-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SyIpqmW6Z+ppcu7juqC+sMBzSJ4e+eF5aMPm3VMSHWgeauFoEgFoQ34eo2amDtO4 Ly15VgeVfU9OEvo0beaSTw== 0000950116-06-000504.txt : 20060213 0000950116-06-000504.hdr.sgml : 20060213 20060213160626 ACCESSION NUMBER: 0000950116-06-000504 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060213 DATE AS OF CHANGE: 20060213 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CASTLE ENERGY CORP CENTRAL INDEX KEY: 0000709355 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 760035225 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-10990 FILM NUMBER: 06603716 BUSINESS ADDRESS: STREET 1: ONE RADNOR CORPORATE CTR STE 250 STREET 2: 100 MATSONFORD RD CITY: RADNOR STATE: PA ZIP: 19087 BUSINESS PHONE: 6109959400 MAIL ADDRESS: STREET 1: ONE RADNOR CORPORATE CENTER SUITE 250 STREET 2: 100 MATSONFORD CITY: RADNOR STATE: PA ZIP: 19087 FORMER COMPANY: FORMER CONFORMED NAME: MINDEN OIL & GAS INC/NEW DATE OF NAME CHANGE: 19861117 FORMER COMPANY: FORMER CONFORMED NAME: MINDEN HOLDING CO DATE OF NAME CHANGE: 19830310 10-Q 1 ten-q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------- FORM 10-Q (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2005 ------------------ or |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period ended Commission file number: 0-10990 --------- CASTLE ENERGY CORPORATION - -------------------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 76-0035225 - -------------------------------------------------------------------------------- (State or Other Jurisdiction of Incorporation (I.R.S. Employer or Organization) Identification No.) 357 South Gulph Road, Suite 260, King of Prussia, Pennsylvania 19406 - -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (610) 992-9900 ---------------- - -------------------------------------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check |X| whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes |X| No ___. Indicate by check |X| whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. Large Accelerated Filer ___ Accelerated Filer ___ Non-Accelerated Filer |X| Indicate by check |X| whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes __ No |X| Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: 7,305,360 shares of Common Stock, $.50 par value, outstanding as of February 10, 2006. CASTLE ENERGY CORPORATION INDEX
PAGE # ------ Part I. Financial Information --------------------- Item 1. Financial Statements: Consolidated Balance Sheets - December 31, 2005 (Unaudited) and September 30, 2005......................................................................... 2 Consolidated Statements of Operations - Three Months Ended December 31, 2005 and 2004 (Unaudited)......................................................... 3 Condensed Consolidated Statements of Cash Flows - Three Months Ended December 31, 2005 and 2004 (Unaudited)................................................ 4 Consolidated Statements of Stockholders' Equity and Other Comprehensive Income - Year Ended September 30, 2005 and Three Months Ended December 31, 2005 (Unaudited)............................................................. 5 Notes to the Consolidated Financial Statements (Unaudited)................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................................................................. 15 Item 3. Qualitative and Quantitative Disclosures About Market Risk................... 22 Item 4. Controls and Procedures...................................................... 22 Part II. Other Information ----------------- Item 1. Legal Proceedings............................................................ 23 Item 1A. Risk Factors................................................................. 23 Item 6. Exhibits and Reports on 8-K.................................................. 23 Signature ....................................................................................... 24
-1- PART I. FINANCIAL INFORMATION Item 1. Financial Statements CASTLE ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS)
DECEMBER 31, SEPTEMBER 30, 2005 2005 ------------ ------------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents .................................................... $ 21,928 $ 27,759 Restricted cash .............................................................. 921 898 Accounts receivable .......................................................... 729 674 Marketable securities ........................................................ 20 23 Prepaid expenses and other current assets .................................... 202 252 Note receivable - Networked Energy LLC, net of allowance for doubtful account of $125 .................................................................. Investment in Networked Energy LLC, net of impaired reserve of $354 .......... 5 -------- -------- Total current assets ....................................................... 23,805 29,606 Property, plant and equipment, net: Furniture, fixtures, equipment and vehicles .................................. 173 188 Oil and gas properties, net (full cost method): Proved properties ............................................................ 8,531 8,564 Marketable securities ............................................................. 145,859 139,360 Investment in Delta Petroleum Corporation (equity method) ......................... 5 -------- -------- Total assets ................................................................ $178,368 $177,723 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Dividend payable ............................................................. $ 365 $ 361 Accounts payable ............................................................. 541 667 Accrued expenses ............................................................. 477 476 Litigation settlement payable on discontinued refining operations ............ 5,750 Asset retirement obligations ................................................. 4 3 -------- -------- Total current liabilities ................................................. 1,387 7,257 Asset retirement obligations ...................................................... 322 254 Deferred income taxes ............................................................. 41,297 39,422 Other liabilities ................................................................. 22 21 -------- -------- Total liabilities ......................................................... 43,028 46,954 -------- -------- Commitments and contingencies Stockholders' equity: Series B participating preferred stock; par value - $1.00; 10,000,000 shares authorized; no shares issued Common stock; par value - $0.50; 25,000,000 shares authorized; 12,216,404 shares issued at December 31, 2005 and 12,126,404 shares issued at September 30, 2005 ..................................................... 6,109 6,064 Additional paid-in capital ................................................... 89,358 88,500 Accumulated other comprehensive income, net of taxes ......................... 68,330 64,172 Retained earnings ............................................................ 38,210 38,700 -------- -------- 202,007 197,436 Treasury stock at cost - 4,911,044 shares at December 31, 2005 and September 30, 2005 ....................................................... (66,667) (66,667) -------- -------- Total stockholders' equity ................................................ 135,340 130,769 -------- -------- Total liabilities and stockholders' equity ................................ $178,368 $177,723 ======== ========
The accompanying notes are an integral part of these consolidated financial statements -2- CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS ("$000'S" OMITTED EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED)
THREE MONTHS ENDED DECEMBER 31, ------------------------------- 2005 2004 --------- --------- Revenue: Gas sales ............................................................. $ 926 $ 699 -------- --------- 926 699 -------- --------- Expenses: Gas production.......................................................... 142 95 General and administrative.............................................. 1,036 943 Depreciation, depletion and amortization................................ 110 129 -------- --------- 1,288 1,167 -------- --------- Operating income (loss)...................................................... (362) (468) -------- --------- Other income (expense): Interest income......................................................... 108 140 Other income............................................................ 35 9 Equity in income of Delta Petroleum Corporation......................... 842 -------- --------- 143 991 -------- --------- Income (loss) before provision for (benefit of) income taxes................. (219) 523 -------- --------- Provision for (benefit of) income taxes: State (3) 5 Federal................................................................. (91) 175 -------- --------- (94) 180 -------- --------- Net income (loss)............................................................ ($ 125) $ 343 -------- --------- Net income (loss) per share: Basic................................................................... ($ .02) $ .05 ========= ========= Diluted................................................................. ($ .02) $ .05 ========= ========= Weighted average number of common and potential dilutive common shares outstanding: Basic................................................................ 7,262,340 6,892,389 ========= ========= Diluted.............................................................. 7,262,340 7,114,870 ========= =========
The accompanying notes are an integral part of these consolidated financial statements -3- CASTLE ENERGY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ("000'S" OMITTED) (UNAUDITED)
THREE MONTHS ENDED DECEMBER 31, ------------------------------ 2005 2004 ------- ------- Cash flows from (used in) operating activities........................... ($ 6,003) ($ 575) ------- ------- Cash flows from investing activities: Purchase of furniture, fixture, equipment and vehicles........... (85) ------- Net cash provided by (used in) investing activities............ (85) ------- Cash flows from financing activities: Proceeds from exercise of stock options............................. 533 364 Dividends paid to stockholders...................................... (361) (343) ------- ------- Net cash provided by (used in) financing activities.............. 172 21 ------- ------- Net increase (decrease) in cash and cash equivalents..................... (5,831) (639) Cash and cash equivalents - beginning of period.......................... 27,759 33,742 ------- ------- Cash and cash equivalents - end of period................................ $21,928 $33,103 ======= =======
The accompanying notes are an integral part of these consolidated financial statements -4- CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND OTHER COMPREHENSIVE INCOME ("$000'S" OMITTED EXCEPT PER SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30, 2005 AND THREE MONTHS ENDED DECEMBER 31, 2005 (UNAUDITED) ---------------------------------------------------------------------------------------- ACCUMULATED OTHER ADDI- COMPRE- COMPRE- COMMON STOCK TIONAL HENSIVE HENSIVE TREASURY STOCK ----------------- PAID-IN INCOME INCOME RETAINED -------------------- SHARES AMOUNT CAPITAL (LOSS) (LOSS) EARNINGS SHARES AMOUNT TOTAL ------ ------ ------- ------- ------- --------- ------- ------- ------ Balance - October 1, 2005.............. 11,781,404 $5,891 $85,691 $ 170 $48,919 4,911,020 ($66,667) $ 74,004 Treasury stock surrendered............. 24 Options exercised...................... 345,000 173 1,812 1,985 Tax benefit of options exercised....... 677 677 Issuance of additional stock by Delta Petroleum Corporation, net of $180 tax 320 320 Dividends declared ($1.20 per share)... (8,628) (8,628) Comprehensive income (loss): Net income (loss)..................... ($ 1,591) (1,591) (1,591) Other comprehensive income (loss): Equity in other comprehensive income (loss) of Delta Petroleum (1,067) (1,067) (1,067) Corporation, net of $600 tax benefit Reversal of cumulative equity in comprehensive income (loss) of Delta as of April 1, 2005, net of $506 tax 900 900 900 Unrealized gain on marketable securities, net of $35,811 tax ..... 64,169 64,169 64,169 ---------- ------ ------- ------- ------- ------- --------- -------- -------- Total comprehensive income (loss)...... $62,411 ======= Balance - September 30, 2005........... 12,126,404 6,064 88,500 64,172 38,700 4,911,044 (66,667) 130,769 Options exercised...................... 90,000 45 488 533 Tax benefit of options exercised....... 370 370 Dividends declared ($.05 per share).... (365) (365) Comprehensive income (loss): Net income (loss).................... ($ 125) (125) (125) Other comprehensive income (loss): Unrealized gain on marketable securities, net of $2,339 taxes ... 4,158 4,158 4,158 ------- Total comprehensive income (loss)...... $ 4,033 ---------- ------ ------- ======= ------- ------- --------- -------- -------- Balance - December 31, 2005............ 12,216,404 $6,109 $89,358 $68,330 $38,210 4,911,044 ($66,667) $135,340 ========== ====== ======= ======= ======= ========= ======== ========
The accompanying notes are an integral part of these consolidated financial statements -5- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) Note 1 - Basis of Preparation - ----------------------------- The unaudited consolidated financial statements of Castle Energy Corporation (the "Company") included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain reclassifications have been made, where applicable, to make the periods presented comparable. Although certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, the Company believes that the disclosures included herein are adequate to make the information presented not misleading. Operating results for the three month period ended December 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2006 or for subsequent periods. These unaudited consolidated financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2005. In the opinion of the Company, the unaudited consolidated financial statements contain all adjustments necessary for a fair statement of the results of operations for the three month periods ended December 31, 2005 and 2004 and for a fair statement of financial position at December 31, 2005. Note 2 - September 30, 2005 Balance Sheet - ----------------------------------------- The amounts presented in the balance sheet as of September 30, 2005 were derived from the Company's audited consolidated financial statements which were included in its Annual Report on Form 10-K for the fiscal year ended September 30, 2005. Note 3 - Discontinued Operations - -------------------------------- From August 1989 to September 30, 1995, several of the Company's subsidiaries conducted refining operations. By December 12, 1995, the Company's refining subsidiaries had sold all of their refining assets and the purchasers had assumed all related liabilities, including contingent environmental liabilities. The Company's refining subsidiaries own no refining assets, have been inactive for over ten years and are in the process of liquidation. As a result, the Company accounted for its refining operations as discontinued operations. Such discontinued refining operations did not impact the Company's operations from October 1, 1995 through June 30, 2005. In August 2002, Texaco Inc. and certain other subsidiaries of Chevron Corporation (collectively "Chevron") sued the Company and two of its inactive subsidiaries concerning environmental liabilities related to a refinery previously owned by one of the Company's refining subsidiaries. In September 2005, the Company and its subsidiaries settled the lawsuit for $5,750, which the Company paid on October 26, 2005. As a result of this settlement, the Company recorded a loss from discontinued refining operations of $3,392, net of $1,505 of tax recoveries, in the fiscal year ended September 30, 2005. Note 4 - Environmental Liabilities/Litigation - --------------------------------------------- ENVIRONMENTAL LIABILITIES/LITIGATION Chevron Litigation On September 20, 2005, the Company settled its long-standing litigation with Chevron. In exchange for a payment of $5,750 the Company negotiated a settlement agreement which provided mutual releases and a complete and comprehensive indemnification by Texaco Inc. of the Company and related entities and persons against losses or liabilities arising out of or related to the now dismantled Indian Refinery and related properties. -6- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) Chevron had filed the lawsuit against the Company and two of its inactive subsidiaries in August 2002, seeking damages and declaratory relief under contractual and statutory claims arising from environmental contamination at the Indian Refinery. A now inactive subsidiary of the Company had operated that refinery for approximately five years subsequent to approximately seventy-five years of operation by Chevron. The lawsuit claimed that the Company was contractually obligated to indemnify and defend Chevron against all liability and costs, including lawsuits, claims and administrative actions initiated by the United States Environmental Protection Agency ("EPA") and others that Chevron had incurred or might incur as a result of environmental contamination at and around the Indian Refinery, even if that environmental contamination had been caused by Chevron. The suit also sought costs, damages and declaratory relief against the Company under the Federal Comprehensive Environmental Response Compensation Liability Act ("CERCLA"), the Oil Pollution Act of 1990 ("OPA") and the Solid Waste Disposal Act, as amended, ("RCRA"). Chevron had also tendered to the Company the defense of certain third party claims against Chevron in Illinois state court. The Company disputed and contested the claims made by Chevron and denied all liability. All claims in this litigation, as well as any other claims tendered by Chevron, have been resolved by the settlement and the litigation was dismissed with prejudice on October 12, 2005. At September 30, 2005, the Company accrued the $5,750 settlement which it paid on October 26, 2005. OTHER LITIGATION Long Trusts Lawsuit In November 2000, the Company and three of its subsidiaries were defendants in a jury trial in Rusk County, Texas. The plaintiffs in the case, the Long Trusts, are non-operating working interest owners in certain wells previously operated by Castle Texas Production Limited Partnership ("CTPLP"), an inactive exploration and production subsidiary of the Company. The wells were among those sold to Union Pacific Resources Corporation ("UPRC") in May 1997. The Long Trusts claimed that CTPLP did not allow them to sell gas from March 1, 1996 to January 31, 1997 as required by applicable joint operating agreements, and they sued CTPLP and the Company's other subsidiaries, claiming (among other things) breach of contract, breach of fiduciary duty, conversion and conspiracy. The Long Trusts sought actual damages, exemplary damages, prejudgment and post-judgment interest, attorney's fees and court costs. CTPLP counterclaimed for approximately $150 of unpaid joint interest billings plus interest, attorney's fees and court costs. After a three-week trial, the District Court in Rusk County submitted 36 questions to the jury which covered the claims and counterclaim in the lawsuit. Based upon the jury's answers, the District Court entered judgment on some of the Long Trusts' claims against the Company and its subsidiaries, as well as on CTPLP's counterclaim against the Long Trusts. The District Court issued an amended judgment on September 5, 2001 which became final December 19, 2001. The net amount awarded to the plaintiffs was approximately $2,700. The Company and its subsidiaries and the Long Trusts subsequently filed notices of appeal, submitted legal briefs in April 2002, reply briefs in June and July 2002, and ultimately argued the case before the 12th Court of Appeals in Tyler, Texas in October 2002. On July 31, 2003, that court reversed and remanded in part the trial court's judgment against the Company and its subsidiaries while affirming the judgment against the Long Trusts which had awarded damages on the counterclaim asserted by CTPLP. In its decision, the appellate court held that the trial court had submitted erroneous theories to the jury, expressly rejecting the Long Trusts' claims for breach of fiduciary duty, conversion, implied covenants and exemplary damages. It also remanded the Long Trusts' claims for breach of contract to the district court for retrial. The appellate court upheld the trial court's award to CTPLP on its counterclaim for approximately $150 of unpaid joint interests billings, $450 in attorneys' fees, plus interest and court costs. Both the Company and its subsidiaries and the Long Trusts thereafter submitted motions for a rehearing on certain rulings to the 12th Court of Appeals. That court denied both motions for a rehearing. -7- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) The Long Trusts subsequently filed a petition for review with the Supreme Court of Texas. On March 26, 2004, the Texas Supreme Court denied the Long Trusts petition for review and the Long Trusts filed a petition for rehearing with that court two weeks later. That petition was also subsequently denied, whereupon the Court of Appeals issued its mandate on June 9, 2004, completing the appellate process. The supersedeas bond posted by the Company was released, along with a $4,110 letter of credit, including accrued interest, that secured the bond. Certain breach of contract claims by the Long Trusts which were reversed and remanded by the appellate court may be retried by the plaintiffs. Based on the evidence at the initial trial coupled with the guidance to the trial court given in the appellate decision, the Company believes that it will be able to prove that there was no breach of contract and that Long Trusts suffered no damages, and that any such breach of contract claims, even if decided adversely to the Company, will not result in a material loss to the Company. Pursuant to the mandate of the Texas Court of Appeals, the Company moved to sever CTPLP's claims against the Long Trusts from any retrial of the Long Trust's contract claims against the Company and to collect on CTPLP's judgment against the Long Trusts. On September 17, 2004, the Long Trusts filed a Motion for Clarification with the Court of Appeals which in essence sought to reverse that court's severance of CTPLP's claims from the retrial of the Long Trusts' breach of contract claims. The Company filed a Petition for Writ of Mandamus with the Court of Appeals on December 3, 2004, requesting that the trial court be stayed from proceeding further, and be ordered to comply with the June mandate of the Court of Appeals. On January 31, 2005, the Court of Appeals stayed the trial court from proceeding and subsequently denied the Motion for Clarification on March 3, 2005 and the Petition for Writ of Mandamus on March 16, 2005. On May 2, 2005, the trial court from the bench announced that CTPLP's severed claim would be assigned a new case number, but took all other requests for action from the parties under advisement. In August 2005, the Company filed a second Petition for Writ of Mandamus with the Court of Appeals requesting that the calculation of interest due from the Long Trusts be made without a new trial and that Long Trusts be ordered to pay the judgment against it plus interest without delay. The Company estimates the judgment to be $1,067, including accrued interest, as of December 31, 2005. The Company has not accrued any recoveries for this litigation as of December 31, 2005, but will record recoveries if and when they are ultimately realized (collected). Pilgreen Litigation As part of the oil and gas properties acquired from AmBrit Energy Corporation ("AmBrit") in June 1999, Castle Exploration Company, Inc., a wholly-owned subsidiary of the Company ("CECI") acquired a 10.65% overriding royalty interest ("ORRI") in the Simpson lease in south Texas, including the Pilgreen #2ST gas well. CECI subsequently transferred that interest to Castle Texas Oil and Gas Limited Partnership ("CTOGLP"), an indirect wholly-owned subsidiary. Because the operator suspended revenue attributable to the ORRI from first production due to title disputes, AmBrit, the previous owner, filed claims against the operator of the Pilgreen well, and CTOGLP acquired rights in that litigation with respect to the period after January 1, 1999. In August 2002, $282 was released to the Company of which $249 was recorded as income by the Company and the remaining $33 paid to Delta Petroleum Corporation ("Delta"). Because of a claim by Dominion Oklahoma Texas Exploration and Production, Inc. ("Dominion") (see below), a working interest owner in the same well, that CTOGLP's ORRI in the Simpson lease should be deemed burdened by 3.55% overriding royalty interest, there is still a title dispute as to approximately $120 of suspended CTOGLP Pilgreen #2ST production proceeds for the Company's account. (The Company sold all of its oil and gas assets, including the Pilgreen #2ST well, to Delta on May 31, 2002 but effective as of October 1, 2001.) The Company has named Dominion as a defendant in a legal action seeking a declaratory judgment that the Company is entitled to its full 10.65% overriding royalty interest in the Pilgreen well. The litigation is related to the Dominion litigation (see below). The Company and its counsel are currently reviewing the effect of the Court of Appeals' opinion issued in the Dominion litigation on the -8- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) Company's claims in this litigation. Since the Company has not recorded any revenue related to the $120 of suspended revenue, it expects to record $120 of revenue if and when such suspended revenue is realized (collected), but no expense if it fails in this litigation. Christiansen Litigation CTOGLP, along with Delta and several unrelated parties, has also filed suit to collect production proceeds from an additional well on the Simpson lease in which CTOGLP had a 5.325% ORRI suspended by the operator because of title disputes. At the present time, the amount held in escrow applicable to the additional well attributable to the Company's interest is approximately $44. The Company has not recorded any of the net $44 of suspended revenue as income, but will record it as income when and if it is realized (collected). There is no claim or contingent liability against the Company or its subsidiaries in this matter, just a contingent gain if CTOGLP were to prevail. On December 21, 2005, the district court granted a motion for summary judgment in this case, which denied CTOGLP's claim. The Company is currently consulting with its co-plaintiffs in this litigation to assess a possible appeal of this adverse judgement. Dominion Litigation On March 18, 2002, Dominion, operator of the Mitchell and Migl-Mitchell wells in the Southwest Speaks field in south Texas filed suit in Texas against CTOGLP seeking declaratory judgment in a title action that the ORRI held by CTOGLP in these wells should be deemed to be burdened by certain other ORRI's aggregating 3.55% and should therefore be reduced from 10.65% to 7.10%. Dominion also sought an accounting and refund of payments for overriding royalty to CTOGLP in excess of the 7.10% since April 2000. The Company currently estimates the amount in controversy to be approximately $783. In July 2003, Dominion filed a motion for partial summary judgment concerning the Company's claim that it had assumed the liabilities of its predecessor in interest and CTOGLP filed its response to Dominion's motion as well as its own cross motion for partial summary judgment. In September 2003, the District Court of Lavaca County granted Dominion's partial motion for partial summary judgment. In January 2004, Dominion filed a motion for final summary judgment on this matter to which CTOGLP and the other defendants filed a response. In May 2004, the District Court of Lavaca County granted Dominion's motion for final summary judgment, following which the Company appealed both of the District Court's summary judgments to the Court of Appeals in Corpus Christi. By agreement with Dominion, CTOGLP executed a promissory note for $783 guaranteed by the Company and deposited this amount in a separate restricted cash account of CTOGLP to support the note and to avoid the cost of a supersedeas bond. On July 28, 2005, the Court of Appeals issued a Memorandum Opinion that affirmed Dominion's claims to reduce the ORRI, but only to take effect at a date after CTOGLP had sold the ORRI. The Court of Appeals overturned that portion of the judgment that required CTOGLP to refund any money received by it. Dominion petitioned the Supreme Court of Texas for review of this decision. The Texas Supreme Court has requested legal briefs from both sides but has not granted Dominion's petition. The promissory note issued by CTOGLP will be cancelled and the restricted cash account of CTOGLP released when and if the Court of Appeals judgment against Dominion becomes final and non-appealable. -9- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) In fiscal 2004, the Company recorded an $825 loss provision related to the Dominion litigation - primarily as a result of the District Court's granting of Dominion's motions for summary judgment in May 2004. The Company reversed that provision plus $20 of accrued interest on the contingent note during fiscal 2005 primarily because the Court of Appeals reversed that District Court judgment against the Company. Nevertheless, the Company's contingent note payable to Dominion and CTOGLP's restricted cash account are required to remain in place until the Appeals Court judgment becomes non-appealable. If the Supreme Court grants Dominion petition and reverses the Appeals Court decision, the Company would then become liable for the contingent note to Dominion plus interest or some portion thereof. In such case, the Company would again record a loss provision. Note 5 - New Accounting Pronouncements - -------------------------------------- In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"). SFAS No. 123(R) requires an entity to recognize the grant-date fair value of stock options and other equity-based compensation issued to employees in the income statement. Pursuant to a delay in the implementation date by the SEC, SFAS No. 123(R) became effective for the Company beginning October 1, 2005. SFAS No. 123(R) has not had any impact on the Company's operations or net income (loss) to date and the Company does not expect SFAS No. 123(R) to have any impact on its future results of operations or net income (loss) since the Company has not issued any stock options since January 2002 and all stock options issued were vested by July 31, 2002. In addition, at December 31, 2005 no options were outstanding and the Company does not anticipate issuing stock options in the future. In May 2005, the FASB issued SFAS No. 154 Accounting Changes and Error Corrections - a Replacement of APB Opinion No. 20 and FASB Statement No. 3 ("SFAS 154"). SFAS 154 requires retrospective application to prior periods' financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The implementation of FAS 154 is not expected to have a material impact on the Company's consolidated results of operations, financial position or cash flows. In March 2005, the FASB issued FASB Interpretation 47 ("FIN 47"), an interpretation of SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"). FIN 47 clarifies the term "conditional asset retirement obligation" as it is used in SFAS No. 143. The Company applied the guidance of FIN 47 commencing October 1, 2005 and recorded an increase in asset retirement obligations of $64 effective October 1, 2005. The offsetting entry was to oil and gas properties. -10- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) Note 6 - Restricted Cash - ------------------------- Restricted cash consists of the following:
DECEMBER 31, 2005 SEPTEMBER 30, 2005 ----------------- ------------------ (UNAUDITED) Certificate of deposit supporting operating bonds..... $110 $110 Deposit securing contingent promissory note in Dominion litigation............................... 788 788 Other................................................. 23 ---- ---- $921 $898 ==== ====
The certificates of deposit support letters of credit for operating and drilling bonds provided to state or county regulatory agencies. The deposit securing the contingent promissory note in the Dominion litigation is payable only if there is a final judgment against the Company. (See Note 4) Note 7 - Marketable Securities - ------------------------------ The Company's investment in marketable securities was as follows:
DECEMBER 31, 2005 SEPTEMBER 30, 2005 ------------------------- ----------------------------- DELTA DELTA PETROLEUM PETROLEUM CHEVRON CORPORATION CHEVRON CORPORATION ----------- ------------ --------- ------------- Common shares owned........................... 354 6,700,000 354 6,700,000 ===== =========== === ========== Cost.......................................... $ 15 $ 39,892 $15 $ 39,892 Unrealized gain (loss)........................ 5 105,967 8 99,468 ----- ----------- --- ---------- Book (market) value........................... $ 20 $ 145,859 $23 $ 139,360 ===== =========== === ==========
Through March 31, 2005, the Company accounted for its investment in Delta using the equity method. Commencing April 1, 2005, the Company accounted for its investment in Delta as available-for-sale marketable securities. (See Note 9) -11- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) Note 8 - Asset Retirement Obligations - ------------------------------------- Changes in the Company's asset retirement obligations are as follows:
THREE MONTHS ENDED DECEMBER 31, ------------------------------- 2005 2004 ---- ---- Balance - beginning of period........................................ $257 $230 Adjustments.......................................................... 64 10 Accretion of discount................................................ 5 4 ---- ---- Balance - end of period.............................................. $326 $244 ==== ====
Note 9 - Investment in Delta - ----------------------------- Through March 31, 2005, the Company accounted for its investment in Delta using the equity method. Initially, in May 2002, the Company had owned 44% of Delta and three of the Company's directors constituted three of seven Delta directors. By April 1, 2005, the Company's ownership of Delta had decreased to 16% (approximately 15% fully diluted) and the Company's directors only comprised two of nine Delta directors. As a result of these developments, the Company believed it no longer had significant influence on Delta's management and thus, effective April 1, 2005, the Company commenced accounting for its investment in Delta as a marketable available-for-sale security. As a result of the change in accounting method, the book value of the Company's investment in Delta and the Company's cumulative equity in Delta's comprehensive income (loss) at April 1, 2005, under the equity method of accounting, $39,892, became the Company's value of the Delta stock as a marketable security on April 1, 2005. In June 2005, another director of the Company resigned from Delta's Board of Directors resulting in the Company having only one director remaining among Delta's nine directors. At September 30, 2005, the Company owned 6,700,000 shares representing approximately 14% of Delta. At December 31, 2005, the closing market price of Delta's common stock was $21.77 per share. See Notes 7 and 12 and "Critical Accounting Policies." Note 10 - Comprehensive Income (Loss): - -------------------------------------- Comprehensive income (loss) is as follows:
THREE MONTHS ENDED DECEMBER 31, ------------------------------- 2005 2004 ---- ---- Net income (loss)................................................. ($ 125) $343 Equity in other comprehensive income (loss) of Delta, net of taxes .......................................................... 118 Unrealized gain (loss) on marketable securities, net of tax....... 4,158 ------ ---- $4,033 $461 ====== ====
-12- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) Note 11 - Contingent Gain - ------------------------- GAMXX On February 27, 1998, the Company entered into an agreement with Alexander Allen, Inc. ("AA") concerning amounts owed to the Company by AA and its subsidiary, GAMXX Energy, Inc. ("GAMXX"). The Company had made loans to GAMXX through 1991 in the aggregate amount of approximately $8,000 and received a $24,000 mortgage on the GAMXX property, an idle refining plant in Theodore, Alabama. When GAMXX was unable to obtain financing, the Company recorded a one hundred percent loss provision on its loans to GAMXX in 1991 and 1992 while still retaining its lender's lien against GAMXX. The Company subsequently filed and currently maintains a $10,000 lien on the GAMXX properties. In September 2005, the Company entered into an agreement to sell its lender's interest in GAMXX to an outside party for $3,500 in January 2006. The agreement provided that the purchaser is responsible for unpaid property taxes (approximately $1,000 at September 30, 2005) on the property as well as for any environmental remediation that is required. The purchaser made a non-refundable deposit of $10 upon executing the agreement. In January of 2006 the outside party failed to fund the purchase and the agreement expired and the Company did not elect to extend it. In September 2005, another third party purchased the tax lien on the property by paying the unpaid property taxes of $1,000. As a result, the Company or any purchaser of its interest has a year from the date of the purchase of the tax lien to redeem the tax lien by paying the tax lien purchaser $1,000 plus interest. If the tax lien is not redeemed in that one-year period, the property will be owned by the purchaser of the tax lien and the Company's mortgage and lien on the property will be terminated. The Company continues to market its lender's interests in GAMXX. The Company has carried its loans to GAMXX at zero for the last ten years. The Company will record any proceeds as "other income" if and when it collects such amount. Note 12 - Merger Into Delta - --------------------------- On November 8, 2005, the Company entered into a merger agreement (the "Merger Agreement") with Delta. Delta Petroleum Corporation, a newly-formed Delaware corporation and a wholly-owned subsidiary of Delta ("Delta-Delaware" and collectively, with Delta "Delta") and DPCA LLC, a Delaware limited liability company and a newly formed wholly-owned subsidiary of Delta ("DPCA"). Pursuant to the Merger Agreement, the Company will merge with and into DPCA with DPCA as the surviving company and the Company's stockholders will receive approximately 1.164 shares of Delta's common stock for each of their shares of the Company's common stock (or a total of 8,500,000 shares of Delta common stock in the aggregate) (the "Merger"). In the Merger, the 6,700,000 shares of Delta common stock currently owned by the Company will be cancelled. The Merger is designed to be a tax-free exchange for stockholders of both Delta and the Company. The boards of directors of the Company and Delta have approved the Merger. -13- CASTLE ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) (UNAUDITED) The closing of the Merger is subject to approval of the Merger Agreement by the holders of a majority of the shares of the Company's outstanding common stock, review of the related prospectus by regulatory agencies, receipt of legal opinions and other customary closing conditions set forth in the Merger Agreement. The Merger Agreement contains certain termination rights for both Delta and the Company, and further provides that, upon termination of the Merger Agreement under specified circumstances, either party may be required to pay the other a termination fee of $5,000 or reimburse the other party up to $1,000 in fees and expenses actually incurred relating to the transaction contemplated by the Merger Agreement. If the Merger is not completed by March 31, 2006, due to the fault of neither the Company nor Delta, either party can terminate the Merger without penalty. Concurrently with the execution of the Merger Agreement and in order to induce Delta to enter into the Merger Agreement, certain of the Company's officers and all of its directors and the estate and family of the Company's founder and former Chief Executive Officer, Joseph L. Castle II, have entered into voting agreements with Delta pursuant to which they agreed, among other things, to vote all shares of the Company's common stock held by them in favor of the adoption of the Merger Agreement and the other transactions contemplated by the Merger Agreement. The Company's proxy concerning the Merger is currently being reviewed by the SEC. As soon as that review is completed, the Company expects to set a meeting date for a special meeting of its shareholders to vote on the Merger. Note 13 - Subsequent Events --------------------------- On February 6, 2006, the Company entered into a purchase and sale agreement with Networked Energy LLC ("Network"). Pursuant to the terms of that agreement, the Company sold its 45% membership interest in Network to other holders of Network membership units and other Network officers for $5, which was paid to the Company on February 6, 2006. In addition, Network agreed to modifications in the terms of the $125 note owed to the Company by Network. As a result of these modifications, the Company agreed to extend the due date of its note five years until February 6, 2011 and Network and its membership unit holders and officers agreed to dedicate certain cash flows to payment of that note. The Company has classified its investment in Network as current at December 31, 2005. -14- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. ("$000'S" OMITTED EXCEPT SHARE AMOUNTS) RESULTS OF OPERATIONS All statements other than statements of historical fact contained in this report are forward-looking statements. Forward-looking statements in this report generally are accompanied by words such as "anticipate," "believe," "estimate," or "expect" or similar statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove correct. Factors that could cause the Company's results to differ materially from the results discussed in such forward-looking statements are discussed below. All forward-looking statements in this Form 10-Q are expressly qualified in their entirety by the cautionary statements in this paragraph. From August 1989 to September 30, 1995, several of the Company's subsidiaries conducted refining operations. By December 12, 1995, the Company's refining subsidiaries had sold all of their refining assets and the purchasers had assumed all related liabilities, including contingent environmental liabilities. The Company's refining subsidiaries own no refining assets, have been inactive for over ten years and are in the process of liquidation. As a result, the Company has accounted for its refining operations as discontinued operations. Such discontinued refining operations did not impact the Company's operations from October 1, 1995 through June 30, 2005. In August 2002, Chevron sued the Company and two of its inactive subsidiaries concerning environmental liabilities related to a refinery previously owned by one of the Company's inactive refining subsidiaries. In September 2005, the Company and its subsidiaries settled the lawsuit for $5,750, which the Company paid on October 26, 2005. As a result of this settlement, the Company recorded a loss from discontinued refining operations of $3,392, net of $1,505 of tax recoveries, in the fiscal year ended September 30, 2005. (See Note 4) Since November 1996, the Company has reacquired 4,911,044 shares or approximately 69% of its then outstanding common stock (after taking into account a three-for-one stock split in January 2000). As a result of these share acquisitions, earnings and losses per outstanding share have been higher than would have been the case if no shares had been repurchased. Gas sales increased $227 or approximately 32.5% from the quarter ended December 31, 2004 to the quarter ended December 31, 2005. The increase was primarily attributable to a significant increase in the price the Company received for its production. For the quarter ended December 31, 2005, the Company received an average price of $11.63 per thousand cubic feet of natural gas versus only $6.48 per thousand cubic feet of natural gas for the quarter ended December 31, 2004. Production during the quarter ended December 31, 2005 decreased approximately 26.2% from that during the quarter ended December 31, 2004 because of temporary compressor shut downs and other production problems. Gas production expenses increased $47 or approximately 49.5% from the quarter ended December 31, 2004 to the quarter ended December 31, 2005. The increase was caused by well repair and maintenance costs incurred during the quarter ended December 31, 2005. Such expenses do not generally occur evenly throughout a given fiscal period and are best compared on an annual basis. -15- Depreciation, depletion and amortization expense decreased $19 or approximately 14.7% from the quarter ended December 31, 2004 to the quarter ended December 31, 2005 primarily as a result of a decrease in the production of natural gas during the periods being compared and also as a result of a slightly lower depletion rate per thousand cubic feet of natural gas produced during the quarter ended December 31, 2005. General and administrative costs increased $93 or approximately 9.9% from the quarter ended December 31, 2004 to the quarter ended December 31, 2005. The increase was caused primarily by increased compensation costs and non-recurring expenses related to the merger with Delta. Interest income decreased $32 or approximately 22.9% from the quarter ended December 31, 2004 to the quarter ended December 31, 2005 primarily because the Company's excess cash decreased. This decrease was caused, to a large extent, by the payment of $5,750 to Chevron in October 2005 (see Note 4). The Company's equity in Delta's net income decreased from $842 for the quarter ended December 31, 2004 to zero in the quarter ended December 31, 2005. The decrease resulted because the Company commenced accounting for its investment in Delta as a marketable available-for-sale security on April 1, 2005, whereas it had previously accounted for that investment using the equity method and accordingly recorded its proportionate share of Delta's income. The $94 tax recovery for the quarter ended December 31, 2005 resulted primarily from the tax effect of the Company's tax loss during this quarter, offset by the tax benefit related to options exercised during the period. The entire tax recovery for the three months ended December 31, 2005 represents deferred income taxes - not income taxes currently payable. The $180 tax provision for the quarter ended December 31, 2004 represented 34% of pre-tax income and approximated the Company's blended (Federal and state combined) tax rate of 35%. The entire tax provision for the three months ended December 31, 2004 represents deferred income taxes - not income taxes currently payable. LIQUIDITY AND CAPITAL RESOURCES During the three months ended December 31, 2005, the Company used $6,003 in operating activities. During the same period the Company paid $361 for dividends to stockholders. At December 31, 2005, the Company had $21,928 of unrestricted cash, $22,418 of working capital and no long-term debt. As previously reported, the Company entered into the Merger Agreement with Delta on November 8, 2005. Pursuant to that agreement, the Company is to merge into a subsidiary of Delta. The Company is currently involved in clearing its proxy for this merger with the SEC. Closing is expected in late-March 2006, but that date could be delayed or accelerated by regulatory approvals and other factors beyond the Company's control. If the Company or Delta terminates the planned Merger, it is likely that the Company will liquidate although it may continue to operate. Accordingly, the discussion below addresses all three alternatives: completion of the Merger into Delta, liquidation and continuing to operate. Merger into Delta ----------------- Pursuant to the Merger Agreement, the Company would merge into a subsidiary of Delta, all of the Company's outstanding shares of common stock would be cancelled and the Company's stockholders would receive 8,500,000 shares of Delta or approximately 1.164 shares of Delta for each share of the Company's outstanding common stock. As part of the Merger, Delta would also reacquire the -16- 6,700,000 shares of Delta's stock the Company currently owns, resulting in a net issuance of 1,800,000 shares by Delta. The risks that the Merger will not be consummated include but are not limited to the following: a. The stockholders of the Company do not approve the Merger (approval of Delta's stockholders is not required). b. Regulatory reviews or other factors will delay the Merger past April 1, 2006, in which case either party can terminate the Merger without penalty or prevent the Merger from being consummated. The Company and Delta submitted a draft proxy to the SEC on December 22, 2005 and are currently involved in answering the SEC's questions/requests concerning that draft proxy. c. The requisite legal opinions and regulatory approvals will ultimately not be received. d. Either the Company or Delta unintentionally or intentionally does not consummate the Merger despite penalty provisions of up $1,000 and $5,000, respectively, in such cases. Although the Company would consider termination if Delta's stock price were to decline precipitously before closing despite the $5,000 penalty, the Company may nevertheless decide to complete the transaction under such circumstances for two primary reasons. First, approximately 81% of the Company's asset value is currently in the 6,700,000 shares of Delta stock that the Company already holds and thus the Company is already a significant investor in Delta to the extent of those 6,700,000 shares. Furthermore, pursuant to the Merger Agreement, the Company has agreed not to dispose of these shares before the Merger is consummated or the Merger is terminated. Second, by effecting the Merger, the Company will avoid income taxes on the unrealized gain on its 6,700,000 Delta shares. At December 31, 2005, such gain would have been approximately $127,400 and the related income taxes approximately $44,600 (before offset by approximately $3,300 related to tax carryforwards). Nevertheless, if the Company's directors believe that Delta's stock price will decline significantly in the future and remain depressed, they may elect to terminate the Merger, pay the required penalty and sell or distribute Delta's stock to the Company's stockholders after paying the related income taxes on such sale or distribution. Since Delta's stock price has increased from approximately $18.00/share at the time the Merger Agreement was entered into to approximately $20.50 per share currently, it appears unlikely at the present time that the Company's directors will terminate the Merger because of a decline in Delta's stock price. Even if the Company intends to complete the Merger, it is possible that Delta may elect to terminate the Merger despite the penalty provisions. Whether the Merger is terminated by the Company or Delta, the Company would have to decide whether to liquidate or continue to operate if such were the case. If the Merger is completed, the future risk factors applicable to the Company's stockholders become primarily those concerning Delta - not those concerning the Company, whose separate corporate existence would cease upon merging into a subsidiary of Delta. The risk factors concerning Delta's operations and stock are described in Delta's Form 10-K for the year ended June 30, 2005. Such factors include but are not limited to changes in oil and gas prices, drilling and exploration and production risks, Delta's ability to finance its planned drilling activities, Delta's compliance with its debt covenants, severe weather threats to Delta's production in the Gulf Coast region of the United States, Delta's policy of paying no dividends on its common stock and other factors. These risk factors are discussed in greater detail in the proxy statement/prospectus that will be sent to the Company's stockholders in connection with their consideration of the proposed Merger. -17- If the Merger is completed as anticipated, the Company's stockholders will own stock in a company whose assets and liabilities consist of Delta's assets and liabilities and the Company's assets and liabilities excluding the 6,700,000 Delta shares owned by the Company prior to the Merger. As a result, the price of the Delta shares to be owned by the Company's stockholders will depend to a large degree upon the subsequent operations of Delta and the factors noted above concerning Delta. Since the Company's non-cash assets, which Delta will receive under the Merger Agreement, are immaterial compared to Delta's assets, the performance and value of the Company's non-cash assets (oil and gas properties and investment in GAMXX) are not expected to have a material effect on Delta's performance after the Merger. If Delta's post-Merger stock price declines, such decline will affect the value received by the Company's stockholders. Although Delta's average trading volume is currently in excess of 700,000 shares daily versus only approximately 40,000 average shares daily for the Company's stock, Delta's stock price could decline after the Merger if a large number of the Company's stockholders or Delta stockholders attempt to sell their shares shortly after the Merger thus depressing the demand for the stock. Liquidation ----------- If the Merger is not completed as planned it is probable that the Company would liquidate given its small market capitalization, limited operating assets, the increased cost to acquire additional operating assets in the current environment and the ever-increasing regulatory and other costs of remaining a public company. If a decision is made to liquidate, the Company anticipates that it would distribute some cash and/or Delta shares to its stockholders in complete liquidation of their stock as soon as possible while retaining sufficient assets to reasonably provide for existing and anticipated future liabilities, including those related to the current litigation. Such provision would include sufficient assets to provide a reasonable reserve for the Company's current litigation in the event the Company were to receive adverse judgments. If any net assets remain after the Company pays or provides for such remaining liabilities, the net proceeds of such assets would then be distributed to stockholders as a final distribution. The Company would probably also file a no action letter with the SEC seeking relief from continuing SEC reporting requirements during the winding down of its business. Such a plan of liquidation or any other plan of liquidation would be subject to prior approval by the Company's stockholders. The primary risks and costs associated with such a liquidation scenario are as follows: a. Litigation - As noted above, the Company remains a defendant in two unsettled lawsuits. Although the Company does not believe it has any material liabilities with respect to either of these lawsuits and expects to receive a recovery in the Long Trusts' litigation (see Note 4 to this Form 10-Q), any or several of the plaintiffs in these lawsuits could undertake legal actions to delay such litigation or to prevent the Company from making liquidating distributions to its stockholders and/or delay resolution of related litigation. Any resulting litigation could not only cause the Company to incur significant legal costs but could also delay any distributions to stockholders for years and/or reduce such distributions. In addition, even if the Company's stockholders approve any future plan of liquidation, dissident stockholders of the Company could conceivably also take legal actions to prevent the Company from implementing any liquidation plan. b. Tax Risks - The Company currently owns 6,700,000 shares of Delta. The Company's tax basis in such Delta shares is approximately $18,500. Such Delta shares constitute the Company's largest asset. If the Company sells its Delta stock or distributes the Delta stock to its stockholders in liquidation or as a special dividend, the Company will incur a tax liability equal to approximately 35% of the difference between the Company's tax basis and the fair market value of the 6,700,000 Delta shares on the date of distribution. (At December 31, 2005, such fair market value was $145,859.) The tax treatment would be the same as if the Company had sold its Delta shares for their fair market value and then distributed the proceeds to it stockholders. -18- At December 31, 2005, the Company's unrealized appreciation on its Delta stock was approximately $127,400 and the related tax liability approximately $44,600 (before offset by approximately $3,300 related to tax carryforwards). Any such tax income tax liability would significantly reduce distributions available to stockholders. Furthermore, if Delta's stock price increases further, income taxes payable by the Company upon distribution of Delta stock would also increase. c. Continuing Public Company Administrative Burden - If the Company's directors decide to liquidate, the Company will probably seek relief from most of its public company reporting requirements. If such a request is denied by the SEC, the Company would continue incurring the costs of being a public company while having fewer or no operating revenues to absorb such costs. Such costs are significant and probably will increase in the future given the myriad of post-Enron regulatory requirements that are currently being mandated. The result would be a diminution of assets available for distribution to stockholders. For example, commencing September 30, 2006, the Company would face internal control attestation requirements and the costs to comply with such requirements could easily exceed $500 initially. d. Lack of Liquidity - If the Company's directors decide to liquidate and the related plan of liquidation is approved by the Company's stockholders, it is likely that the Company's stock would cease to trade in the Nasdaq National Market after the plan of liquidation is approved. In such case, the market for the Company's stock would be very limited. Stockholders who have used their Company stock as collateral for margin loans would probably be required to provide other collateral to support such loans. Even if the Company is able to distribute Delta stock as part of its initial distribution to stockholders without any legal challenges or other delays, there could be a delay between the date the Company's stock is delisted and the date when the Company's stockholders receive Delta shares that could be substituted as collateral for a margin loan. Stockholders would presumably have to provide other collateral in the interim. e. Liquidation of Assets - The Company's primary remaining assets consist of cash and cash equivalents and the Company's investment in Delta (6,700,000 shares). The Company also owns a lender's interest in GAMXX. Although the value of the Company's gas properties increased in November and December 2005, as the price of natural gas increased, the value of such properties has recently decreased due to significant recent decreases in natural gas prices. Such prices have been extremely volatile in the last 3-4 years and the value of the Company's gas properties can be expected to change as natural gas prices and forecasted natural gas prices change. Moreover, as noted above, Delta's stock has been highly volatile, fluctuating from $8.99 per share to over $24.00 per share during the last year. The amount realized on any sale of the Company's Delta stock would be largely determined by the price of Delta's stock at the time of any sale. Increases or decreases in the price of Delta's stock at the time of sale or distribution to stockholders would, however, be partially offset by increases or decreases in any resulting income tax liability to the Company. f. Legal Uncertainties in Litigation - There is little case law and precedent under applicable Delaware statutes concerning liquidation of a public company such as the Company. Several years may be required to liquidate and application of governing laws may be uncertain. Continuing to Operate --------------------- If the Company does not merge with Delta or liquidate but instead continues to operate, it would be subject to oil and gas price risks, drilling risks, production risks, litigation risks, insurance coverage risks and other general risks inherent in the oil and gas business. In addition, the Company would continue to be exposed to the continuing public company administrative and regulatory burden. At the present time, the Company estimates its annual public company administrative costs to be $600-$800. When the Company becomes subject to internal control attestation requirements (currently expected to be September 30, 2006), such annual public company costs are expected to increase significantly. In addition, the Company faces risks related to its experienced employees. If one or more of its key employees departs, the Company believes it -19- would be extremely difficult to replace such employees since most experienced oil and gas employees reside in areas where the oil and gas industry is concentrated - not in the Philadelphia area where the Company has most of its offices. Finally, the Company's existing gas operations are minuscule compared to those of its competitors yet the Company incurs substantial fixed costs to provide the requisite legal, accounting and production systems to operate and account for its production and to comply with public company reporting requirements. If the Company continues to operate, it would be faced with the prospect of acquiring more oil and gas assets to support its fixed overhead at a time when the prices being paid for oil and gas properties are high, making such investment more risky than previously. Under such circumstances the Company may find it impossible to make the acquisitions it needs to rationalize its fixed operating and public company costs. In addition to the foregoing, if the Company continued to operate it would face risks related to the lack of liquidity for its stockholders (see above discussion under "Liquidation"). At the present time, the Company's anticipated future cash expenditures are primarily recurring general and administrative costs, including legal costs (see Note 4 this Form 10-Q), recurring dividends and lease operating costs related to the Company's gas properties. In addition, the Company would review possible future acquisitions of oil and gas properties and, if the Company is successful in such pursuits, additional expenditures would be required. To the extent that such anticipated expenditures cannot be funded from cash flow from the Company's gas operations, the Company could fund such expenditures using its available cash. If the Company were to make another substantial acquisition at a price in excess of its current cash and other excess liquid working capital, the Company believes it could fund such acquisitions by selling additional shares of Delta or by renewing its previous oil and gas borrowing arrangements with an energy bank and using the related loan proceeds for the acquisition. The Company's future operations would be subject to the following risks: a. Litigation - As noted above, the Company is still a defendant in two significant unsettled lawsuits. Although the Company does not believe it has any material liabilities with respect to any of these lawsuits, the Company could incur significant liabilities if it ultimately is judged to be liable in these lawsuits. This litigation could cause the Company to incur significant legal costs. b. Exploration and Production Price Risk - The Company has not hedged any of its anticipated future gas production because the cost to do so appears excessive when compared to the risk involved. As a result, the Company remains exposed to future gas price changes with respect to all of its anticipated future gas production. Such exposure could be significant given the volatility of gas prices. For example, natural gas prices have increased over 50% from 2002 to 2005 and have then significantly decreased in early 2006 and could either increase or decrease by similar percentages in the future. When the Company acquired its gas properties in March 2004, the prices being received for natural gas were $5.00 to $6.00 per mcf sold. The Company paid for its gas reserve acquisitions using such pricing. If natural gas prices increase or decrease in the future, the increases or decreases will directly impact the Company's gas sales, operating income and net income. In addition, if gas prices are low at the end of the Company's quarterly or annual reporting periods, the value of the Company's gas reserves may decrease such that the Company would be forced to record an impairment provision. See "Critical Accounting Policies" below. c. Exploration and Production Operating Risk - All of the Company's current gas properties are onshore properties with relatively low operating risk. Nevertheless, the Company faces the risks encountered by operating approximately 130 gas wells - including the risk of gas leaks, resulting environmental damage, third party liability claims related to operations, including those in excess of the Company's liability insurance coverage and including claims by landowners where the operated wells are located, as well as other general operating risks. d. Public Market for the Company's Stock - Although there presently exists a market for the Company's stock, such market is volatile and the Company's stock is thinly traded. This volatility may adversely affect the market price and liquidity of the Company's common stock. -20- CRITICAL ACCOUNTING POLICIES: The accounting policies critical to the Company are as follows: FULL COST METHOD OF ACCOUNTING FOR OIL AND GAS PROPERTIES The Company follows the full-cost method of accounting for oil and gas properties and equipment costs. Under this method of accounting, net capitalized costs, less related deferred income taxes, in excess of the present value of net future cash inflows (oil and gas sales less production expenses) from proved reserves, tax effected and discounted at 10%, and the cost of properties not being amortized, if any, are charged to expense (full cost ceiling test). If at a future reporting date oil and gas prices decline, it is possible that the Company's book value will exceed the allowable full cost ceiling and the Company would have to write down its oil and gas properties. Even if oil and gas prices subsequently increase, the write down would not be restored under the full cost method of accounting. Although the Company recorded no full cost ceiling provision through December 31, 2005, it could be required to record such a provision in the future - especially if there were a significant decrease in gas prices by the end of a quarterly or annual financial reporting period. METHOD OF ACCOUNTING FOR INVESTMENT IN DELTA The Company currently owns 6,700,000 shares of Delta. Through March 31, 2005, the Company accounted for its investment in Delta using the equity method of accounting. Under this method the Company increased its investment by its share of Delta's income and decreased its investment by its share of Delta's losses and distributions. The Company also increased its investment for increases in its share of Delta's equity as a result of Delta's issuances of additional Delta equity at prices in excess of the Company's book value. Effective April 1, 2005, the Company commenced accounting for its investment in Delta as a marketable available-for-sale security (see Note 9). As a result, commencing April 1, 2005, pursuant to Statement of Financial Accounting Standards No. 115 ("SFAS 115"), the Company measures its investment in Delta's stock at fair market value (closing prices per the stock exchange) with unrealized gains or losses, net of taxes, recorded in other comprehensive income until the stock is sold or otherwise disposed of. At such time gain or loss will be included in earnings. A decline in the market value of any available for sale security below cost that is deemed to be other than temporary will result in a reduction in the carrying amount to fair value. The impairment will be charged to earnings and a new cost basis for the security will result. Accordingly, the future effect of any change in the market value of Delta stock will affect the Company's equity but will not be recorded in operations until the stock is actually sold or disposed of. -21- ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK On March 30 and 31, 2004, the Company acquired interests in Pennsylvania gas wells. The Company has not hedged its share of the expected natural gas production from these wells. As a result, the Company remains at risk with respect to such unhedged expected production. If market prices increase, gas sales applicable to the unhedged production will increase. If market prices decrease, gas sales and the gross margin related to such unhedged production will decrease. At December 31, 2005, the Company owned 6,700,000 shares of Delta. The stock price of Delta has fluctuated significantly in the last three years and thus the market value of the Company's investment in Delta remains subject to significant changes in the market price of Delta stock. ITEM 4. CONTROLS AND PROCEDURES The conclusions of the Company's Chief Executive Officer and Chief Financial Officer concerning the effectiveness of the Company's disclosure controls and procedures and changes in internal controls as of December 31, 2005 are as follows: a) They have concluded that the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. b) There were no significant changes in the Company's internal controls during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. See Exhibits 31.1 and 31.2 to this Form 10-Q. Effective September 30, 2006, the Company expects that it will be subject to certain attestation requirements concerning the effectiveness of its internal controls pursuant to Section 404 of the Sarbanes Oxley Act. These requirements include management's documenting and testing the Company's internal controls and attesting as to their effectiveness and a reporting by the Company's independent accountants concerning management's attestation. Although the Company has worked diligently to comply with these requirements, the Company has only ten employees and these employees work at four widely scattered locations. The Company's small number of employees and their geographical separation is expected to make compliance with Section 404 - especially with segregation of duty control requirements - very difficult and cost ineffective, if not impossible. If the Company completes its Merger with Delta as planned, the Company will not become subject to these internal control attestation requirements. -22- PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS For additional information regarding lawsuits, reference is made to Item 3 of the Company's Form 10-K (Annual Report) for the fiscal year ended September 30, 2005. Also see Note 4 to the December 31, 2005 consolidated financial statements included in Part I of this Form 10-Q. ITEM 1A. RISK FACTORS See "Liquidation and Capital Resources" above. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (A) Exhibits: Exhibit 11.1 - Statement re: Computation of Earnings Per Share Exhibit 31.1 Certificate of Chief Executive Officer (Section 302 of Sarbanes Oxley Act) Exhibit 31.2 Certificate of Chief Financial Officer (Section 302 of Sarbanes Oxley Act) Exhibit 32.1 Certificate of Chief Executive Officer (Section 906 of Sarbanes Oxley Act) Exhibit 32.2 Certificate of Chief Financial Officer (Section 906 of Sarbanes Oxley Act) (B) Reports on Form 8-K Report dated November 3, 2005 concerning expiration of Registrant's preferred stock purchase right plan Report dated November 8, 2005 concerning planned Merger into subsidiary of Delta Petroleum Corporation -23- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: February 10, 2006 CASTLE ENERGY CORPORATION -------------------- /s/Richard E. Staedtler ------------------------------ Richard E. Staedtler Chief Executive Officer -24- EX-11 2 ex11-1.txt EXHIBIT 11.1
EXHIBIT 11.1 CASTLE ENERGY CORPORATION STATEMENT OF COMPUTATION OF EARNINGS PER SHARE (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) THREE MONTHS ENDED DECEMBER 31, ------------------------------------------------------- 2005 2004 ------------------------- ------------------------- BASIC DILUTED BASIC DILUTED ---------- ---------- ---------- ---------- I. Shares Outstanding, Net of Treasury Stock Purchased During the Period: Stock, net 7,262,340 7,262,340 6,892,389 6,892,389 ---------- ---------- ---------- ---------- Purchase of treasury stock (weighted) 7,262,340 7,262,340 6,892,389 6,892,389 II. Weighted Equivalent Shares: Assumed options and warrants exercised 222,481 ---------- ---------- ---------- ---------- III. Weighted Average Shares and Equivalent Shares 7,262,340 7,262,340 6,892,389 7,114,870 ========== ========== ========== ========== IV. Net Income (Loss) $ (125) $ (125) $ 343 $ 343 ========== ========== ========== ========== V. Net Income (Loss) Per Share ($.02) ($.02) $.05 $.05 ========== ========== ========== ==========
EX-31 3 ex31-1.txt EXHIBIT 31.1 EXHIBIT 31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Richard E. Staedtler, certify that: (1) I have reviewed this quarterly report on Form 10-Q of Castle Energy Corporation for the three months ended December 31, 2005. (2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report. (3) Based on my knowledge, the financial statements and other financial information included in this report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and (15d-15e) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /S/Richard E. Staedtler - ------------------------- Richard E. Staedtler Chief Executive Officer February 10, 2006 EX-31 4 ex31-2.txt EXHIBIT 31.2 EXHIBIT 31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Mary A. Cade, certify that: I have reviewed this quarterly report on Form 10-Q of Castle Energy Corporation for the three months ended December 31, 2005. (1) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report. (2) Based on my knowledge, the financial statements and other financial information included in this report fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. (3) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and (15d-15e) for the registrant and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. (4) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /S/MARY A. CADE - ------------------------- Mary A. Cade Chief Financial Officer February 10, 2006 EX-32 5 ex32-1.txt EXHIBIT 32.1 EXHIBIT 32.1 Statement of Chief Executive Officer Pursuant to Section 1350 of Title 18 of the United States Code Pursuant to Section 1350 of Title 18 of the United States Code, the undersigned, Richard E. Staedtler, the Chief Executive Officer of Castle Energy Corporation (the "Company"), hereby certifies that: I. The Company's Form 10-Q Quarterly Report for the three months ended December 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and II. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: February 10, 2006 /S/RICHARD E. STAEDTLER --------------------- --------------------------- Richard E. Staedtler Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to Castle Energy Corporation and will be retained by Castle Energy Corporation and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 6 ex32-2.txt EXHIBIT 32.2 EXHIBIT 32.2 Statement of Chief Financial Officer Pursuant to Section 1350 of Title 18 of the United States Code Pursuant to Section 1350 of Title 18 of the United States Code, the undersigned, Mary A. Cade, the Chief Financial Officer of Castle Energy Corporation, hereby certifies that: I. The Company's Form 10-Q Quarterly Report for the three months ended December 31, 2005 (the "Report") fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and II. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: February 10, 2006 /S/MARY A. CADE --------------------- --------------------------- Mary A. Cade Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to Castle Energy Corporation and will be retained by Castle Energy Corporation and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----