was reduced by $325,000 and the net amount payable to MGNG was set at $400,000 and the parties signed mutual releases. The Company paid MGNG $400,000 in November 2001.
Pilgreen Litigation
As part of the AmBrit purchase, Castle Exploration Company, Inc. ("CECI") acquired a 10.65% overriding royalty interest ("ORRI") in the Pilgreen #2ST gas well in Texas. Because of title disputes, AmBrit and other interest owners had previously filed claims against the operator of the Pilgreen well, and CECI acquired post January 1, 1999 rights in that litigation. Although revenue attributed to the ORRI has been suspended by the operator since first production, because of recent related appellate decisions and settlement negotiations, the Company believes that revenue attributable to the ORRI should be released to CECI in the near future. As of September 30, 2001, approximately $415,000 attributable to CECI's share of the ORRI revenue was suspended. The Company's policy is to recognize the suspended revenue only when and if it is received.
ITEM 4.
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 2001.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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:
On December 29, 1999, the Company's Board of Directors declared a stock split in the form of a 200% stock dividend applicable to all stockholders of record on January 12, 2000. The additional shares were paid on January 31, 2000 and the Company's shares first traded at post split prices on February 1, 2000. The stock split applied only to the Company's outstanding shares on January 12, 2000 (2,337,629 shares) and did not apply to treasury shares (4,491,017 shares) on that date. As a result of the stock split 4,675,258 additional shares were issued. All share changes have been recorded retroactively in these data and elsewhere in this Form 10-K.
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 three fiscal years ended September 30, 2001.
The final sale of the Company's Common Stock as reported by the NNM on November 30, 2001 was at $5.87.
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. 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 - including a covenant in the Company's letter of credit facility that limits dividends to 50% of the Company's net income.
Approximate Number of Holders of Common Stock
As of November 30, 2001, the Company's Common Stock was held by approximately 3,000 stockholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
During the five fiscal years ended September 30, 2001, the Company consummated a number of transactions affecting the comparability of the financial information set forth below. In May 1997, the Company sold its Rusk County, Texas oil and gas properties and pipeline to UPRC and one of its subsidiaries. In June 1999, CECI acquired all of the oil and gas assets of AmBrit. See Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
("$000's" Omitted Except Per Unit Amounts) - --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
GENERAL
From August 1989 to September 30, 1995, two of the Company's subsidiaries conducted refining operations. By December 12, 1995, the Company's refining subsidiaries had sold all of their refining assets. In addition, Powerine merged into a subsidiary of EMC and was no longer a subsidiary of the Company. The Company's other refining subsidiary, IRLP, owns no refining assets and is in the process of liquidation. As a result, the Company has accounted for its refining operations as discontinued operations in the Company's financial statements as of September 30, 1995 and retroactively. Accordingly, discussion of results of operations has been confined to the results of continuing operations and the anticipated impact, if any, of liquidation of the Company's remaining inactive refining subsidiary and contingent environmental liabilities of the Company or its refining subsidiaries.
Also, as noted above, CECI acquired the oil and gas properties of AmBrit on June 1, 1999. The oil and gas reserves associated with the acquisition were estimated at approximately 12.5 billion cubic feet of natural gas and 2,000,000 barrels of crude oil, roughly 150% of the reserves owned by the Company before the acquisition. Furthermore, as a result of the acquisition, the Company's production of oil and gas increased by approximately 425%. This acquisition impacted consolidated operations for the last four months of fiscal 1999 only.
Gas marketing sales and purchases ceased effective May 31, 1999 by virtue of the scheduled termination of its subsidiaries' gas sales and gas purchase contracts with Lone Star and MGNG. The Company has not replaced these contracts although it continues to seek similar gas marketing acquisitions. As a result, natural gas marketing operations impacted consolidated operations for all of fiscal 1999 and none of fiscal 2000 or fiscal 2001.
Fiscal 2001 vs Fiscal 2000
OIL AND GAS SALES
Oil and gas sales increased $3,185 or 17.7% from fiscal 2000 to fiscal 2001. An analysis of the increase is as follows:
For the year ended September 30, 2001, the Company's net production averaged 718 barrels of crude per day and 8,447 mcfe of natural gas per day versus 764 barrels of crude oil per day and 9,718 mcf of natural gas per day for the year ended September 30, 2000.
The decline in production volumes is primarily attributable to the depletion of the Company's oil and gas reserves and the fact that all but one of the exploratory wells drilled in fiscal 2000 and 2001 by the Company resulted in dry holes rather than production. The decline in production would have been greater by 467,000 mcfe had the Company not acquired twenty- one producing East Texas properties in April 2001 (see Items 1 and 2 above).
At the present time, natural gas spot prices are averaging less than $3.00/mcf - far less than the average price of $4.53/mcf for the year ended September 30, 2001 and the record prices of $9.00/mcf received for some production in January 2001. In addition, current crude prices are slightly below $20.00 per barrel - significantly less than the average price of $27.39 received by the Company for the year ended September 30, 2001. Since the Company has not hedged its production and since most credible experts are not predicting significant increases for oil and gas prices in the short term, the Company expects that its oil and gas revenues will decrease significantly in fiscal 2002 unless the Company successfully drills or acquires new reserves and/or oil and as prices increase significantly. If the Company consummates the intended sale of its domestic oil and gas properties to Delta (see Items 1 and 2 above), oil and gas price or volume increases will affect both operations until closing of the sale and the ultimate purchase price the Company receives. Net cash flow between October 1, 2001, the effective date, and the closing date, would be retained by the Company but would reduce the purchase price paid by Delta.
Oil and gas production expenses increased $1,205 or 19.5% from fiscal 2000 to fiscal 2001. The increase is primarily attributable to the acquisition of twenty-one (21) producing properties in East Texas in April 2001. For the year ended September 30, 2001 oil and gas production expenses, net of income from well operations, were $1.59 per equivalent mcf sold versus $1.19 per equivalent mcf sold for the year ended September 30, 2000. The increase results primarily from two factors. When oil and gas prices increased substantially in the beginning of fiscal 2001, so did operating costs. Such operating costs, however, did not decrease or decreased less than oil and gas prices when oil and gas prices receded sharply later in the fiscal year. A second factor contributing to the increase is the fact that the average age of the Company's producing properties is increasing - especially given the unsuccessful results of the Company's exploratory drilling programs and the resultant lack of reserves added by new drilling. Mature wells typically carry a higher production expense burden than do newer wells that have not yet been significantly depleted.
GENERAL AND ADMINISTRATIVE COSTS
General and administrative costs decreased $210 or 10.3% from fiscal 2000 to fiscal 2001. The decrease is primarily attributable to transferring some costs associated with the Company's Oklahoma City office to corporate, general and administrative costs and decreased consulting costs. Also, see "Corporate General and Administrative Expenses" below.
DEPRECIATION, DEPLETION AND AMORTIZATION
Depreciation, depletion and amortization increased $261 on 8.1% from fiscal 2000 to fiscal 2001. The components of depreciation, depletion and amortization were as follows:
Depreciation and amortization of furniture and fixtures and equipment decreased $97 from fiscal 2000 to fiscal 2001 primarily because certain furniture and fixture assets and vehicles were fully depreciated in fiscal 2000.
For the year ended September 30, 2001, the depletion rate per equivalent mcf was $.72 in fiscal 2001 versus $.57 in fiscal 2000. The increase resulted primarily from two factors. First, in April 2001, the Company acquired twenty-one (21) East Texas wells at a higher cost per equivalent mcfe of reserves than that for the Company's existing reserves, causing the Company's average cost per mcfe of reserves to increase. Second, the depletion rate increased significantly because of significantly lower reserves at September 30, 2001 compared to those at September 30, 2000. Reserves decreased primarily because of much lower oil and gas prices at September 30, 2001 compared to September 30, 2000. The lower reserves and higher costs at September 30, 2001 caused the depletion rate to increase.
IMPAIRMENT OF UNPROVED PROPERTIES
The impairment reserve for unproved properties increased $1,933 from fiscal 2000 to fiscal 2001. To date, the Company has spent $3,597 participating in the drilling of five dry holes or uneconomical wells on three concessions in Romania and $110 with respect to the planned drilling of a sixth wildcat well in the Black Sea on a second phase of one concession. In fiscal 2000, the Company recorded an $832 reserve related to one drilling concession. The $2,765 reserve incurred in 2001 relates to the other two drilling concessions. At September 30, 2001, impairment reserves have been provided for all costs incurred in Romania except the $110 applicable to the planned sixth well in the Black Sea (see Note 4 to the Consolidated Financial Statements included in Item 8
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS ("$000's" Omitted Except Share and Per Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS ("$000's" Omitted Except Share and Per Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS ("$000's" Omitted Except Share and Per Share Amounts)
(continued on next page)
The accompanying notes are an integral part of these consolidated financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS ("$000's" Omitted) (continued from previous page)
The accompanying notes are an integral part of these consolidated financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND OTHER COMPREHENSIVE INCOME ("$000's" Omitted Except Per Share Amounts)
[RESTUBBED TABLE]
The accompanying notes are an integral part of these consolidated financial statements
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
NOTE 1 - BUSINESS AND ORGANIZATION
Business
Castle Energy Corporation (the "Company") is a public company incorporated in Delaware. Mr. Joseph L. Castle II, Chairman of the Board and Chief Executive Officer, and his wife own approximately twenty-three percent (23%) of the Company's outstanding common stock at September 30, 2001.
The Company's only line of business at September 30, 2001 and at present is oil and gas exploration and production. The Company's operations are conducted in the United States and in Romania. Prior to September 30, 1995, several of the Company's subsidiaries and former subsidiaries were involved in the refining business. These subsidiaries discontinued refining operations effective September 30, 1995; however, several contingencies related to closure of these refining assets are still outstanding. From December 1992 to May 31, 1999, several of the Company's subsidiaries were involved in the natural gas marketing business and from December 1992 to May 1997, another subsidiary was involved in the gas transmission business. In May 1997, the Company sold its gas transmission pipeline. All of the related long-term gas sales and gas purchase contracts applicable to the Company's natural gas marketing business expired by their terms on May 31, 1999.
On December 11, 2001, the Company entered into a letter of intent to sell all of its domestic oil and gas properties to another public oil and gas exploration company. See Note 21.
References to the Company mean Castle Energy Corporation, the parent, and/or one or more of its subsidiaries. Such references are used for convenience and are not intended to describe legal relationships.
Oil and Gas Exploration and Production
In June 1999, the Company acquired all of the oil and gas assets of AmBrit Energy Corp. ("AmBrit"). The AmBrit oil and gas assets included interests in approximately 180 wells located in eight states. The proved oil and gas reserves associated with the AmBrit acquisition were estimated to be approximately 12.5 billion cubic feet of natural gas and 2,000,000 barrels of crude oil or approximately one hundred and fifty percent (150%) of the Company's proved reserves before such acquisition. See Note 4.
During fiscal 2000, the Company participated in the drilling of nine exploratory wells in south Texas pursuant to two drilling ventures with other exploration and production companies. Eight of the wells drilled resulted in dry holes while the ninth well was completed as a producing well. During fiscal 2000 and 2001, the Company participated in the drilling of five wildcat wells in Romania. Four of the wells drilled resulted in dry holes. The fifth well produced some volumes of natural gas when tested. The Company considered participating in a four well drilling program offsetting the fifth well but has currently decided not to do so because of the current low prices obtainable for production and the potential costs of constructing a pipeline to transport production to potential purchasers. The Company has also agreed to participate in the drilling of a sixth well in the Black Sea in the spring or early summer of 2002. In December 1999, the Company acquired majority interests in twenty-six (26) offshore Louisiana wells. The Company then sold these wells to Delta Petroleum Company ("Delta"), a public company involved in oil and gas exploration and development, in September 2000.
In April 2001, the Company consummated the purchase of twenty-one (21) operated producing East Texas oil and gas properties from a private company.
See Note 4.
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"). The Company also entered into a gas sales contract and one gas purchase contract with MG Natural Gas Corp. ("MGNG"), a subsidiary of MG Corp. ("MG"), which, in turn, is a United States subsidiary of Metallgesellschaft A.G. ("MGAG"), a German conglomerate. In May 1997, the Company sold its Rusk County, Texas natural gas pipeline to a subsidiary of UPRC and thus exited the gas transmission business while still conducting gas marketing operations. Effective May 31, 1999, the aforementioned gas sales and gas purchases contracts expired by their own terms and were not replaced by other third party gas marketing business.
Refining
IRLP
The Company indirectly entered the refining business in 1989 when one of its subsidiaries acquired the operating assets of an idle refinery located in Lawrenceville, Illinois (the "Indian Refinery"). The Indian Refinery was subsequently operated by one of the Company's subsidiaries, Indian Refining I Limited Partnership ("IRLP"), until September 30, 1995 when it was shut down. On December 12, 1995, IRLP sold the Indian Refinery assets to American Western Refining, L.P. ("American Western"). American Western subsequently filed for bankruptcy and sold the Indian Refinery to an outside party which has substantially dismantled it. American Western subsequently filed a Plan of Liquidation which it expects to be confirmed by the governing bankruptcy court in January 2002. If the Plan is confirmed, IRLP expects to receive $612 which it would then distribute to its vendors.
Powerine
In October 1993, a former subsidiary of the Company purchased Powerine Oil Company ("Powerine"), the owner of a refinery located in Santa Fe Springs, California (the "Powerine Refinery"), from MG. On September 29, 1995, Powerine sold substantially all of its refining plant to Kenyen Projects Limited ("Kenyen"). On January 16, 1996, Powerine merged into a subsidiary of Energy Merchant Corp. ("EMC"), an unaffiliated entity, and EMC acquired the refinery from Kenyen. EMC subsequently sold the refinery to an outside party which, we are informed, continues to seek financing to restart it.
As a result of the transactions with American Western, Kenyen and EMC, the Company's refining subsidiaries disposed of their interests in the refining business. The results of refining operations were shown as discontinued operations in the Consolidated Statement of Operations for the year ended September 30, 1995 and retroactively. Discontinued refining operations have not impacted operations since fiscal 1995. Amounts on the balance sheet reflect the remaining assets and liabilities that are pending final resolution of related contingencies.
Investment In Networked Energy LLC
In August 2000, the Company purchased thirty-five percent (35%) of the membership interests of Networked Energy LLC ("Network") for $500. Network is a private company engaged in the operation of energy facilities that supply power, heating and cooling services directly to retail customers.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General
The significant accounting policies discussed are limited to those applicable to the business segments in which the Company operated during the fiscal years ended September 30, 2001, 2000 and 1999 - natural gas marketing and transmission and exploration and production. References should be made to previous Forms 10-K for summaries of accounting principles applicable to the discontinued refining segment.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Principles of Consolidation
The consolidated financial statements presented include the accounts of the Company and all of its subsidiaries. All intercompany transactions have been eliminated in consolidation.
Revenue Recognition
Natural Gas Marketing
Revenues were recorded when deliveries were made. Essentially all of the Company's deliveries were made under two long-term gas sales contracts, the Lone Star Contract and a gas sales contract with MGNG. These contracts expired May 31, 1999. Exploration and Production
Oil and gas revenues are recorded under the sales method when oil and gas production volumes are delivered to the purchaser. Reimbursement of costs from well operations is netted against the related oil and gas production expenses.
Cash and Cash Equivalents
The Company considers all highly liquid investments, such as time deposits and money market instruments, purchased with a maturity of three months or less, to be cash equivalents.
Natural Gas Transmission
Natural gas transmission assets included gathering systems and pipelines and were depreciated on a straight-line basis over fifteen years, their estimated useful life.
Marketable Securities
The Company currently classifies its investment securities as available-for-sale securities. Pursuant to Statement of Financial Accounting Standards No. 115 ("SFAS 115"), such securities are measured at fair market value in the financial statements with unrealized gains or losses recorded in other comprehensive income until the securities are sold or otherwise disposed of. At such time gain or loss is included in earnings. Prior to July 1, 1999, the Company classified its investment securities as trading securities and included the difference between cost and fair market value in earnings.
Prepaid Gas Purchases
Prepaid gas purchases represented payments made by one of the Company's subsidiaries for gas that the subsidiary was required to take but did not. All prepaid gas purchases related to gas purchases from MGNG. Under the terms of the related gas purchase contracts, the subsidiary was entitled to and did make up the prepaid gas, i.e., to take it and not pay for it, once it had taken the required minimum contract volume for the contract year. Prepaid gas purchase costs were expensed as the subsidiary took delivery of the prepaid gas.
Furniture, Fixtures and Equipment
Furniture, fixtures and equipment are depreciated on a straight-line basis over the estimated useful lives of the assets. Furniture, fixtures and equipment are depreciated on a straight-line basis over periods of three to ten years and rolling stock is depreciated on a straight-line basis over four to five years.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Oil and Gas Properties
The Company follows the full-cost method of accounting for oil and gas properties and equipment costs. Under this method of accounting, all productive and nonproductive costs incurred in the acquisition, exploration and development of oil and gas reserves are capitalized. Capitalized costs are amortized on a composite unit-of-production method by country using estimates of proved reserves. Capitalized costs which relate to unevaluated oil and gas properties are not amortized until proved reserves are associated with such costs or impairment of the related property occurs. Management and drilling fees earned in connection with the transfer of oil and gas properties to a joint venture and proceeds from the sale of oil and gas properties are recorded as reductions in capitalized costs unless such sales are material and involve a significant change in the relationship between the cost and the value of the remaining proved reserves, in which case a gain or loss is recognized. Expenditures for repairs and maintenance of wellhead equipment are expensed as incurred. Net capitalized costs, less related deferred income taxes, in excess of the present value of net future cash inflows (oil and gas sales less production expenses) from proved reserves, tax-effected and discounted at 10%, and the cost of properties not being amortized, if any, are charged to current expense. Amortization and excess capitalized costs, if any, are computed separately for the Company's investment in Romania.
Environmental Costs
The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future expected economic benefit to the Company. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures are recorded when environmental assessment and/or remediation is probable and the costs can be reasonably estimated.
Impairment of Long-Term Assets
The Company reviewed its long-term assets other than oil and gas properties for impairment whenever events or changes in circumstances indicated that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows expected to result from the use of the asset and its eventual disposition were less than the carrying amount of the asset, an impairment loss would have been recognized. Measurement of an impairment loss would be based on the fair market value of the asset. Impairment for oil and gas properties is computed in the manner described above under "Oil and Gas Properties." The Company currently has no significant long-term assets except for its oil and gas properties, for which impairment is recorded pursuant to full cost accounting as described above.
Hedging Activities
Natural Gas Marketing
The Company used hedging strategies to hedge its future natural gas purchase requirements for its gas sales contracts with Lone Star and MGNG (see Note 1). The Company hedged future commitments using natural gas swaps, which were accounted for on a settlement basis. Gains and losses from hedging activities were included in the item being hedged, the cost of gas purchased for the Lone Star Contract or for the contract with MGNG. In order to qualify as a hedge, the change in fair market value of the hedging instrument had to be highly correlated with the corresponding change in the hedged item.
Exploration and Production
The Company used hedging strategies to hedge a significant portion of its crude oil and natural gas production through July 31, 2000. The Company used futures contracts to hedge such production. Gains and losses from hedging activities were deferred and debited or credited to the item being hedged, oil and gas sales, when they occurred. In order to qualify as a hedge the change in fair market value of the hedging instrument was highly correlated with the corresponding change in the hedged item. When the hedging instrument ceased to qualify as a hedge, changes in fair value were charged against or credited to earnings.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Gas Contracts
The purchase price allocated to the Lone Star Contract was capitalized and amortized over the term of the related contract, 6.5 years.
Gas Balancing
Gas balancing activities have been immaterial during the periods reported.
Investment In Network
The Company's investment in Network (the Company owns 35% of Network) is recorded on the equity method. Under this method, the Company records its share of Network's income or loss with an offsetting entry to the carrying value of the Company's investment. Cash distributions, if any, are recorded as reductions in the carrying value of the Company's investment.
The Company's investment in Network exceeded the fair value of the Company's share of Network's assets by $350. Such excess (goodwill) is being amortized on a straight-line method over forty (40) years.
Comprehensive Income
Comprehensive income includes net income and all changes in an enterprise's other comprehensive income including, among other things, unrealized gains and losses on certain investments in debt and equity securities.
Stock Based Compensation
SFAS 123, "Accounting for Stock-Based Compensation," allows an entity to continue to measure compensation costs in accordance with Accounting Principle Board Opinion No. 25 ("APB 25"). The Company has elected to continue to measure compensation cost in accordance with APB 25 and to comply with the required disclosure-only provisions of SFAS 123.
Income Taxes
The Company follows Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." SFAS 109 is an accounting approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements and tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than anticipated enactments of changes in the tax law or tax rates. SFAS 109 also requires that deferred tax assets, if any, be reduced by a valuation allowance based upon whether realization of such deferred tax asset is or is not more likely than not. (See Note 17)
Earnings Per Share
Basic earnings per common share are based upon the weighted average number of common shares outstanding. Diluted earnings per common share are based upon maximum possible dilution calculated using average stock prices during the year.
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 generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), was issued by the Financial Accounting Standards Board in June 1998. Subsequently, SFAS No. 138 "Accounting for Certain Derivative Instruments" ("SFAS No. 138"), an amendment of SFAS No. 133, was issued. SFAS 133 and SFAS 138 standardize the accounting for derivative instruments, including certain derivative instruments embedded in other contracts. Under the standard, entities are required to carry all derivative instruments in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether such instrument has been designated and qualifies as part of a hedging relationship and, if so, depends on the reason for holding it. If certain conditions are met, entities may elect to designate a derivative instrument as a hedge of exposures to changes in fair values, cash flows, or foreign currencies. If the hedged exposure is a fair value exposure, the gain or loss on the derivative instrument is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income (not included in earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness, as well as the ineffective portion of the gain or loss, is reported in earnings immediately. Accounting for foreign currency hedges is similar to the accounting for fair value and cash flow hedges. If the derivative instrument is not designated as a hedge, the gain or loss is recognized in earnings in the period of change. The Company adopted SFAS No. 133 and SFAS No. 138 effective October 1, 2000. The Company ceased hedging its oil and gas production in July 2000. At September 30, 2001 and 2000, the Company had no freestanding derivative instruments in place and had no embedded derivative instruments. As a result, the Company's adoption of SFAS No. 133 and SFAS No. 138 had no impact on its results of operations or financial condition.
Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141") and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") were issued in July 2001. SFAS No. 141 requires that all business combinations entered into subsequent to June 30, 2001 be accounted for under the purchase method of accounting and that certain acquired intangible assets in a business combination be recognized and reported as assets apart from goodwill. SFAS No. 142 requires that amortization of goodwill be replaced with periodic tests of the goodwill's impairment at least annually in accordance with the provisions of SFAS No. 142 and that intangible assets other than goodwill be amortized over their useful lives. The Company adopted SFAS No. 141 in July 2001 and will adopt SFAS No. 142 in the first quarter of fiscal 2003. The Company does not believe that its future adoption of SFAS No. 142 will have a material effect on its results of operations.
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"), which provides accounting requirements for retirement obligations associated with tangible long-lived assets, including: 1) the timing of liability recognition; 2) initial measurement of the liability; 3) allocation of asset retirement cost to expense; 4) subsequent measurement of the liability; and 5) financial statement disclosures. SFAS No. 143 requires that asset retirement cost be capitalized as part of the cost of the related long-lived asset and subsequently allocated to expense using a systematic and rational method. Any transition adjustment resulting from the adoption of SFAS No. 143 would be reported as a cumulative effect of a change in accounting principle. The Company will adopt the statement effective October 1, 2002. At this time, the Company cannot reasonably estimate the effect of the adoption of this statement on either its financial position or results of operations.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
In August 2001, the FASB issued Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which will be effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. SFAS No. 144 requires that long-lived assets to be disposed of by sale be measured at the lower of the carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. SFAS No. 144 broadens the reporting of discontinued operations to include all components of an entity with operations that can be distinguished from the rest of the entity and that will be eliminated from the ongoing operations of the entity in a disposal transaction. After its effective date, SFAS No. 144 will be applied to those transactions where appropriate. The Company will adopt SFAS No 144 effective October 1, 2002. At this time the Company is unable to determine what the future impact of adopting this statement will have on its financial position or results of operations.
NOTE 3 - DISCONTINUED REFINING OPERATIONS
Effective September 30, 1995, the Company's refining subsidiaries discontinued their refining operations.
An analysis of the assets and liabilities related to the refining segment for the period October 1, 1998 to September 30, 2001 is as follows:
As of September 30, 2001, the estimated realizable value of discontinued net refining assets consists of $612 of estimated recoverable proceeds from the American Western note. The estimated value of net refining liabilities retained consist of net vendor liabilities of $1,281 and accrued costs related to discontinued refining operations of $2,155, offset by cash of $420.
"Estimated realizable value of discontinued net refining assets" is based on the transactions consummated by the Company with American Western and transactions consummated by American Western and IRLP subsequently with others and includes management's best estimates of the amounts expected to be realized upon the complete disposal of the refining segment. "Net refining liabilities retained" includes management's best estimates of amounts expected to be paid and amounts expected to be realized on the settlement of this net liability. The amounts the Company ultimately realizes or pays could differ materially from such amounts.
See Notes 12 and 13.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
NOTE 4 - ACQUISITIONS AND DISPOSITIONS
On June 1, 1999, the Company consummated the purchase of all of the oil and gas properties of AmBrit. The oil and gas properties purchased include interests in approximately 180 oil and gas wells in Alabama, Louisiana, Mississippi, Montana, New Mexico, Oklahoma, Texas and Wyoming, as well as undrilled acreage in several of these states. The effective date of the sale for purposes of determining the purchase price was January 1, 1999. The adjusted purchase price after accounting for all transactions between the effective date, January 1, 1999, and the closing date was $20,170. The entire adjusted purchase price was allocated to "Oil and Gas Properties - Proved Properties". Based upon reserve reports initially prepared by the Company's petroleum reservoir engineers, the proved reserves (unaudited) associated with the AmBrit oil and gas assets approximated 2,000,000 barrels of crude oil and 12,500,000 mcf (thousand cubic feet) of natural gas, which, together, approximated 150% of the Company's oil and gas reserves before the acquisition. In addition, the production acquired initially increased the Company's consolidated production by approximately 425%.
The results of operations on a pro-forma basis as though the oil and gas properties of AmBrit had been acquired as of the beginning of the periods indicated are as follows:
These proforma results are presented for comparative purposes only and are not necessarily indicative of the results which would have been obtained had the acquisition been consummated as presented.
Operations related to the AmBrit oil and gas properties have been included in the Company's Consolidated Statements of Operations since June 1, 1999, the closing date of the AmBrit acquisition.
Investment in Drilling Joint Ventures
In fiscal 1999, the Company entered into two drilling ventures to participate in the drilling of up to sixteen exploratory wells in south Texas. During fiscal 2000, the Company participated in the drilling of nine exploratory wells pursuant to the related joint venture operating agreements. Eight wells drilled resulted in dry holes and one well was completed as a producer. The Company has no further drilling obligations under these joint ventures and has terminated participation in each drilling venture. The total cost incurred to participate in the drilling of the exploratory wells was $6,003.
Offshore Louisiana Property Acquisition
In December 1999, a subsidiary of the Company purchased majority interests in twenty-six offshore Louisiana wells from Whiting Petroleum Company ("Whiting"), a public company engaged in oil and gas exploration and development. The adjusted purchase price was $890.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
In September 2000, the subsidiary of the Company sold its interests in the offshore Louisiana wells to Delta. The effective date of the sale was July 1, 2000. The adjusted purchase price of $3,059 consisted of $1,122 cash plus 382,289 shares of Delta's common stock valued at the market price or $1,937 (see Note 8).
Investment in Romanian Concessions
In April 1999, the Company purchased an option to acquire a fifty percent (50%) interest in three oil and gas concessions granted to a subsidiary of Costilla Energy Corporation ("Costilla"), a public oil and gas exploration and production company, by the Romanian government. The Company paid Costilla $65 for the option. In May 1999, the Company exercised the option. As of September 30, 2001, the Company had participated in the drilling of five onshore wildcat wells. Four of those wells resulted in dry holes. Although the fifth well produced some volumes of natural gas when tested, the Company has not been able to obtain a sufficiently high gas price to justify future production and has elected at the present not to undertake an offset drilling program where the fifth well was drilled. As a result, the Company recorded impairment provisions of $2,765 and $832 for the years ended September 30, 2001 and 2000, respectively, for costs incurred for the five onshore wells. The Company has agreed to participate in the drilling of a sixth well, offshore, in the Black Sea in the spring or early summer of 2002.
See Note 10.
Other Exploration and Production Investments
In November and December 1999, the Company acquired additional outside interests in several Alabama and Pennsylvania wells, which it operates, for $2,580.
East Texas Property Acquisition
On April 30, 2001, the Company consummated the purchase of several East Texas oil and gas properties from a private company. The effective date of the purchase was April 1, 2001. These properties included majority interests in twenty-one (21) operated producing oil and gas wells and interests in approximately 6,500 gross acres in three counties in East Texas. The Company estimates the proved reserves acquired were approximately 12.5 billion cubic feet of natural gas and 191,000 barrels of crude oil. The consideration paid, net of purchase price adjustments, was $10,040. The Company used its own internally generated funds to make the purchase.
NOTE 5 - RESTRICTED CASH
Restricted cash consists of the following:
The drilling deposits in escrow in Romania are to be used only to conduct exploratory drilling activities in Romania and cannot be withdrawn or used for other purposes by the Company.
The funds escrowed for litigation settlement pertain to Larry Long Litigation (see Note 13).
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
NOTE 6 - ACCOUNTS RECEIVABLE
Based upon past customer experiences, the limited number of customer accounts receivable relationships, and the fact that the Company's subsidiaries can generally offset unpaid accounts receivable against an outside owner's share of oil and gas revenues, management believes substantially all receivables are collectible. All of the Company's accounts receivable at September 30, 2001 and 2000 consisted of exploration and production trade receivables.
NOTE 7 - NOTE RECEIVABLE - PENN OCTANE
In January 2000, the Company invested $500 in a note due from Penn Octane Corporation ("Penn Octane"), a public company involved in the sale of liquid propane gas into Mexico. The note was originally due on December 15, 2000 and bore interest at 9%, payable quarterly.
In December 2000, the Company agreed to extend the note until June 15, 2002. In return, Penn Octane increased the interest rate on the note to 13.5% and issued to the Company warrants to acquire an additional 62,500 shares of Penn Octane common stock at $3.00 per share. Subsequently, the interest rate was increased to 16.5% and the exercise price on the 62,500 options issued was reduced to $2.50 per share.
Effective September 14, 2001, the Company exercised options to acquire 275,933 shares of common stock of Penn Octane by exchanging its $500 note plus $21 of accrued interest for the shares.
NOTE 8 - MARKETABLE SECURITIES
The Company's investment in marketable securities consists of common shares of Penn Octane, Delta and Chevron/Texaco. At September 30, 1998, the Company accounted for its investment as trading securities. In March 1999, the Company began to account for its investment as available-for-sale securities. The Company's investments in Penn Octane, Delta and Chevron/Texaco common stock and options to buy Penn Octane stock were as follows:
The fair market values of Penn Octane, Delta and Chevron/Texaco shares were based on one hundred percent (100%) of the closing price on September 28, 2001, the last trading day in the Company's fiscal year ending September 30, 2001.
At September 30, 2001 and 2000, the fair market values of the Penn Octane shares include $164 and $1,641, respectively, related to options to acquire Penn Octane common stock held by the Company. The value of such options was computed using the Black-Scholes method (see Note #16).
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
The Company owned 1,343,600 shares of Penn Octane, 382,289 shares of Delta and 177 shares of Chevron/Texaco at September 30, 2001. Of these 501,000 shares of Penn Octane and all 177 shares of Chevron/Texaco were registered. The remaining shares are either in the process of being registered or the Company has registration rights with respect to such shares. At September 30, 2001, the Company also owned options to purchase 74,067 common shares of Penn Octane common stock at $2.50 per share.
At September 30, 2000, the Company owned 1,067,667 shares of Penn Octane and 382,289 shares of Delta, as well as options to purchase 454,167 common shares of Penn Octane at exercise prices of $1.75 to $6.00 per share.
NOTE 9 - FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are as follows:
NOTE 10 - OIL AND GAS PROPERTIES (Unaudited)
Oil and gas properties consist of the following:
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Capital costs incurred by the Company in oil and gas activities are as follows:
Results of operations, excluding corporate overhead and interest expense, from the Company's oil and gas producing activities are as follows:
The income tax provision is computed at the effective tax rate for the related fiscal year.
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:
The increase in the depletion rate in fiscal 2001 resulted primarily because the Company's reserves qualitites decreased significantly as a result of lower oil and gas prices at September 30, 2001. The decrease in reserve quantities without a similar decrease in related costs resulted in a higher depletion rate. In addition, in fiscal 2001, the Company acquired significant East Texas reserves at a higher cost per mcfe than the cost for the Company's existing reserves at the time of the acquisition (see Note 4).
The decrease in the depletion rate in fiscal 2000 resulted primarily because the Company's reserve quantities increased significantly as a result of higher oil and gas prices at September 30, 2000. The increase in reserve quantities without a similar increase in costs resulted in the lower depletion rate.
See Note 21.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
NOTE 11 - PROVED OIL AND GAS RESERVES AND RESERVE VALUATION (UNAUDITED)
Reserve estimates are based upon subjective engineering judgements made by the Company's independent petroleum reservoir engineers, Huntley & Huntley and Ralph E. Davis Associates, Inc. and may be affected by the limitations inherent in such estimations. The process of estimating reserves is subject to continuous revisions as additional information is made available through drilling, testing, reservoir studies and production history. There can be no assurance such estimates will not be materially revised in subsequent periods.
Estimated quantities of proved reserves and changes therein, all of which are domestic reserves, are summarized below:
Although the Company has participated in the drilling of five exploratory wells in Romania, no proved reserves have yet been assigned to any of these wells. As a result, all of the Company's proved oil and gas reserves are located in the United States.
The following is a standardized measure of discounted future net cash flows and changes therein relating to estimated proved oil and gas reserves, as prescribed in Statement of Financial Accounting Standards No. 69. The standardized measure of discounted future net cash flows does not purport to present the fair market value of the Company's oil and gas properties. An estimate of fair value would also take into account, among other factors, the likelihood of future recoveries of oil and gas in excess of proved reserves, anticipated future changes in prices of oil and gas and related development and production costs, a discount factor based on market interest rates in effect at the date of valuation and the risks inherent in reserve estimates.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
The future cash flows were computed using the applicable year-end prices and costs that related to then existing proved oil and gas reserves in which the Company has interests. The estimates of future income tax expense are computed at the blended rate (Federal and state combined) of 36%.
The following were the sources of changes in the standardized measure of discounted future net cash flows:
NOTE 12 - CONTINGENT ENVIRONMENTAL LIABILITY
In December 1995, IRLP, an inactive subsidiary of the Company, sold its refinery, the Indian Refinery, to American Western, an unaffiliated party. As part of the related purchase and sale agreement, American Western assumed all environmental liabilities and indemnified IRLP with respect thereto. Subsequently, American Western filed for bankruptcy and sold the Indian Refinery to an outside party pursuant to a bankruptcy proceeding. The outside party has substantially dismantled the Indian Refinery.
American Western recently filed a Plan of Liquidation. American Western anticipates that the Plan of Liquidation will be confirmed in January 2002.
During fiscal 1998, the Company was informed that the United States Environmental Protection Agency ("EPA") had investigated offsite acid sludge waste found near the Indian Refinery and had investigated and remediated surface contamination on the Indian Refinery property. Neither the Company nor IRLP was initially named with respect to these two actions.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
In October 1998, the EPA named the Company and two of its inactive refining subsidiaries as potentially responsible parties for the expected clean-up of the Indian Refinery. In addition, eighteen other parties were named including Texaco Refining and Marketing, Inc. ("Texaco"), the refinery operator for over 50 years. A subsidiary of Texaco had owned the refinery until December of 1988. The Company subsequently responded to the EPA indicating that it was neither the owner nor the operator of the Indian Refinery and thus not responsible for its remediation.
In November 1999, the Company received a request for information from the EPA concerning the Company's involvement in the ownership and operation of the Indian Refinery. The Company responded to the EPA information request in January 2000.
On August 7, 2000, the Company received notice of a claim against it and two of its inactive refining subsidiaries from Texaco and its parent. Texaco had made no previous claims against the Company although the Company's subsidiaries had owned the refinery from August 1989 until December 1995. In its claim, Texaco demanded that the Company and its former subsidiaries indemnify Texaco for all liability resulting from environmental contamination at and around the Indian Refinery. In addition, Texaco demanded that the Company assume Texaco's defense in all matters relating to environmental contamination at and around the Indian Refinery, including lawsuits, claims and administrative actions initiated by the EPA and indemnify Texaco for costs that Texaco has already incurred addressing environmental contamination at the Indian Refinery. Finally, Texaco also claimed that the Company and two of its inactive subsidiaries are liable to Texaco under the Federal Comprehensive Environmental Response Compensation and Liability Act as owners and operators of the Indian Refinery. The Company responded to Texaco disputing the factual and theoretical basis for Texaco's claims against the Company. The Company's management and special counsel subsequently met with representatives of Texaco but the parties disagreed concerning Texaco's claims.
The Company and its special counsel believe that Texaco's claims are utterly without merit and the Company intends to vigorously defend itself against Texaco's claims and any lawsuits that may follow. In addition to the numerous defenses that the Company has against Texaco's contractual claim for indemnity, the Company and its special counsel believe that by the express language of the agreement which Texaco construes to create an indemnity, Texaco has irrevocably elected to forgo all rights of contractual indemnification it might otherwise have had against any person, including the Company.
In September 1995, Powerine sold the Powerine Refinery to Kenyen Resources ("Kenyen"), an unaffiliated party. In January 1996, Powerine merged into a subsidiary of Energy Merchant Corp. ("EMC"), an unaffiliated party, and EMC assumed all environmental liabilities. In August 1998, EMC sold the Powerine Refinery to a third party, which, we are informed, continues to seek financing to restart the Powerine Refinery.
In July of 1996, the Company was named a defendant in a class action lawsuit concerning emissions from the Powerine Refinery. In April of 1997, the court granted the Company's motion to quash the plaintiff's summons based upon lack of jurisdiction and the Company is no longer involved in the case.
Although the environmental liabilities related to the Indian Refinery and Powerine Refinery have been transferred to others, there can be no assurance that the parties assuming such liabilities will be able to pay them. American Western, owner of the Indian Refinery, filed for bankruptcy and is in the process of liquidation. EMC, which assumed the environmental liabilities of Powerine, sold the Powerine Refinery to an unrelated party, which we understand is still seeking financing to restart that refinery. Furthermore, as noted above, the EPA named the Company as a potentially responsible party for remediation of the Indian Refinery and has requested and received relevant information from the Company. Estimated gross undiscounted clean up costs for this refinery are at least $80,000 - $150,000 according to third parties. If the Company were found liable for the remediation of the Indian Refinery, it could be required to pay a percentage of the clean-up costs. Since the Company's subsidiary only operated the Indian Refinery five years, whereas Texaco and others operated it over fifty years, the Company would expect that its share of remediation liability would be proportional to its years of operation, although such may not be the case. Furthermore, as noted above, Texaco has claimed that the Company indemnified it for all environmental liabilities related to the Indian Refinery. If Texaco were to sue the Company on this theory and prevail in court, the Company could be held responsible for the entire estimated clean up costs of $80,000-$150,000 or more. In such a case, this cost would be far in excess of the Company's financial capability.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
An opinion issued by the U.S. Supreme Court in June 1998 in a comparable matter and a recent decision by the U.S. Appeals Court for the Fifth Circuit supports the Company's positions. Nevertheless, if funds for environmental clean-up are not provided by these former and/or present owners, it is possible that the Company and/or one of its former refining subsidiaries could be named parties in additional legal actions to recover remediation costs. In recent years, government and other plaintiffs have often sought redress for environmental liabilities from the party most capable of payment without regard to responsibility or fault. Whether or not the Company is ultimately held liable in such a circumstance, should litigation involving the Company and/or IRLP occur, the Company would probably incur substantial legal fees and experience a diversion of management resources from other operations.
Although the Company does not believe it is liable for any of its subsidiaries' clean-up costs and intends to vigorously defend itself in such regard, the Company cannot predict the ultimate outcome of these matters due to inherent uncertainties.
NOTE 13 - COMMITMENTS, CONTINGENCIES AND LINE OF CREDIT
Operating Lease Commitments
The Company has the following noncancellable operating lease commitments and noncancellable sublease rentals at September 30, 2001:
Rent expense for the years ended September 30, 2001, 2000 and 1999 was $456, $412 and $386, respectively.
Severance/Retention Obligations
The Company has severance agreements with substantially all of its employees, including five of its officers, that provide for severance compensation in the event substantially all of the Company's or its subsidiaries' assets are sold and the employees are terminated as a result of such sale. Such termination severance commitments aggregated $1,101 at September 30, 2001. No severance obligations were owed to employees at September 30, 2001.
Letters of Credit
At September 30, 2001, the Company had issued letters of credit of $209 for oil and gas drilling, operating and plugging bonds. The letters of credit are renewed semi-annually or annually.
Line of Credit
See Note 21.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Legal Proceedings
Contingent Environmental Liabilities
See Note 12.
General
Long Trusts Lawsuit
In November 2000, the Company and three of its subsidiaries were defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case, the Long Trusts, are non-operating working interest owners in wells previously operated by Castle Texas Production Limited Partnership ("CTPLP"), an inactive exploration and production subsidiary of the Company. The wells were among those sold to Union Pacific Resources Corporation ("UPRC") in May 1997. The Long Trusts claimed that CTPLP did not allow them to sell gas from March 1, 1996 to January 31, 1997 as required by applicable joint operating agreements, and they sued CTPLP and the other defendants, claiming (among other things) breach of contract, breach of fiduciary duty, conversion and conspiracy. The plaintiffs sought actual damages, exemplary damages, pre-judgment and post-judgment interest, attorney's fees and court costs. CTPLP counterclaimed for approximately $150 of unpaid joint interests billings, interest, attorneys' fees and court costs.
After a three-week trial, the District Court in Rusk County submitted 36 questions to the jury which covered all of the claims and counterclaims in the lawsuit. Based upon the jury's answers, the District Court entered judgement granting plaintiffs' claims against the Company and its subsidiaries, as well as CTPLP's counterclaim against the plaintiffs. The District Court issued an amended judgement on September 5, 2001, which became final in December 2001. The net amount awarded to the plaintiffs was approximately $2,700. The Company and its subsidiaries have filed a notice of appeal with the Tyler Court of Appeals and will continue to vigorously contest this matter.
Special counsel to the Company does not consider an unfavorable outcome to this lawsuit probable. The Company's management and special counsel believe that several of the plaintiffs' primary legal theories are contrary to established Texas law and that the Court's charge to the jury was fatally defective. They further believe that any judgment for plaintiffs based on those theories or on the jury's answers to certain questions in the charge cannot stand and will be reversed on appeal. As a result, the Company has not accrued any liability for this litigation. Nevertheless, to pursue the appeal, the Company and its subsidiaries will be required to post a bond to cover the net amount of damages awarded to the plaintiffs and to maintain that bond until the resolution of the appeal (which may take several years). The Company has included the letter of credit to support the bond, estimated at approximately $3,000, in its line of credit with a major energy bank.
See Note 21.
Larry Long Litigation
In May 1996, Larry Long, representing himself and allegedly "others similarly situated," filed suit against the Company, three of the Company's natural gas marketing and transmission and exploration and production subsidiaries, Atlantic Richfield Company ("ARCO"), B&A Pipeline Company, a former subsidiary of ARCO ("B&A"), and MGNG in the Fourth Judicial District Court of Rusk County, Texas. The plaintiff originally claimed, among other things, that the defendants underpaid non-operating working interest owners, royalty interest owners and overriding royalty interest owners with respect to gas sold to Lone Star pursuant to the Lone Star Contract. Although no amount of actual damages was specified in the plaintiff's initial pleadings, it appeared that, based upon the volumes of gas sold to Lone Star, the plaintiff may have been seeking actual damages in excess of $40,000.
After some initial discovery, the plaintiff's pleadings were significantly amended. Another purported class representative, Travis Crim, was added as a plaintiff, and ARCO, B&A and MGNG were dropped as defendants. Although it is not completely clear from the amended petition, the plaintiffs apparently limited their proposed class of plaintiffs to royalty owners and overriding royalty owners in leases owned by the Company's exploration and production subsidiary limited partnership. In amending their pleadings, the plaintiffs revised their basic claim to seeking royalties on certain operating fees paid by Lone Star to the Company's natural gas marketing subsidiary limited partnership.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
In April 2000, Larry Long withdrew as a named plaintiff and in September 2000, the Company and the remaining named plaintiff agreed to settle the case for a payment of $250 by the Company. In July 2001, the Company deposited $250 plus accrued interest of $9 in a litigation settlement account. As of September 30, 2001, $106 had been disbursed from the account.
See Note 21.
MGNG Litigation
On May 4, 1998, CTPLP, a subsidiary of the Company, filed a lawsuit against MGNG and MG Gathering Company ("MGC"), two subsidiaries of MG, in the district court of Harris County, Texas. One of the Company's exploration and production subsidiaries sought to recover gas measurement and transportation expenses charged by the defendants in breach of a certain gas purchase contract. Improper charges exceeded $750 before interest. In October of 1998, MGNG and MGC filed a suit in Harris County, Texas. This suit sought indemnification from two of the Company's subsidiaries in the event CTPLP won its lawsuit against MGNG and MGC. The MG entities cited no basis for their claim of indemnification. The management of the Company and special counsel retained by the Company believe that the Company's subsidiary is entitled to at least $750 plus interest and that the Company's two subsidiaries have no indemnification obligations to MGNG or MGC. The parties participated in mediation but were not able to resolve the issue. In October 1999, MGNG filed a second lawsuit against the Company and three of its subsidiaries claiming $772 was owed to MGNG under a gas supply contract between one of the Company's subsidiaries and MGNG. The suit was filed in the district court of Harris County, Texas. The Company and its subsidiaries believed that they do not owe $772 and were entitled to legally offset some or all of the $772 claimed against amounts owed to CTPLP by MGNG for improper gas measurement and transportation deductions. The Castle entities answered this suit denying MGNG's claims based partially on the right of offset.
In September 2000, the parties agreed to settle all lawsuits. Under the terms of the settlement the amount claimed by MGNG under a gas supply contract was reduced by $325 and the net amount payable to MGNG was set at $400 and the parties signed mutual releases.
See Note 21.
Pilgreen Litigation
As part of the AmBrit purchase, Castle Exploration Company, Inc. ("CECI") acquired a 10.65% overriding royalty interest ("ORRI") in the Pilgreen #2ST gas well in Texas. Because of title disputes, AmBrit and other interest owners had previously filed claims against the operator of the Pilgreen well, and CECI acquired post January 1, 1999 rights in that litigation. Although revenue attributed to the ORRI has been suspended by the operator since first production, because of recent related appellate decisions and settlement negotiations, the Company believes that revenue attributable to the ORR should be released to CECI in the near future. As of September 30, 2001, approximately $415 attributable to CECI's share of the ORRI revenue was suspended. The Company's policy is to recognize the suspended revenue only when and if it is received.
GAMXX
On February 27, 1998, the Company entered into an agreement with Alexander Allen, Inc. ("AA") concerning amounts owed to the Company by AA and its subsidiary, GAMXX Energy, Inc. ("GAMXX"). The Company had made loans to GAMXX through 1991 in the aggregate amount of approximately $8,000. When GAMXX was unable to obtain financing, the Company recorded a one hundred percent loss provision on its loans to GAMXX in 1991 and 1992 while still retaining its lender's lien against GAMXX.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Pursuant to the terms of the GAMXX Agreement, the Company was to receive $1,000 cash in settlement for its loans when GAMXX closed on its financing. GAMXX expected such closing not later than May 31, 1998 but failed to do so. As a result, the Company elected to terminate the GAMXX Agreement. Pursuant to the Agreement, GAMXX agreed to assist the Company in selling GAMXX's assets or the Company's investment in GAMXX. The Company is currently seeking to dispose of its lender's interest in GAMXX and recover some of the loan to GAMXX.
The Company has carried its loans to GAMXX at zero for the last eight years. The Company will record any proceeds as "other income" if and when it collects such amount.
Hedging Activities
Until June 1, 1999, the Company's natural gas marketing subsidiary utilized natural gas swaps to reduce its exposure to changes in the market price of natural gas. Effective May 31, 1999 all natural gas marketing contracts terminated by their own terms. As a result of these hedging transactions, the cost of gas purchases increased $609 for the year ended September 30, 1999.
On June 1, 1999, the Company acquired all of the oil and gas assets of AmBrit (see Note 4) and thereafter commenced hedging sales of the related oil and gas production. As of September 30, 1999, the Company had hedged approximately 54% of its anticipated consolidated crude oil production and approximately 39% of its anticipated consolidated natural gas production for the period from October 1, 1999 to September 30, 2000. The Company used futures contracts to hedge such production. The average hedged prices for crude oil and natural gas, which are based upon futures price on the New York Mercantile Exchange, were $19.85 per barrel of crude oil and $2.66 per mcf of gas. The Company accounted for these futures contracts as hedges and the differences between the hedged price and the exchange price increased or decreased the oil and gas revenues resulting from the sale of production by the Company. Oil and gas production was not hedged after July 2000 production. As a result of these hedging transactions, oil and gas sales decreased $1,528 and $150 for the fiscal years ended September 30, 2000 and 1999, respectively.
At September 30, 2001 and December 14, 2001, the Company had not hedged its anticipated future oil and gas production.
NOTE 14 - EMPLOYEE BENEFIT PLAN
401(K) PLAN
On October 1, 1995, the Company adopted a 401(k) plan (the "Plan") for its employees and those of its subsidiaries. All employees are eligible to participate. Employees participating in the Plan can authorize the Company to contribute up to 15% of their gross compensation to the Plan. The Company matches such voluntary employee contributions up to 3% of employee gross compensation. Employees' contributions to the Plan cannot exceed thresholds set by the Secretary of the Treasury. Vesting of Company contributions is immediate. During the years ended September 30, 2001, 2000 and 1999, the Company's contributions to the Plan aggregated $50, $46 and $37, respectively.
Post-Retirement Benefits
Neither the Company nor its subsidiaries provide any other post-retirement plans for employees.
NOTE 15 - STOCKHOLDERS' EQUITY
On December 29, 1999, the Company's Board of Directors declared a stock split in the form of a 200% stock dividend applicable to all stockholders of record on January 12, 2000. The additional shares were paid on January 31, 2000 and the Company's shares first traded at post-split prices on February 1, 2000. The stock split applied only to the Company's outstanding shares on January 12, 2000 (2,337,629 shares) and did not apply to treasury shares (4,491,017 shares) on that date. As a result of the stock split, 4,675,258 additional shares were issued and the Company's common stock book value was increased $2,338 to reflect additional par value applicable to the additional shares issued to effect the stock split. All share changes, including those affecting the recorded book value of common stock, have been recorded retroactively.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
From November 1996 until September 30, 2001, the Company's Board of Directors authorized the Company to purchase up to 5,267,966 of its outstanding shares of common stock on the open market. As of September 30, 2001, 4,871,020 shares (13,973,054 shares before taking into account the 200% stock dividend effective January 31, 2000) had been repurchased at a cost of $66,506. The repurchased shares are held in treasury
On June 30, 1997, the Company's Board of Directors approved a dividend policy of $.20 per share per year, payable quarterly. The dividend policy remains in effect until rescinded or changed by the Board of Directors. Quarterly dividends of $.05 per share have subsequently been paid.
See Note 21
NOTE 16 - STOCK OPTIONS AND WARRANTS
Option and warrant activities during each of the three years ended September 30, 2001 are as follows (in whole units):
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
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 provides that an aggregate of 1,687,500 shares (after taking into account the 200% stock dividend effective January 31, 2000) of common stock of the Company will be available for awards in the form of stock options, including incentive stock options and non-qualified stock options generally at prices at or in excess of market prices at the date of grant.
The Incentive Plan also provides that each outside director of the Company will annually be granted an option to purchase 15,000 shares of common stock at fair market value on the date of grant.
The Company applies Accounting Principles Board Opinion Number 25 in accounting for options and warrants and accordingly recognizes no compensation cost for its stock options and warrants for grants with an exercise price equal to the current fair market value. The following reflect the Company's pro-forma net income and net income per share had the Company determined compensation costs based upon fair market values of options and warrants at the grant date pursuant to SFAS 123 as well as the related disclosures required by SFAS 123.
A summary of the Company's stock option and warrant activity from October 1, 1998 to September 30, 2001 is as follows:
At September 30, 2001, exercise prices for outstanding options ranged from $3.42 to $8.58. The weighted average remaining contractual life of such options was 5.6 years.
The per share weighted average fair values of stock options issued during fiscal 2001, 2000 and fiscal 1999 were $2.41, $3.29 and $4.56, respectively, on the dates of issuance using the Black-Scholes option pricing model with the following weighted average assumptions: average expected dividend yield - 3.0% in 2001, 3.0% in 2000 and 3.5% in 1999; risk free interest rate - 3.50% in 2001, 5.54% in 2000 and 6.32% in 1999; expected life of 10 years in 2001, 2000 and 1999 and volatility factor of .38 in 2001, .44 in 2000, and .22 in 1999.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
Proforma net income and earnings per share had the Company accounted for its options under the fair value method of SFAS 123 is as follows:
NOTE 17 - INCOME TAXES
Provisions for (benefit of) income taxes consist of:
Deferred tax assets (liabilities) are comprised of the following at September 30, 2001 and 2000:
At September 30, 2001, the Company determined that a portion of the deferred tax asset would more likely than not be realized based upon estimates of future taxable income and upon the projected taxable income resulting from the anticipated sale of its oil and gas assets to Delta and accordingly decreased the valuation allowance by $431 to $3,559.
If recent decreases in oil and gas prices continue and if the sale of the Company's oil and gas assets to Delta is not consummated, the Company may be required to increase its valuation allowance.
See Note 21.
At September 30, 2000, the Company determined that it was more likely than not that a portion of the deferred tax assets would be realized, based on current projections of taxable income due to higher commodity prices at September 30, 2000, and the valuation allowance was decreased by $3,204 to a total valuation allowance of $3,990.
The income tax provision (benefit) differs from the amount computed by applying the statutory federal income tax rate to income before income taxes as follows:
At September 30, 2001, the Company had the following tax carryforwards available:
The net operating loss carryforwards expire from 2001 through 2010.
On September 9, 1994, the Company experienced a change of ownership for tax purposes. As a result of such change of ownership, the Company's net operating loss carryforward became subject to an annual limitation of $7,845. At September 30, 2001 all net operating loss carryforwards of the Company were no longer subject to the annual limitation.
The Company also has approximately $58,688 in individual state tax loss carryforwards available at September 30, 2001. Approximately $47,287 of such carryforwards are primarily available to offset taxable income apportioned to certain states in which the Company has no operations and currently has no plans for future operations. As a result, it is probable most of such state tax carryforwards will expire unused.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
NOTE 18 - RELATED PARTIES
In June 1999, the Company repurchased 24,700 (74,100 after stock split) shares of the Company's common stock from an officer of the Company. Such shares were repurchased at the closing stock price on the date of sale less $.125, resulting in a payment of $434 to the officer. The shares were repurchased pursuant to the Company's share repurchase program.
Another officer of the Company is a 10% shareholder in an unaffiliated company that is entitled to receive 12.5% of the Company's share of net cash flow from its Romanian joint venture after the Company has recovered its investment in Romania.
NOTE 19 - BUSINESS SEGMENTS
As of September 30, 1995, the Company had disposed of its refining segment of the energy business (see Note 3) and operated in only two business segments - natural gas marketing and transmission and exploration and production. In May 1997, the Company sold its pipeline (natural gas transmission) to a subsidiary of UPRC (see Note 4). As a result, the Company was no longer in the natural gas transmission segment but continued to operate in the natural gas marketing and exploration and production segments. On May 31, 1999, the Company's long-term gas sales and gas supply contracts expired by their own terms and the Company exited the natural gas marketing business.
The Company does not allocate interest income, interest expense or income tax expense to these segments.
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
*Consists primarily of intracompany receivables.
For the year ended September 30, 1999, sales by the Company's natural gas marketing subsidiary to Lone Star Gas Company under the Lone Star Contract aggregated $46,802. These amounts constituted approximately 82% of consolidated revenues for the year ended September 30, 1999. The Lone Star contract terminated in May 1999.
At the present time, the Company's consolidated revenues consist entirely of oil and gas sales. Three purchasers of the Company's oil and gas production currently account for approximately 43% of consolidated production and a similar percentage of oil and gas sales and are expected to comprise a similar percentage of oil and gas sales in the future.
NOTE 20 - DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and Cash Equivalents -- the carrying amount is a reasonable estimate of fair value.
Marketable securities are related solely to the Company's investment in Penn Octane, Delta and Chevron/Texaco common stock and options to buy Penn Octane stock and are recorded at fair market value. Market value for common stock is computed to equal the closing share price at year end times the number of shares held by the Company. Fair market value for options is computed using the Black - Scholes option valuation model.
Other Current Assets and Current Liabilities - the Company believes that the book values of other current assets and current liabilities approximate the market values.
NOTE 21 - SUBSEQUENT EVENTS
Subsequent to September 30, 2001, the Company disbursed the remaining $153 from the Larry Long Litigation settlement account (see Note 13).
Subsequent to September 30, 2001, the Company paid MGNG $400 in settlement of the MGNG Litigation (see Note 13).
In November 2001, the Company entered into an agreement for a line of credit of up to $40,000 with an energy bank. Pursuant to the related agreement the energy bank agreed to make available to the Company loans and letters of credit not to exceed a borrowing base determined by the value of the Company's oil and gas reserves using parameters set by the bank. Such borrowing based will be determined no less than semi-annually. The loans and letters of credit will be secured by the Company's oil and gas properties to the extent the amount outstanding under the facility exceeds $10,000. Interest under the facility will accrue at the bank's prime rate or at a LIBOR rate - the choice of rates being determined by the Company. Letters of credit issued under the facility will accrue interest at 2.25% annually. Loans outstanding under the facility will be repaid pursuant to a schedule set by the bank but redetermined at each borrowing base determination date. In addition, the Company is subject to typical financial covenants including minimum tangible net worth, debt service coverage, interest coverage and current ratio limitations, limitations on annual and quarterly dividends the Company may pay to shareholders and other limitations governing capital expenditures. The facility is scheduled to terminate November 30, 2003. The facility also includes a provision to provide letters of credit of up to $3,000 as may be required for the Long Trusts Lawsuit litigation (see Note 13).
Castle Energy Corporation Notes to Consolidated Financial Statements ("$000's" Omitted Except Per Share Amounts)
On December 11, 2001, the Company entered into a letter of intent to sell all of its domestic oil and gas assets to Delta for $20,000 and 9,566,000 shares of commons stock of Delta. The effective date of the proposed sale is October 1, 2001 and the expected closing date is April 30, 2002 or later. The sale is subject to execution of a definitive purchase and sale agreement by both parties, approval of the transaction by both Delta's and the Company's directors and approval of the issuance of the shares to Castle by Delta's shareholders.
If the sale to Delta is not consummated, the Company could continue to operate as it does currently or pursue other alternative strategies.
NOTE 22 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
For the year ended September 30, 2000 revenues from well operations have been retroactively reclassified as reductions of oil and gas production costs.
The sums of the quarterly per share amounts differ from the annual per share amounts primarily because the stock purchases made by the Company were not made in equal amounts and at corresponding times each quarter.
Independent Auditors' Report
The Board of Directors Castle Energy Corporation:
We have audited the accompanying consolidated balance sheets of Castle Energy Corporation and subsidiaries as of September 30, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and other comprehensive income, and cash flows for each of the years in the three year period ended September 30, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United State of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Castle Energy Corporation and subsidiaries as of September 30, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three year period ended September 30, 2001 in conformity with accounting principles generally accepted in the United States of America.
KPMG LLP
Houston, Texas December 18, 2001
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
None
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION**
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**
- -------------- ** The information required by Items 10, 11, 12 and 13 is incorporated by reference to the Registrant's Proxy Statement for its 2002 Annual Meeting of Stockholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. and 2. 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.
3. 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.
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 19, 2001 By: /s/JOSEPH L. CASTLE II --------------------------------- Joseph L. Castle II Chairman of the Board and 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 in the capacities and on the dates indicated.
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS (December 19, 2001)
PRINCIPAL OFFICES