ITEM 3. LEGAL PROCEEDINGS
Contingent Environmental Liabilities - Refining
Until September 30, 1995, the Company, through its subsidiaries, operated in the refining segment of the petroleum business. As operators of refineries, certain of the Company's subsidiaries were potentially liable for environmental costs related to air emissions, ground and water contamination, hazardous waste disposal and third party claims related to the foregoing. Between September 29, 1995 and December 12, 1995 both of the refineries owned by the Company's refining subsidiaries were sold to outside parties. In each case the purchaser assumed all environmental liabilities. Furthermore, on January 16, 1996, Powerine, the subsidiary that previously owned the Powerine Refinery, was effectively acquired by EMC, an outside, unrelated party. The environmental liabilities of the Powerine Refinery and Indian Refinery as of September 30, 1995 were estimated at $23.6 million and $12.5 million, respectively.
As of November 30, 1996, neither of the purchasers of the refineries had restarted the refineries. In addition, the purchaser of the Indian Refinery, American Western, has defaulted on its $5 million note to IRLP and filed a voluntary petition for bankruptcy in the United States Bankruptcy Court in the District of Delaware under Chapter 11 of the United States Bankruptcy Code. American Western is currently seeking to sell the Indian Refinery.
Although the environmental liabilities related to both of the subsidiaries' refineries have been assumed by others, there can be no assurance that the Company or IRLP will not be sued for matters related to environmental liabilities of the refineries. Both of the companies to which the refining assets or refining subsidiary stock were sold are thinly capitalized and without significant financial resources. EMC is currently seeking to raise financing for restarting the Powerine Refinery and American Western is attempting to sell the Indian Refinery. If either of these companies fails in such endeavors and cannot pay such notes or environmental liabilities, it is possible that the Company or IRLP (still a subsidiary of the Company) could be named a party in related legal actions. Although the Company does not believe it has any liability with respect to such environmental liabilities, a court of competent jurisdiction may find otherwise and the Company may be required to fund portions of such liabilities. In recent years, government and other plaintiffs have often sought redress for environmental damage from the party most capable of payment without regard to responsibility and 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 incur substantial legal fees and experience the diversion of management resources from other operations.
General
SWAP Agreement - MGNG
In April 1995, IRLP terminated a Natural Gas Swap Agreement (the "Swap Agreement"), dated October 14, 1994 between MGNG and IRLP, claiming the right to do so based on breaches of other agreements by MG and its affiliates. MGNG disregarded IRLP's termination notice and sent IRLP a termination notice alleging IRLP was the defaulting party and claiming approximately $1.2 million of losses. IRLP has refused to pay MGNG's claim. In June 1995, MGRM, as MGNG's assignee, filed a complaint in Delaware state court, claiming $653,000, consisting of $1,356,000 under the Swap Agreement less $703,000 owed to IRLP by MGNG in transactions unrelated to the Swap Agreement, plus interest. IRLP has answered the complaint. The Company's management believes that IRLP has good defenses to that claim, expects to prevail and to recover its $703,000 receivable. The litigation is related to the Powerine Arbitration (see below) and the Company expects this litigation to be settled at the same time as or shortly after the Powerine Arbitration litigation is settled.
Powerine Arbitration
On April 14, 1995, Powerine repaid all of the indebtedness owed by it to MGTFC, including $10.8 million of disputed amounts (the "Disputed Amount"). On the same day, the Company and two of its subsidiaries and MG and two of its subsidiaries entered into the Payoff Loan and Pledge Agreement ("Payoff Agreement"), which provided the following:
a. MG released Powerine from all liens and claims.
b. MG loaned the Company $10 million.
c. Powerine transferred its claim with respect to the Disputed Amount to the Company.
d. The claim with respect to the Disputed Amount was agreed to be submitted to binding arbitration (the "Powerine Arbitration").
e. MG can offset the $10 million loan to the Company against the $10 million note it issued to the Company as part of the MG Settlement, to the extent the arbitrator decides the claim with respect to the Disputed Amount in MG's favor.
The Disputed Amount relates primarily to disputes over the prices paid by subsidiaries of MG for 388,500 barrels of refined products lifted by MG's subsidiary, MGRM, and nonpayment for refined products that were processed after January 31, 1995 and that MGRM was obligated to, but did not, lift and pay for. To the extent that the arbitrator decides in favor of the Company, the Company's note to MG will be reduced and the net amount due to the Company from MG will be increased. If the arbitrator settles the Disputed Amount entirely in the Company's favor, the Company's note to MG will be cancelled and MG will still owe the Company its $10 million note (due October 14, 1997). If the arbitrator settles the Disputed Amount entirely in MG's favor, the Company's note from MG will be discharged. In such case the Company's future earnings will also be adversely impacted since the Company has not recorded any reserve against the note.
In December 1996, the Company and MG presented oral arguments to the arbitrator. A decision is expected in the second quarter of fiscal 1997.
In January 1996, MG did not pay interest on the $10,000,000 note when such interest was due. As a result, the entire note is due to be paid to the escrow account for the Powerine Arbitration. The Company filed suit in Delaware Superior Court to compel MG to pay the entire note. By its terms the note is due on October 14, 1997. The effect of compelling MG to pay the note into the escrow account, if successful, will be that the note, after adjustment by the Arbitrator, if any, will be paid to the Company when the Arbitration is concluded rather than on October 14, 1997, the due date before MG's default.
Larry Long Litigation
In January 1996, Larry Long, a nonoperating owner of oil and gas wells, filed a suit against the Company, Production, Pipeline, Marketing, ARCO, B&A Pipeline Company, and a subsidiary of MG in the Fourth Judicial District Court of Rusk County, Texas. The plaintiff claims, among other things, that the parties being sued have underpaid non-operating working interest owners, royalty interest owners, and overriding royalty interests owners with respect to gas production from oil and gas properties operated by Production and attempts to bring a class action on behalf of all such owners based upon various legal theories. The plaintiff is seeking recovery of $40,000,000.
The Company has responded to the lawsuit and has asserted that the suit is not a proper class action and that the named plaintiff is not an appropriate class representative. Management of the Company and special counsel retained by the Company believe that there are a number of meritorious defenses to the claims being asserted. Among other defenses, the Company has asserted that many of the matters which form the basis for the plaintiff's claims were resolved adversely to certain of the members of the purported class in prior litigation involving the predecessors in title to the Company's subsidiaries. In addition, the Company believes that the amount claimed by the plaintiff is not supported by the allegations made. Based upon a review of the pleadings which have been filed, the Company believes that the claims are without merit and intends to vigorously defend the lawsuit. The Company has recently filed a petition for summary judgement against Larry Long. The lawsuit is currently in discovery and deposition proceedings.
Powerine Class Action Lawsuit
In July 1996, Powerine was served with a suit concerning operations of the Powerine Refinery in the Superior Court of the State of California in Los Angeles, California. The suit claims the Powerine Refinery is a public nuisance, that it has released excessive toxic and noxious emissions and caused physical and emotional distress on residents living nearby. The Company is also named as a plaintiff in the suit but has not as yet been served with the lawsuit.
The Company believes it is not properly a defendant in the lawsuit, since it did not operate the Powerine Refinery. Furthermore, when the Company sold Powerine in January 1996, the buyer assumed all liabilities, including environmental liabilities.
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 1996.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK 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:
The table below presents the high and low sales prices of the Company's Common Stock as reported by the NNM for each of the quarters during the two fiscal years ended September 30, 1996.
The final sale of the Company's Common Stock as reported by the NNM on November 30, 1996 was $9.31.
Dividends:
The Company has not adopted a formal dividend policy and has not declared a dividend since 1989. The loan agreements currently in place with subsidiaries of the Company limit the amount of cash that subsidiaries can transfer to the parent to 25% of the subsidiaries' cash flow. Accordingly, not all of the subsidiaries' profits are available for dividends.
Approximate Number of Holders of Common Stock
As of November 30, 1996, the Company's Common Stock was held by approximately 4,000 stockholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
During the Company's five fiscal years ended September 30, 1996, the Company consummated a number of transactions affecting the comparability of the financial information set forth below. In August 1989, the Company acquired the Indian Refinery. From April 1990 until November 1990, the Company performed refurbishment work on the Indian Refinery and recommenced operations in November 1990. In February 1992, the Company entered into a product offtake agreement with MGR&M ("Indian Offtake Agreement") which was restructured and extended in May 1993. In December 1992, the Company acquired certain assets from ARCO. In June 1993, the Company sold its business of administration of oil and gas partnerships. In October 1993, the Company acquired the Powerine Refinery. During 1995, the Company reached a settlement with MG and its affiliates which would affect the results of operations for all future periods. In September 1995, the Company discontinued its refining operations. See Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
("000's" Omitted) - -------------------------------------------------------------------------------
RESULTS OF OPERATIONS
GENERAL
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. In addition, Powerine, one of the Company's refining subsidiaries, merged into a subsidiary of EMC and was no longer a subsidiary of the Company. The Company's other refining subsidiaries own no refining assets and are in the process of liquidation. As a result, the Company has accounted for its refining operations as discontinued operations in the Company's financial statements as of September 30, 1996 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 remaining inactive refining subsidiaries.
Fiscal 1996 vs Fiscal 1995
Revenues
Gas sales from natural gas marketing decreased $10,931 or 15.5% from fiscal 1995 to fiscal 1996. The net decrease was caused by three factors one of which increased gas sales and the other two of which decreased gas sales. Gas sales increased $1,833 or 2.6% as a result of gas sales to MGNG commencing in June of 1996 and other gas sales in the first half of fiscal 1996. In fiscal 1995 virtually all gas sales were to Lone Star. This increase was offset by a 5.7% scheduled reduction in contract volumes under the Lone Star Contract and a 12.4% reduction in volumes of gas otherwise delivered to Lone Star in fiscal 1996. Although the volumes sold to Lone Star annually are essentially fixed (the Lone Star Contract has a take-or-pay provision), the Lone Star contract year is from February 1 to January 31 whereas the Company's fiscal year is from October 1 to September 30. Furthermore, although the volumes to be taken by Lone Star in a given contract year are fixed, there is no provision requiring fixed monthly or daily volumes and deliveries accordingly vary with Lone Star's seasonal and peak demands. Such variances have been significant. As a result, Lone Star deliveries, although fixed for a contract year, may be skewed and not proportional for the Company's fiscal year. On January 31, 1997, the annual contract volume will decrease approximately 1.5% and remain at such decreased level through the end of the Lone Star Contract.
Oil and gas sales from the exploration and production segment increased $62 or .7% as a result of offsetting factors. Production, expressed in equivalent units of natural gas, decreased approximately 10% while the prices received for oil and gas production increased approximately 11%. At the current time gas prices are higher than they have been for several years although there can be no assurance this trend will continue.
Expenses
Gas purchases decreased $5,937 or 14.8% from fiscal 1995 to fiscal 1996. The decrease closely parallels the decrease in gas sales. In fiscal 1995 gas purchases comprised 57% of gas sales versus 57.6% of gas sales in fiscal 1996.
Oil and gas production expenses decreased $321 or 13.6% from fiscal 1995 to fiscal 1996. The decrease results primarily from two factors: decreased ad valorem (property) taxes and decreased well maintenance in the summer of 1996 when the Company expected to sell its oil and gas properties. As a result of such deferral of maintenance, it is anticipated that oil and gas production expenses will be slightly higher in fiscal 1997 now that the Company has withdrawn its oil and gas properties from the market and expects to continue to operate and produce them.
General and administrative expenses applicable to the exploration and production segment increased $165 or 15.4% from fiscal 1995 to fiscal 1996. The increase was caused by increased salaries, insurance and employee benefit costs and increased legal fees.
Depreciation, depletion and amortization decreased $446 or 16.1%. Approximately 10% of the decrease was caused by and parallels a 10% decrease in oil and gas production. The remaining 6.1% decrease is attributable to changes in estimates concerning proved reserves.
Corporate general and administrative expenses decreased $1,496 or 30% from fiscal 1995 to fiscal 1996. The decrease was primarily attributable to decreased legal fees, employee salaries and employee benefits.
Other income increased $2,642 or 940.2%. All of the increase is attributable to recoveries from a plaintiff escrow fund related to shareholder litigation. The amount recovered and recorded as other income in fiscal 1996 was $2,725. There was no counterpart to this item in fiscal 1995.
Interest expense decreased $2,087 or 51.6% from fiscal 1995 to fiscal 1996. The decrease parallels the decrease in outstanding long-term debt. As a result of the refinancing of the GECC loan on November 26, 1996 the Company replaced a fixed 8.33% rate of interest with a floating interest rate equal to the prime rate plus 1%. The prime rate is currently 8.25%. As a result of the refinancing, changes in the prime rate will henceforth impact the Company's interest expense and results of operations.
The income tax benefit has been determined pursuant to "Financial Accounting Standards Number 109 - Accounting for Income Taxes (FAS 109)." The tax benefit in fiscal 1996 results from changes in management's assessment of the probability of future taxable income. As a result of the tax benefit recorded in fiscal 1996, the Company expects to provide for income taxes at a 36% blended statutory rate for the remainder of the Lone Star Contract for book purposes. During this period the Company expects to pay income taxes at a 2% effective rate, consisting of federal alternative minimum tax (see Note 19 to the Consolidated Financial Statements).
Fiscal 1995 vs Fiscal 1994
Revenues
Gas sales from natural gas marketing increased $9,174 or 15% from fiscal 1994 to fiscal 1995. Under the Company's long-term gas sale contract with Lone Star, the price received for gas is essentially fixed through May 31, 1999. The variance in gas sales, therefore, is almost entirely attributable to the volumes of gas delivered. Although the volumes sold to Lone Star annually are essentially fixed (the Lone Star Contract has a take-or-pay provision), the Lone Star contract year is from February 1 to January 31 whereas the Company's fiscal year is from October 1 to September 30. Furthermore, although the volumes to be taken by Lone Star in a given contract year are fixed, there is no provision requiring fixed monthly or daily volumes and deliveries accordingly vary with Lone Star's seasonal and peak demands. Such variances have been significant. As a result, Lone Star deliveries, although fixed for a contract year, may be skewed and not proportional for the Company's fiscal year. Lone Star deliveries and sales for 1995 approximated those which would have occurred if daily takes under the Lone Star Contract had been fixed and equal. Except for $84, all fiscal 1995 sales by the natural gas marketing and transmission segment were to Lone Star.
Exploration and production revenues increased $645 or 7.5% from fiscal 1994. The increase is primarily attributable to increased gas prices. Production for fiscal 1994 consisted of 3,918 equivalent mcf (consisting of 52 barrels of crude and 3,606 mcf of gas) versus 4,027 equivalent mcf (consisting of 51 barrels of crude and 3,721 mcf of gas) for fiscal 1995. The net increase in equivalent mcf was 109 equivalent mcf or 2.8%. Average gas prices increased $.11 per mcf or 5.4% from $2.02 in fiscal 1994 to $2.13 in fiscal 1995. The increase in production consisted of two factors: an increase resulting from the purchase of the production payment from ARCO in October 1994 (see footnote 4 to the consolidated financial statements) offset by a similar decline in production from the Company's other depleting wells. With the exception of the ARCO production payment purchase, only $199 was invested in oil and gas properties in fiscal 1995.
Expenses
Gas purchases increased $3,131 or 8.5% from fiscal 1994. In fiscal 1994 gas purchases constituted 60.5% of gas sales versus 57% of gas sales in fiscal 1995. The decrease in the gas purchase cost percentage is primarily attributable to the elimination of deferred gas purchase cost. In fiscal 1994, a deferred gas purchase cost of $2,400 was included in gas purchase
cost. This cost represented additional deferred gas purchase costs that the Company expected to pay after the GECC Loan was repaid. As a result of the MG Settlement on October 14, 1994 the deferred gas purchase obligation was discharged and did not apply to most of fiscal 1995.
Operating costs of the natural gas transmission segment increased $69 or 6.1% from 1994 to 1995. This increase consists primarily of wage increases given to pipeline personnel.
General and administrative expenses applicable to natural gas marketing and transmission decreased $306 or 28.1% from fiscal 1994 to fiscal 1995. The decrease occurred primarily because of a decrease in insurance and legal costs.
Operating (oil and gas production) expenses in the exploration and production segment decreased $263 or 10% from fiscal 1994 to fiscal 1995. The decrease results primarily from decreased operating costs applicable to non-operated wells and significantly decreased property taxes.
General and administrative costs applicable to exploration and production decreased $359 or 25.1% from 1994 to 1995. The decrease results primarily from decreased insurance expense, administrative fees and legal costs.
Interest expense decreased $5,187 or 56.2% from fiscal 1994 to fiscal 1995. The decrease results entirely from the decrease in the GECC Loan and the discharge of a $9.5 million subordinated loan due to MGTFC on October 14, 1994 as part of the MG Settlement.
The tax provision allocation applicable to continuing operations has been determined pursuant to "Financial Accounting Standards Number 109 - Accounting for Income Taxes" ("FAS 109"). The management of the Company believes that the intraperiod tax provision allocation between continuing and discontinued operations is misleading because the tax rate applicable to continuing operations does not approximate the tax rate expected by the Company in future years.
Fiscal 1994 vs Fiscal 1993
Revenues
Revenues from natural gas marketing increased by $4,583 or 8.1% for the year ended September 30, 1994, principally as a result of the Company's acquisition of the Lone Star Contract from ARCO on December 3, 1992. The increased sales for the additional two months in fiscal 1994 were slightly offset by decreased average daily quantities sold to Lone Star during the year ended September 30, 1994. The average daily takes of gas under the Lone Star Contract decreased 14% in 1994. The decrease in daily takes is attributable to small decreases in the annual contractual volumes under the Lone Star Contract and seasonal requirements of Lone Star within a contract year.
Exploration and production revenues decreased $1,572 or 15.5% for the year ended September 30, 1994 as compared to the prior year primarily as a result of the June 30, 1993 sale of certain exploration and production properties, as well as the general depletion of other Company wells. Furthermore, the Company drilled no new wells in fiscal 1994 and made minimal capital investments to enhance existing production. This was partially offset by the addition of 100 working oil and gas wells on December 3, 1992.
Operating Income and Expenses
Natural gas marketing earned operating income of approximately $10.6 million in fiscal 1994 versus $10.9 million in fiscal 1993. The decrease is primarily attributable to the decreased average daily quantities sold to Lone Star which was offset by an increase attributable to twelve months of operations in 1994 as compared with ten months in 1993.
Operating income for the exploration and production operations was approximately $2.4 million in 1994 as compared with $3.2 million in fiscal 1993. The decrease results from the sale of certain properties in June 1993 and the loss of administrative revenues as a result of the sale of the Company's partnership management business in June 1993. This is partially offset by the addition of 100 working oil and gas wells on December 3, 1992.
Corporate general and administrative expenses increased $3.3 million over the corresponding period in 1993. This increase is primarily attributable to legal fees associated with defending the Stockholder Litigation and related matters.
Other Expenses
Interest expense increased $116 or 1.3% from fiscal 1993. The net increase is the result of two offsetting factors. Interest expense decreased because the loan principal of the GECC Loan and a subordinated loan to MGTFC decreased in 1994. Interest expense increased in 1994 because the loans, which were used to finance the acquisition of the ARCO assets, were not made until December 1992 hence such loans were outstanding for less than a whole year in fiscal 1993.
Income Taxes
The Company allocated the 1994 tax provision between continuing and discontinued operations retroactively pursuant to FAS 109. The Company believes such allocation is misleading for the reason noted above.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity and capital resources position has improved considerably since September 30, 1995. During fiscal 1996 the Company generated $26,864 of operating cash flow. Approximately 91% of this operating cash flow was restricted to and used to reduce the GECC loan and pay related interest expense. As noted above, the Company refinanced the GECC loan and entered into a $25,000 credit facility on November 26, 1996. As of December 1, 1996, $11,126 was outstanding and $13,874 was still available under that facility. In addition, under the new credit facility required principal payments are only $500 per month instead of the entire cash flow generated by the natural gas marketing and transmission and exploration and production subsidiaries as was the case with the previous loan from General Electric Capital Corporation ("GECC"), the Company's natural gas marketing and transmission segment lender.
As noted previously, the Company withdrew its natural gas marketing and transmission and exploration and production assets from the market and is currently planning to operate these assets rather than sell them. Such plans also include drilling much of the Company's undrilled Texas acreage and other capital projects.
As a result of the foregoing the Company's expected cash obligations and resources from October 1, 1996 to September 30, 1999 are as follows:
The foregoing analysis assumes that stock repurchase, drilling and other capital expenditures obligations are undertaken. Although the Company intends to spend funds for each of these activities, it is not obligated to do so. Furthermore, no cash proceeds with respect to the Powerine Arbitration are included although the Company expects to recover all or most of the $10,000 at stake. Finally, as of December 3, 1996, the Company has an additional $13,874 of funds available for these anticipated cash obligations under its $25,000 credit facility.
Although the Company has exited the refining business and does not anticipate any further required expenditures related to discontinued refining operations, interested parties could seek redress from the Company for vendor or environmental liabilities. In the past, government and other plaintiffs have often named the most financially capable parties in such cases regardless of the existence or extent of actual liability. Although the Company's management does not believe the Company would ultimately be held liable and has not included any related costs in the above projections, there can be no assurance such will be the case. Even if the Company were to prevail in such litigation, the related legal costs and distraction of the Company's management resources from continuing operations could be significant.
Finally, the above projections assume that the Company's cash flows will not be adversely impacted by any of the factors discussed subsequently under "Risk Factors." Obviously, if such is not the case and such factors do impact the Company, results could vary and vary significantly from those set forth above.
INFLATION AND CHANGING PRICES
Natural Gas Marketing and Transmission
The Company's gas sales contract with Lone Star is essentially a fixed price contract. It continues through May 1999. The Company's gas supply contract is also a fixed price contract. The result is that the Company's gross margin is essentially "locked in" and does not change with inflation. Although there are some operating costs applicable to the natural gas marketing and pipeline transmission segment, which tend to increase with inflation, they are minor and inflation of such costs without concomitant inflation in revenues does not significantly impact operating profits.
Exploration and Production
Oil and gas sales are determined by markets locally and worldwide and often move inversely to inflation. Whereas operating expenses related to oil and gas sales may be expected to parallel inflation, such costs have often tended to move more in response to oil and gas sales prices than in response to inflation.
General
As noted above, the Company entered into a $25 million facility from a bank syndicate on November 26, 1996. The effective interest rate on the facility is the prime rate plus 1%. To the extent that the Company uses the facility and the prime rate fluctuates, the Company's cost of capital will fluctuate. If the Company draws down all or most of the entire $25,000 facility and the prime rate changes significantly, the effect on the Company's results of operations could be significant.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has released several pronouncements that are not effective until future years. The Company believes that such pronouncements, when effective, will not materially affect the Company's financial condition or results of operations.
RISK FACTORS
The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this section of Item 7 to this Form 10-K to do so. The Company cautions readers that the following important risk factors could affect the Company's future results of operations, liquidity and capital resources and financial condition and could cause the Company's actual future results of operations, liquidity and capital resources and financial condition to differ materially from those expressed in forward looking statements made by or on behalf of the Company.
Refinery Matters
American Western Note
As a result of the sale of the Indian Refinery, IRLP received a $5,000 note from the purchaser, American Western. At September 30, 1996, the note plus accrued interest aggregated $5,387. At the same date, IRLP owed vendors
approximately $7,000. IRLP believes that it can fully discharge its vendor liabilities if it receives the entire $5,387 due from the American Western note. In November 1996, American Western filed for bankruptcy and has undertaken to sell the Indian Refinery while in bankruptcy. Although IRLP holds a first mortgage on the Indian Refinery, other creditors of American Western hold a lien superior to that of IRLP. If the Indian Refinery is sold, there can be no assurance that IRLP's share of the proceeds will be sufficient to settle its vendor liabilities. If the Indian Refinery is not sold, IRLP will not be able to settle its vendor liabilities. In either of these situations, IRLP may file for bankruptcy since its only significant asset is its note due from American Western. Although the Company does not believe such a development would affect its projected cash flow, such may not be the case, as explained below.
Although the Company's subsidiaries' have disposed of their two refineries, the Company's future results of operations and cash flow could be adversely affected by contingent liabilities, including environmental liabilities, related to such refineries if the purchasers of such refineries are unable to satisfy such liabilities and the Company becomes liable for such liabilities, including the environmental liabilities as discussed above. In addition, one purchaser is obligated to subsidiaries of the Company for an aggregate of $6,358 in notes and accrued interest, which may not be paid if the purchaser does not receive sufficient proceeds from the sale of the Indian Refinery. See Item 3 - "Legal Proceedings." Although the Company does not believe it has any liabilities with respect to environmental liabilities of the refineries, a court of competent jurisdiction may find otherwise and the Company may be required to fund portions of such liabilities. In recent years, government and other plaintiffs have often sought redress for environmental damage 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 incur substantial legal fees and experience a diversion of management resources from other operations.
Supply Risk - MGNG Supply Contract
Approximately 82% of the gas currently delivered to Lone Star pursuant to the Lone Star Contract is provided by MGNG, including approximately 6% of such volumes purchased by MGNG from outside owners in wells operated by Production. The Lone Star Contract expires on May 31, 1999. MGNG is a wholly-owned subsidiary of MG, which, in turn, is indirectly owned by MG AG. If spot gas prices increase significantly and MGNG has not hedged its future commitment to supply gas to the Company or if MGNG experiences financial problems, MGNG may be unable to meet its gas supply commitments to the Company. If MGNG does not fulfill its gas supply commitment to the Company, the Company may not be able to fulfill its gas delivery commitment to Lone Star or to achieve the gross margins currently being earned. This would adversely impact the Company's results of operations and cash flow. Under such circumstances the Company may not be able to recover lost profits and cash flow from MGNG despite provisions providing for such recovery.
Credit Risk - Lone Star
At the current time, virtually all of the Company's gas marketing volumes and approximately 75% of the Company's own gas production is sold to a single customer, Lone Star, under a long-term gas sales contract which terminates on May 31, 1999. Although Lone Star has paid for all gas purchased when such payments were due, any inability of Lone Star to continue to pay for gas purchased would adversely affect the Company.
Supply Risk - MGNG Sales Contract
The Company has a commitment to sell 7,356 btu's of natural gas to MGNG ratably from June 1, 1996 to May 31, 1999. At September 30, 1996, the remaining commitment of natural gas to be sold to MGNG was 6,537 btu's. Of this remaining volume, only 14% was hedged as of September 30, 1996. If gas prices remain high, as is the situation currently, the Company may incur significant losses when it purchases the unhedged gas to provide the remaining gas to be sold to MGNG (see Note 15 to the Consolidated Financial Statements).
Drilling Risk
After obtaining the requisite financing, the Company anticipates spending as much as $28,000 during the next three years (and as much as $42,000 over the next five years) to drill new wells primarily on acreage acquired from ARCO. Drilling is inherently risky and there can be no assurance that any wells drilled will be economically viable or enable the Company to recover the costs of drilling. If the initial wells drilled by the Company do not find the reserves expected, the Company may not drill additional wells and the revenues and cash flow expected from such drilling may never materialize.
In addition, an outside interest owner has filed a lawsuit against the Company and three of its subsidiaries (see Item 3 - "Legal Proceedings - Larry Long Litigation"). The Company's management believes that the plaintiff's claims were already resolved in the Company's favor in prior litigation and has filed for summary judgement against the plaintiff. If the issues in such lawsuit are not resolved in the Company's favor or the landowners owning the land on which the new wells are to be drilled do not agree in advance to the gas prices being paid by Marketing, drilling may be postponed until after May 31, 1999. At such time, the Company believes that the pricing issues raised in the Larry Long litigation are no longer applicable.
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. In addition, the Company's earnings history is sporadic and the Company has not paid dividends since 1989. Although the Company believes that its earnings and cash flow will be more predictable in the future, there can be no assurance that such will be the case. Such volatility may adversely affect the market price and liquidity of the Company's common stock. In addition, there are presently, to the Company's knowledge, several brokerage firms making a market in the Company's common stock. Any cessation of such market making activities by such brokerage firms could adversely affect the market for the Company's common stock.
As noted earlier, IRLP's only significant asset is a $5.4 million note due from American Western yet IRLP owes approximately $7.0 million to trade vendors. As noted above American Western recently filed for bankruptcy and is conducting an auction to sell its assets. If IRLP does not receive sufficient proceeds for its note to satisfy its trade vendors IRLP may file a voluntary petition for bankruptcy. Under such circumstances the share price of the Company's common stock may decrease significantly given the required public releases and the perceived public reaction to such releases and the estimated period of time customarily required for such proceedings.
Operational Considerations
The Company's operations are subject to the risks inherent in the pipeline and oil and gas industries, including the risks of fire, explosion, pipe failure and environmental accidents such as oil spills, gas leaks and ruptures or discharges of toxic gases, the occurrence of any of which could result in substantial losses to the Company due to injury or loss of life, severe damage to or destruction of property, natural resources and equipment, pollution or other environmental damage, clean-up responsibilities, regulatory investigation and penalties and suspension of operations. The Company's operations could be subject to significant interruption in the event any of these or other problems developed. In accordance with customary industry practice, the Company maintains significant liability, property and business interruption insurance against most, but not all, of the risks described above. There can be no assurance that such an adverse event will not happen, that the Company's insurance will be adequate to cover any losses or liabilities or that it would not have a material adverse effect on the Company's financial condition or results of operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
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 Per Share Amounts)
(Continued on next page)
The accompanying notes are an integral part of these financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS ("000's" Omitted Except Per Share Amounts) (continued from previous page)
The accompanying notes are an integral part of these financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS ("000's" Omitted Except Share Amounts)
The accompanying notes are an integral part of these financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS ("000's" Omitted Except Share Amounts)
(continued on next page)
The accompanying notes are an integral part of these financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS ("000's" Omitted Except Share Amounts) (continued from previous page)
The accompanying notes are an integral part of these financial statements
CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) ("000's" Omitted Except Share Amounts)
The accompanying notes are an integral part of these financial statements
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
NOTE 1 - BUSINESS AND ORGANIZATION
Settlement with Principal Stockholder
Castle Energy Corporation ("Castle" or the "Company") is a Delaware corporation. From September 1989 until October 14, 1994, its principal shareholder was Metallgesellschaft Corporation ("MG"), an indirect wholly-owned subsidiary of Metallgesellschaft AG ("MG AG"), a German conglomerate which had, in the past, owned as much as 49% of the Company. In addition, the Company had extensive transactions and agreements with MG and its affiliates as described in Notes 17 and 20. On August 31, 1994, the Company entered into two agreements with MG and its affiliates which terminated most relationships with MG and significantly restructured the remaining relationships (the "MG Settlement") (see Note 3). All amounts related to transactions with MG and its affiliates are not reported as related party transactions subsequent to October 14, 1994.
Business Segments
The Company's principal lines of business are natural gas marketing and transmission and oil and gas exploration and production. Until September 30, 1995, the Company's major business segment was refining (see Note 3). The Company's operations are conducted within the United States.
Natural Gas Marketing and Transmission
On December 3, 1992, the Company acquired from Atlantic Richfield Company ("ARCO") a long-term natural gas sales agreement (the "Lone Star Contract") with the Lone Star Gas Company ("Lone Star"), a 77-mile pipeline in Rusk County, Texas (the "Castle Pipeline"), majority working interests in approximately 100 producing oil and gas wells and several gas supply contracts. The acquisition of the Castle Pipeline and the gas contracts created a new business segment for the Company.
At present the principal use of the Castle Pipeline is to deliver gas pursuant to the Lone Star Contract. The Company entered into a management service contract with MG Gathering Corp. ("MGG"), a subsidiary of MG, to operate the Castle Pipeline. Subsequent to September 30, 1996, the Company's pipeline subsidiary notified MGG of its intent to terminate the management service contract with MGG (see Note 24).
The Lone Star Contract expires May 31, 1999. This contract provides for minimum daily deliveries of gas at specific fixed prices, and also includes certain minimum amounts under take-or-pay provisions. Based on reserve reports, management believes approximately 16% of the annual contract volumes can be supplied from Company-operated wells; the Company has entered into a long-term contract with MG Natural Gas Corp. ("MGNG"), a subsidiary of MG, to supply the remaining 84% of the annual contract volumes needed for the Lone Star Contract. For the year ended September 30, 1996, approximately 95% of all gas volumes and 97% of all gas sales by the natural gas marketing and transmission segment were sold to Lone Star. Until June of 1996 in excess of 99% of all gas volumes sold by the natural gas marketing and transmission segment were sold to Lone Star.
In addition to the Lone Star Contract, a subsidiary of the Company has a contract to sell 7,356 btu's (British thermal units) of natural gas at a fixed price from June 1, 1996 to May 31, 1999.
Oil and Gas Exploration and Production
The Company's oil and gas exploration and production operations currently include interests in approximately 450 producing oil and gas wells located in nine states, including the Texas reserves acquired in connection with the acquisition of the natural gas marketing and transmission assets. At present, approximately 75% of the Company's natural gas production is sold to Lone Star as described above.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Refining
IRLP
The Company entered the refining business in 1989 when it acquired the operating assets of an idle refinery located in Lawrenceville, Illinois (the "Indian Refinery"), which was owned and operated by the Company's subsidiary, Indian Refining I Limited Partnership ("IRLP"), until September 30, 1995 when it was shut down. On December 12, 1995, the Indian Refinery assets were sold (for legal purposes) to American Western Refining, L.P. ("American Western") (see Note 3).
Powerine
In October 1993, the Company purchased Powerine Oil Company ("Powerine"), the owner of a refinery located in Santa Fe Springs, California (the "Powerine Refinery") from MG (see Note 4). From October 1, 1993 to February 1, 1995, Powerine sold all of its refined products to MGRM under a product offtake agreement (the "Powerine Offtake Agreement") subject to MGRM's obligation to purchase refined products from raw materials on hand at the Powerine Refinery at (or subject to contracts calling for delivery to the Powerine Refinery by) February 1, 1995. MGRM's failure to purchase products refined after February 1, 1995 is at issue in the Powerine Arbitration (see Note 15). 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") (see Note 3). Results of Powerine's operations are included in these financial statements (discontinued operations - refining) commencing October 1, 1993.
As a result of the transactions with Kenyen, American Western and EMC, the Company disposed of its interests in the refining segment. The results of refining operations are shown as discontinued operations in the Consolidated Statement of Operations.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
The significant accounting policies discussed are limited to those applicable to the Company's continuing business segments - natural gas marketing and exploration and production. References should be made to previous Forms 10-K for summaries of accounting principles applicable to the discontinued refining segment.
Principles of Consolidation
The consolidated financial statements presented include the accounts of the Company and its subsidiaries. All significant intercompany transactions have been eliminated in consolidation.
Revenue Recognition
Natural Gas Marketing and Transmission
Revenues are recorded when deliveries are made. Essentially all of the Company's deliveries are made under two contracts, the Lone Star Contract and a contract with MGNG.
Exploration and Production
Oil and gas revenues are recorded when oil and gas volumes are delivered to the purchaser. Fees from well operations are recorded when earned.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
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.
Property, Plant and Equipment
Natural gas transmission, property, plant and equipment and furniture, fixtures and equipment are stated at the lower of cost or impaired (fair market) value. Depreciation on natural gas transmission, property, plant and equipment is recorded on a straight-line basis over fifteen years, the estimated useful life of the assets. Furniture, fixtures and equipment is depreciated on a straight-line basis over periods of three to ten years, the estimated useful lives of the assets.
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 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 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 cost and the value of 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 in excess of the estimated present value of future cash inflows from proved oil and gas reserves, reduced by operating expenses and future development expenditures, if any, are charged to current expense.
Impairment of Long-Term Assets
The Company adopted Financial Accounting Standard No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of" during the second quarter of fiscal 1995. The effect of adoption was not significant. Accordingly, the Company reviews its long-term assets other than oil and gas properties for impairment whenever events or changes in circumstance indicate 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 is less than the carrying amount of the asset, an impairment loss is 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."
Hedging Activities
The Company employs hedging strategies to hedge its future natural gas purchase requirements for its gas sales contract to MGNG (see Notes 1 and 15). The Company hedges future commitments. Gains and losses from hedging activities are credited or debited to the item being hedged, the cost of gas purchased for the MGNG gas sales contract.
Other Assets
Costs applicable to the issuance of debt are capitalized and amortized using the interest method based upon the scheduled debt repayment terms.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Gas Contracts
The purchase price allocated to the Lone Star Contract was capitalized and is being amortized over the term of the related contract (6.5 years).
Gas Balancing
The Company operates under several natural gas sales contracts where it is entitled to sell other owners' shares of natural gas produced from a well if such other owners do not elect to sell their shares of production. Under the terms of the related joint operating agreements, the non-selling owners are entitled to make up gas sales from the Company's share of production in the future. The Company records sales of other owners' production as deferred revenue and recognizes such deferred revenue when the other owners make up their gas balancing deficiency from the Company's share of production.
Income Taxes
In October 1992, the Company adopted Statement of Financial Accounting Standards No. 109 (FAS 109), "Accounting for Income Taxes." FAS 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 or tax returns. In estimating future tax consequences, FAS 109 generally considers all expected future events other than anticipated enactments of changes in the tax law or rates. (See Note 19). FAS 109 also requires that tax provisions and recoveries related to changes in the valuation reserve for deferred tax assets because of a change in circumstances that causes a change in judgement about the realizability of the related deferred tax asset in future years be allocated entirely to continuing operations.
Earnings Per Share
Primary earnings per common share are based upon the weighted average number of common and common equivalent (if considered dilutive) shares outstanding using either the treasury stock or modified treasury stock method. Fully diluted earnings per common share are presented for all succeeding annual periods where the dilution in earnings per share resulting from full dilution is greater than 3%.
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.
NOTE 3 - MG SETTLEMENT AND DISCONTINUED OPERATIONS - REFINING
On August 31, 1994, the Company entered into agreements with MG and certain of its affiliates pursuant to which the parties thereto agreed to amend or terminate a number of contractual relationships. In the first step of the MG Settlement, which closed on September 9, 1994, MG transferred 3,600,000 shares of common stock of the Company to the Company in exchange for $39,817 of participations the Company held in debt obligations of the Company and its affiliates to MG Trade Finance Corp. ("MGTFC"), a wholly-owned subsidiary of MG.
In the second step of the MG Settlement, which closed on October 14, 1994, MG (a) cancelled certain debt obligations owed to MGTFC by the Company and its affiliates and assumed IRLP's obligations under its $120,000 Senior Facility with Societe Generale, together totaling $321,282, (b) transferred back to the Company the remaining 969,000 shares of common
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
stock held by MG and a $5,500 debenture convertible into 500,000 shares of common stock, (c) issued to the Company a $10,000 note payable in three years, (d) terminated all of its interests in the Company's natural gas operations and (e) agreed to supply all crude oil necessary for the Company to meet its delivery obligations under a forward sale contract with a third party entered into during September 1993. In exchange for the foregoing, IRLP and Powerine (i) amended their Offtake Agreements to terminate effective February 1, 1995 although sales under the Powerine Offtake Agreement were to continue subsequently, (ii) amended their working capital facilities to terminate on March 31, 1995, and (iii) transferred to MG certain of the Company's participations in debt obligations of the Company and its affiliates to MGTFC. In connection with the MG Settlement, IRLP and MGNG also entered into a four-year natural gas swap agreement and MG agreed that the Company, through March 31, 1995, could unilaterally terminate its gas supply agreement with MGNG ("MGNG Gas Supply Agreement"). As a result of the MG Settlement, the Company realized a gain of $391,135, consisting of $396,166 gross proceeds less $5,031 of investment banking fees and related expenses.
The completion of the transactions contemplated by the MG Settlement had, among others, three consequences for the Company. First, the offtake agreements with MG terminated and the Company, until it sold the Refineries, was required to market its own products and was subject to market risks. Second, also in 1995, the working capital facilities provided by MGTFC terminated. Third, for Federal and state income tax purposes, the Company recognized income of approximately $391 million, on which, after giving effect to applicable net operating loss and other tax carryforwards and other items of expense and deduction, Federal and state income taxes of approximately $91 million would have been owed had the Company not disposed of or discontinued the refining operations.
After the MG Settlement was consummated, the Company decided to discontinue the operations of its refining business and to sell or retire its two refineries. At December 31, 1994, the Company provided $345,008 for the estimated impairment of the related refinery assets.
In July 1995, operations ceased at the Powerine Refinery and Powerine retired the assets of the Powerine Refinery. On September 29, 1995, Powerine sold substantially all of the refining plant assets to Kenyen, retaining certain rack facilities and the land on which the Powerine Refinery is situated. The purchase price was $22,763 consisting of $3,000 cash and a note for $19,763. The note was secured by the Powerine refining plant and bore interest at 10%. The note was due in three equal installments of principal and interest of $7,108 (of which $19,763 is principal) on April 30, June 30 and September 30, 1996. On January 16, 1996 Powerine merged into a subsidiary of EMC and was no longer a subsidiary of the Company. As part of the sale, EMC also indemnified Powerine and the Company for any and all environmental liabilities of Powerine.
On September 30, 1995, operations also ceased at the Indian Refinery and IRLP retired the plant assets of the Indian Refinery. On December 12, 1995, IRLP sold the plant assets of the Indian Refinery to American Western, a subsidiary of Gadgil Western Corporation ("Gadgil"). The purchase price was $8,000, including $3,000 cash and a note for $5,000. The note bears interest at 8% and was due on the earlier of October 31, 1996 or the date American Western obtained financing to restart the Indian Refinery. The note is secured by the real property and the Indian Refinery. American Western also assumed certain liabilities of IRLP, including employee pension and all environmental liabilities, in conjunction with the sale. Indian Oil Company ("IOC"), another wholly-owned refining subsidiary, also sold certain precious metal catalysts to American Western for a note for $1,803.
On October 31, 1996, American Western failed to pay the $5,000 note plus $387 of related accrued interest. On November 6, 1996, American Western filed a voluntary petition for bankruptcy in the United States Bankruptcy Court in the District of Delaware under Chapter 11 of the United States Bankruptcy Code. Shortly thereafter, American Western filed motions to approve debtor in possession financing and the sale of the Indian Refinery. Both motions were approved.
American Western expects to sell the Indian Refinery in January 1997. Although IRLP holds a first mortgage on the Indian Refinery other creditors of American Western hold a lien superior to that of IRLP. There can, however, be no assurance that the Indian Refinery will be sold or that the proceeds, if any, to IRLP will equal the note plus interest which is owed to IRLP by American Western. IRLP intends to use the note proceeds, if any, to pay its vendor liabilities, which approximated $7,000 at September 30, 1996. If IRLP does not receive sufficient note proceeds to settle its vendor liabilities, IRLP may file a voluntary petition for bankruptcy.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
In May 1996, IOC seized the platinum securing the $1,803 note and processed approximately fifty-one percent of the platinum. The proceeds were applied to the note. As of September 30, 1996, $971, consisting of $833 of principal and $138 of accrued interest was still owed on the note by American Western. Although IRLP believes the value of the platinum is sufficient to pay such outstanding principal and interest on the note, a vendor of IRLP has obtained a restraining order which precludes IOC from processing the platinum. IOC is seeking to reverse the restraining order so it can continue processing the platinum and obtain payment for its platinum note. The platinum is security for a loan to a financial institution. This loan aggregated $756 at September 30, 1996.
As a result of the discontinuance of refining operations, all assets and liabilities related to the refining segment have been netted. The realizable value of net refining assets is shown under the caption "Estimated realizable value of discontinued net refining assets" on the accompanying Consolidated Balance Sheet. The estimated value of the refining liabilities retained is shown under the caption "Net refining liabilities retained."
An analysis of the assets and liabilities related to the refining segment for the period September 30, 1995 to September 30, 1996 is as follows:
"Estimated realizable value of discontinued net refining assets" is based on the transactions consummated with American Western and EMC and includes management's best estimates of the amounts expected to be realized on the 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 could differ materially in the near term from such amounts.
Summary operating results of discontinued operations are as follows and include the $391,135 gain realized on the settlement with MG in 1995 and the $323,078 impairment write-down in 1995. No refining operations were recorded in 1996 because processing had ceased by September 30, 1995 and all refining subsidiaries were in the process of liquidation.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
In computing the operating results of discontinued operations, interest expense specifically associated with refining debt has been included in discontinued operations.
NOTE 4 -- ACQUISITIONS
Purchase of Powerine
As of October 1, 1993, the Company acquired from MG an option to acquire Powerine, the owner of the Powerine Refinery, a 49,500 barrel per day refinery located in Santa Fe Springs, California in consideration of (i) the payment of $8,000; (ii) the assumption of a $3,027 indemnity obligation related to yield losses incurred by Powerine under a processing arrangement with MG, (iii) the assumption of a $2,675 tax indemnification to the previous owner of Powerine; (iv) the assumption of debt obligations to MG of $128,002 and other liabilities of $44,933; and (v) the payment of transaction costs of $980. In addition, the Company borrowed $2,971 from MGTFC to purchase feedstocks. The acquisition was accounted for as a purchase at predecessor basis due to the significant related party relationship. The Company recorded $160,106 of refinery assets, $14,151 of other tangible assets and the remaining $13,360 of goodwill and deferred tax assets. The Company immediately exercised the option to acquire Powerine for a nominal amount, and concurrently (a) entered into the Powerine Offtake Agreement with MG (b) amended Powerine's loan agreement with MGTFC and (c) amended the Company's crude oil supply agreement with MG to include Powerine as a party. To finance the acquisition, a subsidiary company resold to MGTFC a cash participation in the revolving credit facility provided by MGTFC to IRLP. On January 16, 1996, Powerine merged into a subsidiary of EMC (see Note 3). The results of operations of Powerine are included in the statement of operations (discontinued operations - refining) commencing October 1, 1993.
Purchase of ARCO Royalty
In October 1994, one of the Company's exploration and production subsidiaries purchased certain royalty interests held by ARCO in wells purchased by another of the Company's exploration and production subsidiaries from ARCO in December 1992. The purchase price was $3,823.
NOTE 5 - RESTRICTED CASH
Restricted cash consists of the following:
Subsequent to September 30, 1996, the lender escrow was released in conjunction with the Company's refinancing of its natural gas marketing loan from General Electric Capital Corporation ("GECC") (see Notes 14 and 24).
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 offset unpaid accounts receivable against an outside owner's share of oil and gas revenues, management believes all receivables to be collectible. Accounts receivable consist of the following:
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Account receivable due from Lone Star aggregated $8,149 and $4,044 at September 30, 1996 and 1995, respectively.
NOTE 7 - PROPERTY, PLANT AND EQUIPMENT
Natural gas transmission consists of the following:
Furniture, fixtures and equipment are as follows:
NOTE 8 - GAS CONTRACTS
Gas contracts consist of the following:
NOTE 9 - OIL AND GAS PROPERTIES
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Capital costs incurred by the Company in oil and gas activities, all of which are located in the United States, 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 blended rate (Federal and state combined) of 36% in 1996 and 40% in 1995 and 1994.
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:
NOTE 10 -- 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, Ryder Scott Company Petroleum Engineers and Huntley & Huntley, 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.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Estimated quantities of proved reserves and changes therein, all of which are domestic reserves, are summarized below:
The revisions of previous estimates result from significant additions of proved undeveloped and proved developed non-producing reserves.
All of the Company's oil and gas reserves are located in 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.
The future cash flows were computed using the applicable year-end prices and costs and respective year-end statutory tax rates that related to then existing proved oil and gas reserves in which the Company has mineral interests. The estimates of future income tax expense are computed at the blended rate (Federal and state combined) of 36% in 1996 and 40% in 1995 and 1994.
The following were the sources of changes in the standardized measure of discounted future net cash flows:
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
NOTE 11 -- OTHER ASSETS
Other assets consist of the following:
NOTE 12 -- ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses consist of the following:
Other current liabilities consist of the following:
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
NOTE 13 -- ENVIRONMENTAL MATTERS
As noted previously, the purchasers of Powerine and the Indian Refinery assumed all of the environmental liabilities of Powerine, the Powerine Refinery and the Indian Refinery. At the time such environmental liabilities were assumed by the purchasers, their recorded book values were $23,561 for the Powerine Refinery and $12,500 for the Indian Refinery.
As of November 30, 1996, EMC had not obtained financing and had not restarted the Powerine Refinery. On November 6, 1996, American Western filed a voluntary petition for bankruptcy and thereafter obtained bankruptcy court approval to sell the Indian Refinery to the highest bidder.
Accordingly, although the environmental liabilities related to both of the Company's Refineries have been assumed by others, there can be no assurance that the Company or one of its subsidiaries will not be sued for matters related to environmental liabilities of the Refineries. The purchasers of Powerine and the Indian Refinery are thinly capitalized and without significant financial resources. One purchaser, American Western, has filed for bankruptcy and plans to sell the Indian Refinery to the highest bidder. If either of these companies fails in such endeavors and they or their successors cannot pay their environmental liabilities, it is possible that the Company or IRLP (still a subsidiary of the Company) could become a party in related legal actions. Although the Company does not believe it has any liabilities with respect to environmental liabilities of the refineries, a court of competent jurisdiction may find otherwise and the Company may be required to fund portions of such liabilities. In recent years, government and other plaintiffs have often sought redress for environmental damage 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 incur substantial legal fees and experience a diversion of management resources from other operations.
NOTE 14 -- DEBT
Long-term debt consists of the following:
The General Electric Corp. ("GECC") loan was made to two of the Company's natural gas subsidiaries, Castle Texas Pipeline L.P. ("Pipeline") and CEC Gas Marketing L.P. ("Marketing"). The GECC loan bore interest of 8.33% and was secured by a first security interest in all of the assets of Pipeline and Marketing, as well as a pledge of the partnership interests and capital stock of the general and limited partners of these partnerships. All of the cash flow generated by Pipeline and Marketing was dedicated to repayment of the GECC loan.
Subsequent to September 30, 1996, the GECC loan was refinanced (see Note 24).
In May 1996, the Company entered into a subordinated term loan facility of $3,800. The loan was subordinated to the GECC Loan, was payable over 18 months and bore interest at the prime rate plus 1%. In November 1996, the Company entered into a $25,000 facility with a syndicate of banks and the subordinated lender contributed its loan to the new facility (see Note 24).
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
The balance sheet classification and scheduled maturities of long term debt at September 30, 1996 are based upon the repayment schedule of the $25,000 facility (see Note 24).
The other long-term debt of $2,500 earned interest at the twelve-month LIBOR rate determined annually on December 11, plus 1/2%. The debt was due to a financial institution which was previously a shareholder of the Company. The debt was repaid in June 1996.
Long-term debt-related party consists of a loan from Stockholder which earned interest at the twelve-month LIBOR rate determined annually on December 11, plus 1/2%. The debt was due to a stockholder who was also a director of the Company until January 5, 1996. The debt was repaid in June 1996.
Maturities
The scheduled maturities of long-term debt outstanding as of September 30, 1996 are as follows:
For the Year Ending September 30, - --------------------------------- 1997.................................................... $ 8,172 1998.................................................... 5,834 --------- $14,006 ========= NOTE 15 -- COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments
The Company has the following noncancellable operating lease commitments at September 30, 1996:
For the Year Ending September 30, - --------------------------------- 1997................................................. $227 1998................................................. 189 1999................................................. 34 ------ $450 ======
Rent expense for the years ended September 30, 1996, 1995 and 1994, excluding refining related rent expense, was $236, $255 and $255, respectively.
Compensation/Severance Obligations
As of September 30, 1996, the Company had the following compensation obligations under employment agreements with three officers of three of its subsidiaries:
For the Year Ending September 30, - --------------------------------- 1997................................................. $251 1998................................................. 53 ------ $304 ======
The Company entered into the employment agreements in fiscal 1995 and fiscal 1996.
In addition, the Company and its subsidiaries have severance agreements with all of their employees that provide for severance compensation, in the event substantially all of the Company's assets are sold and the employees are terminated. Such severance obligations, net of $95 compensation obligations, approximate $1,000 at September 30, 1996. In addition, in the event of such sale of substantially all its assets, the Company has agreed to pay the remaining contractual obligations under its agreement with Terrapin Resources, Inc. (see below) and to pay its Chairman his accumulated retirement benefit (see Note 16).
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Letters of Credit
At September 30, 1996, the Company had issued letters of credit of $216 for oil and gas drilling, operating and plugging bonds. The letters of credit are renewed semi-annually or annually.
At September 30, 1996, the Company had also guaranteed gas purchase obligations related to its gas marketing activities. At the present level of gas purchases by such subsidiaries, such guarantees approximate $800.
Long Term Supply Commitments
The Company has a gas purchase agreement with MGNG (see Note 20). Aggregate future purchase commitments under the gas purchase long-term supply commitment are as follows:
For the Year Ending September 30, - --------------------------------- 1997............................................... $29,705 1998............................................... 30,444 1999............................................... 20,727 -------- $80,876 ========
If MGNG fails to perform its obligations under this contract, there is no assurance that Marketing could fulfill its obligations under the Lone Star Contract in a manner which would permit Marketing to maintain its current profit margin on sales of natural gas.
The Company also has a commitment to sell 7,356 btu's (British thermal units) of natural gas at a fixed price from June 1, 1996 to May 31, 1999 to MGNG. The Company anticipates supplying the gas from gas purchases on the spot market. The Company's obligations to sell natural gas to MGNG at September 30, 1996 are as follows:
For the Year Ending September 30, - --------------------------------- BTU's (British Thermal Units) ----------------------- 1997......................................... 2,452 1998......................................... 2,452 1999......................................... 1,633 ----- 6,537 =====
Prior to September 30, 1996, Production entered into fixed price contracts to hedge 14% of the gas to be sold to MGNG at a fixed price. At September 30, 1996, the market value of the hedges was approximately $316 and the excess of the gas sales price to MGNG over the hedged cost was approximately $136. Production has not yet hedged the other 86% of the gas that must be delivered to MGNG under the contract. If spot gas prices are above the fixed price to MGNG, Production could incur a loss when it buys the gas to supply MGNG on the remaining unhedged volumes. At December 31, 1996, the cost to purchase fixed price contracts for the remaining unhedged deliveries to MGNG exceeded the gas sales revenues to be received from MGNG by approximately $825. In addition, Production has provided a $264 margin account deposit and must provide additional cash in a margin account if the market price of gas is less than the fixed price.
The notional amounts of fixed price contracts for natural gas were as follows:
September 30, 1996 ------------------ Fixed price contracts to buy gas........................ $2,070 Fixed price contracts to sell gas....................... (418) ------- Net..................................................... $1,652 =======
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Management Agreements
The Company has two long-term management agreements with a subsidiary of Terrapin Resources, Inc. ("Terrapin") to provide accounting and management with respect to the Company's exploration and production assets and to provide corporate accounting services. Terrapin is wholly-owned by an officer of the Company. Obligations under these agreements are as follows:
For the Year Ending September 30, - --------------------------------- 1997................................................. $ 384 1998................................................. 399 1999................................................. 277 -------- $1,060 ========
Lone Star Contract
Additionally, the Company's natural gas marketing and pipeline segment sells substantially all of its natural gas to only one customer -- Lone Star. Sales to Lone Star by the Natural Gas Marketing and Transmission segment aggregated $62,140, $74,675 and $66,393 for the fiscal years ended September 30, 1996, 1995 and 1994, respectively. Approximately 24% of Lone Star's requirements under the gas sales contract are currently supplied from wells operated by the Company. The balance of these requirements are purchased from MGNG pursuant to a gas purchase contract. If MGNG were to fail to perform its obligations under this contract, there could be no assurance that the Company could fulfill its obligations under the Lone Star Contract in a manner which would permit the Company to maintain its current profit margin on sales of natural gas.
Legal Proceedings
Powerine Arbitration
On April 14, 1995, Powerine repaid all of the indebtedness owed by it to MGTFC, including $10.8 million of disputed amounts (the "Disputed Amount"). On the same day, the Company and two of its subsidiaries and MG and two of its subsidiaries entered into the Payoff Loan and Pledge Agreement ("Payoff Agreement"), which provided the following:
a. MG released Powerine from all liens and claims.
b. MG loaned the Company $10 million.
c. Powerine transferred its claim with respect to the Disputed Amount to the Company.
d. The claim with respect to the Disputed Amount was submitted to binding arbitration (the "Powerine Arbitration").
e. MG can offset the $10 million loan to the Company against the $10 million note it issued to the Company as part of the MG Settlement, to the extent the arbitrator decides the claim with respect to the Disputed Amount in MG's favor.
The Disputed Amount relates primarily to disputes over the prices paid by subsidiaries of MG for 388,500 barrels of refined products lifted by MG's subsidiary, MGRM, and nonpayment for refined products that were processed after January 31, 1995 and that MGRM was obligated to, but did not, lift and pay for. To the extent that the arbitrator decides in favor of the Company, the Company's note to MG will be reduced and the net amount due to the Company from MG will be increased. If the arbitrator settles the Disputed Amount entirely in the Company's favor, the Company's note to MG will be cancelled and MG will still owe the Company its $10,000 note (due October 14, 1997). If the arbitrator settles the Disputed Amount entirely in MG's favor, the Company's note from MG will be discharged and the Company will incur a $10,000 loss from discontinued refining operations. In such case the Company's future earnings will also be adversely impacted since the Company has not recorded any reserve against the note. Although the Company expects to prevail, there can be no assurance such will be the case.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
In December 1996, the Company and MG presented oral arguments to the arbitrator. A decision is expected in the second quarter of fiscal 1997.
In January 1996, MG did not pay interest on the $10,000 note when such interest was due. As a result, the entire note is due to be paid to the escrow account for the Powerine Arbitration. The Company is litigating to compel MG to pay the entire note. By its terms the note is due on October 14, 1997. The effect of compelling MG to pay the note into the escrow account, if successful, will be that the note, after adjustment by the Arbitrator, if any, will be paid to the Company when the Arbitration is concluded rather than on October 14, 1997, the due date before MG's default.
Swap Agreement - MGNG
In April 1995, IRLP terminated a Natural Gas Swap Agreement (the "Swap Agreement"), dated October 14, 1994 between MGNG and IRLP, claiming the right to do so based on breaches of other agreements by MG and its affiliates. MGNG disregarded IRLP's termination notice and sent IRLP a termination notice alleging IRLP was the defaulting party and claiming approximately $1,200 of losses. IRLP has refused to pay MGNG's claim. In June 1995, MGRM, as MGNG's assignee, filed a complaint in Delaware state court, claiming $653, consisting of $1,356 under the Swap Agreement less $703 owed to IRLP by MGNG in transactions unrelated to the Swap Agreement, plus interest. IRLP has answered the complaint. The Company's management believes that IRLP has good defenses to that claim, expects to prevail and to recover its $703 receivable. This litigation is related to the Powerine Arbitration (see above) and the Company expects this litigation to be settled at the same time as or shortly after the Powerine Arbitration litigation is settled.
Powerine Class Action Lawsuit
In July 1996, Powerine was served with a suit concerning operations of the Powerine Refinery. The suit claims the Powerine Refinery is a public nuisance, that it has released excessive toxic and noxious emissions and caused physical and emotional distress on residents living nearby. The Company is also named as a defendant in the suit but has not as yet been served with the lawsuit.
The Company believes it is not properly a defendant in the lawsuit, since it did not operate the Powerine Refinery. Furthermore, when the Company sold Powerine in January 1996, the buyer assumed all liabilities, including environmental liabilities.
Larry Long Litigation
Larry Long filed a suit against the Company, Production, Pipeline, Marketing, ARCO, a subsidiary of ARCO and MGNG. The plaintiff claims, among other things, that the parties being sued have underpaid non-operating working interest owners, royalty interest owners, and overriding royalty interests owners with respect to gas production from oil and gas properties operated by Production and attempts to bring a class action on behalf of all such owners based upon various legal theories. The plaintiff is seeking recovery of $40,000.
The Company has responded to the lawsuit and has asserted that the suit is not a proper class action and that the named plaintiff is not an appropriate class representative. Management of the Company and special counsel retained by the Company believe that there are a number of meritorious defenses to the claims being asserted. Among other defenses, the Company has asserted that many of the matters which form the basis for the plaintiff's claims were resolved adversely to certain of the members of the purported class in prior litigation involving the predecessors in title to the Company's subsidiaries. In addition, the Company believes that the amount claimed by the plaintiff is far in excess of and not supported by the allegations made. Based upon a review of the pleadings which have been filed, the Company believes that the claims are without merit and intends to vigorously defend the lawsuit. The Company has recently filed a petition for summary judgement against Larry Long. The lawsuit is currently in discovery and deposition proceedings.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Stockholder Litigation Recovery
In December 1995, the Company received $2,725 from a plaintiff class escrow fund related to stockholder litigation. The parties reached a settlement with respect to the stockholder litigation in October 1994. The proceeds to the Company represent unclaimed funds that were to revert to the Company pursuant to the Settlement Order for the litigation. The recovery is shown as "Other Income" in the Consolidated Statement of Operations.
NOTE 16 -- EMPLOYEE BENEFIT PLANS:
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 could 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 year ended September 30, 1996, the Company's and its subsidiaries' contributions to the Plan aggregated $26.
Although the Company's refining subsidiaries sponsored pension, profit sharing and 401(k) plans for their employees, such plans were transferred to the purchasers of such refineries and the purchasers assumed all related plan liabilities.
Post Retirement Benefits
Neither the Company nor its subsidiaries provide any other post retirement plans for employees. The Company has, however, granted the Company's Chief Executive Officer a retirement benefit. At September 30, 1996, the Chief Executive Officer's accrued retirement benefit was $848.
NOTE 17 -- STOCKHOLDERS' EQUITY
On December 2, 1993, the Company consummated a public offering of its common stock. Pursuant to the terms of the offering, the Company sold 2,800,000 shares of common stock to the public and 700,000 shares of common stock to MG at a gross offering price of $15.00 per share. The offering resulted in aggregate net proceeds to the Company of $48,178. Of such amount, $30,800 was used to pay down various debt obligations of the Company owed to MGTFC. The remainder of such amount was used for general corporate purposes. As a result of the offering, MG's percentage ownership of the Company's common stock was reduced from approximately 49% to approximately 41%. All treasury stock of the Company was reissued in conjunction with the offering.
On April 21, 1994, the Board of Directors of the Company adopted a Stockholder Rights plan under which one preferred stock purchase right has been distributed for each outstanding share of the Company's common stock. Each right initially entitles holders of common stock to buy one-hundredth of one share of a new series of preferred stock at an exercise price of $35.00. The rights will be exercisable only if a person or group, without the prior approval of the Company's Board of Directors, acquires 15% or more of the outstanding common stock or announces a tender offer as a result of which such person or group would own 15% or more of the common stock. If a person to whom these provisions apply becomes a beneficial owner of 15% or more of the outstanding common stock, each right (other than rights held by such acquiring person) will also enable its holder to purchase common stock (or equivalent securities) of the Company having a value of $70.00 for a purchase price of $35.00. In addition, if the Company is involved in a merger or other business combination with another entity, at or after the time that any person acquires 15% or more of the outstanding common stock, each right will entitle its holder to purchase, at $35.00 per right, common shares of such other entity having a value of $70.00
On September 9, 1994, the Company acquired and cancelled 3,600,000 shares of its common stock from MG. On October 14, 1994, 969,000 shares of common stock were surrendered by MG and cancelled by the Company, reducing MG's ownership of the Company's common stock to zero. In addition, the convertible debenture was cancelled and all warrants were subsequently cancelled (see Notes 3, 18 and 20).
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Subsequent to September 30, 1996, the Company repurchased 3,500 of its shares pursuant to a share repurchase plan (see Note 24).
Pursuant to the terms of its $25,000 credit facility with a syndicate of banks, the Company's natural gas marketing and transmission and exploration and production subsidiaries are precluded from paying more than 25% of quarterly cash flow, as defined, to the parent. The book value of the restricted net assets of the related natural gas marketing and transmission and exploration and production subsidiaries aggregated $76,719 at September 30, 1996 (see Note 24).
NOTE 18 -- STOCK OPTIONS AND WARRANTS
Option and warrant activities during each of the three years ended September 30, 1996 are as follows (in whole units):
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
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
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 562,500 shares of common stock of the Company will be available for awards in the form of stock options, including incentive stock options and non-qualified stock options generally at prices at or in excess of market prices at the date of grant.
The Incentive Plan also provides that each outside director of the Company will annually be granted an option to purchase 5,000 shares of common stock at fair market value on the date of grant.
In conjunction with the MG Settlement, certain warrants were cancelled (see Note 3).
In December 1996, 162,500 options expired, 10,000 options were exercised and an additional 32,000 options were issued. The exercise price was the market price on date of issuance.
In addition to stock options and warrants, the Company has issued the following stock appreciation rights:
The stock appreciation rights entitled the holder to cash compensation equal to the difference between the price per share of the Company's common stock and the measurement price with respect to the number of rights issued, subject to adjustment. Costs associated with stock appreciation rights were recorded over the relevant period of employment. During the years ended September 30, 1995 and 1994, the Company recorded (income) expense related to stock appreciation rights of ($1,162) and $4,848, respectively.
The stock appreciation rights cancelled in fiscal 1996 were cancelled as part of severance settlements with former officers of the Company and IRLP.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
NOTE 19 -- INCOME TAXES
Provisions for (benefit of) income taxes consist of:
The intraperiod tax allocation was made pursuant to FAS 109.
Deferred tax assets (liabilities) are comprised of the following at September 30, 1996 and 1995:
Upon adoption of FAS 109, the Company recorded an asset of $73,909 and provided a valuation reserve against the asset of $65,395. During fiscal 1993, the Company reduced the valuation reserve based upon the Company's entering into certain long-term purchase and sale commitments, refinancing its debt and the related earnings projections. At September 30, 1994, the Company adjusted its valuation reserve such that the remaining deferred tax assets approximated the net tax benefit that the Company expected to realize from its net operating loss carryforwards as a result of the gain realized from the MG Settlement (See Note 3). As a result of unanticipated delays and larger than expected losses in the sale of its refineries, the Company did not realize all of its tax carryforwards. As a result, the Company provided a $31,955 valuation reserve at
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
December 31, 1994 which was subsequently increased to $33,110 at September 30, 1995. During the year ended September 30, 1996, the Company reduced its valuation reserve to $13,944 in anticipation of future taxable income from the Lone Star Contract and the decreased probability of additional losses related to discontinued refining operations.
The Company has recorded a net deferred tax asset of $7,716 at September 30, 1996. Realization is dependent on generating sufficient taxable income through the remaining term of the Lone Star Contract. Although realization is not assured, management believes it is more likely than not that the deferred tax asset will be realized.
The income tax provision (benefit) differs from the amount computed by applying the statutory federal income tax rate to income (loss) before income taxes as follows:
The tax provision (benefit) applicable to discontinued operations - refining differs from the amount computed by applying the statutory federal income tax rate to income (loss) before income taxes as follows:
At September 30, 1996, the Company had the following tax carryforwards available:
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
The net operating loss and investment tax credit carryforwards expire from 1997 through 2008. Of the Company's net operating losses, approximately $6,821 (approximately $2,341 for alternative minimum tax purposes) are applicable to subsidiaries acquired by the Company and may only be used to offset future taxable income of the acquired companies which generated the loss. Similar restrictions apply to all of the Company's investment tax credit carryforwards and approximately $9,000 of the Company's statutory depletion carryforwards.
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 became subject to an annual limitation of $7,845. Such annual limitation, however, was increased by the amount of net built in gain at the time of the change of ownership. Such net built-in gain aggregated $219,430. During fiscal 1995, the Company utilized $81,175 of its net operating loss, including $72,653 of built-in gain, to offset the gain from the MG Settlement (see Note 3). During fiscal 1996, the Company utilized $9,657 of its operating loss, including $1,812 of built-in gain.
The Company also has approximately $61,200 in individual state tax loss carryforwards available at September 30, 1996. Such carryforwards are primarily available to offset taxable income apportioned to certain states in which the Company previously incurred refining losses and currently has only minor operations and no current plans for future operations.
NOTE 20 -- RELATED PARTIES
During the fiscal year ended September 30, 1994, the Company conducted several transactions with its principal stockholder, MG, and its subsidiaries. As a result of the MG Settlement on October 14, 1994, MG's ownership of the Company was reduced to zero and MG was thereafter no longer a related party. The following summarizes the MG subsidiaries with which the Company and its affiliates conducted transactions, and the nature and dollar amount of such related party transactions.
The MG affiliates and subsidiaries which the Company engaged in transactions were as follows:
Metallgesellschaft Corp. A.G. ("MG AG"), German parent Metallgesellschaft Corp. ("MG"), U.S. subsidiary MG Refining and Marketing, Inc. ("MGRM"), U.S. subsidiary MG Trade Finance Corp. ("MGTFC"), U.S. subsidiary MG Futures, Inc. ("MGF"), U.S. subsidiary MG Natural Gas Corp. ("MGNG"), U.S. subsidiary MG Gathering Corp ("MGG"), U.S. subsidiary MGPC Petcoke, Inc. ("MG Petcoke"), U.S. subsidiary
All of the above U.S. subsidiaries are directly or indirectly wholly-owned by MG which, in turn, is indirectly owned by MG AG.
The fiscal 1994 transactions with MG and its affiliates are as follows:
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
In addition to the above-related party transactions with MG and its affiliates, the Company undertook the following related party transactions:
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Sale of Subsidiaries
On March 31, 1993, the Company entered into an agreement to sell to Terrapin Resources, Inc. ("Terrapin") its oil and gas partnership management businesses for $1,100 ($800 note bearing interest at 8% per annum and $300 cash) which approximated book value. The closing of the stock purchase transaction occurred on June 30, 1993. Terrapin is wholly-owned by a former officer and director of the Company. In November 1994, this former officer and director rejoined the Company as an officer. In December 1994, the note was repaid.
In conjunction with the sale of its partnership management business, the Company and Production entered into two management agreements with Terrapin to manage its exploration and production operations. The second agreement was amended in 1996 to include corporate accounting functions. Management fees incurred to Terrapin for the years ended September 30, 1996, 1995 and 1994 aggregated $613, $579 and $584, respectively.
Purchase of IRLP Interests
During 1993, the Company acquired the partnership units of IRLP it did not already own. Certain of these units were acquired from an officer of the Company for an aggregate of 262,500 stock appreciation rights, entitling the holder to cash compensation equal to the difference between the price per share of the Company's common stock and stated prices. In November 1994, 112,500 stock appreciation rights were exercised for $1,026 and the remaining 150,000 stock appreciation rights were surrendered as part of the Company's severance agreement with the officer for $500.
Professional Fees
A former officer of the Company is also a partner in a law firm which served as general counsel to the Company. Legal fees incurred by the Company to this firm during the years ended September 30, 1996, 1995 and 1994 were $307, $2,593 and $5,101, respectively. The officer resigned on June 5, 1995.
A former member of the Board of Directors is also a partner in a law firm which currently serves as general counsel for the Company. Legal fees incurred by the Company to this firm during fiscal 1996, 1995 and 1994 approximated $317, $1,225 and $806, respectively. The partner in the law firm resigned as a director of the Company on October 6, 1995.
Loan to Officer
On February 26, 1993, an officer of IRLP was loaned $250. The principal amount of the loan was due and payable in full on the earlier of January 31, 1996 or the termination of the officer's employment. The loan accrued interest at the prime rate in effect on the date of the loan as adjusted each January 1. The officer terminated his employment on December 22, 1995. The loan and accrued interest was offset against compensation due to the officer as part of the officer's severance. In addition, the officer surrendered all stock appreciation rights which he held.
CORE, Inc.
In the first quarter of fiscal 1995, the Company decided to dispose of its refining operations. During the period from October 14, 1994 to September 29, 1995, the Company financed three attempts to sell one or both of its refineries to CORE Refining Corporation ("CORE") (previously SIPAC, Inc.). CORE is wholly-owned by a director of the Company. The director was also the President and Chief Operating Officer of the Company until January 1996. Pursuant to several agreements with CORE, the Company agreed to reimburse CORE for certain expenses incurred by CORE in attempting to raise financing for a management buyout of one or both of the Company's Refineries. Such agreements with CORE also provided that the Company would be reimbursed for most of such funding should CORE succeed in raising financing. In September 1995, the third CORE attempt to obtain financing for the management buyout failed. During the year ended September 30, 1995, IRLP recorded $3,768 of expenses related to CORE. The Company is not responsible for any CORE expenses incurred after September 29, 1995.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
Payment of Legal Fees for Former Director
In conjunction with the MG Settlement, the Company paid legal fees incurred by a director of the Company. For the years ended September 30, 1996, 1995 and 1994, such fees were $3, $327 and $191, respectively. The director resigned in June 1995.
NOTE 21 -- BUSINESS SEGMENTS
Prior to August 14, 1989, when the Indian Refinery was acquired, the Company was involved in only one business segment, the exploration for and the production of oil and gas and administration of related oil and gas partnerships. Upon the acquisition of the Indian Refinery in August 1989, the Company became engaged in an additional business segment, refining. This segment had no operations until October 1, 1990. On December 3, 1992, the Company entered a third segment of the petroleum business - natural gas marketing. The Company disposed of its partnership administration business in June 1993 but continued its exploration and production business. As a result of the foregoing, the Company operated in three segments of the petroleum business during the fiscal years ended September 30, 1995 and 1994 - refining, natural gas marketing and transmission and exploration and production. As of September 30, 1995, the Company had disposed of its refining segment (see Note 3) and thus operated in only two business segments in fiscal 1996 - natural gas marketing and transmission and exploration and production.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
- ---------------- (1) Includes $152,945 of additions related to the acquisition of Powerine.
NOTE 22 -- DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash, Cash Equivalents and Temporary Investments -- For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
Note receivable - MG - at September 30, 1996, the Company had the following long-term note receivable:
Note - MG $10,000 8%
The Company believes the interest rate on the note approximates the market value given the guarantee of the note by MG AG.
Debt -- At September 30, 1996, the Company had the following debt with interest rates which were fixed:
GECC Loan............................. $10,488 8.33% Subordinated Loan..................... $ 3,518 Prime plus 1%
The Company has recently conducted negotiations with prospective lenders and has ascertained that an interest rate of approximately 9.25% would have been likely if the Company were to have refinanced the GECC loan at September 30, 1996. Accordingly, the estimated fair market value of the GECC loan at September 30, 1996, based upon an interest rate of 9.25%, and anticipated future cash flows, is approximately $10,472.
All other debt is at rates tied to market indices and is considered to be stated at fair value.
Hedges -- At September 30, 1996, the Company had hedged approximately 910 btu of gas that it expects to purchase to sell to MGNG. The book value of such hedges is zero. The fair market value, based upon the market value of the related fixed price hedge contracts, was $316 at September 30, 1996.
Other Current Assets and Current Liabilities - the Company believes that the book values of other current assets and current liabilities approximate the market values.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
NOTE 23 -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following information has been restated to reflect the discontinuance of refining operations, retroactively.
Net income for the quarter ended September 30, 1996 includes an $11,259 tax benefit related to a change in the valuation reserve for deferred tax assets (see Note 2 and 19).
See Note 3 for a discussion of the first quarter gain on the MG Settlement and the quarterly adjustments to the carrying value of net refining assets. Changes in the valuation reserve for deferred tax assets are discussed in Note 19.
The sum of the quarterly per share amounts ($2.09) differs from the annual per share amount ($2.20) primarily because of the 969,000 shares of the Company's common stock acquired on October 14, 1994 as part of the MG Settlement (see Note 3).
NOTE 24 -- SUBSEQUENT EVENTS
Refinancing of GECC Debt
On November 26, 1996, the Company entered into a $25,000 credit facility with a syndicate of banks, including its subordinated lender. The credit facility consists of a $10,000 revolving credit facility and a $15,000 term loan facility. The revolving credit facility is repayable on December 31, 1997. The revolving credit borrowing base is equal to calculated values for the Lone Star Contract and the Company's proved developed producing reserves less the amount outstanding under the term loan facility and cannot exceed $10,000. The term loan facility is $15,000 and is repayable at $500 per month with a balloon payment of remaining principal on May 31, 1999. The revolving credit and term loan facilities bear interest at the prime rate plus 1% and are secured by all of the Company's natural gas marketing and exploration and production assets, as well as the stock and partnership interests of its natural gas marketing and exploration and production subsidiaries. The proceeds of the $25,000 credit facility are to be used to repay the GECC loan, to finance drilling of the Company's Texas properties and for other capital projects. In addition, up to $11,000 can be used to repurchase the Company's stock. The credit facility also contains working capital and tangible net worth covenants.
Castle Energy Corporation Notes to Consolidated Financial Statements ("000's" Omitted Except Share and Per Share Amounts)
As of December 1, 1996, $11,126 was outstanding under the new facility, consisting of $7,592 used to repay the GECC loan, $3,409 contributed by the subordinated lender and a $125 facility fee paid to the bank syndicate.
Repurchase of Shares
In October 1996, the Company announced a plan to repurchase up to 1,000,000 of its shares. Subsequently, the Company repurchased 3,500 of its shares on the open market for $31.
Termination of MG Management Agreements
In December 1996, the Company informed MG of its intention to terminate its pipeline management and gas services agreements with subsidiaries of MG. These agreements are to be terminated January 31, 1997 and the Company intends to perform these functions internally.
Stock Options
In December 1996, 162,500 options expired, 10,000 options were exercised and an additional 32,000 options were issued (see Note 18).
SCHEDULE III
CASTLE ENERGY CORPORATION (PARENT) CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994
The following represents the financial position, statements of operations and statements of cash flows for Castle Energy Corporation, the parent company, as of September 30, 1996, 1995 and 1994 and for the three periods then ended.
CASTLE ENERGY CORPORATION CONDENSED BALANCE SHEETS ("000's" Omitted, except share amounts)
SCHEDULE III
CASTLE ENERGY CORPORATION (PARENT) CONDENSED STATEMENTS OF OPERATIONS ("000's" Omitted)
SCHEDULE III
CASTLE ENERGY CORPORATION (PARENT) CONDENSED STATEMENTS OF CASH FLOWS ("000's" Omitted)
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors CASTLE ENERGY CORPORATION
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Castle Energy Corporation and its subsidiaries at September 30, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Philadelphia, PA January 9, 1997
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
There have been no disagreements on any matter of accounting principles or financial statement disclosure with the Company's independent accountants during the fiscal years ended September 30, 1996, 1995 or 1994 which will be filed with the Securities Exchange Commission pursuant to Rule 14g-6 under the Securities Exchange Act of 1934.
PART III
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 Item 10, 11, 12 and 13 are incorporated by reference to the Registrant's Proxy Statement for its 1997 Annual Meeting of Stockholders.
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 to 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.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the last quarter of the Company's fiscal year ended September 30, 1996.
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: January 3, 1997 By:/s/JOSEPH L. CASTLE II ---------------------- Joseph L. Castle II Chairman of the Board and Chief Executive Officer
Date: January 2, 1997 By:/s/RICHARD E. STAEDTLER ----------------------- Richard E. Staedtler Senior Vice President, Chief Financial Officer and Chief Accounting 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.
/s/JOSEPH L. CASTLE II Chairman of the Board January 3, 1997 - ---------------------- Joseph L. Castle II
/s/MARTIN R. HOFFMANN Director January 7, 1997 - ---------------------- Martin R. Hoffmann
/s/WILLIAM S. SUDHAUS Director January 3, 1997 - ---------------------- William S. Sudhaus
/s/SIDNEY F. WENTZ Director January 3, 1997 - ---------------------- Sidney F. Wentz
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS (December 31, 1996)
JOSEPH L. CASTLE II WILLIAM S. SUDHAUS
Director Director Chairman & Chief Executive Officer President of TALON Resources
MARTIN R. HOFFMANN SIDNEY F. WENTZ
Director Director Of Counsel to Washington, D.C. Chairman of The Robert Wood Johnson Office of Skadden, Arps, Slate, Foundation Meagher & Flom
OPERATING OFFICERS
JOSEPH L. CASTLE II RICHARD E. STAEDTLER Chairman & Chief Executive Officer Chief Financial Officer Chief Accounting Officer
PRINCIPAL OFFICES
Headquarters Drilling And Operating
Castle Energy Corporation Castle Exploration Company, Inc. One Radnor Corporate Center 1815 Washington Road Suite 250 Pittsburgh, PA 15241-1423 100 Matsonford Road Radnor, PA 19087
Exploration And Production Natural Gas Transmission and Marketing
Castle Texas Production Limited Partnership Castle Texas Pipeline Limited 2410 State Highway, 322 North Partnership Henderson, Texas 75652 2410 State Highway, 322 North Henderson, Texas 75652
CEC Gas Marketing Limited Partnership 2410 State Highway, 322 North Henderson, Texas 75652
AGENTS
Counsel Independent Reservoir Engineers
Duane, Morris & Heckscher Huntley & Huntley, Inc. One Liberty Place, 42nd Floor 340 Mansfield Avenue Philadelphia, PA 19103-7396 Pittsburgh, PA 15220
Independent Accountants Ryder Scott Company Petroleum Engineers 600 Seventeenth Street, Suite 900N Price Waterhouse LLP Denver, Colorado 80202 Thirty South Seventeenth Street Philadelphia, PA 19103
Registrant and Transfer Agent
American Stock Transfer 40 Wall Street, 46th Floor New York, New York 10005