** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM10-KSB**

 

 

**                               **ý**       ANNUALREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the fiscal year ended September30, 2005**

** **

**                               **o**         TRANSITIONREPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**CommissionFile Number 1-5103**

 

**BARNWELLINDUSTRIES, INC.**

(Name of small businessissuer in its charter)

 

| **Delaware**                                                    | ** ** | **72-0496921**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |       | (I.R.S. Employer Identification  No.) |

**1100Alakea Street, Suite 2900, Honolulu, Hawaii 96813-2833**

(Addressof principal executive offices)          (Zipcode)

 

**(808)531-8400**

(Issuer’s telephonenumber)

 

**Securitiesregistered under Section 12(b) of the Exchange Act:**

| **Title  of each class** | ** ** | **Name of  each exchange on which registered** |
|--------------------------|------------|------------------------------------------------|
| Common Stock,  par value |       | American Stock  Exchange                       |
| $0.50 per share          |       |                                           |

 

Securities registeredunder Section 12(g) of the Exchange Act: None

 

Check whether the issuer is not required to file reports pursuant toSection 13 or 15(d) of the Exchange Act.  o

 

Check whether the issuer (1) filed all reports required to be filed bySection 13 or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

                                                                              Yes       ý                        No         o

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-KSB or any amendment tothis Form 10-KSB.                                                                                      ý

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

                                                                              Yes       o                        No         ý

 

Issuer’s revenues for the fiscal year ended September 30, 2005: **$44,210,000**

 

Theaggregate market value of the voting stock held by non-affiliates (3,169,552shares) of the Registrant on December 20, 2005, based on the closing priceof $20.50 on that date on the American Stock Exchange, was $64,976,000.

 

Asof December 20, 2005 there were 8,169,060 shares of common stock, par value$0.50, outstanding.

DocumentsIncorporated by Reference

                                1.    Proxystatement to be forwarded to shareholders on or about January 19, 2006 isincorporated by reference in Part III hereof.

 

Transitional Small Business Disclosure Format                                         Yes o   No   ý

 

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TABLE OF CONTENTS
|                                     |                                                                                                                   |   |   |
|------------------------------------------|------------------------------------------------------------------------------------------------------------------------|--------|--------|
| PART  I                                  |                                                                                                                   |   |
| Discussion of Forward-Looking Statements |                                                                                                                   |
| Item 1.                                  | Description  of Business                                                                                               |   |
|                                     | General Development of Business                                                                                        |   |
|                                     | Financial Information about  Industry Segments                                                                         |   |
|                                     | Narrative Description of  Business                                                                                     |   |
|                                     | Financial Information about  Foreign and Domestic Operations and Export Sales                                          |   |
| Item 2.                                  | Description  of Property                                                                                               |   |
|                                     | Oil and  Natural Gas Operations                                                                                        |   |
|                                     | General                                                                                                                |   |
|                                     | Well Drilling Activities                                                                                               |   |
|                                     | Oil and Natural Gas Production                                                                                         |   |
|                                     | Productive Wells                                                                                                       |   |
|                                     | Developed Acreage and  Undeveloped Acreage                                                                             |   |
|                                     | Reserves                                                                                                               |   |
|                                     | Estimated Future Net Revenues                                                                                          |   |
|                                     | Marketing of Oil and Natural Gas                                                                                       |   |
|                                     | Governmental Regulation                                                                                                |   |
|                                     | Competition                                                                                                            |   |
|                                     | Contract Drilling Operations                                                                                           |   |
|                                     | Activity                                                                                                               |   |
|                                     | Competition                                                                                                            |   |
|                                     | Land  Investment Operations                                                                                            |   |
|                                     | Activity                                                                                                               |   |
|                                     | Competition                                                                                                            |   |
|                                     | Corporate Office                                                                                                       |   |
| Item 3.                                  | Legal  Proceedings                                                                                                     |   |
| Item 4.                                  | Submission of Matters to a  Vote of Security Holders                                                                   |   |
| PART II                                  |                                                                                                                   |   |
| Item 5.                                  | Market  For Common Equity and Related Stockholder Matters                                                              |   |
| Item 6.                                  | Management’s  Discussion and Analysis or Plan of Operation                                                        |   |
|                                     | Results  of Operations                                                                                                 |   |
|                                     | Liquidity and Capital Resources                                                                                        |   |
| Item 7.                                  | Financial Statements                                                                                                   |   |
| Item 8.                                  | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                             |   |
| Item 8A.                                 | Controls and  Procedures                                                                                               |   |
| Item 8B.                                 | Other Information                                                                                                      |   |
| PART III                                 |                                                                                                                   |   |
| Item 9.                                  | Directors,  Executive Officers, Promoters and Control Persons, Compliance With  Section 16(a) of the Exchange Act |   |
| Item 10.                                 | Executive  Compensation                                                                                                |   |
| Item 11.                                 | Security  Ownership of Certain Beneficial Owners and Management                                                        |   |
| Item 12.                                 | Certain  Relationships and Related Transactions                                                                        |   |
| Item 13.                                 | Exhibits and  Reports on Form 8-K                                                                                      |   |
| Item 14.                                 | Principal  Accountant Fees and Services                                                                                |   |

 

2

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PART I

 

Forward-LookingStatements

 

This Form 10-KSB, and the documents incorporatedherein by reference, contain forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended, including various forecasts,projections of Barnwell Industries, Inc.’s (referred to herein together withits subsidiaries as “Barnwell”) future performance, statements of Barnwell’splans and objectives and other similar types of information.  Although Barnwell believes that itsexpectations are based on reasonable assumptions, it cannot assure that theexpectations contained in such forward-looking statements will beachieved.  Such statements involve risks,uncertainties and assumptions, including, but not limited to, those relating tothe factors discussed below, in other portions of this Form 10-KSB, in the Notesto Consolidated Financial Statements, and in other documents filed by Barnwellwith the Securities and Exchange Commission from time to time, which couldcause actual results to differ materially from those contained in suchstatements.  These forward-lookingstatements speak only as of the date of filing of this Form 10-KSB, andBarnwell expressly disclaims any obligation or undertaking to publicly releaseany updates or revisions to any forward-looking statements contained herein.

 

Barnwell’s oil and natural gas operations are affectedby domestic and international political, legislative, economic, regulatory andlegal actions.  Such actions may includechanges in the policies of the Organization of Petroleum Exporting Countries orother developments involving or affecting oil-producing countries, includingmilitary conflict, embargoes, internal instability or actions or reactions ofthe government of the United States in anticipation of or in response to suchdevelopments.  Domestic and internationaleconomic conditions, such as recessionary trends, inflation, interest costs,monetary exchange rates and labor costs, as well as changes in the availabilityand market prices of crude oil, natural gas and other petroleum products, mayalso have a significant effect on Barnwell’s oil and natural gasoperations.  While Barnwell maintainsreserves for anticipated liabilities and carries various levels of insurance,Barnwell could be affected by civil, criminal, regulatory or administrativeactions, claims or proceedings.  Inaddition, climate and weather can significantly affect Barnwell in several ofits operations.  Barnwell’s oil and gasoperations are also affected by political developments and laws andregulations, particularly in the United States and Canada, such as restrictionson production, restrictions on imports and exports, the maintenance ofspecified reserves, tax increases and retroactive tax claims, expropriation ofproperty, cancellation of contract rights, environmental protection controls,environmental compliance requirements and laws pertaining to workers’ healthand safety.  Costs of compliance withenvironmental laws are ingrained in Barnwell’s expenses and not distinguishedfrom other costs and expenses.

 

Barnwell’s land investment business segment isaffected by the condition of Hawaii’s real estate market.  The Hawaii real estate market is affected byHawaii’s economy and Hawaii’s tourism industry, as well as the United States’economy in general.  Any future cashflows from Barnwell’s land development activities are subject to, among otherfactors, the level of real estate activity and prices, the demand for newhousing and second homes on the Island of Hawaii, the rate of increase in thecost of building materials and labor, the introduction of building codemodifications, changes to zoning laws, and the level of confidence in Hawaii’seconomy.

 

Barnwell’s contract drilling operations, which arelocated in Hawaii, are also indirectly affected by the factors discussed in thepreceding paragraph.  Barnwell’s contractdrilling operations are 

 

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materially dependent upon levels of land development activity inHawaii.  Such activity levels areaffected by both short-term and long-term trends in Hawaii’s economy.  A decline in land development activity inHawaii could have a material adverse effect on Barnwell’s contract drillingrevenues and profitability.

 

All dollar amounts in this report are in U.S. dollars,unless otherwise noted.

 

 

Item 1.            Description of Business

 

                (a)       GeneralDevelopment of Business

 

Barnwell was incorporated in Delaware in 1956.  During its last three fiscal years, Barnwellwas engaged in 1) oil and natural gas exploration, development, production andsales primarily in Canada (oil and natural gas segment), 2) investment inleasehold land in Hawaii (land investment segment), and 3) well drilling,contract labor servicing for geothermal well drilling and workovers, and waterpumping system installation and repair in Hawaii (contract drilling segment).

 

Barnwell’s oil and natural gas activities comprise itslargest business segment.  Approximately 74%of Barnwell’s revenues for the fiscal year ended September 30, 2005 wasattributable to its oil and natural gas activities.  Barnwell’s contract drilling activities accountedfor 17% of fiscal 2005 revenues; Barnwell’s land investment segment revenuesaccounted for 7% of fiscal 2005 revenues; and other revenues comprised 2% offiscal 2005 revenues.  Approximately 97%of Barnwell’s capital expenditures for the fiscal year ended September 30, 2005was attributable to oil and natural gas activities and 3% was applicable toother activities.

 

(i)            Oil and Natural Gas Activities. Barnwell’s wholly-owned subsidiary, Barnwell of Canada, Limited, isinvolved in the acquisition, exploration and development of oil and natural gasproperties, principally in Alberta, Canada. Barnwell of Canada initiates and participates in exploratory anddevelopmental operations for oil and natural gas on property in which it has aninterest, and evaluates proposals by third parties with regard to participationin such exploratory and developmental operations elsewhere.  Barnwell’s oil and natural gas segment derived62% of its oil and natural gas revenues in fiscal 2005 from four individuallysignificant marketers, ProGas Limited (25%), Glencoe Resources Limited(15%), Coral Energy Canada Inc. (11%), and Plains Marketing Canada, L.P. (11%).

 

(ii)           ContractDrilling.  Barnwell’s wholly-owned subsidiary, Water ResourcesInternational, Inc. (“Water Resources”), drills wells and installs and repairswater pumping systems in Hawaii.  WaterResources owns and operates four rotary drill rigs, a rotary drill/workoverrig, pump installation and service equipment, and maintains drilling materialsand pump inventory in Hawaii.  WaterResources’ contracts are usually fixed price per lineal foot drilled or dayrate contracts that are either negotiated with private entities or are obtainedthrough competitive bidding with various private entities or local, state and federalagencies.  Barnwell’s contract drillingsubsidiary derived 63%, 70%, and 66% of its contract drilling revenues infiscal 2005, 2004, and 2003, respectively, pursuant to federal, State of Hawaiiand county contracts.

 

(iii)          LandInvestment.  Barnwell owns a 77.6%controlling interest in Kaupulehu Developments, a Hawaii general partnershipwhich owns interests in leasehold land and development rights for propertylocated approximately six miles north of the Kona International Airport in theNorth 

 

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Kona District of the Island of Hawaii. Between 1986 and 1989, Kaupulehu Developments obtained the state andcounty zoning changes necessary to permit development of the Four SeasonsResort Hualalai at Historic Ka’upulehu and Hualalai Golf Club, which opened in1996, a second golf course, and single-family and multi-family residentialunits.  These projects were developed onleasehold land acquired from Kaupulehu Developments by Kaupulehu Makai Venture,an unrelated entity that is an affiliate of Kajima Corporation of Japan.  Kaupulehu Developments later obtained thestate and county zoning changes necessary to permit development of single-familyand multi-family residential units, a golf course and a limited commercial areaon approximately 870 leasehold acres located adjacent to and north of the FourSeasons Resort Hualalai at Historic Ka’upulehu. In 2004, Kaupulehu Developments’ leasehold interest in the firstincrement of these 870 acres was sold to WB KD Acquisition LLC, an independentthird party.

 

Kaupulehu Developments currently owns developmentrights under option; rights to receive percentage payments on the firstincrement of the approximately 870 leasehold acres; an interest in leaseholdland zoned for resort/residential development within the second increment ofthe approximately 870 leasehold acres, which is under a right of negotiation;and approximately 1,000 acres of vacant leasehold land zoned conservation.

 

                (b)       FinancialInformation about Industry Segments

 

Revenues of each industry segment for the fiscal yearsended September 30, 2005, 2004, and 2003 are summarized as follows (allrevenues were from unaffiliated customers with no intersegment sales ortransfers):

 
| ** **             | ** ** | **2005**       | ** **     | **2004**   | ** ** | **2003**   | ** ** |
|------------------------|------------|----------------|----------------|------------|------------|------------|------------|
| Oil and natural gas    | ** ** | **$**          | **32,724,000** | ** ** | **74**     | %          | $          | 23,840,000 |   | 62 | % | $ | 19,830,000 |   | 82 | % |
| Contract drilling      | ** ** | **7,644,000**  | ** **     | **17**     | %          | 3,690,000  |       | 10 | % | 2,050,000 |   | 9 | % |
| Land investment        | ** ** | **3,047,000**  | ** **     | **7**      | %          | 10,077,000 |       | 26 | % | 1,220,000 |   | 5 | % |
| Other                  | ** ** | **652,000**    | ** **     | **2**      | %          | 827,000    |       | 2 | % | 720,000 |   | 3 | % |
| Revenues from segments | ** ** | **44,067,000** | ** **     | **100**    | %          | 38,434,000 |       | 100 | % | 23,820,000 |   | 99 | % |
| Interest income        | ** ** | **143,000**    | ** **     | **0**      | %          | 106,000    |       | 0 | % | 340,000 |   | 1 | % |
| Total revenues         | ** ** | **$**          | **44,210,000** | ** ** | **100**    | %          | $          | 38,540,000 |   | 100 | % | $ | 24,160,000 |   | 100 | % |
|                        |            |                |                |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

For further discussion see Note 11 (SEGMENT ANDGEOGRAPHIC INFORMATION) and Note 13 (CONCENTRATIONS OF CREDIT RISK) of “Notesto Consolidated Financial Statements” in Item 7.

 

                (c)       NarrativeDescription of Business

 

See the table above in Item 1(b) detailing revenue ofeach industry segment and description of each industry segment of Barnwell’sbusiness under Item 2.

 

Asof September 30, 2005, Barnwell employed 52 employees, 50 of which are on afull-time basis.  Twenty-five areemployed in contract drilling activities, 16 are employed in oil and naturalgas activities, and 11 are members of the corporate and administrative staff.

 

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Forfurther discussion see the “Governmental Regulation” section and the “Competition”section in Item 2 hereof.

 

(d)                     Financial Information about Foreign andDomestic Operations and Export Sales

 

Revenues and long-lived assets by geographic area forthe three years ended and as of September 30, 2005, 2004 and 2003 are setforth in Note 11 (SEGMENT AND GEOGRAPHIC INFORMATION) of “Notes to ConsolidatedFinancial Statements” in Item 7.

 

 

Item 2.            Description of Property

 

OIL AND NATURAL GASOPERATIONS

 

General

 

Barnwell’s investments in oil and natural gasproperties consist of investments in Canada, principally in the Province ofAlberta, with minor holdings in the Provinces of Saskatchewan and BritishColumbia.  These property interests areprincipally held under governmental leases or licenses.  Under the typical Canadian provincialgovernmental lease, Barnwell must perform exploratory operations and complywith certain other conditions.  Leaseterms vary with each province, but, in general, the terms grant Barnwell theright to remove oil, natural gas and related substances subject to payment ofspecified royalties on production.

 

Barnwellinitiates and participates in exploratory and developmental operations for oiland natural gas on property in which it has an interest.  Barnwell also evaluates proposals by thirdparties for participation in other exploratory and developmentalopportunities.  All exploratory anddevelopmental operations are overseen by Barnwell’s Calgary, Alberta staffalong with independent consultants as necessary.  In fiscal 2005, Barnwell participated inexploratory and developmental operations in the Canadian Province of Alberta,although Barnwell does not limit its consideration of exploratory anddevelopmental operations to this area.

 

Barnwell’s producing natural gas and oil propertiesare located principally in Alberta.  Asmall number of producing properties, representing less than 5% of production,are located in British Columbia and Saskatchewan.  The Province of Alberta determines itsroyalty share of natural gas and of oil by using reference prices that averageall natural gas sales and oil sales, respectively, in Alberta.  Royalty rates are calculated on a slidingscale basis, increasing as prices increase up to a maximum royalty rate of 35%.  Additionally, Barnwell pays gross overridingroyalties and leasehold royalties on a portion of its natural gas and oil salesto parties other than the Province of Alberta.

 

Infiscal 2005 and 2004, the weighted average rate of royalties paid on all ofBarnwell’s natural gas was approximately 27%. The weighted average rate of all royalties paid to governments andothers on natural gas from the Dunvegan Unit, Barnwell’s principal oil andnatural gas property, before the Alberta Royalty Tax Credit, was approximately31% and 30% in fiscal 2005 and 2004, respectively.  New production coming on line at lowerroyalty rates essentially offset the increase in the weighted average royaltyrate at Dunvegan.

 

6

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Infiscal 2005 and 2004, the weighted average royalty rate paid on oil wasapproximately 24% and 22%, respectively. The increase in the weighted average royalty rate on oil was primarilydue to higher oil prices and the expiry of certain royalty holidays on new oilproperties.

 

Prices of natural gas are typically higher in thewinter than at other times due to demand for heating.  Prices of oil are also subject to seasonalfluctuations, but to a lesser degree. Unit sales of oil and natural gas are based on the quantity producedfrom the properties by the operator based on sound petroleum practices and applicablerules and regulations.  During periods oflow demand for natural gas, the operator of the Dunvegan property may re-injectnatural gas into underground storage facilities for delivery at a future date.

 

Well Drilling Activities

 

Duringfiscal 2005, Barnwell participated in the drilling of 70 gross developmentwells and 10 gross exploratory wells, of which management believes 69should be capable of production and 11 are dry holes.  The most significant drilling operations tookplace in the Dunvegan, Bonanza, Doris and Progress areas.

 

Thefollowing table sets forth more detailed information with respect to the numberof exploratory (“Exp.”) and development (“Dev.”) wells drilled for the fiscalyears ended September 30, 2005, 2004, and 2003 in which Barnwell participated:

 
| ** ** | ** ** | **Productive** | ** ** | **Productive** | ** ** | **Total Productive** | ** ** | ** **    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------|------------|----------------|------------|----------------|------------|----------------------|------------|---------------|------------|-----------------|------------|------------|------------|------------|------------|
| ** ** | ** ** | **Oil Wells**  | ** ** | **Gas Wells**  | ** ** | **Wells**            | ** ** | **Dry Holes** | ** ** | **Total Wells** | ** ** |
| ** ** | ** ** | **Exp.**       | ** ** | **Dev.**       | ** ** | **Exp.**             | ** ** | **Dev.**      | ** ** | **Exp.**        | ** ** | **Dev.**   | ** ** | **Exp.**   | ** ** | **Dev.** | ** ** | **Exp.** | ** ** | **Dev.** | ** ** |
| **2005**   | ** ** | ** **     | ** ** | ** **     | ** ** | ** **           | ** ** | ** **    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Gross*** | ** ** | **1.0**        | ** ** | **7.0**        | ** ** | **4.0**              | ** ** | **57.0**      | ** ** | **5.0**         | ** ** | **64.0**   | ** ** | **5.0**    | ** ** | **6.0** | ** ** | **10.0** | ** ** | **70.0** | ** ** |
| **Net***   | ** ** | **0.3**        | ** ** | **1.7**        | ** ** | **1.0**              | ** ** | **7.3**       | ** ** | **1.3**         | ** ** | **9.0**    | ** ** | **1.6**    | ** ** | **1.6** | ** ** | **2.9** | ** ** | **10.6** | ** ** |
|       |       |           |       |           |       |                 |       |          |       |            |       |       |       |       |       |   |   |   |   |   |   |
| 2004       |       |           |       |           |       |                 |       |          |       |            |       |       |       |       |       |   |   |   |   |   |   |
| Gross*     |       | 3.0            |       | 5.0            |       | 6.0                  |       | 120.0         |       | 9.0             |       | 125.0      |       | 7.0        |       | 3.0 |   | 16.0 |   | 128.0 |   |
| Net*       |       | 0.9            |       | 0.3            |       | 2.1                  |       | 7.9           |       | 3.0             |       | 8.2        |       | 3.1        |       | 0.3 |   | 6.1 |   | 8.5 |   |
|       |       |           |       |           |       |                 |       |          |       |            |       |       |       |       |       |   |   |   |   |   |   |
| 2003       |       |           |       |           |       |                 |       |          |       |            |       |       |       |       |       |   |   |   |   |   |   |
| Gross*     |       | —         |       | 5.0            |       | 8.0                  |       | 40.0          |       | 8.0             |       | 45.0       |       | 5.0        |       | 7.0 |   | 13.0 |   | 52.0 |   |
| Net*       |       | —         |       | 1.5            |       | 2.1                  |       | 7.5           |       | 2.1             |       | 9.0        |       | 1.5        |       | 2.1 |   | 3.6 |   | 11.1 |   |

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*                 The term “Gross” refers to the total number of wellsin which Barnwell owns an interest, and “Net” refers to Barnwell’s aggregateinterest therein.  For example, a 50%interest in a well represents 1 gross well, but 0.5 net well.  The gross figure includes interests owned ofrecord by Barnwell and, in addition, the portion owned by others.

 

The Dunvegan Unit, in which Barnwell holds an 8.9%working interest, is Barnwell’s principal oil and natural gas property and islocated in Alberta, Canada.  At September30, 2005, the Dunvegan Unit had 188 producing natural gas wells.  In fiscal 2005, Barnwell participated in thedrilling of 41 gross (3.7 net) development gas wells in the Dunvegan area, allof which were successful.  Total capitalexpenditures at Dunvegan were $4,299,000 in fiscal 2005 as compared to$3,670,000 and $1,223,000 in 

 

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fiscal 2004 and 2003, respectively. Barnwell expects that fiscal 2006 capital expenditures at Dunvegan willdecline from fiscal 2005’s level.

 

                Capitalexpenditures totaled $2,023,000 in the Doris area in fiscal 2005 as compared to$735,000 in fiscal 2004.  Six gross wells(2.4 net wells) were drilled in fiscal 2005 of which four gross wells (1.7 netwells) were successful and two gross wells (0.7 net well) were unsuccessful.  In the Doris area Barnwell acquired oil andnatural gas rights in 4,480 gross (3,200 net) acres of undeveloped land infiscal 2005.  At September 30, 2005Barnwell held a 44% average working interest in productive wells in the Dorisarea.

 

                Capital expenditures totaled$1,987,000 in the Bonanza area in fiscal 2005 as compared to $1,740,000 infiscal 2004.  Five gross wells (1.6 netwells) were drilled in fiscal 2005 of which two gross wells (0.6 net wells)were successful and tied in and producing at September 30, 2005, and threegross wells (1.0 net wells) were unsuccessful. In the Bonanza area Barnwell acquired oil and natural gas rights in 6,400gross (3,348 net) acres of undeveloped land in fiscal 2005.  At September 30, 2005 Barnwell held a 32%average working interest in productive wells in the Bonanza area.

 

                Capitalexpenditures totaled $1,670,000 in the Progress area in fiscal 2005 as comparedto $550,000 in fiscal 2004.  Three grosswells (0.9 net well) were drilled in fiscal 2005 of which two were successfuland one is being evaluated.  In theProgress area Barnwell acquired oil and natural gas rights in 1,280 gross (720net) acres of undeveloped land in fiscal 2005. At September 30, 2005 Barnwell held a 32% average working interest in productivewells in the Progress area.

 

                Capitalexpenditures totaled $531,000 in the Wood River area in fiscal 2005 as comparedto $615,000 in fiscal 2004.  Four grosswells (0.4 net wells) were successfully drilled in fiscal 2005.  At September 30, 2005 Barnwell held a 14%average working interest in productive wells in the Wood River area.

 

Barnwell’saverage working interest in wells drilled in fiscal 2005 was approximately 17%,as compared to 10% in fiscal 2004 and 23% in fiscal 2003.  The increase in fiscal 2005, as compared tofiscal 2004, was principally due to an 81 gross (2.7 net) well drilling programin fiscal 2004 in the Hilda area, where Barnwell’s interest averaged 3.3%, whichreduced Barnwell’s average net interest in fiscal 2004.  In fiscal 2005, Barnwell initiated 27 grosswells (8.8 net wells) as compared to 20 gross wells (7.9 net wells) in fiscal 2004.

 

Oil and Natural GasProduction

 

The following table summarizes (a) Barnwell’s net unitproduction for the last three fiscal years, based on sales of crude oil,natural gas, condensate and other natural gas liquids, from all wells in whichBarnwell has or had an interest, and (b) the average sales prices and averageproduction costs for such production during the same periods.  Production amounts reported are net ofroyalties and the Alberta Royalty Tax Credit. Barnwell’s net production in fiscal 2005, 2004, and 2003 was derivedprimarily from the Province of Alberta.

 

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| ** **                                            | ** ** | **Year Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|
| ** **                                            | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Annual net production:                                |       |                         |       |   |   |   |   |
| Natural gas  liquids (BBLS)*                          | ** ** | **114,000**                  |       | 105,000 |   | 85,000 |   |
| Oil (BBLS)*                                           | ** ** | **139,000**                  |       | 154,000 |   | 142,000 |   |
| Natural gas  (MCF)*                                   | ** ** | **3,621,000**                |       | 3,383,000 |   | 3,175,000 |   |
|                                                  |       |                         |       |   |   |   |   |
| Annual average  sale price per unit of production:    |       |                         |       |   |   |   |   |
| BBL of liquids**                                      | ** ** | **$**                        | **31.84**  |   | $ | 24.18 |   | $ | 21.50 |   |
| BBL of oil**                                          | ** ** | **$**                        | **48.11**  |   | $ | 33.24 |   | $ | 27.69 |   |
| MCF of natural  gas***                                | ** ** | **$**                        | **5.93**   |   | $ | 4.60 |   | $ | 4.27 |   |
|                                                  |       |                         |       |   |   |   |   |
| Annual average  production cost per MCFE produced**** | ** ** | **$**                        | **1.20**   |   | $ | 1.11 |   | $ | 0.93 |   |
|                                                  |       |                         |       |   |   |   |   |
| Annual average  depletion cost per MCFE produced***** | ** ** | **$**                        | **1.66**   |   | $ | 1.31 |   | $ | 0.90 |   |

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*                                         When used in this report, the term “BBL(S)”means stock tank barrel(s) of oil equivalent to 42 U.S. gallons and the term “MCF”means 1,000 cubic feet of natural gas at 14.65 pounds per square inch absoluteand 60 degrees F.

**                                  Calculated on revenues before royaltyexpense and royalty tax credit divided by gross production.

***                           Calculated on revenues net of pipelinecharges before royalty expense and royalty tax credit divided by grossproduction.

****                    Naturalgas liquids, oil and natural gas units were combined by converting barrels ofnatural gas liquids and oil to an MCF equivalent (“MCFE”) on the basis of 1 BBL= 5.8 MCF.  Excludes natural gas pipelinecharges.

*****             Naturalgas liquids, oil and natural gas units were combined by converting barrels ofnatural gas liquids and oil to an MCF equivalent (“MCFE”) on the basis of 1 BBL= 5.8 MCF.

 

Infiscal 2005, approximately 68%, 21% and 11% of Barnwell’s oil and natural gasrevenues were from the sale of natural gas, oil and natural gas liquids,respectively.

 

Infiscal 2005, Barnwell’s net production after royalties for natural gas averaged9,920 MCF per day, an increase of 7% from 9,240 MCF per day in fiscal2004.  Gross natural gas production alsoincreased 7% in fiscal 2005, as compared to fiscal 2004.  Dunvegan contributed approximately 48% ofBarnwell’s net natural gas production in fiscal 2005, an increase from 44% infiscal 2004 due to the new well drilling at Dunvegan.

 

Barnwell’smajor oil producing properties are the Red Earth, Chauvin and Bonanza areas inCanada.  In fiscal 2005, net productionafter royalties for oil averaged 380 barrels per day, a decrease of 10% from420 barrels per day in fiscal 2004.  Thisdecrease was principally due to natural production declines at Red Earth.

 

Infiscal 2005, net production after royalties for natural gas liquids averaged 310barrels per day, an increase of 7% from 290 barrels per day in fiscal2004.  This increase was due to higherDunvegan 

 

9

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production which increased 12% or 29barrels per day.  Dunvegan contributedapproximately 82% of Barnwell’s net natural gas liquids production in fiscal2005.

 

Theaverage production cost per MCFE was $1.20 for fiscal 2005, an 8% increase from$1.11 for fiscal 2004.  The increase was dueto an 8% increase in the average exchange rate of the Canadian dollar to theU.S. dollar in fiscal 2005, as compared to fiscal 2004.

 

Theaverage depletion cost per MCFE was $1.66 for fiscal 2005, a 27% increase from$1.31 for fiscal 2004.  The increase wasdue to a 17% increase in the depletion rate and an 8% increase in the averageexchange rate of the Canadian dollar to the U.S. dollar.

 

Thehigher depletion rate is due to increases in Barnwell’s costs of finding anddeveloping proven reserves, and costs that are incurred to decrease the rate ofproduction declines or maintain or increase rates of production from reservesfound in previous years.  Barnwell’s costof finding and developing proven reserves has increased due to the cost of oiland natural gas exploration and development having increased along with productprices, the drilling of unsuccessful wells, and as a portion of recent oil andnatural gas capital expenditures were for the development of existing reserves.

 

Infiscal 2004, approximately 67%, 22% and 11% of Barnwell’s oil and natural gasrevenues were from the sale of natural gas, oil and natural gas liquids,respectively.

 

Infiscal 2004, Barnwell’s net production after royalties for natural gas averaged9,240 MCF per day, an increase of 6% from 8,700 MCF per day in fiscal2003.  Gross natural gas production alsoincreased 6% in fiscal 2004, as compared to fiscal 2003.  Dunvegan contributed approximately 44% ofBarnwell’s net natural gas production in fiscal 2004, an increase from 43% infiscal 2003.

 

Infiscal 2004, net production after royalties for oil averaged 420 barrels perday, an increase of 8% from 390 barrels per day in fiscal 2003.  This increase was due to new production fromthe Bonanza and Wizard Lake areas, partially offset by decreases in productionat certain older properties.

 

Infiscal 2004, net production after royalties for natural gas liquids averaged290 barrels per day, an increase of 26% from 230 barrels per day in fiscal2003.  This increase was due to increasedproduction from the Dunvegan area and to a fire in early October 2002 at aDunvegan gas plant that prevented stripping of natural gas liquids from thenatural gas, resulting in an approximately 6,000 barrel decline in liquids netproduction in fiscal 2003.

 

Theaverage production cost per MCFE was $1.11 for fiscal 2004, a 19% increase from$0.93 for fiscal 2003.  The increase wasdue to the addition of new properties, costs incurred to re-enter wells forrepair, maintenance and cleaning, and inflationary pressures on oil fieldservice costs.  Also contributing to theincrease was a 10% increase in the average exchange rate of the Canadian dollarto the U.S. dollar which increased the average production cost per MCFE by $0.10in fiscal 2004, as compared to fiscal 2003.

 

Theaverage depletion cost per MCFE was $1.31 for fiscal 2004, a 46% increase from$0.90 for fiscal 2003.  The increase isthe result of increased costs of finding and developing proven reserves, ascompared to prior years, and a 10% increase in the average exchange rate of theCanadian dollar to the U.S. dollar which increased the average depletion costper MCFE by $0.12 in fiscal 2004, as compared to fiscal 2003.

 

10

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Thefollowing table sets forth the gross and net number of productive wells Barnwellhas an interest in as of September 30, 2005

 

## ProductiveWells

| ** **       | ** ** | **Productive Wells*** | ** ** |
|------------------|------------|-----------------------|------------|
| ** **       | ** ** | **Gross****           | ** ** | **Net**** | ** ** |
| **Location**     | ** ** | **Oil**               | ** ** | **Gas** | ** ** | **Oil** | ** ** | **Gas** | ** ** |
| Canada           |       |                  |       |   |   |   |   |   |   |
| Alberta          |       | 142                   |       | 581 |   | 24.1 |   | 57.8 |   |
| Saskatchewan     |       | 7                     |       | 34 |   | 0.3 |   | 5.6 |   |
| British Columbia |       | 2                     |       | — |   | 0.5 |   | — |   |
| Total            |       | 151                   |       | 615 |   | 24.9 |   | 63.4 |   |

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*                                         Twelvegross natural gas wells have dual or multiple completions and two gross oilwells have dual completions.

**                                  Please see note (2) on the followingtable.

 

Developed Acreage andUndeveloped Acreage

 

The following table sets forth certain informationwith respect to oil and natural gas properties of Barnwell as of September 30,2005

 
| ** **       | ** ** | ** **     | ** ** | ** **      | ** ** | ** **      | ** ** | ** ** | ** ** | **Developed and** | ** ** |
|------------------|------------|----------------|------------|-----------------|------------|-----------------|------------|------------|------------|-------------------|------------|
| ** **       | ** ** | **Developed**  | ** ** | **Undeveloped** | ** ** | **Undeveloped** | ** ** |
| ** **       | ** ** | **Acreage(1)** | ** ** | **Acreage(1)**  | ** ** | **Acreage(1)**  | ** ** |
| **Location**     | ** ** | **Gross(2)**   | ** ** | **Net(2)**      | ** ** | **Gross(2)**    | ** ** | **Net(2)** | ** ** | **Gross(2)**      | ** ** | **Net(2)** | ** ** |
| Canada           |       |           |       |            |       |            |       |       |       |              |       |   |   |
| Alberta          |       | 231,425        |       | 33,328          |       | 237,021         |       | 102,150    |       | 468,446           |       | 135,478 |   |
| British Columbia |       | 1,597          |       | 476             |       | 3,490           |       | 1,115      |       | 5,087             |       | 1,591 |   |
| Saskatchewan     |       | 3,140          |       | 426             |       | —          |       | —     |       | 3,140             |       | 426 |   |
| Total            |       | 236,162        |       | 34,230          |       | 240,511         |       | 103,265    |       | 476,673           |       | 137,495 |   |

----

(1)                “Developed Acreage” includes the acres covered byleases upon which there are one or more producing wells.  “Undeveloped Acreage” includes acres coveredby leases upon which there are no producing wells and which are maintained ineffect by the payment of delay rentals or the commencement of drilling thereon.

 

(2)                “Gross”also refers to the total number of acres or wells in which Barnwell owns aninterest, and “Net” refers to Barnwell’s aggregate interest therein.  For example, a 50% interest in a 320 acrelease represents 320 Gross Acres and 160 Net Acres.  The gross acreage and well figures includeinterests owned of record by Barnwell and, in addition, the portion owned byothers.

 

Barnwell’sleasehold interests in its undeveloped acreage expire over the next fiscalyears, if not developed, as follows: 6% expire during fiscal 2006; 6% expireduring fiscal 2007; 18% expire during fiscal 2008; 32% expire during fiscal2009; and 25% expire during fiscal 2010. Thirteen percent of Barnwell’sundeveloped acreage is not subject to expiration because they are related toheavy oil and other areas where leases are allowed to continue indefinitelywithout having a well on the acreage.  

 

11

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Therecan be no assurance that Barnwell will be successful in renewing its leaseholdinterests in the event of expiration.

 

Barnwell’s undeveloped acreage includes majorconcentrations in Alberta, at Bremner (8,640 net acres), Bonanza (6,352 netacres), Boundary Lake (6,326 net acres), Thornbury (6,261 net acres), Mulligan(4,708 net acres), Paddle River (5,760 net acres), Swalwell (4,000 net acres),Red Earth (3,271 net acres) and Doris (5,568 net acres).

 

# Reserves

 

Theamounts set forth in the table below, prepared by Paddock Lindstrom &Associates Ltd., Barnwell’s independent reservoir engineering consultants,summarize the estimated net quantities of proved producing reserves and provedreserves of crude oil (including condensate and natural gas liquids) andnatural gas as of September 30, 2005, 2004, and 2003 on all properties in whichBarnwell has an interest.  These reservesare before deductions for indebtedness secured by the properties and are basedon constant dollars.  No estimates oftotal proved net oil or natural gas reserves have been filed with or includedin reports to any federal authority or agency, other than the United States Securitiesand Exchange Commission, since October 1, 2003.

 

Proved Producing Reserves
| ** **                                             | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|
| ** **                                             | ** ** | **2005**          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Oil - barrels  (BBLS) (including natural gas liquids): |       |              |       |   |   |   |   |
| Dunvegan                                               | ** ** | **456,000**       |       | 446,000 |   | 479,000 |   |
| All other  properties                                  | ** ** | **646,000**       |       | 689,000 |   | 783,000 |   |
| Total                                                  | ** ** | **1,102,000**     |       | 1,135,000 |   | 1,262,000 |   |
|                                                   |       |              |       |   |   |   |   |
| Natural gas —  thousand cubic feet (MCF):         |       |              |       |   |   |   |   |
| Dunvegan                                               | ** ** | **12,947,000**    |       | 13,796,000 |   | 13,598,000 |   |
| All other  properties                                  | ** ** | **8,895,000**     |       | 7,818,000 |   | 7,865,000 |   |
| Total                                                  | ** ** | **21,842,000**    |       | 21,614,000 |   | 21,463,000 |   |

 

Total Proved Reserves

  (Includes Proved Producing Reserves)
| ** **                                             | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|
| ** **                                             | ** ** | **2005**          | ** ** | **2004** | ** ** | **2003** | ** ** |
| Oil - barrels  (BBLS) (including natural gas liquids): |       |              |       |   |   |   |   |
| Dunvegan                                               | ** ** | **489,000**       |       | 524,000 |   | 559,000 |   |
| All other  properties                                  | ** ** | **817,000**       |       | 780,000 |   | 842,000 |   |
| Total                                                  | ** ** | **1,306,000**     |       | 1,304,000 |   | 1,401,000 |   |
|                                                   |       |              |       |   |   |   |   |
| Natural gas —  thousand cubic feet (MCF):         |       |              |       |   |   |   |   |
| Dunvegan                                               | ** ** | **13,858,000**    |       | 15,975,000 |   | 16,095,000 |   |
| All other  properties                                  | ** ** | **11,376,000**    |       | 10,850,000 |   | 11,544,000 |   |
| Total                                                  | ** ** | **25,234,000**    |       | 26,825,000 |   | 27,639,000 |   |

 

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As of September 30, 2005, essentially all of Barnwell’sproved producing and total proved reserves were located in the Province ofAlberta, with minor volumes located in the Provinces of Saskatchewan andBritish Columbia.

 

Duringfiscal 2005, Barnwell’s total net proved reserves, including proved producingreserves, of oil, condensate and natural gas liquids increased by 2,000barrels, and total net proved reserves of natural gas decreased by 1,591,000MCF.

 

Thechange in oil, condensate and natural gas liquids reserves was the net resultof production during the year of 253,000 barrels, the addition of 179,000barrels from the drilling of productive wells, and the independent engineer’s76,000 barrel upward revision of Barnwell’s oil reserves.

 

Thechange in natural gas reserves was the net result of production during the yearof 3,621,000 MCF, the addition of 3,266,000 MCF from the drilling of productivenatural gas wells and the independent engineer’s 1,236,000 MCF downwardrevision of Barnwell’s natural gas reserves. The downward revision was caused by prior year wells not performing asanticipated.

 

Barnwell’s working interest in the Dunvegan areaaccounted for approximately 55% and 60% of its total proved natural gasreserves at September 30, 2005 and 2004, respectively, and approximately 37%and 40% of total proved oil and natural gas liquids reserves at September 30,2005 and 2004, respectively.

 

Thefollowing table sets forth Barnwell’s oil and natural gas reserves at September30, 2005, by property name, based on information prepared by Paddock Lindstrom& Associates Ltd.  Gross reserves arebefore the deduction of royalties; net reserves are after the deduction of royaltiesnet of the Alberta Royalty Tax Credit. This table is based on constant dollars where reserve estimates arebased on sales prices, costs and statutory tax rates in existence at the dateof the projection.  Oil, which includesnatural gas liquids, is shown in thousands of barrels (“MBBLS”) and natural gasis shown in millions of cubic feet (“MMCF”).

 

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OIL AND NATURAL GAS RESERVES AT SEPTEMBER 30,2005

 
| ** **                      | ** ** | **Total Proved Producing** | ** ** | **Total Proved** | ** ** |
|---------------------------------|------------|----------------------------|------------|------------------|------------|
| ** **                      | ** ** | **Oil & NGL**          | ** ** | **Gas**          | ** ** | **Oil & NGL** | ** ** | **Gas** | ** ** |
| **Property Name**               | ** ** | **Gross**                  | ** ** | **Net**          | ** ** | **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
| ** **                      | ** ** | **(MBBLS)**                | ** ** | **(MMCF)**       | ** ** | **(MBBLS)** | ** ** | **(MMCF)** | ** ** |
| **Dunvegan**                    | ** ** | **656**                    | ** ** | **456**          | ** ** | **16,394** | ** ** | **12,947** | ** ** | **704** | ** ** | **489** | ** ** | **17,616** | ** ** | **13,858** | ** ** |
| Red Earth                       |       | 332                        |       | 290              |       | — |   | — |   | 351 |   | 304 |   | — |   | — |   |
| Bonanza/Balsam                  |       | 104                        |       | 87               |       | 1,036 |   | 856 |   | 105 |   | 87 |   | 1,227 |   | 1,000 |   |
| Pouce Coupe South               |       | 11                         |       | 7                |       | 1,359 |   | 1,105 |   | 11 |   | 7 |   | 1,359 |   | 1,105 |   |
| Medicine River                  |       | 38                         |       | 28               |       | 902 |   | 606 |   | 38 |   | 28 |   | 902 |   | 606 |   |
| Doris                           |       | 3                          |       | 3                |       | 1,196 |   | 936 |   | 3 |   | 3 |   | 1,770 |   | 1,379 |   |
| Leduc                           |       | 8                          |       | 6                |       | 721 |   | 591 |   | 8 |   | 6 |   | 778 |   | 640 |   |
| Faith South                     |       | —                     |       | —           |       | — |   | — |   | — |   | — |   | 1,011 |   | 790 |   |
| Hillsdown                       |       | 13                         |       | 10               |       | 581 |   | 465 |   | 29 |   | 23 |   | 746 |   | 597 |   |
| Chauvin                         |       | 96                         |       | 85               |       | 13 |   | 11 |   | 96 |   | 85 |   | 13 |   | 11 |   |
| Wood River                      |       | 4                          |       | 4                |       | 533 |   | 445 |   | 43 |   | 36 |   | 786 |   | 652 |   |
| Progress                        |       | 22                         |       | 21               |       | 575 |   | 473 |   | 114 |   | 102 |   | 766 |   | 612 |   |
| Thornbury                       |       | —                     |       | —           |       | 745 |   | 651 |   | — |   | — |   | 779 |   | 680 |   |
| Charlotte Lake                  |       | —                     |       | —           |       | 292 |   | 268 |   | — |   | — |   | 512 |   | 452 |   |
| Pouce Coupe                     |       | 4                          |       | 4                |       | 430 |   | 361 |   | 4 |   | 4 |   | 430 |   | 361 |   |
| Rat Creek                       |       | 30                         |       | 24               |       | 232 |   | 199 |   | 30 |   | 24 |   | 232 |   | 199 |   |
| Hilda                           |       | —                     |       | —           |       | 231 |   | 222 |   | — |   | — |   | 231 |   | 222 |   |
| Zama                            |       | —                     |       | —           |       | 52 |   | 36 |   | — |   | — |   | 296 |   | 196 |   |
| Mulligan                        |       | 1                          |       | 1                |       | 240 |   | 195 |   | 1 |   | 1 |   | 240 |   | 195 |   |
| Wizard Lake                     |       | 26                         |       | 22               |       | — |   | — |   | 26 |   | 22 |   | — |   | — |   |
| Armada                          |       | —                     |       | —           |       | 141 |   | 135 |   | — |   | — |   | 141 |   | 135 |   |
| Boundary Lake                   |       | —                     |       | —           |       | 544 |   | 396 |   | 17 |   | 15 |   | 544 |   | 396 |   |
| Smaller Alberta properties      |       | 41                         |       | 35               |       | 631 |   | 602 |   | 41 |   | 35 |   | 696 |   | 660 |   |
| Boundary Lake, British Columbia |       | 20                         |       | 18               |       | 219 |   | 201 |   | 38 |   | 34 |   | 385 |   | 347 |   |
| Hatton, Saskatchewan            |       | —                     |       | —           |       | 196 |   | 141 |   | — |   | — |   | 196 |   | 141 |   |
| Webb-Beverley, Saskatchewan     |       | 1                          |       | 1                |       | — |   | — |   | 1 |   | 1 |   | — |   | — |   |
| **TOTAL**                       | ** ** | **1,410**                  | ** ** | **1,102**        | ** ** | **27,263** | ** ** | **21,842** | ** ** | **1,660** | ** ** | **1,306** | ** ** | **31,656** | ** ** | **25,234** | ** ** |

 

Properties are located in Alberta, Canada unlessotherwise noted.

 

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Estimated Future Net Revenues

 

The following table sets forth Barnwell’s “EstimatedFuture Net Revenues” from total proved oil, natural gas and condensate reservesand the present value of Barnwell’s “Estimated Future Net Revenues” (discountedat 10%).  Estimated future net revenuesfor total proved reserves are net of estimated development costs.  Net revenues have been calculated usingcurrent sales prices and costs, after deducting all royalties net of theAlberta Royalty Tax Credit, operating costs, future estimated capital expenditures,and income taxes.

 

 

| ** **                                                    | ** ** | **Proved Producing** | ** **  | **Total Proved** | ** ** |
|---------------------------------------------------------------|------------|----------------------|-------------|------------------|------------|
| **Year ending September 30,**                                 | ** ** | **Reserves**         | ** **  | **Reserves**     | ** ** |
|                                                          |       |                 |        |             |       |
| 2006                                                          |       | $                    | 27,384,000  |             | $          | 31,741,000 |   |
| 2007                                                          |       | 22,607,000           |        | 27,607,000       |       |
| 2008                                                          |       | 18,324,000           |        | 21,860,000       |       |
| Thereafter                                                    |       | 78,557,000           |        | 90,125,000       |       |
|                                                          |       | $                    | 146,872,000 |             | $          | 171,333,000 |   |
|                                                          |       |                 |        |             |       |
| Present value  (discounted at 10%) at September 30, 2005 |       | $                    | 102,663,000 |             | $          | 119,762,000 |   |

 

Marketing of Oil andNatural Gas

 

Barnwell sells substantially all of its oil andcondensate production under short-term contracts between itself and marketersof oil.  The price of oil and condensate isfreely negotiated between the buyers and sellers.

 

Naturalgas sold by Barnwell is generally sold under both long-term and short-termcontracts with prices indexed to market prices. The price of natural gas and natural gas liquids is freely negotiatedbetween buyers and sellers.  In fiscal 2005,2004, and 2003, Barnwell took virtually all of its oil and natural gas “in kind”where Barnwell markets the products instead of having the operator of aproducing property market the products on Barnwell’s behalf.

 

Infiscal 2005, natural gas production from the Dunvegan Unit was responsible forapproximately 46% of Barnwell’s natural gas revenues, as compared to 42% in fiscal2004.  In fiscal 2005, Barnwell had fourindividually significant marketers that accounted for 62% of Barnwell’s oil andnatural gas revenues.  A substantialportion of Barnwell’s Dunvegan natural gas production and natural gasproduction from other properties is sold to aggregators and marketers undervarious short-term and long-term contracts, with the price of natural gasdetermined by negotiations between the aggregators and the finalpurchasers.  In fiscal 2005, more than50% of Barnwell’s oil and natural gas revenues were from products sold at spotprices.

 

# GovernmentalRegulation

 

The jurisdictions in which the oil and natural gasproperties of Barnwell are located have regulatory provisions relating topermits for the drilling of wells, the spacing of wells, the prevention of 

 

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oil and natural gas waste, allowable rates of production and othermatters.  The amount of oil and naturalgas produced is subject to control by regulatory agencies in each province andstate that periodically assign allowable rates of production.  The Province of Alberta and Government ofCanada also monitor and regulate the volume of natural gas that may be removedfrom the province and the conditions of removal.

 

There is no current government regulation of the pricethat may be charged on the sale of Canadian oil or natural gas production.  Canadian natural gas production destined forexport is priced by market forces subject to export contracts meeting certaincriteria prescribed by Canada’s National Energy Board and the Government ofCanada.

 

The right to explore for and develop oil and naturalgas on lands in Alberta, Saskatchewan and British Columbia is controlled by thegovernments of each of those provinces. Changes in royalties and other terms of provincial leases, permits andreservations may have a substantial effect on Barnwell’s operations.  In addition to the foregoing, in the future,Barnwell’s Canadian operations may be affected from time to time by politicaldevelopments in Canada and by Canadian federal, provincial and local laws andregulations, such as restrictions on production and export, oil and natural gasallocation and rationing, price controls, tax increases, expropriation ofproperty, modification or cancellation of contract rights, and environmentalprotection controls.  Furthermore,operations may also be affected by United States import fees and restrictions.

 

Different royalty rates are imposed by the provincialgovernments, the Government of Canada and private interests with respect to theproduction and sale of crude oil, natural gas and liquids.  In addition, provincial governments receiveadditional revenue through the imposition of taxes on crude oil and natural gasowned by private interests within the province. Essentially, provincial royalties are calculated as a percentage ofrevenue and vary depending on production volumes, selling prices and the dateof discovery.

 

In 2002, Canadian taxpayers were not permitted todeduct royalties, taxes, rentals and similar levies paid to the federal orprovincial governments in connection with oil and natural gas production incomputing income for Canadian federal income tax purposes.  However, they were allowed to deduct a “ResourceAllowance” which is 25% of the taxpayer’s “Resource Profits for the Year”(essentially, net income from the production of oil, natural gas or minerals)in computing their taxable income.

 

In November 2003, Royal Assent was received on a billpassed by the Parliament of Canada, which was then enacted into law, to reduceCanada’s corporate tax rate on “resource” income (income derived from oil andnatural gas operations) over a four-year period beginning January 1, 2003 from29% to 21% with the 21% tax rate commencing on January 1, 2007.  Additionally, the bill phases in over thesame four-year period tax deductions for royalties, which previously were nottax deductible, and phases out the Resource Allowance deduction along withother changes.  Accordingly, duringfiscal 2004, Barnwell’s Canadian deferred income tax liabilities were reducedby approximately $1,440,000 due to the reduction in Canada’s federal corporatetax rate.

 

In Alberta, a producer of oil or natural gas isentitled to a credit against the royalties payable to the Crown by virtue ofthe Alberta Royalty Tax Credit program. The Alberta Royalty Tax Credit rate is based on a price-sensitiveformula and varies between 75% at prices below a specified royalty tax creditreference price and 25% at prices above a specified royalty tax creditreference price.  The Alberta Royalty TaxCredit will be applied to a maximum annual amount of $2,000,000 Canadiandollars of 

 

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Alberta Crown royalties payable for each producer or associated groupof producers.  Crown royalties onproduction from producing properties acquired from corporations claimingmaximum entitlements to the Alberta Royalty Tax Credit will generally not beeligible for the Alberta Royalty Tax Credit. The rate is established quarterly based on the average royalty taxcredit reference price, as determined by the Alberta Department of Energy.  The royalty tax credit reference price isbased on a weighted average oil and gas price.

 

TheProvince of Alberta has stated that changes in the Alberta Royalty Tax Creditwill be announced three years in advance. The government of Alberta has considered limiting the Alberta RoyaltyTax Credit on some basis, as yet undetermined, to entities that invest in oiland natural gas in Alberta.  Barnwellcurrently does such investing.  TheAlberta Royalty Tax Credit program has been in effect in various forms since1974 and Barnwell anticipates that it will be continued in some form for theforeseeable future.  In fiscal 2005, Barnwell’sAlberta Royalty Tax Credit totaled approximately $409,000.  If the Alberta Royalty Tax Credit is discontinued,it will have an adverse effect on Barnwell.

 

Competition

 

The majority of Barnwell’s natural gas sales takeplace in Alberta, Canada.  Natural gasprices in Alberta are generally competitive with other major North Americanareas due to increased pipeline capacity into the United States.  Barnwell’s oil and natural gas liquids aresold in Alberta with prices determined by the world price for oil.

 

Barnwell competes in the sale of oil and natural gason the basis of price, and on the ability to deliver products.  The oil and natural gas industry is intenselycompetitive in all phases, including the exploration for new production andreserves and the acquisition of equipment and labor necessary to conductdrilling activities.  The competitioncomes from numerous major oil companies as well as numerous other independentoperators.  There is also competitionbetween the oil and natural gas industry and other industries in supplying theenergy and fuel requirements of industrial, commercial and individualconsumers.  Barnwell is a minorparticipant in the industry and competes in its oil and natural gas activitieswith many other companies having far greater financial, technical and otherresources.

 

 

CONTRACT DRILLINGOPERATIONS

 

Barnwellowns 100% of Water Resources International, Inc. (“Water Resources”) whichdrills water and exploratory wells and installs and repairs water pumpingsystems in Hawaii.  Water Resources ownsand operates four Spencer-Harris portable rotary drill rigs ranging in drillingcapacity from 3,500 feet to 7,000 feet, and an IDECO H-35 rotary drill/workoverrig which it had leased to an oil company during the latter part of fiscal 2003through the end of fiscal 2005. Additionally, Water Resources leases a three-quarter of an acremaintenance facility in Honolulu, Hawaii and a one acre maintenance and storagefacility with 2,800 square feet of interior space in Kawaihae, Hawaii, andmaintains an inventory of drilling and pump supplies.  As of September 30, 2005, Water Resourcesemployed 25 drilling, pump and administrative employees, none of whom are unionmembers.

 

Water Resources drills water, water monitoring andgeothermal wells of varying depths in Hawaii and also installs and repairswater pumps and is the state of Hawaii’s distributor for Floway pumps andequipment.  The demand for WaterResources’ services is primarily dependent upon land development activities inHawaii.  Water Resources markets itsservices to land developers and 

 

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government agencies, and identifies potential contracts through publicnotices, its officers’ involvement in community activities and referrals.  Contracts are usually fixed price per linealfoot or day rate contracts and are negotiated with private entities or obtainedthrough competitive bidding with private entities or with local, state and federalagencies.  Contract revenues are not dependentupon the discovery of water, geothermal production zones or other similartargets, and contracts are not subject to renegotiation of profits ortermination at the election of the governmental entities involved.  Contracts provide for arbitration in theevent of disputes.

 

Barnwell’scontract drilling subsidiary derived 63%, 70%, and 66% of its contract drillingrevenues in fiscal 2005, 2004, and 2003, respectively, pursuant to federal,State of Hawaii and county contracts.  AtSeptember 30, 2005, Barnwell had accounts receivable from the State of Hawaiiand county entities totaling approximately $621,000.  Barnwell has lien rights on wells drilled andpumps installed for federal, State of Hawaii, county and private entities.

 

Barnwell’s contract drilling segment currentlyoperates in Hawaii and is not subject to seasonal fluctuations.

 

Activity

 

Infiscal 2005, Water Resources started seven well drilling contracts and sevenpump installation contracts and completed five well drilling contracts and fivepump installation contracts.  Five of thecompleted well drilling contracts and one of the completed pump contracts werestarted in the prior year.  Seventy-twopercent (72%) of well drilling and pump installation jobs, representing 63% oftotal contract drilling revenues in fiscal 2005, have been pursuant togovernment contracts.

 

AtSeptember 30, 2005, Water Resources had a backlog of nine well drillingcontracts and ten pump installation and repair contracts, seven and four ofwhich were in progress as of September 30, 2005.

 

The dollar amount of Water Resources’ backlog of firmwell drilling and pump installation and repair contracts at November 30, 2005and 2004 was as follows:

 

| ** **                   | ** ** | **2005**      | ** **    | **2004**  | ** ** |
|------------------------------|------------|---------------|---------------|-----------|------------|
| Well drilling                | ** ** | **$**         | **2,000,000** |      | $          | 4,500,000 |   |
| Pump installation and repair | ** ** | **1,500,000** |          | 1,100,000 |       |
|                         | ** ** | **$**         | **3,500,000** |      | $          | 5,600,000 |   |

 

Allof the contracts in backlog at November 30, 2005 are expected to be completedwithin fiscal year 2006.

 

# Competition

 

Water Resources utilizes rotary drill rigs andcompetes with other drilling contractors in Hawaii which use drill rigs similarto Water Resources’ drilling rigs, and newer or top head rotary drilling rigsthat drill as quickly as Water Resources’ equipment but require lesslabor.  These competitors are alsocapable of installing and repairing vertical turbine and submersible waterpumping systems in Hawaii.  Thesecontractors compete actively with Water Resources for government and privatecontracts.  Pricing is Water Resources’major method of competition; reliability of service is also a significantfactor.

 

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Competitive pressures are expected to remain high,thus there is no assurance that the increase in available or awarded jobs whichoccurred in fiscal 2005 will continue.

 

 

LAND INVESTMENTOPERATIONS

 

Barnwell owns a 77.6% controlling interest inKaupulehu Developments, a Hawaii general partnership that owns interests inleasehold land and development rights for property located approximately sixmiles north of the Kona International Airport in the North Kona District of theIsland of Hawaii.  Between 1986 and 1989,Kaupulehu Developments obtained the state and county zoning changes necessaryto permit development of the Four Seasons Resort Hualalai at Historic Ka’upulehuand Hualalai Golf Club, which opened in 1996, a second golf course, and single-familyand multiple-family residential units. These projects were developed on leasehold land acquired from KaupulehuDevelopments by Kaupulehu Makai Venture, an unrelated entity that is anaffiliate of Kajima Corporation of Japan. The development rights held by Kaupulehu Developments are forresidentially-zoned leasehold land within and adjacent to the Hualalai GolfClub and are under option to Kaupulehu Makai Venture.

 

In 1993, Kaupulehu Developments submitted a rezoningpetition to the State Land Use Commission and in 1998, filed an Application fora Project District zoning ordinance and a Special Management Area Use PermitPetition with the County of Hawaii to reclassify conservation-zoned land tozoning which allows resort/residential development.  In October 2001, Kaupulehu Developmentsreceived final approval for the reclassification.

 

On February 13, 2004, Kaupulehu Developments enteredinto a Purchase and Sale Agreement with WB KD Acquisition LLC (“WB”) by whichKaupulehu Developments transferred its leasehold interest in approximately 870acres zoned for resort/residential development, in two increments, to WB.  There is no affiliation between KaupulehuDevelopments and WB.  WB is an affiliateof Westbrook Partners LLC, an affiliate of the developers of the Kuki’oResort.  The first increment (“IncrementI”) is an area planned for approximately 80 single-family lots and a beach clubon the portion of the property bordering the Pacific Ocean.  The purchasers of the 80 single-family lotswill have the right to apply for membership in the Kuki’o Resort Golf and BeachClub, which is located adjacent to and south of the Four Seasons ResortHualalai at Historic Ka’upulehu.  Thesecond increment (“Increment II”) is the remaining portion of the approximately870-acre property and is zoned for single-family and multi-family residentialunits and a golf course and clubhouse.

 

With respect to Increment I,Kaupulehu Developments received a non-refundable $11,550,000 payment (“ClosingPayment”) in February 2004 and is entitled to receive payment of the followingpercentages of the gross proceeds generated from the sale by WB ofsingle-family lots in Increment I (“Percentage Payments”): 9% of the grossproceeds from single-family lot sales up to aggregate gross proceeds of$100,000,000; 10% of such aggregate gross proceeds greater than $100,000,000but less than $300,000,000; and 14% of such aggregate gross proceeds in excessof $300,000,000.  If prior to December31, 2005,  Kaupulehu Developments has notreceived Percentage Payments equal to or greater than $2,500,000 in theaggregate, WB will pay Kaupulehu Developments the amount by which the aggregateamount of all prior Percentage Payments made by WB to Kaupulehu Developments isless than $2,500,000.  If prior toDecember 31, 2006, Kaupulehu Developments has not received Percentage Payments(including payments in lieu of Percentage Payments as described in theimmediately preceding sentence) equal to or greater than $5,000,000 in theaggregate, then WB will pay Kaupulehu 

 

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Developments the amount by which theaggregate amount of all such payments is less than $5,000,000.  Until the formal granting of access andutility easements by third parties to WB have been completed, WB is entitled,but not required, to withhold payment of Percentage Payments and the minimumpayments described above to Kaupulehu Developments until WB’s aggregate grossproceeds generated by the sale of single-family lots in Increment I exceeds$75,000,000.  As of the date of thisfiling, Kaupulehu Developments has received no Percentage Payments and it isBarnwell’s understanding that the conditions regarding the formal granting ofeasements are in progress but have not yet been completed.  There is no assurance that any of thesefuture payments will be received.

 

WB also agreed to pay Kaupulehu Developmentsnon-refundable interim payments of $50,000 per month (“Interim Payments”),until the first to occur of the closing of the sale of the 40th single-familylot sold in Increment I or WB’s payment to Kaupulehu Developments of a total of$900,000 in Interim Payments subsequent to February 2004.  Kaupulehu Developments received InterimPayments totaling $350,000 through fiscal 2004.

 

Kaupulehu Developments, WB and The Trustees of TheEstate of Bernice Pauahi Bishop (“KS”) also entered into an agreement (the “Step-InRights Agreement”) whereby if WB elects not to proceed with development ofIncrement I within the time frame set forth in the Step-In Rights Agreement,which may be extended by KS, or defaults under the terms of its lease with KS,Kaupulehu Developments would have the right to succeed to WB’s development rightsand develop the property without any payment to WB.

 

With respect to Increment II, Kaupulehu Developmentsand WB agreed to use diligent efforts to negotiate, and attempt to document andenter into, prior to the date which is three (3) years following the closing ofthe sale of the first single-family lot in Increment I, an agreement withregards to the ownership and development of Increment II.  WB, however, may terminate such negotiationsat any time without any further obligation.  Under the terms of the Step-In RightsAgreement, if at the end of three years following the closing of the sale ofthe first single-family lot in Increment I the parties have not entered into adefinitive agreement with respect to Increment II, the leasehold rights with respectto Increment II will revert to Kaupulehu Developments.  In 2005, Kaupulehu Developments and WB heldseveral meetings to discuss possible development scenarios for Increment II.  No agreement has been reached with WB for thedevelopment of Increment II although the discussions between the parties areongoing.

 

Activity

 

During the year ended September 30, 2005, KaupulehuDevelopments received $550,000 of Interim Payments, before minority interest,and has received in full the aforementioned $900,000 of Interim Payments as ofAugust 2005.

 

In March 2004, WB commenced engineering ofinfrastructure, preparation of covenants, conditions and restrictions for acommunity association, and preparation of legal documents to enable real estatesales, and broke ground and graded several miles of access roads.  In 2004, WB received final subdivisionapproval from the County of Hawaii for the first phase of 38 lots.  In 2005, WB received federal and State ofHawaii approvals to begin marketing the first phase of 38 lots of IncrementI.  Additionally, during 2004 and 2005,WB excavated, processed and placed material on the single-family lots bringinga majority of the first phase of 38 lots to finished grade.

 

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On December 31, 2004, Kaupulehu MakaiVenture exercised the portion of its development rights option due on that dateand paid Kaupulehu Developments $2,656,000. Barnwell accounts for sales of development rights under option by use ofthe cost recovery method, whereby no operating profit is recognized until cashreceived exceeds the cost and the estimated future costs related to developmentrights sold.  Accordingly, the $2,656,000 of revenues attributable tothe development rights sale in December 2004 was reduced by $159,000 of feesrelated to the sale, resulting in net revenues of $2,497,000 and a $1,950,000operating profit, after minority interest. There were no other costs deducted from revenues from the sale of developmentrights in fiscal 2005 as all capitalized costs associated with the developmentrights were expensed in previous years under the cost recovery method.  At September 30, 2005, approximately 81 acresremain under option.

 

The total amount of remaining future developmentrights option receipts at September 30, 2005, if all options are fullyexercised, was $15,937,500, comprised of six payments of $2,656,250 due on eachDecember 31 of years 2005 to 2010.  InNovember 2005, Kaupulehu Makai Venture paid Kaupulehu Developments $2,875,000upon exercising the portion of its development rights option due on December31, 2005 of $2,656,000 and a portion, $219,000, of its development rightsoption due on December 31, 2006, bringing the total remaining futuredevelopment rights option receipts to $13,063,000.  If any annual option payment is not made, thethen remaining development right options will expire.  There is no assurance that any portion of theremaining options will be exercised.

 

The interests held by Kaupulehu Developments atSeptember 30, 2005 include the development rights under option; the rights toreceive Increment I Percentage Payments; the leasehold land zoned forresort/residential development within Increment II, which is under a right ofnegotiation with WB; and approximately 1,000 acres of vacant leasehold landzoned conservation.

 

Competition

 

Barnwell’s land investment segment is subject tointense competition in all phases of its operations including the acquisitionof new properties, the securing of approvals necessary for land rezoning, andthe search for potential buyers of property interests presently owned.  The competition comes from numerousindependent land development companies and other industries involved in landinvestment activities.  The principalfactors affecting competition are the location of the project and pricing.  Kaupulehu Developments is a minor participantin the land development industry and competes in its land investment activitieswith many other entities having far greater financial and other resources.

 

For the past couple of years, Hawaii’s economy hasexperienced some growth and the South Kohala/North Kona area of the island ofHawaii, the area in which Kaupulehu Developments’ property is located, hasexperienced strong demand for residential real estate.  This trend continued through fiscal 2005 andis not expected to decline significantly in the near term, although there canbe no assurance this trend will in fact continue.

 

 

CORPORATE OFFICE

 

InDecember 2003, Barnwell purchased the space it was leasing for its corporateoffices located at 1100 Alakea Street, Suite 2900, Honolulu, Hawaii 96813 for$1,057,000, of which $883,000 was financed by a note payable to a Hawaii bankand the remainder was paid in cash.  Theseller was A&B Alakea LLC, an independent third party.  The note was payable in monthly principalpayments of 

 

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approximately$3,000, plus interest, and was due in full in December 2006.  Barnwell repaid the note in full in fiscal2004.  The space purchased has 4,662useable square feet in an office building in downtown Honolulu, Hawaii.

 

 

Item 3.            LegalProceedings

 

                Barnwellis occasionally involved in routine litigation and is subject to governmentaland regulatory controls that are incidental to the business.  Barnwell’s management believes that routineclaims and litigation involving Barnwell are not likely to have a materialadverse effect on its financial position, results of operations or liquidity.

 

 

Item 4.            Submission of Matters to a Voteof Security Holders

 

                TheBoard of Directors and the stockholders of Barnwell, on May 11, 2005 andOctober 7, 2005, respectively, approved an amendment (the “Amendment”) toBarnwell’s Certificate of Incorporation to increase the authorized number ofshares of Barnwell’s common stock, par value $0.50, from 4,000,000 shares to20,000,000 shares.  The Amendment becameeffective on October 12, 2005 upon the filing of the Amendment with theSecretary of State of the State of Delaware.

 

 

 

PART II

 

Item 5.            Market For Common Equity andRelated Stockholder Matters

 

In December 2004, Barnwell declared a two-for-onestock split in the form of a stock dividend. The new shares were distributed on January 28, 2005 to all shareholdersof record as of January 11, 2005.

 

On October 17, 2005, Barnwell declared a three-for-onestock split in the form of a stock dividend. The new shares were distributed on November 14, 2005 to all shareholdersof record as of October 28, 2005.  Allinformation in this Form 10-KSB has been adjusted to reflect the stock splitsfor all periods presented.

 

The principal market on which Barnwell’s common stockis being traded is the American Stock Exchange. The following tables present the quarterly high and low sales prices, onthe American Stock Exchange, for Barnwell’s common stock during the periodsindicated (split-adjusted):

 
| **Quarter Ended**  | ** ** | **High** | ** ** | **Low** | ** ** | **Quarter Ended**  | ** ** | **High**          | ** ** | **Low** | ** ** |
|--------------------|------------|----------|------------|---------|------------|--------------------|------------|-------------------|------------|---------|------------|
| December 31, 2003  |       | $        | 5.67       |    | $          | 4.13               |       | December 31, 2004 |       | $       | 12.36      |   | $ | 7.67 |   |
| March 31, 2004     |       | 8.00     |       | 5.23    |       | March 31, 2005     |       | 18.62             |       | 12.08   |       |
| June 30, 2004      |       | 8.33     |       | 6.87    |       | June 30, 2005      |       | 24.21             |       | 17.73   |       |
| September 30, 2004 |       | 8.03     |       | 7.00    |       | September 30, 2005 |       | 22.92             |       | 18.17   |       |
|                    |            |          |            |         |            |                    |            |                   |            |         |            |  |  |  |  |

 

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As of December 14, 2005,there were 8,169,060 (split-adjusted) shares of common stock, par value $0.50,outstanding.  There were approximately 1,500holders of the common stock of the registrant as of December 14, 2005.

 

On December 9, 2005, Barnwell declared a cash dividendof $0.025 per share payable January 4, 2006, to stockholders of record onDecember 20, 2005.

 

In August 2005, Barnwell declared a cash dividend of$0.02 per share (split-adjusted), payable September 15, 2005, to stockholdersof record on September 1, 2005.

 

In May 2005, Barnwell declared a cash dividend of $0.02per share (split-adjusted), payable June 15, 2005, to stockholders ofrecord on June 1, 2005.

 

In February 2005, Barnwell declared a cash dividend of$0.02 per share (split-adjusted), payable March 15, 2005, to stockholders ofrecord on March 1, 2005.

 

In December 2004, Barnwell declared a cash dividendof $0.04 per share (split-adjusted), payable January 5, 2005, to stockholdersof record on December 20, 2004.

 

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Item 6.    MANAGEMENT’S DISCUSSION AND ANALYSIS ORPLAN OF OPERATION

 

The following discussion is intended to assist in theunderstanding of the consolidated balance sheets of Barnwell Industries, Inc.and subsidiaries (collectively referred to herein as “Barnwell”) as ofSeptember 30, 2005 and 2004, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income, and cash flows foreach of the years in the three-year period ended September 30, 2005.  This discussion should be read in conjunctionwith the Consolidated Financial Statements and related Notes to ConsolidatedFinancial Statements included in this report.

 

 

# **USE OF ESTIMATES IN THEPREPARATION OF FINANCIAL STATEMENTS**

 

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets, liabilities, revenues and expenses and the disclosure ofcontingent assets and liabilities. Actual results could differ significantly from those estimates.

 

 

# **CRITICAL ACCOUNTING POLICIES ANDESTIMATES**

 

In response to U.S.Securities and Exchange Commission Release No. 33-8040, “Cautionary AdviceRegarding Disclosure About Critical Accounting Policies,” Barnwell hasidentified certain of its policies as being of particular importance to theunderstanding of its financial position and results of operations and whichrequire the application of significant judgment by management.

 

Oil and natural gas properties

 

Barnwell uses the full cost method of accounting underwhich all costs incurred in the acquisition, exploration and development of oiland natural gas reserves, including costs related to unsuccessful wells andestimated future site restoration and abandonment, are capitalized until suchtime as the aggregate of such costs net of accumulated depletion and oil andgas related deferred income taxes, on a country-by-country basis, equals thesum of 1) the discounted present value (at 10%), using prices as of the end ofthe fiscal year on a constant basis, of Barnwell’s estimated future net cashflows from estimated production of proved oil and natural gas reserves asdetermined by independent petroleum engineers, less estimated futureexpenditures to be incurred in developing and producing the proved reserves butexcluding future cash outflows associated with settling asset retirementobligations accrued on the balance sheet; plus 2) the cost of major developmentprojects and unproven properties not subject to depletion, if any; plus 3) thelower of cost or estimated fair value of unproven properties included in costssubject to depletion; less 4) related income tax effects.  If net capitalized costs exceed this limit,the excess is expensed.  Depletion iscomputed using the units-of-production method whereby capitalized costs, net ofsalvage values, plus estimated future costs to develop proved reserves andsatisfy asset retirement obligations, are amortized over the total estimatedproved reserves on a country-by-country basis. Investments in major development projects are not depleted until eitherproved reserves are associated with the projects or impairment has beendetermined.  At September 30, 2005 and2004, Barnwell had no investments in major oil and natural gas developmentprojects that were not being depleted. General and administrative costs related to oil and natural gasoperations are expensed as incurred. Proceeds from the disposition of minor producing oil and natural gasproperties are credited 

 

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to the cost of oil and natural gas properties.  Gains or losses are recognized on thedisposition of significant oil and natural gas properties.

 

Investment in land and revenue recognition

 

Barnwell’s investment in land is comprised ofdevelopment rights under option; rights to receive percentage payments;leasehold land interests in land zoned resort/residential which are under rightof negotiation; and land zoned conservation which is not under option or rightof negotiation.  Investment in land isreported at the lower of the asset carrying value or fair value, less costs tosell, and is evaluated for impairment whenever events or changes incircumstances indicate that the recorded investment balance may not be fullyrecoverable.

 

Costs incurred for the acquisition and improvement ofleasehold land interests, including capitalized interest, are included in theconsolidated balance sheets under the caption “Investment in Land.”

 

Sales of development rights under option and revenuesfrom the sale of Increment I of leasehold land interests are accounted forunder the cost recovery method.  Underthe cost recovery method, no operating profit is recognized until cash receivedexceeds the cost and the estimated future costs related to the developmentrights sold.

 

Contract drilling

 

Revenues, costs and profits applicable to contractdrilling contracts are included in the consolidated statements of operationsusing the percentage of completion method, principally measured by thepercentage of labor dollars incurred to date for each contract to totalestimated labor dollars for each contract. Contract losses are recognized in full in the period the losses areidentified.  The performance of drillingcontracts may extend over more than one year and, in the interim periods,estimates of total contract costs and profits are used to determine revenuesand profits earned for reporting the results of contract drilling operations.  Revisions in the estimates required bysubsequent performance and final contract settlements are included asadjustments to the results of operations in the period such revisions andsettlements occur.  Contracts are normallyless than one year in duration.

 

Income taxes

 

Deferred income taxes are determined using the assetand liability method.  Deferred taxassets and liabilities are recognized for the estimated future tax impacts ofdifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax ratesin effect for the year in which those temporary differences are expected to berecovered or settled.  The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inincome in the period that includes the enactment date.

 

A valuation allowance isprovided when it is more likely than not that some portion or all of thedeferred tax asset will not be realized. Barnwell has established a valuation allowance primarily for the U.S.tax effect of deferred Canadian taxes, foreign tax credits, accrued expensesand state of Hawaii net operating loss carryforwards which may not berealizable in future years as there can be no assurance of any specific levelof earnings or that the timing of U.S. earnings will coincide with the paymentof Canadian taxes to enable Canadian taxes to be fully deducted (orrecoverable) for U.S. tax purposes.

 

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Net deferred tax assets at September 30,2005 of $4,800,000 consists of $3,322,000 related to expenses accrued for bookpurposes but not for tax purposes and $972,000 related to the excess of thecost basis of investment in land for tax purposes over the cost basis ofinvestment in land for book purposes. Canadian deferred tax assets related to expenses accrued for bookpurposes but not for tax purposes are estimated to be realized through futureCanadian income tax deductions against future Canadian oil and natural gasearnings.  U.S. deferred tax assetsrelated to expenses accrued for book purposes but not for tax purposes and theexcess of the cost basis of investment in land for tax purposes over the costbasis of investment in land for book purposes are estimated to be realized fromdeductions against future U.S. earnings from sales of interests in leaseholdland and land development rights. Additionally, at September 30, 2005, Barnwell had a deferred tax assetof $461,000 for alternative minimum tax credit carryforwards which areavailable to reduce future U.S. federal regular income taxes over an indefiniteperiod, and a net deferred tax asset of $45,000 for a state net operating losscarryforward which is available to reduce future state income taxes arisingfrom future sales of interests in leasehold land and land development rights andexpires if not utilized on or before September 30, 2025.  The amount of deferred income tax assetsconsidered realizable may be reduced if estimates of future taxable income arereduced.

 

Pension Plan

 

Barnwell sponsors a noncontributory definedbenefit pension plan covering substantially all of its U.S. employees, withbenefits based on years of service and the employee’s highest consecutive five-yearaverage earnings.  Barnwell accounts forits defined benefit pension plan in accordance with Statement of FinancialAccounting Standards No. 87, “Employers’ Accounting for Pensions,” whichrequires that amounts recognized in financial statements be determined on anactuarial basis.  Statement of FinancialAccounting Standards No. 87 requires that the effects of the performance of thepension plan’s assets and changes in pension liability discount rates onBarnwell’s computation of pension income (expense) be amortized over futureperiods.  Any variances in the futurebetween the assumed rates utilized for actuarial purposes and the actual ratesexperienced by the plan may materially affect Barnwell’s results of operationsor financial condition.

 

During and as of the end of fiscal 2005 andfiscal 2004, Barnwell assumed an expected long-term rate of return on planassets of 8% and an expected rate of future annual compensation increases of 5%.

 

At the end of each year, Barnwell determines thediscount rate to be used to calculate the present value of planliabilities.  The discount rate is anestimate of the current interest rate at which the pension liabilities could beeffectively settled at the end of the year. In estimating this rate, Barnwell looks to rates of return onhigh-quality, fixed-income investments. At September 30, 2005, Barnwell determined this rate to be 5.25% ascompared to a discount rate of 5.75% used at September 30, 2004.

 

At September 30, 2005, Barnwell’s accruedbenefit cost was $517,000.  For the yearended September 30, 2005, Barnwell recognized a net periodic benefit cost of $249,000and recorded an additional minimum liability of $132,000.

 

Asset Retirement Obligation

 

On October 1, 2002, Barnwell adopted Statementof Financial Accounting Standards (“SFAS”) No. 143, “Accounting for AssetRetirement Obligations,” which requires that the fair value of a liability 

 

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foran asset retirement obligation be recognized in the period in which it isincurred if a reasonable estimate of fair value can be made.  The asset retirement obligation reflectsBarnwell’s obligation to plug and abandon natural gas and oil wells, dismantleand remove related equipment and plants, and restore the properties to asuitable condition at the end of oil and gas operations based on Barnwell’s netownership interest in the properties. The asset retirement obligation is recorded at fair value in the periodin which it is incurred along with a corresponding increase in the carryingamount of the related asset.  Barnwellhas estimated fair value by discounting the estimated future cash outflowsrequired to settle abandonment and restoration liabilities.  The present value calculation includesnumerous estimates, assumptions and judgments regarding the existence ofliabilities, the amount and timing of cash outflows required to settle theliability, what constitutes adequate restoration, inflation factors, creditadjusted discount rates, and consideration of changes in legal, regulatory,environmental and political environments. Asset retirement costs included in the carrying amount of the relatedasset are depleted over the estimated life of the associated reserves, and thediscounted present value of the asset retirement obligation is accreted andincluded in oil and natural gas operating expenses.  Abandonment and restoration cost estimatesare determined in conjunction with Barnwell’s reserve engineers based onhistorical information regarding costs incurred to abandon and restore similarwell sites, information regarding current market conditions and costs, andknowledge of subject well sites and properties.

 

 

# **CONTRACTUAL OBLIGATIONS**

 

                The following table lists thescheduled maturities of long-term debt, estimating that Barnwell’s creditfacility with the Royal Bank of Canada will be renewed on each annual renewaldate, currently April 30, and scheduled minimum rental payments ofnon-cancelable operating leases for office space and leasehold land:

 
| ** **                  | ** ** | **Payments Due by Fiscal Year** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| **Contractual Obligations** | ** ** | **2006**                        | ** ** | **2007-2008** | ** ** | **2009-2010** | ** ** | **After 2010** | ** ** | **Total** | ** ** |
| Long-term debt              |       | $                               | —     |   | $ | — |   | $ | — |   | $ | 11,576,000 |   | $ | 11,576,000 |   |
| Operating leases            |       | 518,000                         |       | 940,000 |   | 862,000 |   | 2,167,000 |   | 4,487,000 |   |
|                        |       |                            |       |   |   |   |   |   |   |   |   |
| Total                       |       | $                               | 518,000    |   | $ | 940,000 |   | $ | 862,000 |   | $ | 13,743,000 |   | $ | 16,063,000 |   |
|                             |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thereis no assurance that the bank will in fact extend the term of the facility oneach renewal date or that the facility will be renewed at its currentamount.  The following table lists thescheduled maturities of long-term debt assuming that the facility will not berenewed on the next renewal date and that Barnwell then elects to convert therevolving facility to term status, and scheduled minimum rental payments ofnon-cancelable operating leases for office space and leasehold land:

 
| ** **                  | ** ** | **Payments Due by Fiscal Year** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| **Contractual Obligations** | ** ** | **2006**                        | ** ** | **2007-2008** | ** ** | **2009-2010** | ** ** | **After 2010** | ** ** | **Total** | ** ** |
| Long-term debt              |       | $                               | —     |   | $ | 11,576,000 |   | $ | — |   | $ | — |   | $ | 11,576,000 |   |
| Operating leases            |       | 518,000                         |       | 940,000 |   | 862,000 |   | 2,167,000 |   | 4,487,000 |   |
|                        |       |                            |       |   |   |   |   |   |   |   |   |
| Total                       |       | $                               | 518,000    |   | $ | 12,516,000 |   | $ | 862,000 |   | $ | 2,167,000 |   | $ | 16,063,000 |   |

 

The lease payments for land are subject torenegotiation after December 31, 2005. Per the lease agreement, the lease payments will remain unchangedpending an appraisal, after which the lease rent 

 

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will be adjusted to fair market value. Barnwell currently does not know the amount of the new lease paymentswhich could be effective January 1, 2006; they may remain unchanged or increase.  The future rental payment disclosures aboveassume the minimum lease payments for land in effect at December 31, 2005remain unchanged through December 2025, the end of the lease term.

 

 

# **OVERVIEW**

 

Barnwell is engaged in the following lines ofbusiness: 1) oil and natural gas exploration, development, production and salesessentially all in Canada (oil and natural gas segment), 2) investment inleasehold land in Hawaii (land investment segment), and 3) drilling wells andinstalling and repairing water pumping systems in Hawaii (contract drillingsegment).

 

Barnwell sells substantially all of its oil andcondensate production under short-term contracts with marketers of oil.  Natural gas sold by Barnwell is generallysold under both long-term and short-term contracts with pricesindexed to market prices.  The price ofnatural gas, oil and natural gas liquids is freely negotiated between thebuyers and sellers.  Market prices forpetroleum products are dependent upon factors such as, but not limited to,changes in weather, storage levels, and output. Petroleum and natural gas prices are very difficult to predict andfluctuate significantly.  For example,natural gas prices for Barnwell, based on quarterly averages during the threeyears ended September 30, 2005, have ranged from a low of $3.26 per thousandcubic feet to a high of $7.25 per thousand cubic feet, and tend to be higher inthe winter than in the summer due to increased demand.  Oil and natural gas exploration, developmentand operating costs generally follow trends in product market prices, thus intimes of higher product prices the cost of exploration, development andoperation of oil and natural gas properties will tend to escalate as well.  Barnwell’s oil and natural gas operationsmake capital expenditures in the exploration, development, and production ofoil and natural gas.  Cash outlays forcapital expenditures are largely discretionary, however, a minimum level ofcapital expenditures is required to replace depleting reserves.  Due to the nature of oil and natural gasexploration and development, significant uncertainty exists as to the ultimatesuccess of any drilling effort.

 

Barnwellowns a 77.6% controlling interest in Kaupulehu Developments, a Hawaii generalpartnership which owns interests in leasehold land and development rights forproperty located approximately six miles north of the Kona InternationalAirport in the North Kona District of the Island of Hawaii, adjacent to andnorth of the Four Seasons Resort Hualalai at Historic Ka’upulehu, between theQueen Kaahumanu Highway and the Pacific Ocean.  Kaupulehu Developments’ development rights are under option to adeveloper and revenues are recognized when options are exercised.  In February 2004, Kaupulehu Developmentsentered into an agreement with an independent buyer whereby KaupulehuDevelopments transferred its leasehold interest in approximately 870 acreszoned for resort/residential development, in two increments, to the buyer.  For the first increment (“Increment I”),Kaupulehu Developments received an $11,550,000 cash closing payment in February2004 and is also entitled to receive future payments from the buyer based onthe following percentages of gross receipts from the developer’s sales ofsingle-family residential lots in Increment I: 9% of the gross proceeds fromsingle-family lot sales up to aggregate gross proceeds of $100,000,000; 10% ofsuch aggregate gross proceeds greater than $100,000,000 but less than$300,000,000; and 14% of such aggregate gross proceeds in excess of$300,000,000.  For the second increment (“IncrementII”), Kaupulehu Developments agreed to use diligent efforts to negotiate, andattempt to document and enter into, prior to the date which is three (3) yearsfollowing the closing of the sale of the first single-family lot in IncrementI, an agreement with regards to the ownership and development of IncrementII.  The area in 

 

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whichKaupulehu Developments’ interests are located has experienced strong demand forpremium residential real estate in recent years, however there is no assurancethat any future development rights or percentage payments will be received.

 

Barnwell also drills wells and installs and repairswater pumping systems in Hawaii. Contract drilling results are highly dependent upon the quantity, dollarvalue and timing of contracts awarded by governmental and private entities andcan fluctuate significantly.  Water welldrilling and pump installation operating profits during fiscal 2005 reflectedthe impact of increased activity in the number and value of contracts awardedby the various governmental and private entities.  Contract drilling operating profits have,however, started to decrease in recent months, and management expects a lowerlevel of activity and operating profit in fiscal 2006, as compared to fiscal2005.

 

 

### RESULTSOF OPERATIONS

 

Summary

 

Barnwellgenerated net earnings of $6,027,000 in fiscal 2005, a $2,683,000 decrease fromnet earnings of $8,710,000 in fiscal 2004. The decrease was the result of fiscal 2004 net earnings including thereceipt of a closing payment from the sale of an interest in leasehold land inFebruary 2004 which generated an operating profit, after minority interest andbefore taxes, of approximately $5,200,000, and deferred income tax benefits of$1,740,000 resulting from the enactment of reductions in Canadian federal andAlberta income tax rates; there were no such items in fiscal 2005.  Additionally, earnings decreased due to an increasein stock appreciation rights expense, after income taxes, of $1,608,000 in fiscal2005 resulting from an increase in the market price of Barnwell’s stock and theissuance of additional stock options that have stock appreciation rights.  These decreases in net earnings werepartially offset by increases in operating profits generated by Barnwell’s oiland natural gas and contract drilling segments.

 

Thefiscal year average exchange rate of the Canadian dollar to the U.S. dollarincreased 8% in fiscal 2005, as compared to fiscal 2004, and the exchange rateof the Canadian dollar to the U.S. dollar increased 9% at September 30, 2005,as compared to September 30, 2004.  Thisincrease in the value of the Canadian dollar in U.S. dollars increased Barnwell’sreported assets and liabilities and revenues and expenses.

 

Barnwellgenerated net earnings of $8,710,000 in fiscal 2004, a $6,390,000 increase fromnet earnings of $2,320,000 in fiscal 2003. The increase was the result of an increase in land investment operatingprofit due to the sale of an interest in leasehold land referred to above,higher operating profit from the sale of development rights, and deferredincome tax benefits of $1,740,000 resulting from a reduction in Canadian incometax rates.

 

Oil and Natural GasRevenues

 

Selected OperatingStatistics

 

                The followingtables set forth Barnwell’s annual net production and annual average price perunit of production for fiscal 2005 as compared to fiscal 2004, and fiscal 2004as compared to fiscal 2003.  Productionamounts reported are net of royalties and the Alberta Royalty Tax Credit.

 

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Fiscal 2005 - Fiscal 2004

 
| ** **         | ** ** | **Annual Net Production** | ** ** |
|--------------------|------------|---------------------------|------------|
| ** **         | ** ** | ** **                | ** ** | ** ** | ** ** | **Increase (Decrease)** | ** ** |
| ** **         | ** ** | **2005**                  | ** ** | **2004** | ** ** | **Units** | ** ** | **%** | ** ** |
| Natural gas (MCF)* | ** ** | **3,621,000**             |       | 3,383,000 |   | 238,000 |   | 7 | % |
| Oil (Bbl)**        | ** ** | **139,000**               |       | 154,000 |   | (15,000 | ) | (10 | )% |
| Liquids (Bbl)**    | ** ** | **114,000**               |       | 105,000 |   | 9,000 |   | 9 | % |

 
| ** **         | ** ** | **Annual Average Price Per Unit** | ** ** |
|--------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | ** **                        | ** ** | ** ** | ** ** | **Increase** | ** ** |
| ** **         | ** ** | **2005**                          | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
| Natural gas (MCF)* | ** ** | **$**                             | **5.93**   |   | $ | 4.60 |   | $ | 1.33 |   | 29 | % |
| Oil (Bbl)**        | ** ** | **$**                             | **48.11**  |   | $ | 33.24 |   | $ | 14.87 |   | 45 | % |
| Liquids (Bbl)**    | ** ** | **$**                             | **31.84**  |   | $ | 24.18 |   | $ | 7.66 |   | 32 | % |

 

 

Fiscal 2004 - Fiscal 2003

 
| ** **         | ** ** | **Annual Net Production** | ** ** |
|--------------------|------------|---------------------------|------------|
| ** **         | ** ** | ** **                | ** ** | ** ** | ** ** | **Increase** | ** ** |
| ** **         | ** ** | **2004**                  | ** ** | **2003** | ** ** | **Units** | ** ** | **%** | ** ** |
| Natural gas (MCF)* |       | 3,383,000                 |       | 3,175,000 |   | 208,000 |   | 7 | % |
| Oil (Bbl)**        |       | 154,000                   |       | 142,000 |   | 12,000 |   | 8 | % |
| Liquids (Bbl)**    |       | 105,000                   |       | 85,000 |   | 20,000 |   | 24 | % |

 
| ** **         | ** ** | **Annual Average Price Per Unit** | ** ** |
|--------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | ** **                        | ** ** | ** ** | ** ** | **Increase** | ** ** |
| ** **         | ** ** | **2004**                          | ** ** | **2003** | ** ** | **$** | ** ** | **%** | ** ** |
| Natural gas (MCF)* |       | $                                 | 4.60       |   | $ | 4.27 |   | $ | 0.33 |   | 8 | % |
| Oil (Bbl)**        |       | $                                 | 33.24      |   | $ | 27.69 |   | $ | 5.55 |   | 20 | % |
| Liquids (Bbl)**    |       | $                                 | 24.18      |   | $ | 21.50 |   | $ | 2.68 |   | 12 | % |

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                  *MCF = 1,000 cubic feet.  Natural gas price per unit is net of pipelinecharges.

                **Bbl = stock tank barrel equivalent to 42 U.S.gallons

 

Oiland natural gas revenues increased $8,884,000 (37%) from $23,840,000 in fiscal2004 to $32,724,000 in fiscal 2005, due to increases in prices for allpetroleum products and increases in natural gas production, partially offset bya decrease in net oil production. Natural gas production increased essentially due to an increase inproduction at Dunvegan, Barnwell’s principal oil and gas property, and whereBarnwell has invested a significant amount of capital these past three years,approximately $9,192,000.  Net naturalgas production at Dunvegan increased 227,000 MCF or 15% and net natural gasliquids and oil production at Dunvegan increased 10,000 barrels or 12%.  Natural gas production also increased atBarnwell’s newer properties at Doris, Malmo and Armada, but declined at Balsam,Bonanza, Leduc and Progress, which are also newer properties, and at otherolder properties which largely offset the net increase in production at thenewer properties.  Additionally, naturalgas and natural 

 

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gasliquids production at Dunvegan was reduced by approximately 30,000 MCF and 3,000barrels, respectively, in fiscal 2005 as compared to fiscal 2004 due to plantmaintenance in the current fiscal year. There was no such plant maintenance program in fiscal 2004.  Such plant maintenance usually occursannually and management expects the operator to perform plant maintenance nextyear.

 

Oilproduction declined in fiscal 2005 due to a 12,000 barrel (15%) decline inproduction at Barnwell’s largest oil producing property, Red Earth, principallydue to the natural aging of the property. Oil production also declined at other mature properties but thesedeclines were offset by increases in production at Balsam and Bonanza, two ofBarnwell’s newer properties.

 

Oiland natural gas revenues increased $4,010,000 (20%) from $19,830,000 in fiscal2003 to $23,840,000 in fiscal 2004, due to increases in both prices andproduction volumes for all petroleum products. Natural gas prices increased 8%, and natural gas production increased7%.  The increase in natural gasproduction was due to both new production from the Bonanza, Doris, South PouceCoupe and Leduc areas and natural gas production from the Dunvegan propertywhich increased approximately 7% as a result of an infill drilling program infiscal 2004 and late fiscal 2003 which added 39 gross development wells (3.4net wells).  The increase in natural gasproduction was partially offset by production declines at the Thornbury, PouceCoupe, Progress, and Pollockville areas. Oil prices increased 20%, and oil production increased 8% due to newproduction from the Wizard Lake and Bonanza areas, partially offset by a decreasein production from older oil properties. Natural gas liquids prices increased 12%, and natural gas liquidsproduction increased 24% due to the infill drilling program at the Dunveganarea mentioned above and due to the fact that fiscal 2003 natural gas liquidsproduction was impacted by a fire in early October 2002 at a Dunvegan gas plantwhich prevented stripping of natural gas liquids from the natural gas; thisresulted in an approximately 6,000 barrel lower liquids net production infiscal 2003, as compared to fiscal 2004.

 

Oil and Natural Gas Operating Expenses

 

Operating expenses increased $926,000 (16%) to $6,899,000in fiscal 2005, as compared to $5,973,000 in fiscal 2004.  The increase was primarily due to an 8%increase in the average exchange rate of the Canadian dollar to the U.S. dollarthat increased oil and natural gas operating expenses $546,000 in fiscal 2005as compared to the prior year.  Alsocontributing to the increase were operating expenses on new wells.

 

Operatingexpenses increased $1,301,000 (28%) to $5,973,000 in fiscal 2004, as comparedto $4,672,000 in fiscal 2003, due to the addition of new properties, costsincurred to re-enter wells for repair, maintenance and cleaning, andinflationary pressures on oil field service costs.  Also contributing to the increase was a 10%increase in the average exchange rate of the Canadian dollar to the U.S. dollarthat increased oil and natural gas operating expenses $505,000 in fiscal 2004,as compared to fiscal 2003.

 

Sale of Interest in Leasehold Land, Sale ofDevelopment Rights, and Minority Interest in Earnings

 

OnFebruary 13, 2004, Kaupulehu Developments, a land development generalpartnership in which Barnwell owns a 77.6% controlling interest, entered into aPurchase and Sale Agreement with WB KD Acquisition LLC (“WB”) by whichKaupulehu Developments transferred its leasehold interest in approximately 870acres zoned for resort/residential development, in two increments, to WB.  There is no affiliation between KaupulehuDevelopments and WB.  WB is an affiliateof Westbrook 

 

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Partners LLC,an affiliate of the developers of the Kuki’o Resort.  Increment I is an area planned forapproximately 80 single-family lots and a beach club on the portion of theproperty bordering the Pacific Ocean. The purchasers of the 80 single-family lots will have the right to applyfor membership in the Kuki’o Resort Golf and Beach Club, which is locatedadjacent to and south of the Four Seasons Resort Hualalai at Historic Ka’upulehu.  Increment II is the remaining portion of theapproximately 870-acre property and is zoned for single-family and multi-familyresidential units and a golf course and clubhouse.

 

With respect to Increment I,Kaupulehu Developments received a non-refundable $11,550,000 payment (“ClosingPayment”) in February 2004 and is entitled to receive payment of the followingpercentages of the gross proceeds generated from the sale by WB ofsingle-family lots in Increment I (“Percentage Payments”): 9% of the grossproceeds from single-family lot sales up to aggregate gross proceeds of$100,000,000; 10% of such aggregate gross proceeds greater than $100,000,000but less than $300,000,000; and 14% of such aggregate gross proceeds in excessof $300,000,000.  If prior to December31, 2005,  Kaupulehu Developments has notreceived Percentage Payments equal to or greater than $2,500,000 in theaggregate, WB will pay Kaupulehu Developments the amount by which the aggregateamount of all prior Percentage Payments made by WB to Kaupulehu Developments isless than $2,500,000.  If prior toDecember 31, 2006, Kaupulehu Developments has not received Percentage Payments(including payments in lieu of Percentage Payments as described in theimmediately preceding sentence) equal to or greater than $5,000,000 in theaggregate, then WB will pay Kaupulehu Developments the amount by which theaggregate amount of all such payments is less than $5,000,000.  Until the formal granting of access andutility easements by third parties to WB have been completed, WB is entitled,but not required, to withhold payment of Percentage Payments and the minimumpayments described above to Kaupulehu Developments until WB’s aggregate grossproceeds generated by the sale of single-family lots in Increment I exceeds$75,000,000.  As of the date of thisfiling, Kaupulehu Developments has received no Percentage Payments and it isBarnwell’s understanding that the conditions regarding the formal granting ofeasements are in progress but have not yet been completed.  There is no assurance that any of thesefuture payments will be received.

 

WBalso agreed to pay Kaupulehu Developments non-refundable interim payments of$50,000 per month (“Interim Payments”), until the first to occur of the closingof the sale of the 40th single-family lot sold in Increment I or WB’s paymentto Kaupulehu Developments of a total of $900,000 in Interim Payments subsequentto February 2004.  Kaupulehu Developmentsreceived the $900,000 of Interim Payments in full as of August 2005.

 

KaupulehuDevelopments, WB and The Trustees of The Estate of Bernice Pauahi Bishop (“KS”)also entered into an agreement (the “Step-In Rights Agreement”) whereby if WBelects not to proceed with development of Increment I within the time frame setforth in the Step-In Rights Agreement, which may be extended by KS, or defaultsunder the terms of its lease with KS, Kaupulehu Developments would have theright to succeed to WB’s development rights and develop the property withoutany payment to WB.

 

In March 2004, WB commenced engineering ofinfrastructure, preparation of covenants, conditions and restrictions for acommunity association, and preparation of legal documents to enable real estatesales, and broke ground and graded several miles of access roads.  In 2004, WB received final subdivisionapproval from the County of Hawaii for the first phase of 38 lots.  In 2005, WB received federal and State ofHawaii approvals to begin marketing the first phase of 38 lots of IncrementI.  

 

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Additionally, during 2004 and 2005, WB excavated, processed and placedmaterial on the single-family lots bringing a majority of the first phase of 38lots to finished grade.

 

Withrespect to Increment II, Kaupulehu Developments and WB agreed to use diligentefforts to negotiate, and attempt to document and enter into, prior to the datewhich is three (3) years following the closing of the sale of the firstsingle-family lot in Increment I, an agreement with regards to the ownershipand development of Increment II.  WB,however, may terminate such negotiations at any time without any furtherobligation.  Under the terms of theStep-In Rights Agreement, if at the end of three years following the closing ofthe sale of the first single-family lot in Increment I the parties have notentered into a definitive agreement with respect to Increment II, the leaseholdrights with respect to Increment II will revert to Kaupulehu Developments.  In 2005, Kaupulehu Developments and WB heldseveral meetings to discuss possible development scenarios for IncrementII.  No agreement has been reached withWB for the sale and development of Increment II, although discussions betweenthe parties are ongoing.  Accordingly, norevenues or cost of sales have been recognized on Increment II.

 

Thesale of Kaupulehu Developments’ interest in Increment I in fiscal 2004 wasaccounted for by use of the cost recovery method, under which no operatingprofit is recognized until cash received exceeds the cost and the estimatedfuture costs related to the leasehold interest sold.  The revenue from the $11,550,000 ClosingPayment plus $350,000 of post-closing Interim Payments received in Marchthrough September 2004, was reduced by $693,000 of fees related to the sale,approximately $402,000 in other costs related to the sale, and $3,475,000 ofpreviously capitalized costs relating to Increment I.  The $7,330,000 of net revenue from theClosing Payment and Interim Payments for the year ended September 30, 2004is recorded in the Consolidated Statements of Operations as “Sale of interestin leasehold land, net.”  Operatingprofit on the Increment I transaction, after minority interest, totaledapproximately $5,470,000 for the year ended September 30, 2004.  During the year ended September 30, 2005,Kaupulehu Developments received additional Interim Payments, before minorityinterest, totaling $550,000.

 

Thedevelopment rights held by Kaupulehu Developments are for residentially-zonedleasehold land within and adjacent to the Hualalai Golf Club and are underoption to Kaupulehu Makai Venture, an unrelated entity that is an affiliate ofKajima Corporation of Japan.  Netrevenues from the sale of development rights were $2,497,000 for each of theyears ended September 30, 2005 and 2004. In December 2004, Kaupulehu Makai Venture exercised the portion of itsdevelopment rights option that was to expire on December 31, 2004 and paidKaupulehu Developments $2,656,000. Revenue from the development rights sales was reduced by $159,000 offees related to the sale, resulting in net revenues of $2,497,000 and a$1,950,000 operating profit, after minority interest, on the transaction.  On December 31, 2003, Kaupulehu Makai Ventureexercised the portion of its development rights option expiring on that date andsent Kaupulehu Developments the required $2,656,000 option payment, which wasreceived by Kaupulehu Developments in January 2004.  Revenue from the option exercise was reducedby $159,000 of fees related to the sale, resulting in net revenues of $2,497,000and a $1,950,000 operating profit, after minority interest, on thetransaction.  There were no other costsdeducted from revenues from the sale of development rights in the years endedSeptember 30, 2005 and 2004 as all capitalized costs associated with thedevelopment rights were expensed in previous years under the cost recoverymethod.  In the year ended September 30,2003, $2,125,000 of revenues from the sale of development rights was reduced by$128,000 of fees related to the sale and $1,277,000 of cost basis related tothe development rights, resulting in net revenues of $720,000 and a $280,000operating profit, after minority interest, on the transaction.

 

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Thetotal amount of remaining future development rights option receipts atSeptember 30, 2005, if all options are fully exercised, was $15,937,500,comprised of six payments of $2,656,250 due on each December 31 of years 2005to 2010.  In November 2005, KaupulehuMakai Venture paid Kaupulehu Developments $2,875,000 upon exercising theportion of its development rights option due on December 31, 2005 of $2,656,000and a portion, $219,000, of its development rights option due on December 31,2006, bringing the total remaining future development rights option receipts to$13,063,000.  If any annual optionpayment is not made, the then remaining development right options willexpire.  There is no assurance that anyportion of the remaining options will be exercised.

 

Theaforementioned $159,000 in fees ($112,000, net of minority interest) on theproceeds from the sale of development rights in fiscal 2005 and 2004 and$693,000 ($486,000, net of minority interest) on the proceeds from the sale ofinterest in leasehold land in the year ended September 30, 2004 were paid toNearco, Inc., a company controlled by Mr. Terry Johnston, a director ofBarnwell and an indirect 21.8% owner of Kaupulehu Developments.  Under an agreement entered into in 1987,prior to Mr. Johnston’s election to Barnwell’s Board of Directors, Barnwell isobligated to pay Nearco 2% of Kaupulehu Developments’ gross receipts from thesale of real estate interests, and Cambridge Hawaii Limited Partnership, a49.9% partner of Kaupulehu Developments in which Barnwell purchased a 55.2%interest in April 2001, is obligated under an agreement entered into in 1987 topay Nearco 4% of Kaupulehu Developments’ gross receipts from the sale of realestate interests.  Fees of $128,000($89,000, net of minority interest) on the proceeds from sales of developmentrights were paid in the year ended September 30, 2003.  The fees represent compensation for promotionand marketing of Kaupulehu Developments’ property and were determined based onthe estimated fair value of such services. Barnwell believes the fees are fair and reasonable compensation for suchservices.

 

Feeswere also paid to Nearco for consulting services related to KaupulehuDevelopments’ leasehold land.  In fiscal2005, 2004 and 2003, consulting service fees paid to Nearco totaled $268,000,$273,000 and $218,000, respectively, and were included in general andadministrative expenses.  In addition,$52,000 of fees were paid to Nearco in fiscal 2004 for services related to theclosing of the February 2004 sale of an interest in leasehold land.  These fees were a direct cost of the sale andaccordingly reduced the revenues recognized from the sale under the costrecovery method.  Barnwell believes thefees are fair and reasonable compensation for such services.

 

Contract Drilling

 

Contractdrilling revenues and costs are associated with well drilling and water pumpinstallation, replacement and repair in Hawaii.

 

Contractdrilling revenues increased $3,954,000 (107%) to $7,644,000 in fiscal 2005, ascompared to $3,690,000 in fiscal 2004, and contract drilling operating expensesincreased $2,581,000 (81%) to $5,765,000 in fiscal 2005, as compared to $3,184,000in fiscal 2004.  Operating profit before generaland administrative expenses increased $1,346,000 (330%) from $408,000 in fiscal2004 to $1,754,000 in fiscal 2005 due to an increase in water well drilling activity andhigher margins on contracts performed throughout most of fiscal 2005, ascompared to fiscal 2004.  Contractdrilling revenues and costs are not seasonal in nature but can fluctuatesignificantly based on the awarding and timing of contracts, which aredetermined by contract drilling customer demand.  Management currently estimates that operatingprofit will be lower in fiscal 2006 due to lower estimated margins on contractsin backlog.

 

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AtSeptember 30, 2005, there was a backlog of nine well drilling contracts and tenpump installation and repair contracts, seven and four of which were inprogress as of September 30, 2005.  Thebacklog of contract drilling revenues as of November 30, 2005 was approximately$3,500,000.

 

Contractdrilling revenues increased $1,640,000 (80%) to $3,690,000 in fiscal 2004, ascompared to $2,050,000 in fiscal 2003, and contract drilling operating expensesincreased $1,256,000 (65%) to $3,184,000 in fiscal 2004, as compared to$1,928,000 in fiscal 2003.  Operatingprofit before depreciation increased $384,000 (315%) from $122,000 in fiscal2003 to $506,000 in fiscal 2004.  Theincreases were due to an increase in water well drilling activity as there werefour drilling rigs operating at the same time for a portion of fiscal 2004, butnot during fiscal 2003.

 

Gas Processing and Other Income

 

Gas processing and otherincome decreased $388,000 (33%) to $795,000 in fiscal 2005 as compared to$1,183,000 in fiscal 2004.  In fiscal2004, Kaupulehu Developments received $250,000 in income related tonegotiations on the development of Kaupulehu Developments’ resort/residentialacreage; such negotiation revenues discontinued with the consummation ofKaupulehu Developments’ sale of an interest in leasehold land in February 2004,therefore there were no such revenues in fiscal 2005.  In addition, fiscal 2004 gas processing andother income included a $139,000 gain from the sale of a parcel of vacant landformerly used as a storage and maintenance yard by Barnwell’s contract drillingsegment; there was no such sale in fiscal 2005.

 

Gas processing and other income decreased $377,000(24%) to $1,183,000 in fiscal 2004, as compared to $1,560,000 in fiscal2003.  In fiscal 2004, KaupulehuDevelopments received $250,000 in income related to negotiations on thedevelopment of Kaupulehu Developments’ resort/residential acreage, as comparedto $500,000 in fiscal 2003, a decrease of $250,000; these revenues discontinuedwith the consummation of Kaupulehu Developments’ sale of an interest inleasehold land in February 2004.  Inaddition, interest income decreased in fiscal 2004, as compared to fiscal 2003,as fiscal 2003 interest income included $102,000 of interest on an income taxrefund from the Canadian government relating to Barnwell’s fiscal 1994 taxreturn (there was no such income in fiscal 2004), and as a note receivable thatwas outstanding during all of fiscal 2003 was repaid in February 2004, whichresulted in an approximately $100,000 decrease in interest income.  These decreases were partially offset by anincrease in other income in fiscal 2004 from the aforementioned $139,000 gainfrom the sale of a parcel of vacant land. The remainder of the decrease was primarily due to a $30,000 decrease ingas processing fees due to a decrease in the processing of third-party gas, ascompared to the prior year.

 

General and Administrative Expenses

 

Generaland administrative expenses increased $3,820,000 (48%) to $11,731,000 in fiscal2005, as compared to $7,911,000 in fiscal 2004. The increase was due in part to a $2,509,000 increase in stockappreciation rights expense resulting from an increase in Barnwell’s stockprice and the issuance of additional stock options with stock appreciationrights in fiscal 2005, as compared to the prior year.  Personnel costs also increased by $1,192,000in fiscal 2005 as a result of the addition of new personnel in the oil andnatural gas operations and increased compensation costs.  In addition, professional fees increased $215,000in the current year due to higher legal and audit fees, as a result ofincreased costs of regulatory compliance, and consulting services related toBarnwell’s oil and natural gas leases.

 

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Generaland administrative expenses increased $1,940,000 (32%) to $7,911,000 in fiscal2004, as compared to $5,971,000 in fiscal 2003. The increase was due to the impact of an increase in Barnwell’s stockprice on stock appreciation rights, which increased general and administrativeexpenses by $765,000 as compared to the prior year, $733,000 of bonuses issuedin conjunction with the consummation of Kaupulehu Developments’ sale of an interestin leasehold land in February 2004, and $443,000 of higher payroll costs, ascompared to the prior year.

 

Generaland administrative expenses also includes fees paid to Nearco, Inc., an entitycontrolled by Mr. Terry Johnston, a director of Barnwell and an indirect 21.8%owner of Kaupulehu Developments, for consulting services related to KaupulehuDevelopments’ leasehold land.  Fees paidto Nearco, Inc. totaled $268,000, $273,000 and $218,000 in fiscal 2005, 2004and 2003, respectively.  Barnwell believesthe fees are fair and reasonable compensation for such services.

 

Depletion, Depreciation and Amortization

 

Depletion, depreciationand amortization increased $2,027,000 (30%) to $8,788,000 in fiscal 2005, ascompared to $6,761,000 in fiscal 2004, due to a 17% increase inthe depletion rate, a 4% increase in production (in MCF equivalents where onebarrel of oil and natural gas liquids are converted to 5.8 MCF equivalents) andan 8% increase in the average exchange rate of the Canadian dollar to the U.S.dollar.

 

The higher depletion rateis due to increases in Barnwell’s costs of finding and developing provenreserves, and costs that are incurred to decrease the rate of productiondeclines or maintain or increase rates of production from reserves found inprevious years.  Barnwell’s cost offinding and developing proven reserves has increased due to the cost of oil andnatural gas exploration and development having increased along with productprices, the drilling of unsuccessful wells, and as a portion of recent oil andnatural gas capital expenditures were for the development of existing reserves.

 

Depletion, depreciationand amortization increased $2,428,000 (56%) to $6,761,000 in fiscal 2004, ascompared to $4,333,000 in fiscal 2003, due to a 33% increase in the depletionrate, a 9% increase in production, and a 10% increase in the fiscal yearaverage exchange rate of the Canadian dollar to the U.S. dollar.

 

Interest Expense

 

Interest expenseincreased $129,000 (26%) to $616,000 in fiscal 2005, as compared to $487,000 infiscal 2004, due to higher average interest rates during fiscal 2005 ascompared to fiscal 2004.

 

Theaverage interest rate incurred during fiscal 2005 on Barnwell’s borrowings fromthe Royal Bank of Canada increased to 4.82%, as compared to 3.67% in fiscal 2004.  The weighted average balance of outstandingborrowings from the Royal Bank of Canada remained relatively unchanged atapproximately $10,300,000 in fiscal 2005 and 2004.

 

Interest expenseincreased $45,000 (10%) to $487,000 in fiscal 2004, as compared to $442,000 infiscal 2003, as there was no capitalization of interest in fiscal 2004, ascompared to $45,000 of capitalized interest in fiscal 2003.

 

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The majority of Barnwell’sdebt is denominated in U.S. dollars. Therefore, the increase in the average exchange rate of the Canadiandollar to the U.S. dollar had a minimal impact on interest expense.

 

Foreign Currency Fluctuations

 

In addition to U.S.operations, Barnwell conducts foreign operations in Canada.  Consequently, Barnwell is subject to foreigncurrency translation and transaction gains and losses due to fluctuations ofthe exchange rates between the Canadian dollar and the U.S. dollar.

 

Thefiscal year average exchange rate of the Canadian dollar to the U.S. dollarincreased 8% in fiscal 2005, as compared to fiscal 2004, and the exchange rateof the Canadian dollar to the U.S. dollar increased 9% at September 30, 2005,as compared to September 30, 2004. Accordingly, the assets, liabilities, stockholders’ equity and revenuesand expenses of Barnwell’s subsidiaries operating in Canada haveincreased.  Barnwell’s Canadian dollarassets are greater than its Canadian dollar liabilities; therefore, increasesin value of the Canadian dollar to the U.S. dollar generate other comprehensiveincome.  The fiscal year average exchangerate of the Canadian dollar to the U.S. dollar increased 10% in fiscal 2004, ascompared to fiscal 2003, and the exchange rate of the Canadian dollar to theU.S. dollar increased 7% at September 30, 2004, as compared to September 30,2003.  Other comprehensive income due toforeign currency translation adjustments for fiscal 2005 was $1,543,000, a $117,000decrease from other comprehensive income of $1,660,000 in fiscal 2004.

 

Foreign currencytransaction gains and losses were not material in fiscal 2005, 2004, and 2003and are reflected in general and administrative expenses.

 

The impact offluctuations of the exchange rates between the Canadian dollar and the U.S.dollar may be material from period to period. Barnwell cannot accurately predict future fluctuations between theCanadian and U.S. dollars.

 

Income Taxes

 

In November 2003, RoyalAssent was received on a bill passed by the Parliament of Canada, which wasthen enacted into law, to reduce Canada’s corporate tax rate on “resource”income (income derived from oil and natural gas operations) over a four-yearperiod beginning January 1, 2003 from 29% to 21% beginning January 1,2007.  Additionally, the bill phases inover the same four-year period tax deductions for royalties, which previouslywere not tax deductible, and phases out the Resource Allowance deduction alongwith other changes.  Accordingly, duringfiscal 2004, Barnwell’s Canadian deferred income tax liabilities were reducedby approximately $1,440,000 due to the reduction in Canada’s federal corporatetax rate.  There was no benefitattributable to changes in Canada’s corporate tax rate on “resource” income infiscal 2005 or fiscal 2003.  Barnwell’sCanadian deferred income tax liabilities were also reduced by approximately$300,000 in fiscal 2004 as a result of the Province of Alberta’s reduction ofthe province’s corporate tax rate from 13.0% to 12.5%, effective April 1, 2003(enacted into law in December 2003), and from 12.5% to 11.5%, effective April1, 2004 (enacted into law in May 2004). In April 2002, the legislative assembly of the Province of Albertapassed a bill to reduce the province’s corporate tax rate from 13.5% to 13.0%,effective April 1, 2002.  The bill wasenacted into law in December 2002.  Thereduction in the tax rate reduced Canadian deferred income tax liabilities byapproximately $75,000 in fiscal 2003. There was no such reduction recorded in fiscal 2005.

 

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Environmental Matters

 

Federal, state, and Canadian governmental agenciesissue rules and regulations and enforce laws to protect the environment whichare often difficult and costly to comply with and which carry substantialpenalties for failure to comply, particularly in regard to the discharge ofmaterials into the environment.  Theregulatory burden on the oil and gas industry increases its cost of doingbusiness.  These laws, rules andregulations affect the operations of Barnwell and could have a material adverseeffect upon the earnings or competitive position of Barnwell.  Although Barnwell’s experience has been tothe contrary, there is no assurance that this will continue to be the case.

 

Inflation

 

The effect of inflation on Barnwell has generally beento increase its cost of operations, interest cost (as a substantial portion ofBarnwell’s debt is at variable short-term rates of interest which tend toincrease as inflation increases), general and administrative costs and directcosts associated with oil and natural gas production and contract drillingoperations.  Oil and natural gas pricesrealized by Barnwell are essentially determined by world prices for oil andwestern Canadian/Midwestern U.S. prices for natural gas.

 

Recent Accounting Pronouncements

 

In November 2004, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.151, “Inventory Costs, an amendment of Accounting Research Bulletin (“ARB”) No.43, Chapter 4.”  SFAS No. 151 amends the guidance in ARB No. 43, Chapter4, “Inventory Pricing” to clarify the accounting for abnormal amounts of idlefacility expense, freight handling costs, and wasted material (spoilage).  SFAS No. 151 requires that those items berecognized as current-period charges regardless of whether they meet thecriterion of “so abnormal.”  In addition,SFAS No. 151 requires that allocation of fixed production overhead to the costsof conversion be based on the normal capacity of the productionfacilities.  The provisions of SFAS No.151 will be effective for fiscal years beginning after June 15, 2005.  Adoption of the provisions of SFAS No. 151is not expected to have a material impact on Barnwell’s financial condition,results of operations, or liquidity.

 

In December 2004, the FASB issued SFAS No. 123(R), “Share-BasedPayment.”  SFAS No. 123(R) replaces SFAS No. 123, “Accounting for StockIssued to Employees,” and supersedes Accounting Principal Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees.”  SFAS No. 123(R)requires that compensation costs relating to share-based payment transactionsbe recognized in the consolidated financial statements.  Compensation costs will be measured based onthe fair value of the equity or liability instruments issued.  SFAS No. 123(R) is effective, as adjusted bythe U.S. Securities and Exchange Commission, as of the beginning of the firstannual reporting period that begins after June 15, 2005, or for small businessfilers, as of the beginning of the first annual reporting period that beginsafter December 15, 2005.  Barnwell iscurrently evaluating the provisions of SFAS No. 123(R) and has not yetdetermined whether it will use the modified prospective or the modified retrospectivemethods allowed by SFAS No. 123(R), nor has it determined its impact on itsfinancial condition, results of operations, or liquidity.

 

38

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In December 2004, the FASB issued SFAS No.152, “Accountingfor Real Estate Time-Sharing Transactions — an amendment of FASB Statements No.66 and 67.”  SFAS No. 152 amends SFAS No.66, “Accounting for Sales of Real Estate,” to reference the financialaccounting and reporting guidance for real estate time-sharing transactionsprovided in the American Institute of Certified Public Accountants (“AICPA”)Statement of Position (“SOP”) 04-2, “Accounting for Real Estate Time-SharingTransactions.”  SFAS No. 152 also amendsSFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real EstateProjects,” to state that the guidance for incidental operations and costsincurred to sell real estate projects does not apply to real estatetime-sharing transactions.  Theaccounting for such operations and costs is subject to the guidance in SOP04-2.  SFAS No. 152 is effective forfinancial statements for fiscal years beginning after June 15, 2005, withearlier application encouraged.  Adoptionof the provisions of SFAS No. 152 is not expected to have a material impact onBarnwell’s financial condition, results of operations, or liquidity.

 

In December 2004, the FASB issued SFAS No. 153, “Exchangeof Nonmonetary Assets, an amendment of APB Opinion No. 29, ‘Accounting forNonmonetary Transactions.’”  SFAS No. 153is based on the principle that exchange of nonmonetary assets should bemeasured based on the fair market value of the assets exchanged.  SFAS No. 153 eliminates the exception ofnonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance.  SFAS No. 153 iseffective for nonmonetary asset exchanges in fiscal periods beginning afterJune 15, 2005.  Adoption of theprovisions of SFAS No. 153 is not expected to have a material impact onBarnwell’s financial condition, results of operations, or liquidity.

 

On February 7, 2005, the Office of the ChiefAccountant of the Securities and Exchange Commission issued a letter to theAICPA expressing its views regarding certain operating lease accounting issuesand their application under accounting principles generally accepted in theUnited States of America.  Barnwell’saccounting for operating leases was evaluated by Barnwell’s management usingthe guidance provided in this letter, and it was determined that any changes inaccounting as a result of the aforementioned letter would not have a materialimpact on Barnwell’s financial condition, results of operations or liquidity.

 

In March 2005, the FASB issued FASB Interpretation No.47 (“FIN”), “Accounting for Conditional Asset Retirement Obligations — aninterpretation of FASB Statement No. 143.” FIN 47 clarifies that the term “conditional asset retirement obligation”as used in FASB Statement No. 143, “Accounting for Asset RetirementObligations,” refers to a legal obligation to perform an asset retirementactivity in which the timing and (or) method of settlement are conditional on afuture event that may or may not be within the control of the entity.  Accordingly, an entity is required torecognize a liability for the fair value of a conditional asset retirementobligation if the fair value of the liability can be reasonably estimated.  FIN 47 is effective for fiscal years endingafter December 15, 2005.  Adoption of theprovisions of FIN 47 is not expected to have a material impact on Barnwell’sfinancial condition, results of operations or liquidity.

 

On March 29, 2005, the Securities and ExchangeCommission (“SEC”) staff issued Staff Accounting Bulletin (“SAB”) No. 107, “Share-BasedPayment”, which expressed the SEC staff’s views on SFAS No. 123(R), but did notmodify any of SFAS No. 123(R)’s provisions. Barnwell is evaluating the views expressed by the SEC in SAB No. 107 inconjunction with its assessment of SFAS No. 123(R)’s impact.

 

39

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In May 2005, the FASB issued SFAS No. 154, “AccountingChanges and Error Correction — a replacement of APB Opinion No. 20 andFASB Statement No. 3.”  Thisstatement changes the requirements for the accounting for and reporting of achange in accounting principle and applies to all voluntary changes inaccounting principle.  It also applies tochanges required by an accounting pronouncement in the unusual instance thatthe pronouncement does not include specific transition provisions.  When a pronouncement includes specifictransition provisions, those provisions should be followed.  APB No. 20 required that most voluntarychanges in accounting principle be recognized by including in net income of theperiod of the change the cumulative effect of changing to the new accountingprinciple.  This statement requiresretrospective application to prior period financial statements of changes inaccounting principle, unless it is impracticable to determine either theperiod-specific effects or the cumulative effect of the change.  Theprovisions of SFAS No. 154 are effective for fiscal years beginning afterDecember 15, 2005.

 

 

LIQUIDITY AND CAPITALRESOURCES

 

Cash Flows, Debt and Available Credit

 

Cashflows provided by operations totaled $14,213,000 for fiscal 2005, an increaseof $8,065,000 as compared to $6,148,000 of cash flows provided by operationsfor the same period in the prior year.  Theincrease was due to higher operating cash flow generated by Barnwell’s oil andnatural gas and contract drilling segments.

 

Cash flows used ininvesting activities totaled $13,423,000 for fiscal 2005, a decrease of $14,980,000from cash flows provided by investing activities of $1,557,000 in fiscal 2004.  Thedecrease in investing cash flows is primarily due to 1) Kaupulehu Developments’receipt of a closing payment for the sale of an interest in leasehold land inFebruary 2004 which generated approximately $10,460,000 of cash, net ofassociated costs, 2) collection in full of a $1,311,000 note receivable infiscal 2004, and 3) receipt of $440,000 of proceeds, net of associated costs,from the sale of land that was previously utilized as a contract drillingstorage yard in fiscal 2004; there were no such proceeds received in fiscal2005.  Capital expenditures increasedfrom $12,109,000 in fiscal 2004 to $16,715,000 in fiscal 2005, an increase of$4,606,000.  Barnwell also invested$3,400,000 in certificates of deposit at various financial institutions,partially offset by $3,087,000 of proceeds received on matured certificates ofdeposit, in fiscal 2005, as compared to $1,387,000 of investments in certificates of deposit,net of proceeds from matured certificates of deposit, in fiscal 2004.  In both periods Barnwellreceived $2,497,000, net of expenses, from the sale of development rights.  Barnwellalso received a total of approximately $558,000 related to gas over bitumenroyalty adjustments in fiscal 2005; there were no such proceeds received infiscal 2004.

 

During fiscal 2005,Barnwell used $2,000 of cash flows for financing activities, a $4,944,000decrease as compared to $4,946,000 of cash flows used in financing activitiesin fiscal 2004.  This was principally dueto Barnwell borrowing $1,116,000 under the Royal Bank of Canada facility in fiscal2005, as compared to the repayment of $1,408,000 of long-term debt in fiscal2004.  In fiscal 2005, Barnwelldistributed $513,000 to minority interests resulting from KaupulehuDevelopments’ property sales, a $2,120,000 decrease in minority interestdistributions compared to $2,633,000 in fiscal 2004, as distributions in theprior year included distributions on the aforementioned receipt of a closingpayment for the sale of an interest in leasehold land in February 2004.  Barnwell also paid $802,000 in dividends, 

 

40

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a $321,000decrease from $1,123,000 of dividends paid in fiscal 2004, and collected$197,000 in proceeds from employees’ exercise of stock options as compared to$218,000 collected in fiscal 2004.

 

On December 3, 2004,Barnwell declared a cash dividend of $0.04 per share (split-adjusted), payableJanuary 5, 2005, to stockholders of record on December 20, 2004.

 

Also on December 3, 2004, Barnwell declared a two-for-onestock split in the form of a stock dividend. The new shares were distributed on January 28, 2005 to all shareholdersof record as of January 11, 2005.

 

On February 14, 2005,Barnwell declared a cash dividend of $0.02 per share (split-adjusted), payableMarch 15, 2005, to stockholders of record on March 1, 2005.

 

On May 11, 2005, Barnwelldeclared a cash dividend of $0.02 per share (split-adjusted), payable June 15,2005, to stockholders of record on June 1, 2005.

 

On August 11, 2005,Barnwell declared a cash dividend of $0.02 per share (split-adjusted), payableSeptember 15, 2005, to stockholders of record on September 1, 2005.

 

On October 17, 2005,Barnwell declared a three-for-one stock split in the form of a stockdividend.  The new shares weredistributed on November 14, 2005 to all shareholders of record as of October28, 2005.

 

On December 9, 2005, Barnwell declared a cash dividendof $0.025 per share payable January 4, 2006, to stockholders of record onDecember 20, 2005.

 

The Royal Bank of Canadahas renewed Barnwell’s credit facility through April 2006 at an unchanged$19,000,000 Canadian dollars, approximately US$16,300,000, at September 30, 2005.  All other terms of the credit facilityremained unchanged upon renewal.  Thebank affirmed that it will not require any repayments under the facility beforeOctober 1, 2006.  Accordingly, Barnwellhas classified outstanding borrowings under the facility as long-term debt.

 

At September 30, 2005,Barnwell had $5,492,000 in cash and cash equivalents, $1,700,000 incertificates of deposit with maturity dates ranging from October 2005 to September2006, and approximately $4,700,000 of available credit under its creditfacility with the Royal Bank of Canada. Barnwell believes its future cash flows from operations, land segmentsales, and available credit will be sufficient to fund its estimated capitalexpenditures for at least the next twelve months and meet the repaymentschedule on its long-term debt.  However,if oil and natural gas production remains at or declines from current levels oroil and natural gas prices decline from current levels, current working capitalbalances and cash flows generated by operations may not be sufficient to fundBarnwell’s current projected level of oil and natural gas capital expenditures,in which case Barnwell may fund capital expenditures with funds generated byland segment sales, long-term debt borrowings, or it may reduce future oil andnatural gas capital expenditures.  Additionally,if Barnwell’s credit facility with a Canadian bank is reduced below the currentlevel of borrowings under the facility after the April 2006 review, Barnwellmay be required to reduce expenditures or seek alternative sources of financingto make any required payments under the facility. 

 

41

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Oil and Natural Gas Capital Expenditures

 

In fiscal 2005, Barnwell’soil and natural gas capital expenditures, including accrued capitalexpenditures, increased $6,353,000 (53%) from $11,876,000 in fiscal 2004 to $18,229,000in fiscal 2005.  Barnwellparticipated in drilling 80 (13.5 net) wells, 69 (10.3 net) of which wereinitially deemed by management to be successful, and replaced 71% of oilproduction (including natural gas liquids) and 90% of natural gasproduction.  Of these 80 wells in fiscal2005, Barnwell initiated 27 gross wells (8.8 net wells).  Of the $18,229,000 total oil and natural gasproperties investments for fiscal 2005, $2,695,000 (15%) was for acquisition ofleases and lease rentals, $1,523,000 (8%) was for geological and geophysicalcosts, $8,170,000 (45%) was for intangible drilling costs, $5,080,000 (28%) wasfor production equipment, and $761,000 (4%) was for future site restoration andabandonment costs.  The major areas of investmentsin fiscal 2005 were in the Dunvegan, Bonanza, Doris, and Progress areas ofAlberta.

 

Thefollowing table sets forth the gross and net numbers of oil and natural gaswells Barnwell participated in drilling for each of the last three fiscalyears:

 
| ** **                             | ** ** | **2005**  | ** ** | **2004** | ** ** | **2003**  | ** ** |
|----------------------------------------|------------|-----------|------------|----------|------------|-----------|------------|
| ** **                             | ** ** | **Gross** | ** ** | **Net**  | ** ** | **Gross** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Net** | ** ** |
|                                   |       |      |       |     |       |      |       |   |   |   |   |   |   |
| Exploratory oil and natural gas wells  | ** ** | **10**    | ** ** | **2.9**  |       | 16        |       | 6.1 |   | 13 |   | 3.6 |   |
|                                   |       |      |       |     |       |      |       |   |   |   |   |   |   |
| Development oil and natural gas wells  | ** ** | **70**    | ** ** | **10.6** |       | 128       |       | 8.5 |   | 52 |   | 11.1 |   |
|                                   |       |      |       |     |       |      |       |   |   |   |   |   |   |
| Successful oil and natural gas wells   | ** ** | **69**    | ** ** | **10.3** |       | 134       |       | 11.2 |   | 53 |   | 11.1 |   |
|                                   |       |      |       |     |       |      |       |   |   |   |   |   |   |
| Unsuccessful oil and natural gas wells | ** ** | **11**    | ** ** | **3.2**  |       | 10        |       | 3.4 |   | 12 |   | 3.6 |   |

 

Barnwellestimates that oil and natural gas capital expenditures for fiscal 2006 willrange from $14,000,000 to $18,000,000. This estimated amount may increase or decrease as dictated by management’sassessment of the oil and natural gas environment and prospects.

 

42

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Item 7.    FINANCIALSTATEMENTS

 

 

 

 

**Report of Independent RegisteredPublic Accounting Firm**

 

 

 

The Board of Directors

Barnwell Industries, Inc.:

 

We have audited the accompanying consolidatedbalance sheets of Barnwell Industries, Inc. and subsidiaries as of September 30,2005 and 2004, and the related consolidated statements of operations,stockholders’ equity and comprehensive income, and cash flows for each of theyears in the three-year period ended September 30, 2005. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these consolidatedfinancial statements based on our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Barnwell Industries, Inc. and subsidiaries as ofSeptember 30, 2005 and 2004, and the results of their operations and theircash flows for each of the years in the three-year period endedSeptember 30, 2005, in conformity with U.S. generally accepted accountingprinciples.

 

As discussed in note 5 to the consolidatedfinancial statements, effective October 1, 2002, the Company changed its methodof accounting for asset retirement obligations.

 

 

/s/KPMG LLP

 

Honolulu,HawaiiDecember 9, 2005

 

43

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BARNWELL INDUSTRIES, INC.AND SUBSIDIARIES

CONSOLIDATED BALANCESHEETS

 
| ** **                                                                                                                                                                                               | ** ** | **September 30,** | ** **     |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|----------------|
| ** **                                                                                                                                                                                               | ** ** | **2005**          | ** **     | **2004** | ** ** |
| ASSETS                                                                                                                                                                                                   |       |              |           |   |   |
| CURRENT ASSETS:                                                                                                                                                                                          |       |              |           |   |   |
| Cash and cash  equivalents                                                                                                                                                                               | ** ** | **$**             | **5,492,000**  |   | $ | 4,497,000 |   |
| Certificates of  deposit                                                                                                                                                                                 | ** ** | **1,700,000**     |           | 1,387,000 |   |
| Accounts  receivable, net                                                                                                                                                                                | ** ** | **8,279,000**     |           | 5,513,000 |   |
| Deferred income  taxes                                                                                                                                                                                   | ** ** | **3,030,000**     |           | 1,231,000 |   |
| Other current  assets                                                                                                                                                                                    | ** ** | **1,582,000**     |           | 1,574,000 |   |
| TOTAL CURRENT  ASSETS                                                                                                                                                                                    | ** ** | **20,083,000**    |           | 14,202,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| INVESTMENT IN LAND                                                                                                                                                                                       | ** ** | **3,033,000**     |           | 3,033,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| PROPERTY AND EQUIPMENT, NET                                                                                                                                                                              | ** ** | **61,861,000**    |           | 47,852,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| TOTAL ASSETS                                                                                                                                                                                             | ** ** | **$**             | **84,977,000** |   | $ | 65,087,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                |       |              |           |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                     |       |              |           |   |   |
| Accounts payable                                                                                                                                                                                         | ** ** | **$**             | **5,653,000**  |   | $ | 3,142,000 |   |
| Accrued capital  expenditures                                                                                                                                                                            | ** ** | **4,462,000**     |           | 2,882,000 |   |
| Accrued stock  appreciation rights                                                                                                                                                                       | ** ** | **4,371,000**     |           | 1,115,000 |   |
| Accrued  long-term compensation costs                                                                                                                                                                    | ** ** | **1,249,000**     |           | 973,000 |   |
| Other accrued  compensation costs                                                                                                                                                                        | ** ** | **3,828,000**     |           | 1,965,000 |   |
| Other current  liabilities                                                                                                                                                                               | ** ** | **1,720,000**     |           | 2,794,000 |   |
| TOTAL CURRENT  LIABILITIES                                                                                                                                                                               | ** ** | **21,283,000**    |           | 12,871,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| LONG-TERM DEBT                                                                                                                                                                                           | ** ** | **11,576,000**    |           | 10,165,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| ASSET RETIREMENT OBLIGATION                                                                                                                                                                              | ** ** | **2,845,000**     |           | 1,775,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| DEFERRED INCOME TAXES                                                                                                                                                                                    | ** ** | **12,935,000**    |           | 10,719,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| MINORITY INTEREST                                                                                                                                                                                        | ** ** | **312,000**       |           | 408,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                                                                                            |       |              |           |   |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                               |       |              |           |   |   |
| Common stock,  par value $0.50 per share: Authorized,  20,000,000 shares; 8,169,060  issued and outstanding at September 30, 2005, 7,992,060 issued and outstanding at September 30, 2004 |       | **4,085,000**     |           | 3,996,000 |   |
| Retained  earnings                                                                                                                                                                                       | ** ** | **30,317,000**    |           | 24,984,000 |   |
| Accumulated  other comprehensive income, net                                                                                                                                                             | ** ** | **1,624,000**     |           | 169,000 |   |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                                                                                                         | ** ** | **36,026,000**    |           | 29,149,000 |   |
|                                                                                                                                                                                                     |       |              |           |   |   |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                          | ** ** | **$**             | **84,977,000** |   | $ | 65,087,000 |   |
|                                                                                                                                                                                                          |            |                   |                |  |  |  |  |  |  |

See Notes to Consolidated Financial Statements

 

44

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BARNWELLINDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTSOF OPERATIONS

 

 

 
| ** **                                             | ** ** | **Year ended September 30,** | ** **     |
|--------------------------------------------------------|------------|---------------------------------------------|----------------|
| ** **                                             | ** ** | **2005**                                    | ** **     | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                              |       |                                        |           |   |   |   |   |
| Oil and natural  gas                                   | ** ** | **$**                                       | **32,724,000** |   | $ | 23,840,000 |   | $ | 19,830,000 |   |
| Contract  drilling                                     | ** ** | **7,644,000**                               |           | 3,690,000 |   | 2,050,000 |   |
| Sale of interest  in leasehold land, net               | ** ** | **550,000**                                 |           | 7,330,000 |   | — |   |
| Sale of development  rights, net                       | ** ** | **2,497,000**                               |           | 2,497,000 |   | 720,000 |   |
| Gas processing  and other                              | ** ** | **795,000**                                 |           | 1,183,000 |   | 1,560,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
| ** **                                             |       | **44,210,000**                              |           | 38,540,000 |   | 24,160,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
| Costs and expenses:                                    |       |                                        |           |   |   |   |   |
| Oil and natural  gas operating                         | ** ** | **6,899,000**                               |           | 5,973,000 |   | 4,672,000 |   |
| Contract  drilling operating                           | ** ** | **5,765,000**                               |           | 3,184,000 |   | 1,928,000 |   |
| General and  administrative                            | ** ** | **11,731,000**                              |           | 7,911,000 |   | 5,971,000 |   |
| Depletion,  depreciation and amortization              | ** ** | **8,788,000**                               |           | 6,761,000 |   | 4,333,000 |   |
| Interest  expense, net                                 | ** ** | **616,000**                                 |           | 487,000 |   | 442,000 |   |
| Minority  interest in earnings                         | ** ** | **417,000**                                 |           | 2,207,000 |   | 309,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
|                                                   | ** ** | **34,216,000**                              |           | 26,523,000 |   | 17,655,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
| Earnings before income taxes                           | ** ** | **9,994,000**                               |           | 12,017,000 |   | 6,505,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
| Provision for income taxes                             | ** ** | **3,967,000**                               |           | 3,307,000 |   | 4,185,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
| NET EARNINGS                                           | ** ** | **$**                                       | **6,027,000**  |   | $ | 8,710,000 |   | $ | 2,320,000 |   |
|                                                   |       |                                        |           |   |   |   |   |
| BASIC EARNINGS PER COMMON SHARE                        | ** ** | **$**                                       | **0.74**       |   | $ | 1.10 |   | $ | 0.29 |   |
| DILUTED EARNINGS PER COMMON SHARE                      | ** ** | **$**                                       | **0.70**       |   | $ | 1.03 |   | $ | 0.28 |   |
|                                                   |       |                                        |           |   |   |   |   |
| WEIGHTED AVERAGE  NUMBER OF COMMON SHARES OUTSTANDING: |       |                                        |           |   |   |   |   |
| BASIC                                                  | ** ** | **8,152,531**                               |           | 7,943,682 |   | 7,887,060 |   |
|                                                   |       |                                        |           |   |   |   |   |
| DILUTED                                                | ** ** | **8,643,032**                               |           | 8,441,372 |   | 8,217,567 |   |
|                                                        |            |                                             |                |  |  |  |  |  |  |  |  |  |

 

 

See Notesto Consolidated Financial Statements

 

45

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BARNWELL INDUSTRIES, INC.AND SUBSIDIARIES

CONSOLIDATED STATEMENTSOF CASH FLOWS

 
| ** **                                                                                             | ** ** | **Year ended September 30,** | ** **    |
|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|---------------|
| ** **                                                                                             | ** ** | **2005**                                    | ** **    | **2004** | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                                                  |       |                                        |          |   |   |   |   |
| Net earnings                                                                                           | ** ** | **$**                                       | **6,027,000** |   | $ | 8,710,000 |   | $ | 2,320,000 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:                   |       |                                        |          |   |   |   |   |
| Depreciation,  depletion and amortization                                                              | ** ** | **8,788,000**                               |          | 6,761,000 |   | 4,333,000 |   |
| Minority  interest in earnings                                                                         | ** ** | **417,000**                                 |          | 2,207,000 |   | 309,000 |   |
| Accretion of  asset retirement obligation                                                              | ** ** | **140,000**                                 |          | 100,000 |   | 85,000 |   |
| Sale of development rights, net                                                    | ** ** | **(2,497,000**                              | )             | (2,497,000 | ) | (720,000 | ) |
| Sale of interest  in leasehold land, net                                                | ** ** | **(550,000**                                | )             | (7,330,000 | ) | — |   |
| Deferred income taxes                                                                        | ** ** | **(1,587,000**                              | )             | (307,000 | ) | 709,000 |   |
| Gain on sale of  contract drilling yard                                                                | ** ** | **—**                                  |          | (139,000 | ) | — |   |
| Increase (decrease) from changes in  current assets and liabilities | ** ** | **3,475,000**                               |          | (1,357,000 | ) | 1,479,000 |   |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Net cash provided by operating activities                                     | ** ** | **14,213,000**                              |          | 6,148,000 |   | 8,515,000 |   |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Cash flows from investing activities:                                              |       |                                        |          |   |   |   |   |
| Proceeds from  matured certificates of deposit                                                         | ** ** | **3,087,000**                               |          | 595,000 |   | — |   |
| Proceeds from sale of development rights, net                            | ** ** | **2,497,000**                               |          | 2,497,000 |   | 1,997,000 |   |
| Proceeds from  gas over bitumen royalty adjustments                                                    | ** ** | **558,000**                                 |          | — |   | — |   |
| Proceeds from sale of interest  in leasehold land, net                        | ** ** | **550,000**                                 |          | 10,805,000 |   | — |   |
| Proceeds from  collection of note receivable                                                           | ** ** | —                                      |          | 1,311,000 |   | 70,000 |   |
| Proceeds from  sale of contract drilling yard, net                                                     | ** ** | —                                      |          | 440,000 |   | — |   |
| Investments in  certificates of deposit                                                                | ** ** | **(3,400,000**                              | )             | (1,982,000 | ) | — |   |
| Capital expenditures                                                                              | ** ** | **(16,715,000**                             | )             | (12,109,000 | ) | (9,816,000 | ) |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Net cash (used in)  provided by investing activities                               | ** ** | **(13,423,000**                             | )             | 1,557,000 |   | (7,749,000 | ) |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Cash flows from financing activities:                                              |       |                                        |          |   |   |   |   |
| Long-term debt borrowings  (repayments)                                                      | ** ** | **1,116,000**                               |          | (1,408,000 | ) | (360,000 | ) |
| Proceeds from  exercise of stock options                                                               | ** ** | **197,000**                                 |          | 218,000 |   | — |   |
| Distributions to minority interest partners                                        | ** ** | **(513,000**                                | )             | (2,633,000 | ) | (275,000 | ) |
| Payment of dividends                                                                         | ** ** | **(802,000**                                | )             | (1,123,000 | ) | — |   |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Net cash used in financing activities                                         | ** ** | **(2,000**                                  | )             | (4,946,000 | ) | (635,000 | ) |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Effect of exchange rate  changes on cash and cash equivalents  | ** ** | **207,000**                                 |          | 90,000 |   | 28,000 |   |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Net increase in  cash and cash equivalents                                    | ** ** | **995,000**                                 |          | 2,849,000 |   | 159,000 |   |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Cash and cash equivalents at beginning of year                      | ** ** | **4,497,000**                               |          | 1,648,000 |   | 1,489,000 |   |
|                                                                                                   |       |                                        |          |   |   |   |   |
| Cash and cash equivalents at end of year                            | ** ** | **$**                                       | **5,492,000** |   | $ | 4,497,000 |   | $ | 1,648,000 |   |
|                                                                                                        |            |                                             |               |  |  |  |  |  |  |  |  |  |

See Notes to Consolidated Financial Statements

 

46

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

Years ended September 30,2005, 2004 and 2003

 
| ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **   | ** ** | ** **             | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|-------------------|------------|--------------|------------|-------------------|------------|--------------|------------|------------------------|------------|
| ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **        | ** ** | ** **   | ** ** | **Other**         | ** ** | ** **   | ** ** | **Total**              | ** ** |
| ** **                                                                                        | ** ** | ** ** | ** ** | **Common** | ** ** | **Paid-In**    | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Treasury** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                        | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Income**        | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Stock**    | ** ** | **Equity**             | ** ** |
| Balance at  September 30, 2002 — as previously reported                                 |       | 1,642,797  |       | $          | 821,000    |           | $          | 3,139,000         |       |         |       | $                 | 19,698,000 |         | $          | (3,883,000             | )          | $ | (4,854,000 | ) | $ | 14,921,000 |   |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Effect of stock  dividends issued to effect stock splits                                          |       | 6,244,263  |       | 3,123,000  |       | (3,139,000     | )          |              |       | (4,838,000   | )          |              |       | 4,854,000    |       | —                 |       |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Comprehensive  income:                                                                            |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Net earnings                                                                                      |       |       |       |       |       |           |       | $                 | 2,320,000  |         | 2,320,000  |              |       |         |       |                   | 2,320,000  |   |
| Other  comprehensive income, net of income taxes — foreign currency translation  adjustments |       |       |       |       |       |           |       | 2,392,000         |       |         |       | 2,392,000         |       |         |       | 2,392,000              |       |
| Total  comprehensive income                                                                       |       |       |       |       |       |           |       | $                 | 4,712,000  |         |       |              |       |         |       |                   |       |   |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| At September 30,  2003                                                                            |       | 7,887,060  |       | $          | 3,944,000  |           | $          | —            |       |         |       | $                 | 17,180,000 |         | $          | (1,491,000             | )          | $ | — |   | $ | 19,633,000 |   |

 

(continued on next page)

 

47

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

Years ended September 30,2005, 2004 and 2003

 

(continued from previous page)

 
| ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **   | ** ** | ** **             | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|-------------------|------------|--------------|------------|-------------------|------------|--------------|------------|------------------------|------------|
| ** **                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **        | ** ** | ** **   | ** ** | **Other**         | ** ** | ** **   | ** ** | **Total**              | ** ** |
| ** **                                                                                        | ** ** | ** ** | ** ** | **Common** | ** ** | **Paid-In**    | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Treasury** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                        | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Income**        | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Stock**    | ** ** | **Equity**             | ** ** |
| Balance at  September 30, 2003 — as previously reported                                 |       | 1,642,797  |       | $          | 821,000    |           | $          | 3,139,000         |       |         |       | $                 | 22,018,000 |         | $          | (1,491,000             | )          | $ | (4,854,000 | ) | $ | 19,633,000 |   |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Effect on  beginning balances of stock dividends issued to effect stock splits                    |       | 6,244,263  |       | 3,123,000  |       | (3,139,000     | )          |              |       | (4,838,000   | )          |              |       | 4,854,000    |       | —                 |       |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Exercise of stock  options, 105,000 shares (split-adjusted)                                       |       | 105,000    |       | 52,000     |       | 166,000        |       |              |       |         |       |              |       |         |       | 218,000                |       |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Tax benefit from  employee stock option transactions                                              |       |       |       |       |       | 51,000         |       |              |       |         |       |              |       |         |       | 51,000                 |       |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Effect on current  period activity of stock dividends issued to effect stock split                |       |       |       |       |       | (217,000       | )          |              |       | 217,000      |       |              |       |         |       | —                 |       |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Dividends  declared ($0.14 per share, split-adjusted)                                             |       |       |       |       |       |           |       |              |       | (1,123,000   | )          |              |       |         |       | (1,123,000             | )          |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Comprehensive  income:                                                                            |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| Net earnings                                                                                      |       |       |       |       |       |           |       | $                 | 8,710,000  |         | 8,710,000  |              |       |         |       |                   | 8,710,000  |   |
| Other  comprehensive income, net of income taxes — foreign currency translation  adjustments |       |       |       |       |       |           |       | 1,660,000         |       |         |       | 1,660,000         |       |         |       | 1,660,000              |       |
| Total  comprehensive income                                                                       |       |       |       |       |       |           |       | $                 | 10,370,000 |         |       |              |       |         |       |                   |       |   |
|                                                                                              |       |       |       |       |       |           |       |              |       |         |       |              |       |         |       |                   |       |
| At  September 30, 2004                                                                       |       | 7,992,060  |       | $          | 3,996,000  |           | $          | —            |       |         |       | $                 | 24,984,000 |         | $          | 169,000                |       | $ | — |   | $ | 29,149,000 |   |

 

(continued on next page)

 

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

Years ended September 30,2005, 2004 and 2003

 

(continued from previous page)

 
| ** **                                                                                                 | ** ** | ** **    | ** ** | ** ** | ** **    | ** **     | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated**   | ** **     | ** **   | ** ** | ** **             | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------|------------|------------|---------------|----------------|------------|-------------------|------------|--------------|------------|-------------------|----------------|--------------|------------|------------------------|------------|
| ** **                                                                                                 | ** ** | ** **    | ** ** | ** ** | ** **    | **Additional** | ** ** | ** **        | ** ** | ** **   | ** ** | **Other**         | ** **     | ** **   | ** ** | **Total**              | ** ** |
| ** **                                                                                                 | ** ** | ** **    | ** ** | **Common** | ** **    | **Paid-In**    | ** ** | **Comprehensive** | ** ** | **Retained** | ** ** | **Comprehensive** | ** **     | **Treasury** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                                                 | ** ** | **Shares**    | ** ** | **Stock**  | ** **    | **Capital**    | ** ** | **Income**        | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** **     | **Stock**    | ** ** | **Equity**             | ** ** |
| Balance at  September 30, 2004 — as previously reported                                          |       | 1,660,297     |       | $          | 830,000       |           | $          | 3,399,000         |       |         |       | $                 | 29,605,000     |         | $          | 169,000                |       | $ | (4,854,000 | ) | $ | 29,149,000 |   |
|                                                                                                       |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Effect on  beginning balances of stock dividends issued to effect stock splits                             |       | 6,331,763     |       | 3,166,000  |          | (3,399,000     | )          |              |       | (4,621,000   | )          |              |           | 4,854,000    |       | —                 |       |
|                                                                                                       |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Exercise of stock  options, 177,000 shares net of 30,000 tendered and placed in treasury  (split-adjusted) |       | 177,000       |       | 89,000     |          | 345,000        |       |              |       |         |       |              |           | (237,000     | )          | 197,000                |       |
|                                                                                                       |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Effect on current  period activity of stock dividends issued to effect stock split                         |       |          |       |       |          | (345,000       | )          |              |       | 108,000      |       |              |           | 237,000      |       | —                 |       |
|                                                                                                       |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Dividends  declared ($0.10 per share, split-adjusted)                                                      |       |          |       |       |          |           |       |              |       | (802,000     | )          |              |           |         |       | (802,000               | )          |
|                                                                                                       |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Comprehensive  income:                                                                                     |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Net earnings                                                                                               |       |          |       |       |          |           |       | $                 | 6,027,000  |         | 6,027,000  |              |           |         |       |                   | 6,027,000  |   |
| Other  comprehensive income (loss), net of income taxes:                                                   |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| Foreign currency  translation adjustments, net of $1,277,000 of taxes                                      |       |          |       |       |          |           |       | 1,543,000         |       |         |       | 1,543,000         |           |         |       | 1,543,000              |       |
| Minimum pension  liability adjustment, net of $44,000 tax benefit                                          |       |          |       |       |          |           |       | (88,000           | )          |         |       | (88,000           | )              |         |       | (88,000                | )          |
| Total  comprehensive income                                                                                |       |          |       |       |          |           |       | $                 | 7,482,000  |         |       |              |           |         |       |                   |       |   |
|                                                                                                       |       |          |       |       |          |           |       |              |       |         |       |              |           |         |       |                   |       |
| **At  September 30, 2005**                                                                            | ** ** | **8,169,060** | ** ** | **$**      | **4,085,000** | ** **     | **$**      | **—**        |       |         | ** ** | **$**             | **30,317,000** | ** **   | **$**      | **1,624,000**          | ** ** | **$** | **—** | ** ** | **$** | **36,026,000** | ** ** |

 

See Notes to Consolidated Financial Statements

 

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**BARNWELLINDUSTRIES, INC.**

**AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**YEARS ENDED SEPTEMBER 30, 2005, 2004 AND 2003**

 

 

**1.             DESCRIPTION OF THE REPORTINGENTITY AND BUSINESS**

 

Theconsolidated financial statements include the accounts of Barnwell Industries,Inc. and all majority-owned subsidiaries, including an indirect 77.6%-ownedland development general partnership, (collectively referred to herein as “Barnwell”).  All significant intercompany accounts andtransactions have been eliminated.

 

Duringits last three fiscal years, Barnwell was engaged in exploring for, developing,producing and selling oil and natural gas in Canada, investing in leaseholdland in Hawaii, and drilling wells and installing and repairing water pumpingsystems in Hawaii.  Barnwell’s oil andnatural gas activities comprise its largest business segment.  Approximately 74% of Barnwell’s revenues and97% of Barnwell’s capital expenditures for the fiscal year ended September 30,2005 were attributable to its oil and natural gas activities.  Barnwell’s contract drilling activitiesaccounted for 17% of fiscal 2005 revenues; Barnwell’s land investment segmentrevenues accounted for 7% of fiscal 2005 revenues; and other revenues comprised2% of fiscal 2005 revenues.

 

 

**2.             SIGNIFICANT ACCOUNTING POLICIES**

 

Cash and Cash Equivalentsand Certificates of Deposit

 

Cash and cash equivalentsinclude cash on hand, demand deposits and short-term investments with originalmaturities of three months or less.  AtSeptember 30, 2005, Barnwell had $1,700,000 of certificates of deposit atvarious financial institutions with maturities ranging from October 2005 toSeptember 2006.  As the originalmaturities of these certificates of deposit are greater than three months, theyare excluded from cash and cash equivalents and are reported separately on theConsolidated Balance Sheets.

 

# Trade AccountsReceivable

 

                Tradeaccounts receivable are recorded at the invoiced amount and do not bearinterest.  The allowance for doubtfulaccounts is Barnwell’s best estimate of the amount of probable credit losses inBarnwell’s existing accounts receivable and is based on historical write-offexperience.  Account balances are chargedoff against the allowance after all means of collection have been exhausted andthe potential for recovery is considered remote.  Barnwell does not have any off-balance sheetcredit exposure related to its customers.

 

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Oil and Natural GasProperties

 

Revenues associated with thesale of oil, natural gas and natural gas liquids are recognized in theconsolidated statements of operations when the oil, natural gas and natural gasliquids are delivered and title has passed to the customer.

 

Barnwell uses the full costmethod of accounting under which all costs incurred in the acquisition,exploration and development of oil and natural gas reserves, including costsrelated to unsuccessful wells and estimated future site restoration andabandonment, are capitalized until such time as the aggregate of such costs netof accumulated depletion and oil and gas related deferred income taxes, on acountry-by-country basis, equals the sum of 1) the discounted present value (at10%), using prices as of the end of the fiscal year on a constant basis, ofBarnwell’s estimated future net cash flows from estimated production of provedoil and natural gas reserves as determined by independent petroleum engineers,less estimated future expenditures to be incurred in developing and producingthe proved reserves but excluding future cash outflows associated with settlingasset retirement obligations accrued on the balance sheet; plus 2) the cost ofmajor development projects and unproven properties not subject to depletion, ifany; plus 3) the lower of cost or estimated fair value of unproven propertiesincluded in costs subject to depletion; less 4) related income taxeffects.  If net capitalized costs exceedthis limit, the excess is expensed. Depletion is computed using the units-of-production method whereby capitalizedcosts, net of salvage values, plus estimated future costs to develop provedreserves and satisfy asset retirement obligations, are amortized over the totalestimated proved reserves on a country-by-country basis.  Investments in major development projects arenot depleted until either proved reserves are associated with the projects orimpairment has been determined.  AtSeptember 30, 2005 and 2004, Barnwell had no investments in major oil andnatural gas development projects that were not being depleted.  General and administrative costs related tooil and natural gas operations are expensed as incurred.  Proceeds from the disposition of minorproducing oil and natural gas properties are credited to the cost of oil andnatural gas properties.  Gains or lossesare recognized on the disposition of significant oil and natural gasproperties.

 

Investment in Land andRevenue Recognition

 

Barnwell’s investment inland is comprised of development rights under option; rights to receivepercentage payments on the first increment; leasehold land interests in landzoned resort/residential which are under right of negotiation; and land zonedconservation which is not under option or under a right of negotiation.  Investment in land is reported at the lowerof the asset carrying value or fair value, less costs to sell, and is evaluatedfor impairment whenever events or changes in circumstances indicate that therecorded investment balance may not be fully recoverable.

 

Costs incurred for theacquisition and improvement of leasehold land interests, including capitalizedinterest, are included in the consolidated balance sheets under the caption “Investmentin Land.”

 

Sales of development rightsunder option and revenues from the sale of Increment I of leasehold landinterests are accounted for under the cost recovery method.  Under the cost recovery method, no operatingprofit is recognized until cash received exceeds the cost and the estimatedfuture costs related to the development rights sold.

 

51

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Contract Drilling

 

Revenues, costs and profitsapplicable to contract drilling contracts are included in the consolidatedstatements of operations using the percentage of completion method, principallymeasured by the percentage of labor dollars incurred to date for each contractto total estimated labor dollars for each contract.  Contract losses are recognized in full in theperiod the losses are identified.  Theperformance of drilling contracts may extend over more than one year and, inthe interim periods, estimates of total contract costs and profits are used todetermine revenues and profits earned for reporting the results of contractdrilling operations.  Revisions in the estimatesrequired by subsequent performance and final contract settlements are includedas adjustments to the results of operations in the period such revisions andsettlements occur.  Contracts arenormally less than one year in duration.

 

Long-lived Assets

 

Long-lived assets to be heldand used, other than oil and natural gas properties, are evaluated forimpairment whenever events or changes in circumstances indicate that thecarrying amount of an asset may not be fully recoverable.  If the future cash flows expected to resultfrom use of the asset (undiscounted and without interest charges) are less thanthe carrying amount of the asset, an impairment loss is recognized.  Such impairment loss is measured as theamount by which the carrying amount of the asset exceeds the fair value of theasset.  Long-lived assets to be disposedof are reported at the lower of the asset carrying value or fair value, lesscost to sell.

 

Drilling Rigs, OtherProperty and Equipment

 

Drilling rigs and otherproperty and equipment are stated at cost. Depreciation is computed using the straight-line method based onestimated useful lives.

 

Inventories

 

Inventories are comprised ofdrilling materials and are valued at the lower of weighted average cost ormarket value.

 

Environmental

 

Barnwell is subject toextensive environmental laws and regulations. These laws, which are constantly changing, regulate the discharge ofmaterials into the environment and maintenance of surface conditions and mayrequire Barnwell to remove or mitigate the environmental effects of the disposalor release of petroleum or chemical substances at various sites.  Environmental expenditures are expensed orcapitalized depending on their future economic benefit.  Expenditures that relate to an existingcondition caused by past operations and that have no future economic benefitsare expensed.  Liabilities forexpenditures of a noncapital nature are recorded when environmental assessmentand/or remediation is probable, and the costs can be reasonably estimated.

 

Asset Retirement Obligation

 

OnOctober 1, 2002, Barnwell adopted Statement of Financial Accounting Standards (“SFAS”)No. 143, “Accounting for Asset Retirement Obligations,” which requires that thefair value of a liability for an asset retirement obligation be recognized inthe period in which it is incurred if a reasonable estimate of fair value canbe made.  Barnwell’s estimated siterestoration and abandonment costs of its 

 

52

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oil and naturalgas properties are capitalized as part of the carrying amount of oil andnatural gas properties and depleted over the life of the related reserves.  The liability is accreted at the end of eachperiod through charges to oil and natural gas operating expense.  If an obligation is settled for other thanthe carrying amount of the liability, Barnwell will recognize a gain or loss onsettlement.

 

In September 2004, theSecurities and Exchange Commission (“SEC”) released Staff Accounting Bulletin (“SAB”)No. 106 which expresses the SEC’s views regarding the application of SFAS No.143, “Accounting for Asset Retirement Obligations,” by oil and gas producingcompanies following the full cost accounting method.  SAB No. 106 addresses the calculation ofceiling tests for full-cost oil and gas companies, depreciation, depletion andamortization as affected by the adoption of SFAS No. 143, as well as therelated required disclosures.  Barnwelladopted the provisions of SAB No. 106 during the year ended September 30, 2004.  The adoption of SAB No. 106 had no materialimpact on Barnwell’s financial condition, results of operations or liquidity.

 

Income Taxes

 

Deferred income taxes aredetermined using the asset and liability method.  Deferred tax assets and liabilities arerecognized for the estimated future tax impacts of differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  Deferred taxassets and liabilities are measured using enacted tax rates in effect for theyear in which those temporary differences are expected to be recovered orsettled.  The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date.

 

Earnings Per Common Share

 

InDecember 2004, Barnwell’s Board of Directors declared a two-for-one stock splitin the form of a 100% stock dividend. The shares were distributed on January 28, 2005 to all shareholders ofrecord as of January 11, 2005.  Therewere 1,361,510 shares outstanding on January 11, 2005 before the split.  Barnwell issued 1,028,223 of new shares andutilized 333,287 shares of treasury stock to execute the stock dividend,resulting in outstanding shares of 2,723,020 following the split.  Barnwell’s common stock began trading on asplit-adjusted basis on January 31, 2005.

 

InOctober 2005, Barnwell’s Board of Directors declared a three-for-one stocksplit in the form of a 200% stock dividend. The shares were distributed on November 14, 2005 to all shareholders ofrecord as of October 28, 2005.  Therewere 2,723,020 shares outstanding on October 28, 2005.  Barnwell issued 5,446,040 of new shares toexecute the stock dividend, resulting in outstanding shares of 8,169,060following the split.  Barnwell’s commonstock began trading on a split-adjusted basis on November15, 2005.

 

Allinformation in this Form 10-KSB has been adjusted to reflect the stock splitsfor all periods presented.

 

Basic earnings per shareexcludes dilution and is computed by dividing net earnings by theweighted-average number of common shares outstanding for the period.  Diluted earnings per share includes thepotentially dilutive effect of outstanding common stock options and securitieswhich are convertible to common shares.

 

53

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Reconciliationsbetween the numerator and denominator of the basic and diluted earnings pershare computations (split-adjusted) for the years ended September 30, 2005,2004 and 2003 are as follows:

 
| ** **                                            | ** ** | **September 30, 2005** | ** **    |
|-------------------------------------------------------|------------|------------------------|---------------|
| ** **                                            | ** ** | **Net Earnings**       | ** **    | **Shares** | ** ** | **Per-Share** | ** ** |
| ** **                                            | ** ** | **(Numerator)**        | ** **    | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic earnings per share                              | ** ** | **$**                  | **6,027,000** | ** ** | **8,152,531** | ** ** | **$** | **0.74** | ** ** |
| Effect of dilutive securities  - common stock options | ** ** | **—**             | ** **    | **490,501** | ** ** | ** ** | ** ** |
| Diluted earnings per share                            | ** ** | **$**                  | **6,027,000** | ** ** | **8,643,032** | ** ** | **$** | **0.70** | ** ** |

 

 
| ** **                                            | ** ** | **September 30, 2004** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **Net Earnings**       | ** ** | **Shares** | ** ** | **Per-Share** | ** ** |
| ** **                                            | ** ** | **(Numerator)**        | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic earnings per share                              |       | $                      | 8,710,000  |   | 7,943,682 |   | $ | 1.10 |   |
| Effect of dilutive securities  - common stock options |       | —                 |       | 497,690 |   |   |   |
| Diluted earnings per share                            |       | $                      | 8,710,000  |   | 8,441,372 |   | $ | 1.03 |   |

 

 
| ** **                                            | ** ** | **September 30, 2003** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **Net Earnings**       | ** ** | **Shares** | ** ** | **Per-Share** | ** ** |
| ** **                                            | ** ** | **(Numerator)**        | ** ** | **(Denominator)** | ** ** | **Amount** | ** ** |
| Basic earnings per share                              |       | $                      | 2,320,000  |   | 7,887,060 |   | $ | 0.29 |   |
| Effect of dilutive securities  - common stock options |       | —                 |       | 330,507 |   |   |   |
| Diluted earnings per share                            |       | $                      | 2,320,000  |   | 8,217,567 |   | $ | 0.28 |   |

 

Assumedconversion of convertible debentures to 40,500 shares(split-adjusted) of common stock was excluded from the computation of dilutedearnings per share for the period that the debentures were outstanding duringthe year ended September 30, 2003 because the effect would have beenantidilutive (the convertible debentures were repaid in full on June 30, 2003).

 

Stock-Based Compensation

 

Barnwell applies theintrinsic-value based method of accounting prescribed by Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations including Financial Accounting Standards Board InterpretationNo. 44, “Accounting for Certain Transactions involving Stock Compensation,” toaccount for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grantonly if the current market price of the underlying stock exceeded the exerciseprice.  SFAS No. 123, “Accounting forStock-Based Compensation,” as amended by SFAS No. 148, “Accounting forStock-Based Compensation — Transition and Disclosure,” established accountingand disclosure requirements using a fair-value based method of accounting forstock-based employee compensation plans. As permitted by existing accounting standards, Barnwell has elected tocontinue to apply the intrinsic-value-based method of accounting describedabove, and has adopted only the disclosure requirements of SFAS No. 123, asamended by SFAS No. 148.

 

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Certain stock optionsgranted by Barnwell include stock appreciation rights.  Such options are valued at fair value basedof the difference between the per share exercise price of the options and themarket price of Barnwell’s stock at each period-end for outstanding options, orfor exercised options, the difference between the exercise price and the marketprice at exercise.

 

The following tableillustrates the effect on net earnings and basic and diluted earning per share(split-adjusted) as if the fair-value-based method had been applied to allstock options granted since October 1, 1995.

 
| ** **                                                                                                                                       | ** ** | **Year ended September 30,** | ** **    |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|---------------|
| ** **                                                                                                                                       | ** ** | **2005**                     | ** **    | **2004** | ** ** | **2003** | ** ** |
| Net earnings, as reported                                                                                                                        | ** ** | **$**                        | **6,027,000** |   | $ | 8,710,000 |   | $ | 2,320,000 |   |
|                                                                                                                                             |       |                         |          |   |   |   |   |
| Add: Stock-based employee compensation expense included in reported net  earnings, net of related tax effects                                    | ** ** | **2,244,000**                |          | 636,000 |   | 226,000 |   |
|                                                                                                                                             |       |                         |          |   |   |   |   |
| Deduct: Total stock based employee compensation expense determined under  the fair value based method for all awards, net of related tax effects | ** ** | **(2,374,000**               | )             | (642,000 | ) | (270,000 | ) |
| Pro-forma net earnings                                                                                                                           | ** ** | **$**                        | **5,897,000** |   | $ | 8,704,000 |   | $ | 2,276,000 |   |
|                                                                                                                                             |       |                         |          |   |   |   |   |
| Basic Earnings Per Share:                                                                                                                        |       |                         |          |   |   |   |   |
| As reported                                                                                                                                      | ** ** | **$**                        | **0.74**      |   | $ | 1.10 |   | $ | 0.29 |   |
| Pro forma                                                                                                                                        | ** ** | **$**                        | **0.72**      |   | $ | 1.10 |   | $ | 0.29 |   |
|                                                                                                                                             |       |                         |          |   |   |   |   |
| Diluted Earnings Per Share:                                                                                                                      |       |                         |          |   |   |   |   |
| As reported                                                                                                                                      | ** ** | **$**                        | **0.70**      |   | $ | 1.03 |   | $ | 0.28 |   |
| Pro forma                                                                                                                                        | ** ** | **$**                        | **0.68**      |   | $ | 1.03 |   | $ | 0.28 |   |
|                                                                                                                                                  |            |                              |               |  |  |  |  |  |  |  |  |  |

 

Fair value measurement of optionswithout stock appreciation rights that are included in fiscal 2005 pro-forma netearnings was based on an option-pricing model which included assumptions of a weightedaverage expected life of 5.57 years, expected volatility of 25%, risk-free interestrate of 4%, and an expected dividend yield of 1%. Fair value measurement of optionswithout stock appreciation rights that are included in fiscal 2004 and fiscal 2003pro-forma net earnings was based on an option-pricing model which included assumptionsof a weighted average expected life of 6.40 years, expected volatility of 30%, risk-freeinterest rate of 6.3%, and an expected dividend yield of 0%.

 

Foreign Currency Translation

 

Assetsand liabilities of foreign operations and subsidiaries are translated at the year-endexchange rate and resulting translation gains or losses are accounted for in a stockholders’equity account entitled “accumulated other comprehensive income, net.” Operatingresults of foreign subsidiaries are translated at average exchange rates duringthe period. Realized foreign currency transaction gains or losses were not materialin fiscal years 2005, 2004, and 2003.

 

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Use of Estimates in the Preparationof Financial Statements

 

The preparation of financialstatements in conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues and expenses and the disclosureof contingent assets and liabilities. Actual results could differ significantlyfrom those estimates. Significant assumptions are required in the valuation of deferredtax assets and proved oil and natural gas reserves, and such assumptions may impactthe amount at which deferred tax assets and oil and natural gas properties are recorded.

 

Reclassifications

 

Certain reclassifications havebeen made to the September 30, 2004 and 2003 consolidated financial statements conformto classifications used in the September 30, 2005 consolidated financial statements.

 

 

**3.****                                     ****ACCOUNTS RECEIVABLE AND CONTRACT COSTS**

 

Accountsreceivable are net of allowances for doubtful accounts of $10,000 as of September30, 2005 and 2004. Included in accounts receivable are contract retainage balancesof $531,000 and $242,000 as of September 30, 2005 and 2004, respectively. Thesebalances are expected to be collected within one year, generally within 45 daysafter the related contracts have received final acceptance and approval.

 

Costs and estimated earningson uncompleted contracts are as follows:

 
| ** **                               | ** ** | **September 30,** | ** **    |
|------------------------------------------|------------|-------------------|---------------|
| ** **                               | ** ** | **2005**          | ** **    | **2004** | ** ** |
| Costs incurred on  uncompleted contracts | ** ** | **$**             | **8,854,000** |   | $ | 4,945,000 |   |
| Estimated earnings                       | ** ** | **1,760,000**     |          | 482,000 |   |
|                                     | ** ** | **10,614,000**    |          | 5,427,000 |   |
| Less billings to date                    | ** ** | **10,228,000**    |          | 5,341,000 |   |
|                                     | ** ** | **$**             | **386,000**   |   | $ | 86,000 |   |
|                                          |            |                   |               |  |  |  |  |  |

 

Costs and estimated earnings on uncompleted contractsare included in the consolidated balance sheets as follows:

 
| ** **                                                                                                           | ** ** | **September 30,** | ** **  |
|----------------------------------------------------------------------------------------------------------------------|------------|-------------------|-------------|
| ** **                                                                                                           | ** ** | **2005**          | ** **  | **2004** | ** ** |
| Costs and estimated earnings in excess of billings on uncompleted contracts  (included in other current assets)      | ** ** | **$**             | **758,000** |   | $ | 493,000 |   |
| Billings in excess of costs and estimated earnings on uncompleted  contracts (included in other current liabilities) | ** ** | **(372,000**      | )           | (407,000 | ) |
|                                                                                                                 | ** ** | **$**             | **386,000** |   | $ | 86,000 |   |

 

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**4.             INVESTMENT IN LAND**

 

Background

 

Barnwell owns a 77.6%controlling interest in Kaupulehu Developments, a Hawaii general partnershipthat owns interests in leasehold land and development rights for propertylocated approximately six miles north of the Kona International Airport in theNorth Kona District of the Island of Hawaii. Between 1986 and 1989, Kaupulehu Developments obtained the state andcounty zoning changes necessary to permit development of the Four Seasons ResortHualalai at Historic Ka’upulehu and Hualalai Golf Club, which opened in 1996, asecond golf course, and single-family and multi-family residential units.  These projects were developed on leaseholdland acquired from Kaupulehu Developments by Kaupulehu Makai Venture, anunrelated entity that is an affiliate of Kajima Corporation of Japan.

 

Rezoning and Partial Sale ofInterest in Leasehold Land

 

In 1993, Kaupulehu Developments submitted a rezoningpetition to the State Land Use Commission and in 1998, filed an Application fora Project District zoning ordinance and a Special Management Area Use PermitPetition with the County of Hawaii to reclassify conservation-zoned land tozoning which allows resort/residential development.  In October 2001, Kaupulehu Developmentsreceived final approval for the reclassification.

 

On February 13, 2004, Kaupulehu Developments enteredinto a Purchase and Sale Agreement with WB KD Acquisition LLC (“WB”) by whichKaupulehu Developments transferred its leasehold interest in approximately 870acres zoned for resort/residential development, in two increments, to WB.  There is no affiliation between KaupulehuDevelopments and WB.  WB is an affiliate ofWestbrook Partners LLC, an affiliate of the developers of the Kuki’o Resort.  The first increment (“Increment I”) is anarea planned for approximately 80 single-family lots and a beach club on theportion of the property bordering the Pacific Ocean.  The purchasers of the 80 single-family lotswill have the right to apply for membership in the Kuki’o Resort Golf and BeachClub, which is located adjacent to and south of the Four Seasons ResortHualalai at Historic Ka’upulehu.  Thesecond increment (“Increment II”) is the remaining portion of the approximately870-acre property and is zoned for single-family and multi-family residentialunits and a golf course and clubhouse.

 

With respect to Increment I,Kaupulehu Developments received a non-refundable $11,550,000 payment (“ClosingPayment”) in February 2004 and is entitled to receive payment of the followingpercentages of the gross proceeds generated from the sale by WB ofsingle-family lots in Increment I (“Percentage Payments”): 9% of the grossproceeds from single-family lot sales up to aggregate gross proceeds of$100,000,000; 10% of such aggregate gross proceeds greater than $100,000,000but less than $300,000,000; and 14% of such aggregate gross proceeds in excessof $300,000,000.  If prior to December31, 2005,  Kaupulehu Developments has notreceived Percentage Payments equal to or greater than $2,500,000 in theaggregate, WB will pay Kaupulehu Developments the amount by which the aggregateamount of all prior Percentage Payments made by WB to Kaupulehu Developments isless than $2,500,000.  If prior toDecember 31, 2006, Kaupulehu Developments has not received Percentage Payments(including payments in lieu of Percentage Payments as described in theimmediately preceding sentence) equal to or greater than $5,000,000 in theaggregate, then WB will pay Kaupulehu Developments the amount by which theaggregate amount of all such payments is less than $5,000,000.  Until the formal granting of access andutility easements by third parties to WB have been completed, WB is entitled,but not required, to withhold payment of Percentage Payments and the minimum 

 

57

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payments described above to KaupulehuDevelopments until WB’s aggregate gross proceeds generated by the sale ofsingle-family lots in Increment I exceeds $75,000,000.  As of the date of this filing, KaupulehuDevelopments has received no Percentage Payments and it is Barnwell’sunderstanding that the conditions regarding the formal granting of easementsare in progress but have not yet been completed.  There is no assurance that any of thesefuture payments will be received.

 

WB also agreed to pay Kaupulehu Developmentsnon-refundable interim payments of $50,000 per month (“Interim Payments”) untilthe first to occur of the closing of the sale of the 40th single-family lotsold in Increment I or WB’s payment to Kaupulehu Developments of a total of$900,000 in Interim Payments subsequent to February 2004.  Kaupulehu Developments received the $900,000of Interim Payments in full as of August 2005.

 

Kaupulehu Developments, WB and The Trustees of TheEstate of Bernice Pauahi Bishop (“KS”) also entered into an agreement (the “Step-InRights Agreement”) whereby if WB elects not to proceed with development ofIncrement I within the time frame set forth in the Step-In Rights Agreement,which may be extended by KS, or defaults under the terms of its lease with KS,Kaupulehu Developments would have the right to succeed to WB’s developmentrights and develop the property without any payment to WB.

 

In March 2004, WB commencedengineering of infrastructure, preparation of covenants, conditions andrestrictions for a community association, and preparation of legal documents toenable real estate sales, and broke ground and graded several miles of accessroads.  In 2004, WB received finalsubdivision approval from the County of Hawaii for the first phase of 38lots.  In 2005, WB received federal andState of Hawaii approvals to begin marketing the first phase of 38 lots ofIncrement I.  Additionally, during 2004and 2005, WB excavated, processed and placed material on the single-family lotsbringing a majority of the first phase of 38 lots to finished grade.

 

With respect to IncrementII, Kaupulehu Developments and WB agreed to use diligent efforts to negotiate,and attempt to document and enter into, prior to the date which is three (3)years following the closing of the sale of the first single-family lot inIncrement I, an agreement with regards to the ownership and development ofIncrement II.  WB, however, may terminatesuch negotiations at any time without any further obligation.  Under the terms of the Step-In RightsAgreement, if at the end of three years following the closing of the sale ofthe first single-family lot in Increment I the parties have not entered into adefinitive agreement with respect to Increment II, the leasehold rights withrespect to Increment II will revert to Kaupulehu Developments.  In 2005, Kaupulehu Developments and WB heldseveral meetings to discuss possible development scenarios for IncrementII.  No agreement has been reached withWB for the sale and development of Increment II, although discussions betweenthe parties are ongoing.  Accordingly, norevenues or cost of sales have been recognized on Increment II.

 

The sale of Kaupulehu Developments’ interest inIncrement I in fiscal 2004 was accounted for by use of the cost recoverymethod, under which no operating profit is recognized until cash receivedexceeds the cost and the estimated future costs related to the leaseholdinterest sold.  The revenue from the$11,550,000 Closing Payment plus $350,000 of post-closing Interim Paymentsreceived in March through September 2004, was reduced by $693,000 of feesrelated to the sale, approximately $402,000 in other costs related to the sale,and $3,475,000 of previously capitalized costs relating to Increment I.  The $7,330,000 of net revenue from theClosing Payment and Interim Payments for the year ended September 30, 2004 isrecorded in the Consolidated Statements of Operations as “Sale of interest inleasehold land, net.”  Operating profiton the Increment I transaction, after minority interest, totaled approximately$5,470,000 for the year ended September 30, 2004.  During the year ended September 30, 

 

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2005, Kaupulehu Developments received additional Interim Payments,before minority interest, totaling $550,000.

 

Development Rights Under Option

 

The developmentrights held by Kaupulehu Developments are for residentially-zoned leaseholdland within and adjacent to the Hualalai Golf Club and are under option toKaupulehu Makai Venture, an unrelated entity that is an affiliate of KajimaCorporation of Japan.  OnDecember 31, 2002, 2003 and 2004, Kaupulehu Makai Venture exercised the portionof its development rights option due on those dates and paid KaupulehuDevelopments $2,125,000 in fiscal 2003 and $2,656,000 in both fiscal 2005 and2004.  At September 30, 2005,approximately 81 acres remain under option. Barnwell accounts for sales of development rights under option by use ofthe cost recovery method.  Under the costrecovery method, no operating profit is recognized until cash received exceedsthe cost and the estimated future costs related to development rights sold.  In fiscal 2003, $1,277,000 of the proceedsfrom the sales of development rights were applied to reduce the carrying valueof the underlying development rights recorded on the Consolidated BalanceSheets under the caption “Investment in land” to zero.  Sales of development rights were furtherreduced in fiscal 2003 by $128,000 of fees related to the sale and theremaining $720,000 of sales proceeds is recorded in the Consolidated Statementsof Operations for fiscal 2003 as “Sale of development rights, net.” In each of fiscal years 2005 and 2004, $2,656,000 of revenuesattributable to the development rights sale were reduced by $159,000 of feesrelated to the sale, resulting in net revenues of $2,497,000 and a $1,950,000operating profit, after minority interest, on the transactions.  There were no other costs deducted fromrevenues from the sale of development rights in fiscal 2005 and 2004 as allcapitalized costs associated with the development rights were expensed inprevious years under the cost recovery method.

 

The total amount of remaining future developmentrights option receipts at September 30, 2005, if all options are fullyexercised, was $15,937,500, comprised of six payments of $2,656,250 due on eachDecember 31 of years 2005 to 2010.  InNovember 2005, Kaupulehu Makai Venture paid Kaupulehu Developments $2,875,000upon exercising the portion of its development rights option due on December31, 2005 of $2,656,000 and a portion, $219,000, of its development rightsoption due on December 31, 2006, bringing the total remaining futuredevelopment rights option receipts to $13,063,000.  If any annual option payment is not made, thethen remaining development right options will expire.  There is no assurance that any portion of theremaining options will be exercised.

 

Fees

 

The aforementioned $159,000 in fees ($112,000, net ofminority interest) on the proceeds from the sale of development rights infiscal 2005 and 2004 and $693,000 ($486,000, net of minority interest) on theproceeds from the sale of interest in leasehold land in the year ended September30, 2004 were paid to Nearco, Inc., a company controlled by Mr. Terry Johnston,a director of Barnwell and an indirect 21.8% owner of KaupulehuDevelopments.  Under an agreement enteredinto in 1987, prior to Mr. Johnston’s election to Barnwell’s Board ofDirectors, Barnwell is obligated to pay Nearco 2% of Kaupulehu Developments’gross receipts from the sale of real estate interests, and Cambridge HawaiiLimited Partnership, a 49.9% partner of Kaupulehu Developments in whichBarnwell purchased a 55.2% interest in April 2001, is obligated under anagreement entered into in 1987 to pay Nearco 4% of Kaupulehu Developments’gross receipts from the sale of real estate interests.  Fees of $128,000 ($89,000, net of minorityinterest) on the proceeds from sale of development rights were paid in the yearended September 30, 2003.  The feesrepresent compensation for promotion and marketing of Kaupulehu Developments’property and were determined based on the estimated fair value of such 

 

 

59

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services.  Barnwell believes thefees are fair and reasonable compensation for such services.

 

Fees were also paid to Nearco for consulting servicesrelated to Kaupulehu Developments’ leasehold land.  In fiscal 2005, 2004 and 2003, consultingservice fees paid to Nearco totaled $268,000, $273,000 and $218,000,respectively, and were included in general and administrative expenses.  In addition, $52,000 of fees were paid toNearco in fiscal 2004 for services related to the closing of the February 2004sale of an interest in leasehold land.  These fees were a direct cost of the sale and accordingly reduced therevenues recognized from the sale under the cost recovery method.  Barnwell believes the fees are fair andreasonable compensation for such services.

 

Interests at September 30, 2005

 

The interests held by Kaupulehu Developments atSeptember 30, 2005 include the development rights under option; the rights toreceive Increment I Percentage Payments; the leasehold land zoned for resort/residentialdevelopment within Increment II, which is under a right of negotiation with WB;and approximately 1,000 acres of vacant leasehold land zoned conservation.  There is no assurance that any future developmentrights option payments or Percentage Payments will be received, nor is thereany assurance that WB will enter into an agreement with Kaupulehu Developmentsregarding Increment II.  These interestsrelate to land located adjacent to and north of the Four Seasons ResortHualalai at Historic Ka’upulehu, between the Queen Kaahumanu Highway and thePacific Ocean.  Barnwell’s cost ofKaupulehu Developments’ interests is included in the September 30, 2005 and2004 consolidated balance sheets under the caption “Investment in Land” andconsists of the following amounts:

 
| ** **                                                   | ** ** | **September 30,** | ** **    |
|--------------------------------------------------------------|------------|-------------------|---------------|
| ** **                                                   | ** ** | **2005**          | ** **    | **2004** | ** ** |
| Leasehold land interests:                                    | ** ** | ** **        |          |   |   |
| Zoned for resort/residential development — Increment I  | ** ** | **$**             | **—**    |   | $ | – |   |
| Zoned for resort/residential development — Increment II | ** ** | **2,983,000**     |          | 2,983,000 |   |
| Zoned conservation                                           | ** ** | **50,000**        |          | 50,000 |   |
|                                                         | ** ** | **3,033,000**     |          | 3,033,000 |   |
| Development rights under  option                             | ** ** | **—**        |          | — |   |
| Total investment in land                                     | ** ** | **$**             | **3,033,000** |   | $ | 3,033,000 |   |

 

 

**5.             PROPERTY AND EQUIPMENT AND ASSETRETIREMENT OBLIGATION**

 

Barnwell’s property andequipment is detailed as follows:

 
| ** **                                                  | ** ** | ** **    | ** ** | ** **       | ** **      | **Accumulated**   | ** ** | ** **       | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|------------------|-----------------|-------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Estimated** | ** ** | **Gross**        | ** **      | **Depreciation,** | ** ** | **Net**          | ** ** |
| ** **                                                  | ** ** | **Useful**    | ** ** | **Property and** | ** **      | **Depletion and** | ** ** | **Property and** | ** ** |
| **At September 30, 2005:**                                  | ** ** | **Lives**     | ** ** | **Equipment**    | ** **      | **Amortization**  | ** ** | **Equipment**    | ** ** |
| Land                                                        |       |          |       | $                | 365,000         |              | $          | —           |       | $ | 365,000 |   |
| Oil and natural gas properties  (full cost accounting) |       |          |       | 126,105,000      |            | (66,705,000       | )          | 59,400,000       |       |
| Drilling rigs and equipment                                 |       | 3  - 7 years  |       | 4,303,000        |            | (3,951,000        | )          | 352,000          |       |
| Premises                                                    |       | 40  years     |       | 857,000          |            | (38,000           | )          | 819,000          |       |
| Other property and equipment                                |       | 3  - 17 years |       | 3,399,000        |            | (2,474,000        | )          | 925,000          |       |
| Total                                                       | ** ** | ** **    | ** ** | **$**            | **135,029,000** | ** **        | **$**      | **(73,168,000**  | **)**      | **$** | **61,861,000** | ** ** |

 

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| ** **                                                  | ** ** | ** **    | ** ** | ** **       | ** **      | **Accumulated**   | ** ** | ** **       | ** ** |
|-------------------------------------------------------------|------------|---------------|------------|------------------|-----------------|-------------------|------------|------------------|------------|
| ** **                                                  | ** ** | **Estimated** | ** ** | **Gross**        | ** **      | **Depreciation,** | ** ** | **Net**          | ** ** |
| ** **                                                  | ** ** | **Useful**    | ** ** | **Property and** | ** **      | **Depletion and** | ** ** | **Property and** | ** ** |
| **At September 30, 2004:**                                  | ** ** | **Lives**     | ** ** | **Equipment**    | ** **      | **Amortization**  | ** ** | **Equipment**    | ** ** |
| Land                                                        |       |          |       | $                | 365,000         |              | $          | —           |       | $ | 365,000 |   |
| Oil and natural gas properties  (full cost accounting) |       |          |       | 98,832,000       |            | (53,108,000       | )          | 45,724,000       |       |
| Drilling rigs and equipment                                 |       | 3  - 7 years  |       | 4,126,000        |            | (3,906,000        | )          | 220,000          |       |
| Premises                                                    |       | 40  years     |       | 857,000          |            | (17,000           | )          | 840,000          |       |
| Other property and equipment                                |       | 3  - 17 years |       | 3,177,000        |            | (2,474,000        | )          | 703,000          |       |
| Total                                                       | ** ** | ** **    | ** ** | **$**            | **107,357,000** | ** **        | **$**      | **(59,505,000**  | **)**      | **$** | **47,852,000** | ** ** |

 

In October 2004, the Governmentof Alberta enacted amendments to the Natural Gas Royalty Regulation whichprovide a mechanism to reduce royalties calculated through the Crown royaltysystem for operators of gas wells which have been denied the right to produceby the Alberta Energy Utilities Board as a result of recent bitumenconservation decisions.  In December2004, royalty reductions were effected by the Alberta Department of Energy’sInformation Letter 2004-36 which sets out the details of the royaltyadjustment, the impact on the existing temporary assistance received to date byaffected gas well operators, the provisions for potential recapture of theroyalty adjustments, and continuation of impacted petroleum and natural gasagreements.  Barnwell received a total ofapproximately $558,000 related to the aforementioned royalty adjustments forwells in the Thornbury area in fiscal 2005. It is Barnwell’s estimation that the subject Thornbury wells will notrecommence production, thus no returns to the Government of Alberta of theroyalty adjustments received would be required under the recaptureprovisions.  Accordingly, the receiptsare payments for deemed production by the Government of Alberta to Barnwell forcondemnation of the wells, and such receipts were credited to oil and naturalgas properties for book purposes.

 

On October 1, 2002, Barnwelladopted Statement of FinancialAccounting Standards (“SFAS”) No. 143, “Accounting for Asset RetirementObligations,” which requires that the fair value of a liability for an asset retirementobligation be recognized in the period in which it is incurred if a reasonableestimate of fair value can be made. Adoption of SFAS No. 143 increased gross oil and natural gas propertiesby $564,000, decreased accumulated depletion by $546,000, and increased theasset retirement obligation by $1,110,000 on October 1, 2002.  Following the initial implementationof SFAS No. 143, the asset retirement obligation was increased during the yearended September 30, 2003 by $39,000 to reflect obligations incurred on newwells drilled, by $85,000 for accretion of the asset retirement obligation, andby $198,000 for changes in foreign currency translation rates.  During the year ended September 30, 2004, theasset retirement obligation was increased by $133,000 to reflect obligationsincurred on new wells drilled and changes in the timing and amount of estimatedfuture expenditures, by $100,000 for accretion of the asset retirementobligation, and by $110,000 for changes in foreign currency translation rates.

 

During the year endedSeptember 30, 2005, the asset retirement obligation was increased by $221,000to reflect obligations incurred on new wells drilled, $545,000 for changes inthe timing and amount of estimated future expenditures, $140,000 for accretionof the asset retirement obligation, and by $195,000 for changes in foreigncurrency translation rates.  The changesdue to the timing and amount of estimated future expenditures primarilyresulted from an increase in the inflation-adjusted cost of abandonment andrestoration services, due in part to recent rises in oil and natural gasprices.  

 

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The increase was partially offset by $31,000in abandonment and restoration disbursements in fiscal 2005.

 

 

**6.             LONG-TERM DEBT**

 

Barnwell has a creditfacility at the Royal Bank of Canada, a Canadian bank, for approximately$16,300,000 at September 30, 2005. Borrowings under this facility were $11,576,000 and $10,165,000 atSeptember 30, 2005 and 2004, respectively, and are included in long-termdebt.  At September 30, 2005, Barnwellhad unused credit available under this facility of approximately $4,700,000.

 

The facility is available inU.S. dollars at the London Interbank Offer Rate plus 2%, at U.S. prime plus 1%,or in Canadian dollars at Canadian prime plus 1%.  A standby fee of 1% per annum is charged onthe unused facility balance.  Under thefinancing agreement, the facility is reviewed annually, with the next reviewplanned for April 2006.  Subject to that review,the facility may be extended one year with no required debt repayments for oneyear or converted to a 2-year term loan by the bank.  If the facility is converted to a 2-yearterm loan, Barnwell has agreed to the following repayment schedule of the thenoutstanding loan balance:  first year ofthe term period — 20% (5% per quarter), and in the second year of the termperiod  — 80% (5% per quarter for thefirst three quarters and 65% in the final quarter).

 

Barnwellhas the option to change the currency denomination and interest rate applicableto the loan at periodic intervals during the term of the loan.  During the year ended September 30, 2005,Barnwell paid interest at rates ranging from 3.375% to 5.67%.  The weighted average interest rate on the facilityat September 30, 2005 was 5.61%.  Thefacility is collateralized by Barnwell’s interests in its major oil and naturalgas properties and a negative pledge on its remaining oil and natural gasproperties.  The facility is reviewedannually with a primary focus on the future cash flows that will be generatedby Barnwell’s Canadian oil and natural gas properties.  No compensating bank balances are requiredfor this facility.

 

The bank affirmed that itwill not require any repayments under the facility before October 1, 2006.  Accordingly, Barnwell has classifiedoutstanding borrowings under the facility as long-term debt.

 

Duringthe first quarter of fiscal 2003, Barnwell capitalized interest on costsrelated to its investment in land. Attainment of zoning and development entitlements for KaupulehuDevelopments’ leasehold land interests in approximately 870 acres of land zonedfor resort/residential development was substantially complete as of the end ofDecember 2002.  Accordingly, effectiveJanuary 1, 2003, Barnwell no longer capitalizes interest on the accumulateddevelopment costs of the property.

 

Interest costs for the yearsended September 30, 2005, 2004 and 2003 are summarized as follows:

 
| ** **                                             | ** ** | **2005**   | ** **  | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------|------------|------------|-------------|----------|------------|----------|------------|
| Interest costs incurred                                | ** ** | **$**      | **616,000** |     | $          | 487,000  |       | $ | 487,000 |   |
| Less interest costs  capitalized on investment in land | ** ** | **—** |        | —   |       | 45,000   |       |
| Interest expense                                       | ** ** | **$**      | **616,000** |     | $          | 487,000  |       | $ | 442,000 |   |

 

62

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**7.             TAXES ON INCOME**

 

The components of earnings beforeincome taxes are as follows:

 
| ** **                               | ** ** | **Year ended September 30,** | ** **     |
|------------------------------------------|------------|------------------------------|----------------|
| ** **                               | ** ** | **2005**                     | ** **     | **2004** | ** ** | **2003** | ** ** |
| Earnings (loss) before  income taxes in: |       |                         |           |   |   |   |   |
| United States                            | ** ** | **$**                        | **(2,091,000** | ) | $ | 3,592,000 |   | $ | (2,499,000 | ) |
| Canada                                   | ** ** | **12,085,000**               |           | 8,425,000 |   | 9,004,000 |   |
|                                     | ** ** | **$**                        | **9,994,000**  |   | $ | 12,017,000 |   | $ | 6,505,000 |   |

 

The components of theprovision for income taxes related to the above earnings (loss) are as follows:

 
| ** **                     | ** ** | **Year ended September 30,** | ** **    |
|--------------------------------|------------|------------------------------|---------------|
| ** **                     | ** ** | **2005**                     | ** **    | **2004** | ** ** | **2003** | ** ** |
| Current provision:             |       |                         |          |   |   |   |   |
| United States — Federal   | ** ** | **$**                        | **310,000**   |   | $ | 594,000 |   | $ | 143,000 |   |
| United States — State     | ** ** | **—**                   |          | 28,000 |   | — |   |
|                           | ** ** | **310,000**                  |          | 622,000 |   | 143,000 |   |
| Canadian                       | ** ** | **5,244,000**                |          | 2,992,000 |   | 3,333,000 |   |
| Total current                  | ** ** | **5,554,000**                |          | 3,614,000 |   | 3,476,000 |   |
|                           |       |                         |          |   |   |   |   |
| Deferred (benefit)  provision: |       |                         |          |   |   |   |   |
| United States                  | ** ** | **(1,338,000**               | )             | 608,000 |   | (191,000 | ) |
| Canadian                       | ** ** | **(249,000**                 | )             | (915,000 | ) | 900,000 |   |
| Total deferred                 | ** ** | **(1,587,000**               | )             | (307,000 | ) | 709,000 |   |
|                           | ** ** | **$**                        | **3,967,000** |   | $ | 3,307,000 |   | $ | 4,185,000 |   |

 

The U.S. deferred tax benefit of $1,338,000 for fiscal2005 is primarily the result of increases in stock appreciation rightsaccruals, bonus accruals, the excess of depletion and depreciation for bookpurposes over tax, and alternative minimum tax credits generated during theyear which are estimated to have future tax benefits.

 

The U.S. deferred tax expense of $608,000 for fiscal2004 includes reversals of temporary differences, resulting from the excess ofexpenses deductible for tax purposes over expenses recognized under the costrecovery method for books, generated by sales of Kaupulehu Developments’development rights and interest in leasehold land.

 

Barnwell’s Canadian deferredtax benefit of $915,000 for fiscal 2004 was due to a $1,740,000 deferred taxbenefit resulting from reductions in Canadian federal and provincial tax rates,partially offset by Barnwell’s $825,000 Canadian deferred tax provisionresulting from changes in differences between Canadian assets and liabilitiesfor book purposes versus Canadian assets and liabilities for Canadian taxpurposes.  In November 2003, Royal Assentwas received on a bill passed by the Parliament of Canada, which was thenenacted into law, to reduce Canada’s corporate tax rate on “resource” income(income derived from oil and natural gas operations) over a four-year periodbeginning January 1, 2003 from 29% to 21% beginning January 1, 2007.  Additionally, the bill phases in over thesame four-year period tax deductions for royalties, which previously were nottax deductible, and phases out the Resource Allowance deduction along withother changes.  Accordingly, duringfiscal 

 

63

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2004, Barnwell’s Canadian deferred income taxliabilities were reduced by approximately $1,440,000 due to the reduction inCanada’s federal corporate tax rate. There was no benefit attributable to changes in Canada’s corporate taxrate on “resource” income in fiscal 2005 or fiscal 2003.  Barnwell’s Canadian deferred income taxliabilities were also reduced by approximately $300,000 in fiscal 2004 as aresult of the Province of Alberta’s reduction of the province’s corporate taxrate from 13.0% to 12.5%, effective April 1, 2003 (enacted into law in December2003), and from 12.5% to 11.5%, effective April 1, 2004 (enacted into law inMay 2004).  In April 2002, thelegislative assembly of the Province of Alberta passed a bill to reduce theprovince’s corporate tax rate from 13.5% to 13.0%, effective April 1,2002.  The bill was enacted into law inDecember 2002.  The reduction in the taxrate reduced Canadian deferred income tax liabilities by approximately $75,000in fiscal 2003.  There was no suchreduction recorded in fiscal 2005.

 

Barnwell’s Canadian deferredtax provision of $825,000 for fiscal 2004, excluding the deferred tax benefitassociated with the aforementioned reduction in income tax rates, and Barnwell’sCanadian deferred tax provision for fiscal 2003, were primarily due to Barnwell’sCanadian tax deductions related to its oil and natural gas properties exceedingBarnwell’s depletion of its oil and natural gas properties for book purposes.

 

A reconciliation between thereported provision for income taxes and the amount computed by multiplying theearnings before income taxes by the U.S. federal tax rate of 35% is as follows:

 
| ** **                                                                                              | ** ** | **Year ended September 30,** | ** **    |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------|---------------|
| ** **                                                                                              | ** ** | **2005**                     | ** **    | **2004** | ** ** | **2003** | ** ** |
| Tax expense computed by applying statutory rate                                                         | ** ** | **$**                        | **3,498,000** |   | $ | 4,206,000 |   | $ | 2,277,000 |   |
|                                                                                                    |       |                         |          |   |   |   |   |
| Effect of reduction of Canadian tax rates on Canadian deferred taxes                                    | ** ** | **—**                   |          | (1,740,000 | ) | (75,000 | ) |
| Effect of the foreign tax provision, before effect of changes in tax rates,  on the total tax provision | ** ** | **302,000**                  |          | 525,000 |   | 2,042,000 |   |
| State net operating losses (generated) utilized                                                         | ** ** | **(45,000**                  | )             | 83,000 |   | (39,000 | ) |
| State income taxes                                                                                      | ** ** | **—**                   |          | 28,000 |   | — |   |
| Other                                                                                                   | ** ** | **212,000**                  |          | 205,000 |   | (20,000 | ) |
|                                                                                                    | ** ** | **$**                        | **3,967,000** |   | $ | 3,307,000 |   | $ | 4,185,000 |   |
|                                                                                                         |            |                              |               |  |  |  |  |  |  |  |  |  |

 

64

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Thetax effects of temporary differences that give rise to significant portions ofthe deferred tax assets and deferred tax liabilities at September 30, 2005 and2004 are as follows:

 
| ** **                                                                                                  | ** ** | **2005**        | ** **     | **2004**    | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------|----------------|-------------|------------|
| Deferred income tax assets:                                                                                 |       |            |           |        |       |
| U.S. tax effect of deferred Canadian taxes                                                                  | ** ** | **$**           | **3,206,000**  |        | $          | 3,028,000 |   |
| Foreign tax credit carryforwards                                                                            | ** ** | **4,130,000**   |           | 4,261,000   |       |
| Tax basis of investment in land in excess of book basis                                                     | ** ** | **972,000**     |           | 1,165,000   |       |
| Alternative minimum tax credit carryforwards                                                                | ** ** | **461,000**     |           | 116,000     |       |
| Liabilities accrued for books but not for tax under U.S. tax law                                            | ** ** | **3,296,000**   |           | 1,385,000   |       |
| Liabilities accrued for books but not for tax under Canadian tax law                                        | ** ** | **1,874,000**   |           | 768,000     |       |
| Other                                                                                                       | ** ** | **564,000**     |           | 402,000     |       |
| Total gross deferred tax assets                                                                             | ** ** | **14,503,000**  |           | 11,125,000  |       |
| Less-valuation allowance                                                                                    | ** ** | **(9,703,000**  | )              | (8,456,000  | )          |
| Net deferred income tax assets                                                                              | ** ** | **4,800,000**   |           | 2,669,000   |       |
|                                                                                                        |       |            |           |        |       |
| Deferred income tax liabilities:                                                                            |       |            |           |        |       |
| Property and equipment accumulated tax depreciation and depletion in excess  of book under Canadian tax law | ** ** | **(11,303,000** | )              | (9,675,000  | )          |
| Property and equipment accumulated tax depreciation and depletion in excess  of book under U.S. tax law     | ** ** | **(3,064,000**  | )              | (2,141,000  | )          |
| Other                                                                                                       | ** ** | **(338,000**    | )              | (341,000    | )          |
| Total deferred income tax liabilities                                                                       | ** ** | **(14,705,000** | )              | (12,157,000 | )          |
|                                                                                                        |       |            |           |        |       |
| Net deferred income tax liability                                                                           | ** ** | **$**           | **(9,905,000** | )           | $          | (9,488,000 | ) |

 

The total valuation allowance increased $1,247,000and $1,790,000 for the years ended September 30, 2005 and 2003, respectively,and decreased $929,000 for the year ended September 30, 2004.  The changes relate primarily to foreign taxcredit carryforwards and stock appreciation rights accruals for a Canadianemployee for which it is more likely than not that such carryforwards andaccruals will not be utilized in the future to reduce Barnwell’s U.S. taxobligation.

 

A valuation allowance isprovided when it is more likely than not that some portion or all of thedeferred tax asset will not be realized. Barnwell has established a valuation allowance primarily for the U.S.tax effect of deferred Canadian taxes, foreign tax credits, accrued expensesand state of Hawaii net operating loss carryforwards which may not berealizable in future years as there can be no assurance of any specific levelof earnings or that the timing of U.S. earnings will coincide with the paymentof Canadian taxes to enable Canadian taxes to be fully deducted (orrecoverable) for U.S. tax purposes.

 

Netdeferred tax assets at September 30, 2005 of $4,800,000 consists of $3,322,000related to expenses accrued for book purposes but not for tax purposes and$972,000 related to the excess of the cost basis of investment in land for taxpurposes over the cost basis of investment in land for book purposes.  Canadian deferred tax assets related toexpenses accrued for book purposes but not for tax purposes are estimated to berealized through future Canadian income tax deductions against future Canadianoil and natural gas earnings.  U.S.deferred tax assets related to expenses accrued for book 

 

65

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purposes but not for tax purposes and theexcess of the cost basis of investment in land for tax purposes over the costbasis of investment in land for book purposes are estimated to be realized fromdeductions against future U.S. earnings from sales of interests in leaseholdland and land development rights. Additionally, at September 30, 2005, Barnwell had a deferred tax assetof $461,000 for alternative minimum tax credit carryforwards which areavailable to reduce future U.S. federal regular income taxes, over anindefinite period, and a net deferred tax asset of $45,000 for a state net operatingloss carryforward which is available to reduce future state income taxesarising from future sales of interests in leasehold land and land developmentrights and expires if not utilized on or before September 30, 2025.  The amount of deferred income tax assetsconsidered realizable may be reduced if estimates of future taxable income arereduced.

 

 

**8.             PENSION PLAN**

 

Barnwellsponsors a noncontributory defined benefit pension plan covering substantiallyall of its U.S. employees, with benefits based on years of service and theemployee’s highest consecutive five-year average earnings.  Barnwell’s funding policy is intended toprovide for both benefits attributed to service to-date and for those expectedto be earned in the future.

 

Theoverall investment objective of the plan is to provide growth in the assets ofthe plan to fund future benefit obligations while managing risk in order tomeet current benefit obligations. Generally, principal repayments and interest received on governmentmortgage securities provide cash flows to fund current benefitobligations.  Longer-term obligations aregenerally estimated to be provided for by growth in equity securities.  The plan assets at September 30, 2005 wereinvested as follows: 3% in cash, 3% in a certificate of deposit, 41% in debtsecurities, and 53% in equity securities. The plan assets at September 30, 2004 were invested as follows: 1% incash, 3% in a certificate of deposit, 42% in debt securities, and 54% in equitysecurities.  Target asset allocations arenot used, and allocations are adjusted from time to time as dictated by currentand anticipated market conditions and required cash flows.

 

Themeasurement date used to determine pension measures for the pension plan isSeptember 30.

 

66

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                Thefunded status of the pension plan and the amounts recognized in theconsolidated financial statements are as follows:

 
| ** **                                     | ** ** | **September 30,** | ** **    |
|------------------------------------------------|------------|-------------------|---------------|
| ** **                                     | ** ** | **2005**          | ** **    | **2004** | ** ** |
| Change in Benefit  Obligation:                 |       |              |          |   |   |
| Benefit obligation at beginning of year        | ** ** | **$**             | **3,392,000** |   | $ | 3,086,000 |   |
| Service cost                                   | ** ** | **161,000**       |          | 121,000 |   |
| Interest cost                                  | ** ** | **213,000**       |          | 180,000 |   |
| Actuarial loss                                 | ** ** | **767,000**       |          | 125,000 |   |
| Benefits paid                                  | ** ** | **(121,000**      | )             | (120,000 | ) |
| Benefit obligation at end of year              | ** ** | **4,412,000**     |          | 3,392,000 |   |
|                                           |       |              |          |   |   |
| Change in Plan Assets                          |       |              |          |   |   |
| Fair value of plan assets at beginning of year | ** ** | **2,114,000**     |          | 2,027,000 |   |
| Actual return on plan assets                   | ** ** | **186,000**       |          | 133,000 |   |
| Employer contribution                          | ** ** | **150,000**       |          | 74,000 |   |
| Benefits paid                                  | ** ** | **(121,000**      | )             | (120,000 | ) |
| Fair value of plan assets at end of year       | ** ** | **2,329,000**     |          | 2,114,000 |   |
|                                           |       |              |          |   |   |
| Funded status                                  | ** ** | **(2,083,000**    | )             | (1,278,000 | ) |
| Unrecognized prior service cost                | ** ** | **—**        |          | 7,000 |   |
| Unrecognized actuarial loss                    | ** ** | **1,566,000**     |          | 853,000 |   |
| Accrued benefit cost                           | ** ** | **$**             | **(517,000**  | ) | $ | (418,000 | ) |

 

                The accumulated benefitobligation for the pension plan was $2,978,000 and $2,357,000 at September 30,2005 and 2004, respectively.  Statementof Financial Accounting Standards No. 132 requires the recognition of a minimumliability equal to the excess, if any, of the accumulated benefit obligationover plan assets.  At September 30, 2005,Barnwell recognized an additional minimum liability of $132,000 as the accruedbenefit cost was less than the minimum liability.  The increase in the additional minimumliability during the year ended September 30, 2005 was included in othercomprehensive income; there was no additional minimum liability as of September30, 2004.

 

                The actuarial loss of $767,000reported above in the “Change in Benefit Obligation” for the year endedSeptember 30, 2005 is principally due to the change from a 5.75% discount rateto a 5.25% discount rate and the actuaries’ change from the 1983 mortalitytable to the 1994 mortality table.

 
| ** **                                                              | ** ** | **September 30,** | ** **  |
|-------------------------------------------------------------------------|------------|-------------------|-------------|
| ** **                                                              | ** ** | **2005**          | ** **  | **2004** | ** ** |
| Amounts recognized in the consolidated  balance sheet consist of:       |       |              |        |   |   |
| Accrued benefit cost, excluding minimum pension liability               | ** ** | **$**             | **517,000** |   | $ | 418,000 |   |
| Accumulated other comprehensive loss                                    | ** ** | **132,000**       |        | — |   |
| Net amount recognized                                                   | ** ** | **$**             | **649,000** |   | $ | 418,000 |   |
|                                                                    |       |              |        |   |   |
| Assumptions used to determine  the fiscal year-end benefit obligations: |       |              |        |   |   |
| Discount rate                                                           | ** ** | **5.25**          | %           | 5.75 | % |
| Rate of compensation increase                                           | ** ** | **5.00**          | %           | 5.00 | % |

 

67

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| ** **                               | ** ** | **Year ended September 30,** | ** **  |
|------------------------------------------|------------|------------------------------|-------------|
| ** **                               | ** ** | **2005**                     | ** **  | **2004** | ** ** | **2003** | ** ** |
| Net Periodic Benefit Cost  for the Year: |       |                         |        |   |   |   |   |
| Service cost                             | ** ** | **$**                        | **161,000** |   | $ | 121,000 |   | $ | 128,000 |   |
| Interest cost                            | ** ** | **213,000**                  |        | 180,000 |   | 171,000 |   |
| Expected return on plan assets           | ** ** | **(171,000**                 | )           | (157,000 | ) | (144,000 | ) |
| Amortization of net asset                | ** ** | **—**                   |        | — |   | (1,000 | ) |
| Amortization of prior service cost       | ** ** | **6,000**                    |        | 6,000 |   | 6,000 |   |
| Amortization of net actuarial loss       | ** ** | **40,000**                   |        | 18,000 |   | 12,000 |   |
| Net periodic benefit cost                | ** ** | **$**                        | **249,000** |   | $ | 168,000 |   | $ | 172,000 |   |

 
| ** **                                                    | ** ** | **Year ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                    | ** ** | **2005**                     | ** ** | **2004** | ** ** | **2003** | ** ** |
| Assumptions used to  determine the net periodic benefit cost: |       |                         |       |   |   |   |   |
| Discount rate                                                 | ** ** | **5.75**                     | %          | 6.00 | % | 6.50 | % |
| Expected return on plan assets                                | ** ** | **8.00**                     | %          | 8.00 | % | 8.00 | % |
| Rate of compensation increase                                 | ** ** | **5.00**                     | %          | 5.00 | % | 5.00 | % |

 

To develop the expectedlong-term rate of return on assets assumption, historical returns and the futureexpectations for returns for each asset class were considered.

 
| Expected Benefit Payments:                          |   |   |    |
|-----------------------------------------------------|--------|--------|---------|
| Fiscal year ending September 30, 2006               |   | $      | 132,000 |   |
| Fiscal year ending September 30, 2007               |   | $      | 126,000 |   |
| Fiscal year ending September 30, 2008               |   | $      | 119,000 |   |
| Fiscal year ending September 30, 2009               |   | $      | 112,000 |   |
| Fiscal year ending September 30, 2010               |   | $      | 112,000 |   |
| Fiscal years ending September 30, 2011 through 2015 |   | $      | 661,000 |   |

 

                Barnwellestimates that it will contribute approximately $300,000 to the plan duringfiscal 2006.

 

 

**9.             STOCK OPTIONS**

 

In March 1995, Barnwellgranted 120,000 stock options (split-adjusted) to an officer and director ofBarnwell under a non-qualified plan at a purchase price of $3.27 per share(market price on date of grant, split-adjusted).  These options had stock appreciation rightsthat permitted the holder to receive stock, cash or a combination thereof equalto the amount by which the fair market value, at the time of exercise of theoption, exceeds the option price.  Duringthe year ended September 30, 2004, the officer and director exercised the stockappreciation rights feature of 78,000 shares (split-adjusted) of these optionsand the difference between the exercise price and the price per share on thedates of exercise (ranging from $6.99 to $7.50 per share) was paid to thisemployee in cash by Barnwell.  During theyear ended September 30, 2005, the officer and director exercised the stockappreciation rights feature of 42,000 shares (split-adjusted) of these optionsand the difference between the exercise price and the price per share on thedate of exercise ($14.31 per share, split-adjusted) was paid to this employeein cash by Barnwell.  Barnwell recognized$275,000, $392,000 and $101,000 of compensation cost relating to these optionsin the years ended September 30, 2005, 2004 and 2003, respectively.

 

68

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InJune 1998, Barnwell granted 180,000 stock options (split-adjusted) to anofficer of Barnwell’s oil and gas segment under a non-qualified plan at apurchase price of $2.60 per share (market price on date of grant,split-adjusted).  These options are fullyvested and have stock appreciation rights that permit the holder to receivestock, cash or a combination thereof equal to the amount by which the fairmarket value, at the time of exercise of the option, exceeds the optionprice.  The options expire in May2008.  Barnwell recognized $2,223,000,$599,000 and $125,000 of compensation costs relating to these options in theyears ended September 30, 2005, 2004 and 2003, respectively.

 

In December 1999, Barnwellgranted qualified stock options to certain employees of Barnwell to acquire408,000 shares and 174,000 shares of Barnwell’s common stock (split-adjusted)with an exercise price per share of $1.98 (market price at date of grant,split-adjusted) and $2.18 (110% of market price at date of grant,split-adjusted), respectively.  Theseoptions are fully vested.  The $1.98 pershare options expire in December 2009, and the $2.18 per share options expiredin December 2004.  During the year endedSeptember 30, 2005, Barnwell issued 207,000 shares of its common stock tocertain employees resulting from exercises of qualified stock options at exerciseprices ranging from $1.98 to $2.18 per share (split-adjusted).  During the year ended September 30, 2004,Barnwell issued 105,000 shares of its common stock to certain employeesresulting from exercises of qualified stock options at exercise prices rangingfrom $1.98 to $2.18 per share (split-adjusted). No compensation cost was recognized for these options for the yearsended September 30, 2005, 2004 and 2003.

 

In December 2004, Barnwellgranted qualified stock options to certain officers/directors of Barnwell toacquire 210,000 shares of Barnwell’s common stock at a weighted averageexercise price per share of $9.23 (based on grants at market price and 110% ofmarket price at the date of grant, split-adjusted).  These options vest annually over four yearscommencing one year from the date of grant and expire in December 2014 andDecember 2009.  No compensation cost wasrecognized for options granted under this plan for the year ended September 30,2005.  At September 30, 2005, 6,000shares were available for grant under the qualified option plan.

 

In December 2004, Barnwellgranted stock options to certain officers/directors of Barnwell to acquire210,000 shares of Barnwell’s common stock under a non-qualified plan at apurchase price of $8.80 per share (market price on date of grant, split-adjusted).  These options vest annually over five yearscommencing one year from the date of grant and expire in December 2014.  These options have stock appreciation rightsthat permit the holder to receive stock, cash or a combination thereof equal tothe amount by which the fair market value, at the time of exercise of theoption, exceeds the option price. Barnwell recognized $1,001,000 of compensation costs relating to theseoptions in the year ended September 30, 2005.

 

Stock options at September30, 2005 (split-adjusted) were as follows:

 
| ** **              | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **              | ** ** | **Average**             | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** ** | ** **              | ** ** | **Remaining**           | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**            | ** ** | **Number of**           | ** ** | **Contractual**         | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| **exercise prices**     | ** ** | **Shares**              | ** ** | **Life**                | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| $1.98 - $2.60 |       | 426,000                 |       | 3.5  years              |       | $ | 2.24 |   | 426,000 |   | $ | 2.24 |   |
| $8.62 - $9.48 |       | 420,000                 |       | 7.4  years              |       | $ | 9.02 |   | — |   | — |   |
|                    |       |                    |       |                    |       |   |   |   |   |   |   |
| $1.98 - $9.48 |       | 846,000                 |       | 5.5  years              |       | $ | 5.61 |   | 426,000 |   | $ | 2.24 |   |

 

69

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Stock options at September30, 2004 (split-adjusted) were as follows:

 
| ** **              | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **              | ** ** | **Average**             | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** ** | ** **              | ** ** | **Remaining**           | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**            | ** ** | **Number of**           | ** ** | **Contractual**         | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| **exercise prices**     | ** ** | **Shares**              | ** ** | **Life**                | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| $1.98 - $2.60 |       | 633,000                 |       | 3.8  years              |       | $ | 2.20 |   | 633,000 |   | $ | 2.20 |   |
| $3.27                   |       | 42,000                  |       | 0.4  years              |       | $ | 3.27 |   | 42,000 |   | $ | 3.27 |   |
|                    |       |                    |       |                    |       |   |   |   |   |   |   |
| $1.98 - $3.27           |       | 675,000                 |       | 3.5  years              |       | $ | 2.26 |   | 675,000 |   | $ | 2.26 |   |

 

 

Stock options at September30, 2003 (split-adjusted) were as follows:

 
| ** **          | ** ** | **Options outstanding** | ** ** | **Options exercisable** | ** ** |
|---------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **          | ** ** | ** **              | ** ** | **Weighted**            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **          | ** ** | ** **              | ** ** | **Average**             | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **          | ** ** | ** **              | ** ** | **Remaining**           | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**        | ** ** | **Number of**           | ** ** | **Contractual**         | ** ** | **Exercise** | ** ** | **Number of** | ** ** | **Exercise** | ** ** |
| **exercise prices** | ** ** | **Shares**              | ** ** | **Life**                | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| $1.98 - $2.60       |       | 738,000                 |       | 4.6  years              |       | $ | 2.18 |   | 598,500 |   | $ | 2.21 |   |
| $3.27               |       | 120,000                 |       | 1.4  years              |       | $ | 3.27 |   | 120,000 |   | $ | 3.27 |   |
|                |       |                    |       |                    |       |   |   |   |   |   |   |
| $1.98 - $3.27       |       | 858,000                 |       | 4.2  years              |       | $ | 2.33 |   | 718,500 |   | $ | 2.39 |   |

 

 

There were noforfeitures or expirations of unexercised options in the years ended September30, 2005, 2004 and 2003.

 

Barnwell plans torepurchase shares of its common stock from time to time in the open market orin privately negotiated transactions, depending on market conditions.  In December 2005, Barnwell’s Board ofDirectors authorized the purchase of up to 250,000 shares.

 

 

**10.          COMMITMENTS AND CONTINGENCIES**

 

Barnwellhas committed to compensate its Vice President of Canadian Operations pursuantto a long-term incentive compensation plan, the value of which directly relatesto Barnwell’s oil and natural gas segment’s net income and the change in thevalue of Barnwell’s oil and gas reserves since 1998 with adjustments forchanges in natural gas and oil prices and subject to other terms andconditions.  Barnwell recognized$131,000, $60,000 and $166,000 of compensation expense pursuant to thisincentive plan in fiscal 2005, 2004 and 2003, respectively.

 

Barnwell has also committed to compensatecertain Canadian personnel pursuant to a long-term incentive compensation plan,the value of which directly relates to Barnwell’s oil and natural gas segment’snet income and the value of Barnwell’s oil and gas reserves discovered,commencing in fiscal 2002, for projects developed by such personnel.  Barnwell recognized approximately $90,000,$190,000 and $80,000 of costs pursuant to this plan in fiscal 2005, 2004 and2003, respectively.

 

70

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Barnwell has several non-cancelableoperating leases for office space and leasehold land.  Rental expense was $481,000 in 2005, $444,000in 2004, and $474,000 in 2003.  Barnwellis committed under these leases for minimum rental payments summarized byfiscal year as follows: 2006 - $518,000, 2007 - $489,000, 2008 - $451,000, 2009- $431,000, 2010 - $431,000 and thereafter through 2026 an aggregate of$2,167,000.  The lease payments for landare subject to renegotiation after December 31, 2005.  Per the lease agreement, the lease paymentswill remain unchanged pending an appraisal, after which the lease rent could beadjusted to fair market value.  Barnwellcurrently does not know the amount of the new lease payments which could beeffective January 1, 2006; they may remain unchanged or increase.  The future rental payment disclosures aboveassume the minimum lease payments for land in effect at December 31, 2005remain unchanged through December 2025, the end of the lease term.

 

Barnwellis occasionally involved in routine litigation and is subject to governmentaland regulatory controls that are incidental to the ordinary course ofbusiness.  Barnwell’s management believesthat all claims and litigation involving Barnwell are not likely to have amaterial adverse effect on its financial statements taken as a whole.

 

 

**11.          SEGMENT AND GEOGRAPHIC INFORMATION**

 

Barnwelloperates three segments: exploring for, developing, producing and selling oil andnatural gas (oil and natural gas); investing in leasehold land in Hawaii (landinvestment); and drilling wells and installing and repairing water pumpingsystems in Hawaii (contract drilling). Barnwell’s reportable segments are strategic business units that offerdifferent products and services.  Theyare managed separately as each segment requires different operational methods,operational assets and marketing strategies, and operate in differentgeographical locations.

 

71

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Barnwell does not allocategeneral and administrative expenses, interest expense, interest income orincome taxes to segments, and there are no transactions between segments thataffect segment profit or loss.

 
| ** **                                                                 | ** ** | **Year ended September 30,** | ** **     |
|----------------------------------------------------------------------------|------------|------------------------------|----------------|
| ** **                                                                 | ** ** | **2005**                     | ** **     | **2004** | ** ** | **2003** | ** ** |
| Revenues:                                                                  |       |                         |           |   |   |   |   |
| Oil and natural gas                                                        | ** ** | **$**                        | **32,724,000** |   | $ | 23,840,000 |   | $ | 19,830,000 |   |
| Contract drilling                                                          | ** ** | **7,644,000**                |           | 3,690,000 |   | 2,050,000 |   |
| Land investment                                                            | ** ** | **3,047,000**                |           | 10,077,000 |   | 1,220,000 |   |
| Other                                                                      | ** ** | **652,000**                  |           | 827,000 |   | 720,000 |   |
| Total before interest income                                               | ** ** | **44,067,000**               |           | 38,434,000 |   | 23,820,000 |   |
| Interest income                                                            | ** ** | **143,000**                  |           | 106,000 |   | 340,000 |   |
| Total revenues                                                             | ** ** | **$**                        | **44,210,000** |   | $ | 38,540,000 |   | $ | 24,160,000 |   |
|                                                                       |       |                         |           |   |   |   |   |
| Depletion, depreciation and  amortization:                                 |       |                         |           |   |   |   |   |
| Oil and natural gas                                                        | ** ** | **$**                        | **8,447,000**  |   | $ | 6,423,000 |   | $ | 4,026,000 |   |
| Contract drilling                                                          | ** ** | **125,000**                  |           | 98,000 |   | 88,000 |   |
| Other                                                                      | ** ** | **216,000**                  |           | 240,000 |   | 219,000 |   |
| Total                                                                      | ** ** | **$**                        | **8,788,000**  |   | $ | 6,761,000 |   | $ | 4,333,000 |   |
|                                                                       |       |                         |           |   |   |   |   |
| Operating profit (loss) (before general and administrative expenses): |       |                         |           |   |   |   |   |
| Oil and natural gas                                                        | ** ** | **$**                        | **17,378,000** |   | $ | 11,444,000 |   | $ | 11,132,000 |   |
| Contract drilling                                                          | ** ** | **1,754,000**                |           | 408,000 |   | 34,000 |   |
| Land investment, net of minority interest                                  | ** ** | **2,378,000**                |           | 7,612,000 |   | 669,000 |   |
| Other                                                                      | ** ** | **436,000**                  |           | 587,000 |   | 501,000 |   |
| Total                                                                      | ** ** | **21,946,000**               |           | 20,051,000 |   | 12,336,000 |   |
| General and administrative expenses, net of minority interest              | ** ** | **(11,479,000**              | )              | (7,653,000 | ) | (5,729,000 | ) |
| Interest income                                                            | ** ** | **143,000**                  |           | 106,000 |   | 340,000 |   |
| Interest expense                                                           | ** ** | **(616,000**                 | )              | (487,000 | ) | (442,000 | ) |
| Earnings before income taxes                                               | ** ** | **$**                        | **9,994,000**  |   | $ | 12,017,000 |   | $ | 6,505,000 |   |
|                                                                       |       |                         |           |   |   |   |   |
| Capital expenditures:                                                      |       |                         |           |   |   |   |   |
| Oil and natural gas                                                        | ** ** | **$**                        | **18,229,000** |   | $ | 11,876,000 |   | $ | 11,059,000 |   |
| Land investment                                                            | ** ** | **—**                   |           | — |   | 45,000 |   |
| Contract drilling                                                          | ** ** | **242,000**                  |           | 65,000 |   | 72,000 |   |
| Other                                                                      | ** ** | **406,000**                  |           | 1,191,000 |   | 158,000 |   |
| Total                                                                      | ** ** | **$**                        | **18,877,000** |   | $ | 13,132,000 |   | $ | 11,334,000 |   |

 

Depletion per 1,000 cubicfeet (“MCF”) of natural gas and natural gas equivalent (“MCFE”),  converted at a rate of one barrel of oil andnatural gas liquids to 5.8 MCFE, was $1.66 in fiscal 2005, $1.31 in fiscal2004, and $0.90 in fiscal 2003.  Theescalating depletion rate is the result of increased costs of finding anddeveloping proven reserves, as compared to prior years, as well as increases inthe average exchange rate of the Canadian dollar to the U.S. dollar of 8% infiscal 2005, as compared to fiscal 2004, and 10% in fiscal 2004, as compared tofiscal 2003.

 

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ASSETS BY SEGMENT:

 
| ** **                                             | ** ** | **September 30,** | ** **     |
|--------------------------------------------------------|------------|-------------------|----------------|
| ** **                                             | ** ** | **2005**          | ** **     | **2004** | ** ** | **2003** | ** ** |
| Oil and natural gas (1)                                | ** ** | **$**             | **68,592,000** | ** ** | **81** | % | $ | 50,658,000 |   | 78 | % | $ | 40,638,000 |   | 77 | % |
| Contract drilling (2)                                  | ** ** | **2,703,000**     | ** **     | **3** | % | 3,062,000 |   | 5 | % | 1,380,000 |   | 3 | % |
| Land investment (2)                                    | ** ** | **3,033,000**     | ** **     | **4** | % | 3,033,000 |   | 5 | % | 6,508,000 |   | 12 | % |
| Other:                                                 |       |              |           |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents, and certificates of deposit | ** ** | **7,192,000**     | ** **     | **8** | % | 5,884,000 |   | 9 | % | 1,648,000 |   | 3 | % |
| Corporate and other                                    | ** ** | **3,457,000**     | ** **     | **4** | % | 2,450,000 |   | 3 | % | 2,463,000 |   | 5 | % |
| Total                                                  | ** ** | **$**             | **84,977,000** | ** ** | **100** | % | $ | 65,087,000 |   | 100 | % | $ | 52,637,000 |   | 100 | % |
|                                                        |            |                   |                |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)  Primarily located in the Province of Alberta,Canada.(2)  Located in Hawaii.

 

 

LONG-LIVED ASSETS BYGEOGRAPHIC AREA:

 
| ** **    | ** ** | **September 30,** | ** **     |
|---------------|------------|-------------------|----------------|
| ** **    | ** ** | **2005**          | ** **     | **2004** | ** ** | **2003** | ** ** |
| United States | ** ** | **$**             | **5,192,000**  | ** ** | **8** | % | $ | 4,847,000 |   | 10 | % | $ | 7,640,000 |   | 17 | % |
| Canada        | ** ** | **59,702,000**    | ** **     | **92** | % | 46,038,000 |   | 90 | % | 37,816,000 |   | 83 | % |
| Total         | ** ** | **$**             | **64,894,000** | ** ** | **100** | % | $ | 50,885,000 |   | 100 | % | $ | 45,456,000 |   | 100 | % |

 

 

REVENUE BY GEOGRAPHIC AREA:

 
| ** **                         | ** ** | **Year ended September 30,** | ** **     |
|------------------------------------|------------|------------------------------|----------------|
| ** **                         | ** ** | **2005**                     | ** **     | **2004** | ** ** | **2003** | ** ** |
| United States                      | ** ** | **$**                        | **10,803,000** |   | $ | 14,051,000 |   | $ | 3,420,000 |   |
| Canada                             | ** ** | **33,264,000**               |           | 24,383,000 |   | 20,400,000 |   |
| Total (excluding interest  income) | ** ** | **$**                        | **44,067,000** |   | $ | 38,434,000 |   | $ | 23,820,000 |   |

 

 

**12.          FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

                Thecarrying amounts of cash and cash equivalents, certificates of deposit,accounts receivable, and accounts payable approximate fair value because of theshort maturity of these instruments.  Thecarrying value of long-term debt approximates fair value as the termsapproximate current market terms for similar debt instruments of comparablerisk and maturities.

 

                Thedifferences between the estimated fair values and carrying values of Barnwell’sfinancial instruments are not material.

 

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**13.          CONCENTRATIONS OF CREDIT RISK**

 

Barnwell’s oil and natural gas segment derived62% of its oil and natural gas revenues in fiscal 2005 from four individuallysignificant customers, ProGas Limited (25%), Glencoe Resources Limited (15%),Coral Energy Canada Inc. (11%), and Plains Marketing Canada, L.P. (11%).  At September 30, 2005, Barnwell had a totalof $3,370,000 in receivables from these four customers.  In fiscal 2004 Barnwell derived 53% of itsoil and natural gas revenues from three individually significantcustomers.  In fiscal 2003Barnwell derived 64% of its oil and natural gas revenues from four individuallysignificant customers.

 

Barnwell’scontract drilling subsidiary derived 63%, 70%, and 66% of its contract drillingrevenues in fiscal 2005, 2004, and 2003, respectively, pursuant to federal,State of Hawaii and county contracts.  AtSeptember 30, 2005, Barnwell had accounts receivables from the federal, Stateof Hawaii and county entities totaling approximately $621,000.  Barnwell has lien rights on wells drilled andpumps installed for federal, State of Hawaii, county and private entities.

 

Historically, Barnwell hasnot incurred significant credit related losses on its trade receivables, andmanagement does not believe significant credit risk related to these tradereceivables exists at September 30, 2005.

 

74

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**14.          SUPPLEMENTAL STATEMENTS OF CASHFLOWS INFORMATION**

 

The following details theeffect of changes in current assets and liabilities on the consolidatedstatements of cash flows, and presents supplemental cash flow information:

 
| ** **                                                         | ** ** | **Year ended September 30,** | ** **     |
|--------------------------------------------------------------------|------------|------------------------------|----------------|
| ** **                                                         | ** ** | **2005**                     | ** **     | **2004** | ** ** | **2003** | ** ** |
| Increase (decrease) from  changes in:                              |       |                         |           |   |   |   |   |
|                                                               |       |                         |           |   |   |   |   |
| Receivables                                                        | ** ** | **$**                        | **(2,450,000** | ) | $ | (2,439,000 | ) | $ | 548,000 |   |
| Other current assets                                               | ** ** | **151,000**                  |           | (756,000 | ) | 218,000 |   |
| Accounts payable                                                   | ** ** | **2,204,000**                |           | (353,000 | ) | (56,000 | ) |
| Accrued stock appreciation rights                                  | ** ** | **3,036,000**                |           | 680,000 |   | 226,000 |   |
| Accrued long-term and other compensation costs                     | ** ** | **1,745,000**                |           | 654,000 |   | 733,000 |   |
| Other current liabilities                                          | ** ** | **(1,211,000**               | )              | 857,000 |   | (190,000 | ) |
| Increase (decrease) from changes in current assets and liabilities | ** ** | **$**                        | **3,475,000**  |   | $ | (1,357,000 | ) | $ | 1,479,000 |   |
|                                                               | ** ** | ** **                   |           |   |   |   |   |
| Supplemental disclosure of  cash flow information:                 |       |                         |           |   |   |   |   |
|                                                               |       |                         |           |   |   |   |   |
| Cash paid during the year  for:                                    |       |                         |           |   |   |   |   |
| Interest (net of amounts capitalized)                              | ** ** | **$**                        | **616,000**    |   | $ | 448,000 |   | $ | 454,000 |   |
| Income taxes                                                       | ** ** | **$**                        | **5,293,000**  |   | $ | 4,495,000 |   | $ | 2,961,000 |   |

Supplemental Disclosure ofNon-cash Investing and Financing Activities:

In December 2003, Barnwellpurchased the premises and associated fee simple land interest of its corporateoffice in Honolulu, Hawaii, for $1,057,000, of which $883,000 was financed bylong-term debt; the debt was subsequently repaid in full in June 2004.

 

On October 1, 2002, net oiland natural gas properties and the asset retirement obligation increased$1,110,000 as a result of adoption of Statement of Financial AccountingStandards No. 143.

 

**15.          SUBSEQUENT EVENTS**

 

InOctober 2005, Barnwell declared a three-for-one stock split in the form of a stockdividend.  The new shares weredistributed on November 14, 2005 to all shareholders of record as of October28, 2005.  All information in this Form10-KSB has been adjusted to reflect the stock split for all periods presented.

 

In November 2005, Kaupulehu Makai Venture paidKaupulehu Developments $2,875,000 upon exercising the portion of itsdevelopment rights option due on December 31, 2005 of $2,656,000 and a portion,$219,000, of its development rights option due on December 31, 2006.

 

In December 2005, Barnwell declared a cashdividend of $0.025 per share payable January 4, 2006, to stockholders of recordon December 20, 2005.

 

Also in December 2005, Barnwell’s Board ofDirectors authorized the repurchase of up to 250,000 shares of Barnwell’scommon stock from the open market or in privately negotiated transactions.

 

75

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**16.          SUPPLEMENTARY OIL AND NATURAL GASINFORMATION (UNAUDITED)**

 

Thefollowing tables summarize information relative to Barnwell’s oil and naturalgas operations, which are substantially conducted in Canada.  Proved reserves are the estimated quantitiesof crude oil, condensate and natural gas which geological and engineering datademonstrate with reasonable certainty to be recoverable in future years fromknown reservoirs under existing economic and operating conditions.  Proved producing oil and natural gas reservesare reserves that can be expected to be recovered through existing wells withexisting equipment and operating methods. The estimated net interests in total proved and proved producingreserves are based upon subjective engineering judgments and may be affected bythe limitations inherent in such estimations. The process of estimating reserves is subject to continual revision asadditional information becomes available as a result of drilling, testing,reservoir studies and production history. There can be no assurance that such estimates will not be materiallyrevised in subsequent periods.

 

(A)          Oiland Natural Gas Reserves

 

The following table, basedon information prepared by independent petroleum engineers, Paddock Lindstrom& Associates Ltd., summarizes changes in the estimates of Barnwell’s netinterests in total proved reserves of crude oil and natural gas liquids and naturalgas (“MCF” means 1,000 cubic feet of natural gas) which are all in Canada:

 
| ** **                                        | ** ** | **OIL**       | ** ** | **GAS**        | ** ** |
|---------------------------------------------------|------------|---------------|------------|----------------|------------|
| ** **                                        | ** ** | **(Barrels)** | ** ** | **(MCF)**      | ** ** |
| Balance at September 30,  2002                    |       | 1,527,000     |       | 27,166,000     |       |
|                                              |       |          |       |           |       |
| Revisions of previous estimates                   |       | (35,000       | )          | (1,035,000     | )          |
| Extensions, discoveries and other additions       |       | 136,000       |       | 4,683,000      |       |
| Less production                                   |       | (227,000      | )          | (3,175,000     | )          |
| Balance at September 30,  2003                    |       | 1,401,000     |       | 27,639,000     |       |
| ** **                                        | ** ** | ** **    | ** ** | ** **     | ** ** |
| Revisions of previous estimates                   |       | (7,000        | )          | (1,129,000     | )          |
| Proved undeveloped extensions and other additions |       | 54,000        | *     | 1,571,000      | *     |
| Extensions, discoveries and other additions       |       | 115,000       |       | 2,127,000      |       |
| Less production                                   |       | (259,000      | )          | (3,383,000     | )          |
| Balance at September 30,  2004                    |       | 1,304,000     |       | 26,825,000     |       |
|                                              |       |          |       |           |       |
| Revisions of previous estimates                   |       | 76,000        |       | (1,236,000     | )          |
| Extensions, discoveries and other additions       |       | 179,000       |       | 3,266,000      |       |
| Less production                                   |       | (253,000      | )          | (3,621,000     | )          |
| **Balance at September 30, 2005**                 | ** ** | **1,306,000** | ** ** | **25,234,000** | ** ** |

----

*     Theseamounts represent proved undeveloped reserves at Dunvegan added by PaddockLindstrom & Associates, Ltd. based on a drilling program that commenced andwas completed in fiscal 2005.  As ofSeptember 30, 2005, 2003 and 2002, Paddock Lindstrom & Associates, Ltd.reported no proved undeveloped reserves at Dunvegan.

 

76

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| ** **                     | ** ** | **OIL**       | ** ** | **GAS**        | ** ** |
|--------------------------------|------------|---------------|------------|----------------|------------|
| ** **                     | ** ** | **(Barrels)** | ** ** | **(MCF)**      | ** ** |
| Proved producing reserves  at: |       |          |       |           |       |
| September 30, 2002             |       | 1,303,000     |       | 19,612,000     |       |
| September 30, 2003             |       | 1,262,000     |       | 21,463,000     |       |
| September 30, 2004             |       | 1,135,000     |       | 21,614,000     |       |
| **September 30, 2005**         | ** ** | **1,102,000** | ** ** | **21,842,000** | ** ** |

 

 

(B)           CapitalizedCosts Relating to Oil and Natural Gas Producing Activities

 
| ** **                                   | ** ** | **September 30,** | ** **      |
|----------------------------------------------|------------|-------------------|-----------------|
| ** **                                   | ** ** | **2005**          | ** **      | **2004** | ** ** | **2003** | ** ** |
| Proved properties                            | ** ** | **$**             | **117,995,000** |   | $ | 93,732,000 |   | $ | 77,913,000 |   |
| Unproved properties                          | ** ** | **8,110,000**     |            | 5,100,000 |   | 2,950,000 |   |
| Total capitalized costs                      | ** ** | **126,105,000**   |            | 98,832,000 |   | 80,863,000 |   |
| Accumulated  depletion and depreciation | ** ** | **66,705,000**    |            | 53,108,000 |   | 43,404,000 |   |
| Net capitalized costs                        | ** ** | **$**             | **59,400,000**  |   | $ | 45,724,000 |   | $ | 37,459,000 |   |

 

 

(C)                                Costs Incurredin Oil and Natural Gas Property Acquisition, Exploration and Development

 
| ** **                 | ** ** | **Year ended September 30,** | ** **     |
|----------------------------|------------|------------------------------|----------------|
| ** **                 | ** ** | **2005**                     | ** **     | **2004** | ** ** | **2003** | ** ** |
| Acquisition of properties: |       |                         |           |   |   |   |   |
| Unproved                   | ** ** | **$**                        | **2,561,000**  |   | $ | 1,882,000 |   | $ | 715,000 |   |
|                       |       |                         |           |   |   |   |   |
| Proved                     | ** ** | **$**                        | **—**     |   | $ | — |   | $ | 635,000 |   |
|                       |       |                         |           |   |   |   |   |
| Exploration costs          | ** ** | **$**                        | **3,448,000**  |   | $ | 3,460,000 |   | $ | 2,567,000 |   |
|                       |       |                         |           |   |   |   |   |
| Development costs          | ** ** | **$**                        | **12,220,000** |   | $ | 6,534,000 |   | $ | 7,142,000 |   |

 

 

(D)                               The Results ofOperations of Barnwell’s Oil and Natural Gas Producing Activities

 
| ** **                      | ** ** | **Year ended September 30,** | ** **     |
|---------------------------------|------------|------------------------------|----------------|
| ** **                      | ** ** | **2005**                     | ** **     | **2004** | ** ** | **2003** | ** ** |
| Gross revenues                  | ** ** | **$**                        | **43,931,000** |   | $ | 31,776,000 |   | $ | 26,714,000 |   |
| Royalties, net of credit        | ** ** | **11,207,000**               |           | 7,936,000 |   | 6,884,000 |   |
| Net revenues                    | ** ** | **32,724,000**               |           | 23,840,000 |   | 19,830,000 |   |
| Production costs                | ** ** | **6,899,000**                |           | 5,973,000 |   | 4,672,000 |   |
| Depletion and depreciation      | ** ** | **8,447,000**                |           | 6,423,000 |   | 4,026,000 |   |
| Pre-tax results of  operations* | ** ** | **17,378,000**               |           | 11,444,000 |   | 11,132,000 |   |
| Estimated income tax  expense   | ** ** | **8,341,000**                |           | 5,489,000 |   | 5,665,000 |   |
| Results of operations*          | ** ** | **$**                        | **9,037,000**  |   | $ | 5,955,000 |   | $ | 5,467,000 |   |

----

*                 Beforegeneral and administrative expenses, interest expense, and foreign exchangelosses.

 

77

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Revenues and productioncosts for fiscal 2004 and 2003 reflect reclassifications to conform to thepresentation for fiscal 2005.

 

(E)                                 StandardizedMeasure, Including Year-to-Year Changes Therein, of Estimated Discounted FutureNet Cash Flows

 

The following tables havebeen developed pursuant to procedures prescribed by SFAS No. 69, and utilizereserve and production data estimated by petroleum engineers.  The information may be useful for certaincomparison purposes but should not be solely relied upon in evaluating Barnwellor its performance.  Moreover, theprojections should not be construed as realistic estimates of future cashflows, nor should the standardized measure be viewed as representing currentvalue.

 

The estimated future cashflows are based on sales prices, costs, and statutory income tax rates inexistence at the dates of the projections. Material revisions to reserve estimates may occur in the future,development and production of the oil and natural gas reserves may not occur inthe periods assumed and actual prices realized and actual costs incurred areexpected to vary significantly from those used. Management does not rely upon this information in making investment andoperating decisions; rather, those decisions are based upon a wide range offactors, including estimates of probable reserves as well as proved reservesand price and cost assumptions different than those reflected herein.

 

Standardized Measure ofEstimated Discounted Future Net Cash Flows

 
| ** **                                                              | ** ** | **As of September 30,** | ** **      |
|-------------------------------------------------------------------------|------------|-------------------------|-----------------|
| ** **                                                              | ** ** | **2005**                | ** **      | **2004** | ** ** | **2003** | ** ** |
| Future cash inflows                                                     | ** ** | **$**                   | **299,383,000** |   | $ | 168,526,000 |   | $ | 141,809,000 |   |
|                                                                    |       |                    |            |   |   |   |   |
| Future production costs                                                 | ** ** | **(52,253,000**         | )               | (40,351,000 | ) | (37,439,000 | ) |
|                                                                    |       |                    |            |   |   |   |   |
| Future development costs                                                | ** ** | **(2,430,000**          | )               | (3,956,000 | ) | (1,231,000 | ) |
|                                                                    | ** ** | ** **              |            |   |   |   |   |
| Future net cash flows before income taxes                               | ** ** | **244,700,000**         |            | 124,219,000 |   | 103,139,000 |   |
|                                                                    |       |                    |            |   |   |   |   |
| Future income tax expenses                                              | ** ** | **(73,367,000**         | )               | (35,937,000 | ) | (32,604,000 | ) |
|                                                                    |       |                    |            |   |   |   |   |
| Future net cash flows                                                   | ** ** | **171,333,000**         |            | 88,282,000 |   | 70,535,000 |   |
|                                                                    |       |                    |            |   |   |   |   |
| 10% annual discount for timing of cash flows                            | ** ** | **(51,571,000**         | )               | (27,272,000 | ) | (20,998,000 | ) |
|                                                                    |       |                    |            |   |   |   |   |
| Standardized measure of estimated discounted future net cash flows | ** ** | **$**                   | **119,762,000** |   | $ | 61,010,000 |   | $ | 49,537,000 |   |

 

78

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Changes in the StandardizedMeasure of Estimated Discounted Future Net Cash Flows

 
| ** **                                                                       | ** ** | **Year ended September 30,** | ** **      |
|----------------------------------------------------------------------------------|------------|------------------------------|-----------------|
| ** **                                                                       | ** ** | **2005**                     | ** **      | **2004** | ** ** | **2003** | ** ** |
|                                                                             |       |                         |            |   |   |   |   |
| Beginning of year                                                                | ** ** | **$**                        | **61,010,000**  |   | $ | 49,537,000 |   | $ | 32,619,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Sales of oil and natural gas produced, net of production costs                   | ** ** | **(25,727,000**              | )               | (17,875,000 | ) | (15,107,000 | ) |
|                                                                             |       |                         |            |   |   |   |   |
| Net changes in prices and production costs, net of royalties and wellhead  taxes | ** ** | **68,770,000**               |            | 16,363,000 |   | 18,878,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Extensions and discoveries                                                       | ** ** | **29,958,000**               |            | 13,304,000 | *  | 12,673,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Purchases of properties                                                          | ** ** | **—**                   |            | — |   | 971,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Revisions of previous quantity estimates                                         | ** ** | **(4,881,000**               | )               | (2,294,000 | ) | 771,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Net change in Canadian dollar translation rate                                   | ** ** | **4,050,000**                |            | 2,529,000 |   | 4,441,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Changes in the timing of future production and other                             | ** ** | **100,000**                  |            | (1,899,000 | ) | (711,000 | ) |
|                                                                             |       |                         |            |   |   |   |   |
| Net change in income taxes                                                       | ** ** | **(20,159,000**              | )               | (3,956,000 | ) | (7,680,000 | ) |
|                                                                             |       |                         |            |   |   |   |   |
| Accretion of discount                                                            | ** ** | **6,641,000**                |            | 5,301,000 |   | 2,682,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| Net change                                                                       | ** ** | **58,752,000**               |            | 11,473,000 |   | 16,918,000 |   |
|                                                                             |       |                         |            |   |   |   |   |
| End of year                                                                      | ** ** | **$**                        | **119,762,000** |   | $ | 61,010,000 |   | $ | 49,537,000 |   |

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*     $3,260,000of this amount is derived from proved undeveloped reserves at Dunvegan added byPaddock Lindstrom & Associates, Ltd. based on a planned drilling program which commenced and was completed infiscal 2005.  As of September 30,2005 and 2003, Paddock Lindstrom & Associates, Ltd. reported no provedundeveloped reserves at Dunvegan.

 

 

Item8.                                                             Changes in andDisagreements with Accountants on Accounting and Financial Disclosure

 

                                                                                                None.

 

 

Item8A.**                                                  **Controlsand Procedures

As of September 30, 2005, anevaluation was carried out by Barnwell’s Chief Executive Officer and ChiefFinancial Officer of the effectiveness of Barnwell’s disclosure controls andprocedures.  Based on that evaluation,the Chief Executive Officer and Chief 

 

79

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Financial Officer haveconcluded that Barnwell’s disclosure controls and procedures are effective toensure that information required to be disclosed by Barnwell in reports that itfiles or submits under the Securities and Exchange Act of 1934 is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Act of 1934 and the rules thereunder.  There was no change in Barnwell’s internalcontrol over financial reporting during the quarter ended September 30, 2005,that materially affected, or is reasonably likely to materially affect,Barnwell’s internal control over financial reporting.

 

 

Item8B.**                                                    **OtherInformation 

None.

 

 

 

PART III

 

Item9.                                                             Directors,Executive Officers, Promoters and Control Persons, Compliance With Section16(a) of the Exchange Act 

 

                                                                                                The informationrequired is omitted pursuant to General Instruction E.3. of Form 10-KSB, since theRegistrant will file its definitive proxy statement for the 2006 Annual Meetingof Stockholders no later than 120 days after the close of its fiscal year endedSeptember 30, 2005, which proxy statement is incorporated herein by reference.

 

Barnwell adopted a Code ofEthics that applies to its chief executive officer and the chief financialofficer.  This Code of Ethics has beenposted on Barnwell’s website at www.brninc.com.

 

 

Item10.                                                       ExecutiveCompensation

 

                                                                                                The informationrequired is omitted pursuant to General Instruction E.3. of Form 10-KSB, sincethe Registrant will file its definitive proxy statement for the 2006 AnnualMeeting of Stockholders no later than 120 days after the close of its fiscalyear ended September 30, 2005, which proxy statement is incorporated herein byreference.

 

 

Item11.                                                       SecurityOwnership of Certain Beneficial Owners and Management

 

                                                                                                The informationrequired is omitted pursuant to General Instruction E.3. of Form 10-KSB, sincethe Registrant will file its definitive proxy statement for the 2006 AnnualMeeting of Stockholders no later than 120 days after the close of its fiscalyear ended September 30, 2005, which proxy statement is incorporated herein byreference.

 

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#### EquityCompensation Plan Information

 

Thefollowing table provides information about Barnwell’s common stock that may beissued upon exercise of options and rights under all of Barnwell’s existingequity compensation plans as of September 30, 2005 (split-adjusted):

 
| ** **                                                  | ** ** | **(a)**               | ** ** | **(b)**         | ** ** | **(c)**                      | ** ** |
|-------------------------------------------------------------|------------|-----------------------|------------|-----------------|------------|------------------------------|------------|
| ** **                                                  | ** ** | **Number of**         | ** ** | **Weighted-**   | ** ** | **Number of securities**     | ** ** |
| ** **                                                  | ** ** | **securities**        | ** ** | **average**     | ** ** | **remaining available**      | ** ** |
| ** **                                                  | ** ** | **to be issued**      | ** ** | **price of**    | ** ** | **for future issuance**      | ** ** |
| ** **                                                  | ** ** | **upon exercise**     | ** ** | **outstanding** | ** ** | **under equity**             | ** ** |
| ** **                                                  | ** ** | **of outstanding**    | ** ** | **options,**    | ** ** | **compensation plans**       | ** ** |
| ** **                                                  | ** ** | **options, warrants** | ** ** | **warrants**    | ** ** | **(excluding securities**    | ** ** |
| **Plan Category**                                           | ** ** | **and rights**        | ** ** | **and rights**  | ** ** | **reflected in column (a))** | ** ** |
| Equity compensation plans approved by security holders |       | 456,000               |       | $               | 5.32       |                         | 6,000      |   |
| Equity compensation plans not approved by security holders  |       | 390,000               |       | $               | 5.94       |                         | —     |   |
| Total                                                       |       | 846,000               |       | $               | 5.61       |                         | 6,000      |   |

 

Equity compensation plansnot approved by security holders is comprised of the following plan:

 

In June 1998, Barnwellgranted 180,000 stock options (split-adjusted) to an officer of Barnwell’s oiland gas segment under a non-qualified plan at a purchase price of $2.60 pershare (market price on date of grant, split-adjusted).  These options are fully vested and have stockappreciation rights that permit the holder to receive stock, cash or acombination thereof equal to the amount by which the fair market value, at thetime of exercise of the option, exceeds the option price.  The options expire in May 2008.

 

In December 2004, Barnwellgranted stock options to certain officers/directors of Barnwell to acquire210,000 shares of Barnwell’s common stock under a non-qualified plan at apurchase price of $8.80 per share (market price on date of grant,split-adjusted).  These options havestock appreciation rights that permit the holder to receive stock, cash or acombination thereof equal to the amount by which the fair market value, at thetime of exercise of the option, exceeds the option price.  These options vest annually over five yearscommencing one year from the date of grant and expire in December 2014.

 

 

Item12.                                                       CertainRelationships and Related Transactions

 

                                                                                                The informationrequired is omitted pursuant to General Instruction E.3. of Form 10-KSB, sincethe Registrant will file its definitive proxy statement for the 2006 AnnualMeeting of Stockholders no later than 120 days after the close of its fiscalyear ended September 30, 2005, which proxy statement is incorporated herein byreference.

 

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Item13.  Exhibits, List and Reports on Form8-K

(A)                              FinancialStatements

The following consolidated financial statements of Barnwell Industries,Inc. and its subsidiaries are included in Part II, Item 7:
| Report of Independent Registered Public Accounting  Firm — KPMG LLP                                                    |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
| Consolidated  Balance Sheets — September 30, 2005 and 2004                                                             |   |
| Consolidated Statements of Operations — for the three  years ended September 30, 2005                                  |   |
| Consolidated Statements of Cash Flows — for the three  years ended September 30, 2005                                  |   |
| Consolidated Statements of Stockholders’ Equity and  Comprehensive Income for the three years ended September 30, 2005 |   |
| Notes to Consolidated Financial Statements                                                                                  |   |

Scheduleshave been omitted because they were not applicable, not required, or theinformation is included in the consolidated financial statements or notesthereto.

(B)       Reports on Form 8-K

            None.

(C)       Exhibits
| No. 3.1  |   | Certificate of  Incorporation(1)                                                                                                                                       |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| No. 3.2  |   | Amended and  Restated By-Laws(1)                                                                                                                                       |
| No. 4.0  |   | Form of the  Registrant’s certificate of common stock, par value $.50 per share.(2)                                                                               |
| No. 10.1 |   | The Barnwell  Industries, Inc. Employees’ Pension Plan (restated as of  October 1, 1989).(3)                                                            |
| No. 10.2 |   | Phase I Makai  Development Agreement dated June 30, 1992, by and between Kaupulehu Makai  Venture and Kaupulehu Developments.(4)                                       |
| No. 10.3 |   | KD/KMV Agreement  dated June 30, 1992 by and between Kaupulehu Makai Venture and Kaupulehu  Developments.(4)                                                           |
| No. 10.4 |   | Barnwell  Industries, Inc.’s letter to Warren D. Steckley dated May 6, 1998, regarding  certain terms of employment.(5)                                           |
| No. 21   |   | List of  Subsidiaries                                                                                                                                                  |
| No. 31.1 |   | Section 302  Certification by Morton H. Kinzler, Chief Executive Officer                                                                                               |
| No. 31.2 |   | Section 302  Certification by Russell M. Gifford, Chief Financial Officer                                                                                              |
| No. 32   |   | Certification of  Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  Section 1350, as Adopted by Section 906 of the Sarbanes-Oxley Act of 2002 |

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(1)          Incorporated by reference to the Registrant’s Form S-8dated November 8, 1991.

(2)          Incorporated by reference to the registrationstatement on Form S-1 originally filed by the Registrant January 29, 1957and as amended February 15, 1957 and February 19, 1957.

(3)          Incorporated by reference to Form 10-K for the yearended September 30, 1989.

(4)          Incorporated by reference to Form 10-K for the yearended September 30, 1992.

(5)          Incorporated by reference to Form 10-KSB for the yearended September 30, 2000.

 

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Item14.                                                       PrincipalAccountant Fees and Services

 

                                                                                                The informationrequired is omitted pursuant to General Instruction E.3. of Form 10-KSB, sincethe Registrant will file its definitive proxy statement for the 2006 AnnualMeeting of Stockholders no later than 120 days after the close of its fiscalyear ended September 30, 2005, which proxy statement is incorporated herein byreference.

 

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SIGNATURES

 

Inaccordance with Section 13 or 15(d) of the Securities Act, the registrant hasthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
| BARNWELL INDUSTRIES, INC. |
|---------------------------|
| (Registrant)              |
|                      |
| /s/ Russell M. Gifford    |   |
| By:                       | Russell M. Gifford |
|                      | Chief Financial Officer, |
|                      | Executive Vice President, |
|                      | Treasurer and Secretary |
| Date: December 8, 2005    |
|                           |  |  |

 

Inaccordance with Exchange Act the report has been signed below by the followingpersons on behalf of the registrant and in the capacities and on the datesindicated.

 
| /s/ Morton H. Kinzler                |   |                               |
|--------------------------------------|--------|------------------------------------|
| MORTON H. KINZLER                    |   |                               |
| Chief Executive Officer  and         |   |                               |
| Chairman of the Board                |   |                               |
| Date: December 8, 2005               |   |                               |
|                                 |   |                               |
| /s/ Alexander C. Kinzler             |   | /s/ Russell M. Gifford             |
| ALEXANDER C. KINZLER                 |   | RUSSELL M. GIFFORD                 |
| President, Chief Operating  Officer, |   | Executive Vice President,          |
| General Counsel and  Director        |   | Chief Financial Officer, Treasurer |
| Date: December 8, 2005               |   | Secretary and Director             |
|                                 |   | Date: December 8, 2005             |
|                                 |   |                               |
| /s/ Martin Anderson                  |   | /s/ Alan D. Hunter                 |
| MARTIN ANDERSON, Director            |   | ALAN D. HUNTER, Director           |
| Date: December 8, 2005               |   | Date: December 8, 2005             |
|                                 |   |                               |
| /s/ Murray C. Gardner                |   | /s/ Terry Johnston                 |
| MURRAY C. GARDNER,  Director         |   | TERRY JOHNSTON, Director           |
| Date: December 8, 2005               |   | Date: December 9, 2005             |
|                                 |   |                               |   |
| /s/ Erik  Hazelhoff-Roelfzema        |   | /s/ Diane G. Kranz                 |
| ERIK HAZELHOFF-ROELFZEMA             |   | DIANE G. KRANZ, Director           |
| Director                             |   | Date: December 8, 2005             |
| Date: December 9, 2005               |   |                               |
|                                 |   | /s/ Kevin K. Takata                |
|                                 |   | KEVIN K. TAKATA, Director          |
|                                 |   | Date: December 9, 2005             |
|                                      |        |                                    |  |

 

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