** **

**U.S. SECURITIES AND EXCHANGECOMMISSIONWASHINGTON, D.C. 20549**

** **

**FORM 10-KSB**

 

| **ý** |   | **ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|------------------------------------------------------------------------------------------|

 

**Forthe fiscal year ended September 30, 2003**

 
| **o**                                           |   | **TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------------------------------------------------|--------|----------------------------------------------------------------------------------------------|
|                                            |
| **Commission  File Number 1-5103**              |
|                                            |
| **BARNWELL INDUSTRIES, INC.**                   |
| (Name of small  business issuer in its charter) |

 

| **Delaware**                                                            |   | **72-0496921**                        |
|-------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation or organization)         |   | (I.R.S. Employer  Identification No.) |
|                                                                    |   |                                  |
| **1100  Alakea Street, Suite 2900, Honolulu, Hawaii   96813-2833** |
| (Address of  principal executive offices)                               |   | (Zip  code)                           |
|                                                                    |   |                                  |
| **(808)  531-8400**                                                     |
| (Issuer’s  telephone number)                                       |
|                                                                    |   |                                  |
| Securities  registered under Section 12(b) of the Exchange Act:    |
|                                                                    |

 

| **Title  of each class**                                                            |   | **Name  of each exchange on which registered**  |
|-------------------------------------------------------------------------------------|--------|-------------------------------------------------|
| Common Stock, par value  $0.50 per share                                            |   | American Stock Exchange  Toronto Stock Exchange |
|                                                                                |   |                                            |
| Securities  registered under Section 12(g) of the Exchange Act: ** None** |

 

Check whether the issuer(1) filed all reports required to be filed by Section 13 or 15(d) of theExchange Act during the past 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes     ý     No     o

 

Check if there is nodisclosure of delinquent filers in response to Item 405 of Regulation S-B, andno disclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-KSB or any amendment to this Form10-KSB.               ý

 

Issuer’s revenues for thefiscal year ended September 30, 2003: **$23,680,000**

 

The aggregatemarket value of the voting stock held by non-affiliates (640,797 shares) of theRegistrant on December 23, 2003, based on the closing price of $32.00on that date on the American Stock Exchange, was $20,506,000.

 

As ofDecember 23, 2003 there were 1,314,510 shares of common stock, par value$0.50, outstanding.

 

DocumentsIncorporated by Reference

 

1.                         Proxystatement to be forwarded to shareholders on or about January 22, 2004 isincorporated by reference in Part III hereof.

 

TransitionalSmall 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 7A.                                  | Quantitative and Qualitative Disclosures About  Market Risk                                                            |   |
| Item 8.                                   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                  |   |
| Item 8A.                                  | Controls and Procedures                                                                                                |   |
| 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                                                                                 |   |

 

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PART I

 

Forward-Looking Statements

 

This Form 10-KSB, and thedocuments incorporated herein by reference, contain forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933, asamended, and Section 21E of the Securities Exchange Act of 1934, as amended,including various forecasts, projections of Barnwell Industries, Inc.’s(referred to herein together with its subsidiaries as “Barnwell”) futureperformance, statements of Barnwell’s plans and objectives and other similartypes of information.  Although Barnwellbelieves that its expectations are based on reasonable assumptions, it cannotassure that the expectations contained in such forward-looking statements willbe achieved.  Such statements involverisks, uncertainties and assumptions, including, but not limited to, thoserelating to the factors discussed below, in other portions of this Form 10-KSB,in the Notes to Consolidated Financial Statements, and in other documents filedby Barnwell with the Securities and Exchange Commission from time to time,which could cause actual results to differ materially from those contained insuch statements.  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 andnatural gas operations are affected by domestic and international political,legislative, regulatory and legal actions. Such actions may include changes in the policies of the Organization ofPetroleum Exporting Countries or other developments involving or affectingoil-producing countries, including military conflict, embargoes, internalinstability or actions or reactions of the government of the United States inanticipation of or in response to such developments.  Domestic and international economic conditions, such asrecessionary trends, inflation, interest costs, monetary exchange rates andlabor costs, as well as changes in the availability and market prices of crudeoil, natural gas and other petroleum products, may also have a significanteffect on Barnwell’s oil and natural gas operations.  While Barnwell maintains reserves for anticipated liabilities andcarries various levels of insurance, Barnwell could be affected by civil,criminal, regulatory or administrative actions, claims or proceedings.  In addition, climate and weather cansignificantly affect Barnwell in several of its operations.  Barnwell’s oil and gas operations are alsoaffected by political developments and laws and regulations, particularly inthe United States and Canada, such as restrictions on production, restrictionson imports and exports, the maintenance of specified reserves, tax increasesand retroactive tax claims, expropriation of property, cancellation of contractrights, environmental protection controls, environmental compliancerequirements and laws pertaining to workers’ health and safety.  Costs of compliance with environmental lawsare ingrained in Barnwell’s expenses and not distinguished from other costs andexpenses.

 

Barnwell’s landinvestment business segment is affected by the condition of Hawaii’s realestate market.  The Hawaii real estatemarket is affected by Hawaii’s economy in general and Hawaii’s tourism industryin particular.  Any future cash flowsfrom 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 contractdrilling operations, which are located in Hawaii, are also indirectly affectedby the factors discussed in the preceding paragraph.  Barnwell’s contract drilling operations are

 

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materially dependent uponlevels of land development activity in Hawaii. Such activity levels are affected by both short-term and long-termtrends in Hawaii’s economy.  In prioryears, Hawaii’s economy has experienced very slow growth, and as events duringprevious years have demonstrated, any prolonged reduction or lack of growth inHawaii’s economy will depress the demand for Barnwell’s contract drillingservices.  Such a decline could have amaterial adverse effect on Barnwell’s contract drilling revenues andprofitability.

 

Item 1.            Description of Business

 

(a)       General Development of Business

 

Barnwell was incorporatedin Delaware in 1956.  During its lastthree fiscal years, Barnwell was engaged in 1) oil and natural gas exploration,development, production and sales primarily in Canada (oil and natural gassegment), 2) investment in leasehold land in Hawaii (land investment segment),and 3) water and exploratory well drilling, contract labor servicing forgeothermal well drilling and workovers, and water pumping system installationand repair in Hawaii (contract drilling segment).

 

Barnwell’s oil andnatural gas activities comprise its largest business segment.  Approximately 82% of Barnwell’s revenues forthe fiscal year ended September 30, 2003 were attributable to its oiland natural gas activities.  Barnwell’scontract drilling activities accounted for 9% of Barnwell’s revenues in fiscal2003, land investment activities comprised 5% of fiscal 2003 revenues, and gasprocessing and other revenues comprised 4% of fiscal 2003 revenues.  Approximately 98% of Barnwell’s capitalexpenditures for the fiscal year ended September 30, 2003 wereattributable to oil and natural gas activities and 2% were applicable to otheractivities.

 

(i)            Oil and Natural Gas Activities. Barnwell’swholly-owned subsidiary, Barnwell of Canada, Limited, is involved in theacquisition, exploration and development of oil and natural gas properties,principally in Alberta, Canada. Barnwell of Canada, Limited initiates and participates in exploratoryand developmental operations for oil and natural gas on property in which ithas an interest, and evaluates proposals by third parties with regard toparticipation in such exploratory and developmental operations elsewhere.  Barnwell’s oil and natural gas segmentreceived 64% of its oil and natural gas revenues in fiscal 2003 from fourindividually significant customers, ProGas Limited, Coral Energy Canada Inc.,Plains Marketing Canada, L.P., and Petrogas Marketing Ltd.

 

(ii)           Contract Drilling. Barnwell’swholly-owned subsidiary, Water Resources International, Inc., drills water,geothermal and exploratory wells and installs and repairs water pumping systemsin Hawaii.  Water ResourcesInternational, Inc. owns and operates four rotary drill rigs, pump installationand service equipment, leases one rotary drill/workover rig to an oil company,and maintains drilling materials and pump inventory in Hawaii.  Water Resources International, Inc.’scontracts are usually fixed price per lineal foot drilled or day rate contractsthat are either negotiated with private entities or are obtained throughcompetitive bidding with various private entities or local, state and federalagencies.  Barnwell’s contract drillingsubsidiary derived 66%, 70% and 49% of its contract drilling revenues in fiscal2003, 2002 and 2001, respectively, pursuant to Federal, State of Hawaii andcounty contracts.

 

(iii)          Land Investment. Barnwell ownsa 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

 

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Kona District of theIsland of Hawaii.  Between 1986 and1989, Kaupulehu Developments obtained the state and county zoning changesnecessary to permit development of the Four Seasons Resort Hualalai at HistoricKa’upulehu and Hualalai Golf Club, which opened in 1996, a second golf course,and single and multiple family residential units.  These projects were developed on leasehold land acquired fromKaupulehu Developments by Kaupulehu Makai Venture, an unrelated entity that isan affiliate of Kajima Corporation of Japan. Kaupulehu Developments later obtained the state and county zoningchanges necessary to permit development of single and multi-family residentialunits, a golf course and a limited commercial area on approximately 870leasehold acres located adjacent to and north of the Four Seasons ResortHualalai at Historic Ka’upulehu.

 

Kaupulehu Developmentscurrently owns the leasehold rights in these approximately 870 acres andleasehold rights in another approximately 1,000 acres of conservation-zonedland, located adjacent to and contiguous with the 870 acres.  Kaupulehu Developments also owns developmentrights in residentially zoned leasehold land adjacent to and interspersedwithin the Hualalai Golf Club golf course and the second golf course currentlyunder construction.  The developmentrights are under option to Kaupulehu Makai Venture, the owner of the FourSeasons Resort Hualalai at Historic Ka’upulehu.

 

(b)           Financial Information aboutIndustry Segments

 

Revenues of each industrysegment for the fiscal years ended September 30, 2003, 2002 and 2001 aresummarized as follows (all revenues were from unaffiliated customers with nointersegment sales or transfers):

 
|                     |   | **2003**       |           | **2002**   |    | **2001**   |   |
|--------------------------|--------|----------------|----------------|------------|---------|------------|--------|
| Oil  and natural gas     |   | **$**          | **19,350,000** | ** ** | **82**  | **%**      | $      | 11,320,000 |   | 71 | % | $ | 19,870,000 |   | 82 | % |
| Contract  drilling       |   | **2,050,000**  | ** **     | **9**      | **%**   | 3,480,000  |   | 22 | % | 3,290,000 |   | 14 | % |
| Land  investment         |   | **1,220,000**  | ** **     | **5**      | **%**   | 220,000    |   | 1 | % | — |   | — |   |
| Other                    |   | **720,000**    | ** **     | **3**      | **%**   | 598,000    |   | 4 | % | 601,000 |   | 3 | % |
| Revenues  from  segments |   | **23,340,000** | ** **     | **99**     | **%**   | 15,618,000 |   | 98 | % | 23,761,000 |   | 99 | % |
| Interest  income         |   | **340,000**    | ** **     | **1**      | **%**   | 262,000    |   | 2 | % | 329,000 |   | 1 | % |
| Total  revenues          |   | **$**          | **23,680,000** | ** ** | **100** | **%**      | $      | 15,880,000 |   | 100 | % | $ | 24,090,000 |   | 100 | % |

 

For further discussionsee Note 12 (SEGMENT AND GEOGRAPHIC INFORMATION) and Note 14 (CONCENTRATIONS OFCREDIT RISK) of “Notes to Consolidated Financial Statements” in Item 7.

 

(c)           Narrative Description of Business

 

See the table above inItem 1(b) detailing revenue of each industry segment and description of eachindustry segment of Barnwell’s business under Item 2.

 

As ofSeptember 30, 2003, Barnwell employed 37 employees, 35 of which are on afull-time basis.  Ten are employed incontract drilling activities, 16 are employed in oil and natural gasactivities, and 11 are members of the corporate and administrative staff.

 

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

 

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(d)                                 Financial Information about Foreignand Domestic Operations and Export Sales

 

Revenues and long-livedassets by geographic area for the three years ended and as ofSeptember 30, 2003, 2002 and 2001 are set forth in Note 12 (SEGMENT ANDGEOGRAPHIC INFORMATION) of “Notes to Consolidated Financial Statements” in Item7.

 

Item2.            Description of Property

 

OIL AND NATURAL GAS OPERATIONS

 

General

 

Barnwell’s investments inoil and natural gas properties consist of investments in Canada, principally inthe Province of Alberta, with minor holdings in 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 third partiesfor participation in other exploratory and developmental opportunities.  All exploratory and developmental operationsare overseen by Barnwell’s Calgary, Alberta staff along with independentconsultants as necessary.  In fiscal2003, Barnwell participated in exploratory and developmental operations in theCanadian Provinces of Alberta and Saskatchewan, although Barnwell does notlimit its consideration of exploratory and developmental operations to theseareas.

 

Barnwell’s producingnatural gas properties are located principally in Alberta.  A small number of producing properties arelocated in British Columbia and Saskatchewan. The Province of Alberta determines its royalty share of natural gas byusing a reference price that averages all natural gas sales in Alberta.  Royalty rates are calculated on a slidingscale basis, increasing as prices increase. Additionally, Barnwell pays gross overriding royalties on a portion ofits natural gas sales to other parties.

 

Infiscal 2003, 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%.  The weighted average rate ofroyalties paid on all of Barnwell’s natural gas was approximately 28% in fiscal2003, versus approximately 26% in fiscal 2002. The increase in the weighted average royalty rate was primarily due tohigher average annual gas prices in fiscal 2003, as compared to fiscal 2002.

 

6

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In fiscal 2003, virtually all of Barnwell’s oilproduction was from properties located in Alberta.  The Province of Alberta determines its royalty share of oil byusing a reference price that averages all oil sales in Alberta.  Royalty rates are calculated on a slidingscale basis, increasing as prices increase. Additionally, Barnwell pays gross overriding royalties and leaseholdroyalties on a portion of its oil sales to parties other than the Province ofAlberta.  In fiscal 2003 and 2002,the weighted average royalty rate paid on oil was approximately 24% and  25%, respectively.  The decrease in the weighted average royalty rate on oil wasprimarily due to lower royalty rates on new oil production.

 

Prices of natural gas aretypically higher in the winter than at other times due to demand forheating.  Prices of oil are also subjectto seasonal fluctuations, but to a lesser degree.  Unit sales of oil and natural gas are based on the quantityproduced from the properties by the operator based on sound petroleum practicesand applicable rules and regulations. During periods of low demand for natural gas, the operator of theDunvegan property may re-inject natural gas into underground storage facilitiesfor delivery at a future date.

 

Well Drilling Activities

 

Duringfiscal 2003, Barnwell participated in the drilling of 52 gross developmentwells and 13 gross exploratory wells, of which management believes 53should be capable of production. Barnwell also participated in the recompletion of ten gross wells.  The most significant drilling operationstook place in the Bonanza, Leduc, Dunvegan, Progress, Pouce Coupe South andBashaw areas.  New drilling operationstook place in the Armada, Bashaw, Bonanza, Doris, Pine Creek, and Pouce CoupeSouth 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, 2003, 2002 and 2001 in which Barnwellparticipated:

 
|       |   | **Productive  Oil Wells** |       | **Productive  Gas Wells** |       | **Total  Productive  Wells** |       | **Dry Holes** |       | **Total  Wells** |       |
|------------|--------|---------------------------|------------|---------------------------|------------|------------------------------|------------|---------------|------------|------------------|------------|
|       |   | **Exp.**                  |       | **Dev.**                  |       | **Exp.**                     |       | **Dev.**      |       | **Exp.**         |       | **Dev.** |   | **Exp.** |   | **Dev.** |   | **Exp.** |   | **Dev.** |   |
| **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** | ** ** |
|       |   |                      |       |                      |       |                         |       |          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| **2002**   |   |                      |       |                      |       |                         |       |          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Gross*     |   | 3.0                       |       | 3.0                       |       | 1.0                          |       | 5.0           |       | 4.0              |       | 8.0 |   | 1.0 |   | 3.0 |   | 5.0 |   | 11.0 |   |
| Net*       |   | 0.6                       |       | 1.1                       |       | 0.2                          |       | 2.3           |       | 0.8              |       | 3.4 |   | 0.1 |   | 1.1 |   | 0.9 |   | 4.5 |   |
|       |   |                      |       |                      |       |                         |       |          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| **2001**   |   |                      |       |                      |       |                         |       |          |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Gross*     |   | —                    |       | 11.0                      |       | 1.0                          |       | 11.0          |       | 1.0              |       | 22.0 |   | 3.0 |   | 4.0 |   | 4.0 |   | 26.0 |   |
| Net*       |   | —                    |       | 1.5                       |       | 0.2                          |       | 1.5           |       | 0.2              |       | 3.0 |   | 1.2 |   | 1.4 |   | 1.4 |   | 4.4 |   |

 

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*                The term “Gross” refers to the totalnumber of wells in which Barnwell owns an interest, and “Net” refers toBarnwell’s aggregate interest therein. For example, a 50% interest in a well represents 1 gross well, but 0.5net well.  The gross figure includesinterests owned of record by Barnwell and, in addition, the portion owned byothers.

 

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The Dunvegan Unit, inwhich Barnwell holds an 8.9% interest, is Barnwell’s principal oil and naturalgas property and is located in Alberta, Canada.  The Dunvegan Unit has 130 natural gas wells producing from 130well zones.  In fiscal 2003, Barnwellparticipated in the drilling of twelve gross (1.1 net) development gas wellsand recompletion of 5 gas wells (0.4 net wells) in the Dunvegan area.  While these new wells did not add toBarnwell’s proved reserves, they are expected to increase the rate of futureproduction from the area.  Total capitalexpenditures at Dunvegan were $1,223,000 in fiscal 2003 as compared to $325,000and $696,000 in fiscal 2002 and 2001, respectively.

 

Capital expenditures totaled $1,552,000 in the Bonanzaarea, a new area for Barnwell, where three gross wells (1.4 net wells) weredrilled in fiscal 2003.  All three wellswere tied in and producing at September 30, 2003.

 

In the Leduc area,Barnwell drilled three gross successful wells (0.8 net wells) and acquired onegross (0.3 net) well, all of which were producing at September 30,2003.  Capital expenditures in the Leducarea totaled $1,483,000 in fiscal 2003.

 

In the Progress area,where capital expenditures totaled $1,069,000 in fiscal 2003, one unsuccessfulwell was drilled and Barnwell made significant investments in acquiring leasesand seismic data.

 

In the Pouce Coupe Southarea, where capital expenditures totaled $692,000 in fiscal 2003, Barnwelldrilled two successful gross wells (one net well), one of which was producingas of September 30, 2003; the other is expected to be placed in productionin early fiscal 2004.

 

Capital expenditurestotaled $409,000 in fiscal 2003 in the Bashaw area, a new area.  Barnwell participated in drilling one gross(0.4 net) well, a successful gas well which began producing in March 2003,and one gross (0.4 net) well which was dry and abandoned.

 

Barnwell’saverage net interest in wells drilled in fiscal 2003 was approximately 23%, ascompared to 34% in fiscal 2002 and 19% in fiscal 2001.  The decrease in fiscal 2003, as compared tofiscal 2002, was due principally to drilling programs at Dunvegan, 12 gross(1.1 net) wells, and Hatton, Saskatchewan, 13 gross (2.0 net) wells, for atotal of 25 gross (3.1 net) wells or an average net well interest of 12.4% forthese two drilling programs.  Theaverage net interest in all other wells drilled in fiscal 2003 was 29%.  Of the wells drilled in fiscal 2003, 32 wereon prospects developed by Barnwell.

 

Oil and Natural Gas Production

 

The following tablesummarizes (a) Barnwell’s net unit production for the last three fiscal years,based on sales of crude oil, natural gas, condensate and other natural gasliquids, from all wells in which Barnwell has or had an interest, and (b) theaverage sales prices and average production costs for such production duringthe same periods.  Production amountsreported are net of royalties and the Alberta Royalty Tax Credit.  Barnwell’s net production in fiscal 2003,2002 and 2001 was derived primarily from the Province of Alberta.  All dollar amounts in this table are in U.S.dollars.

 

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|                                                 |   | **Year Ended  September 30,** |      |
|------------------------------------------------------|--------|------------------------------------|-----------|
|                                                 |   | **2003**                           |      | **2002** |   | **2001** |   |
| Annual  net production:                              |   |                               |      |   |   |   |   |
| Natural  gas liquids (BBLS)*                         |   | **85,000**                         |      | 94,000 |   | 98,000 |   |
| Oil  (BBLS)*                                         |   | **142,000**                        |      | 148,000 |   | 174,000 |   |
| Natural  gas (MCF)*                                  |   | **3,175,000**                      |      | 3,277,000 |   | 3,269,000 |   |
|                                                 |   |                               |      |   |   |   |   |
| Annual  average sale price per unit of production:   |   |                               |      |   |   |   |   |
| BBL  of liquids**                                    |   | **$**                              | **21.50** |   | $ | 12.46 |   | $ | 22.60 |   |
| BBL  of oil**                                        |   | **$**                              | **27.69** |   | $ | 21.28 |   | $ | 25.44 |   |
| MCF  of natural gas**                                |   | **$**                              | **4.27**  |   | $ | 2.12 |   | $ | 4.02 |   |
|                                                 |   |                               |      |   |   |   |   |
| Annual  average production cost per MCFE produced*** |   | **$**                              | **0.93**  |   | $ | 0.66 |   | $ | 0.72 |   |
|                                                 |   |                               |      |   |   |   |   |
| Annual  average depletion cost per MCFE produced***  |   | **$**                              | **0.90**  |   | $ | 0.71 |   | $ | 0.70 |   |

 

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

**                                  Calculatedon revenues 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.

 

Infiscal 2003, approximately 71%, 20% and 9% of Barnwell’s oil and natural gasrevenues were from the sale of natural gas, the sale of oil and the sale ofnatural gas liquids, respectively.

 

Infiscal 2003, Barnwell’s net production after royalties for natural gas averaged8,700 MCF per day, a decrease of 3% from 8,980 MCF per day in fiscal 2002.  Gross natural gas production remainedconstant, while, on a net basis, natural gas production decreased due to anincrease in royalty rates attributable to increased natural gas prices.  Dunvegan contributed approximately 43% ofBarnwell’s net natural gas production in fiscal 2003.

 

Barnwell’smajor oil producing properties are the Red Earth, Chauvin and Manyberries areasin Canada.  In fiscal 2003, netproduction after royalties for oil averaged 390 barrels per day, a decrease of3% from 400 barrels per day in fiscal 2002.  This decrease was due to natural declines in production fromcertain of Barnwell’s older oil properties, which was partially offset by newproduction at Wizard Lake, Bonanza and Boundary Lake.

 

Infiscal 2003, net production after royalties for natural gas liquids averaged230 barrels per day, a decrease of 12% from 260 barrels per day in fiscal2002.  This decrease was due primarilyto a fire in early October 2002 at a Dunvegan gas plant that preventedstripping of natural gas liquids from the natural gas, resulting in anapproximately 6,000 barrel decline in liquids net production in fiscal2003.  Barnwell did, however, receive ahigher price for its natural gas than it would have if the liquids had

 

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been removed, thereby mitigating some of the impact ofthe liquids production decline.  Thedamage to the gas plant was repaired and the plant resumed operations in lateDecember 2002.

 

Theaverage production cost per MCFE was $0.93 for fiscal 2003, a 41% increase from$0.66 for fiscal 2002.  The increase isdue partly to an oil and natural gas operating expense credit for overchargesof operating expenses for fiscal years 1998 through 2001 from the operator ofthe Dunvegan property totaling $470,000 which was received in fiscal 2002.  The increase was also attributable to higherwell repair and maintenance, electricity, fuel, insurance, and generalmaintenance costs.

 

Infiscal 2002, approximately 62%, 28% and 10% of Barnwell’s oil and natural gasrevenues were from the sale of natural gas, the sale of oil and the sale ofnatural gas liquids, respectively.  Infiscal 2001, approximately 66%, 23% and 11% of Barnwell’s oil and natural gasrevenues were from the sale of natural gas, the sale of oil and the sale ofnatural gas liquids, respectively.

 

 In fiscal 2002, Barnwell’s net productionafter royalties for natural gas averaged 8,980 MCF per day, comparable to 8,950MCF per day in fiscal 2001.  Grossnatural gas production declined 5% as natural declines in gas production atBarnwell’s more mature properties and the watering out of wells at Sunnynookand Pembina were only partially offset by recent development and new productionfrom the Progress and Pollockville areas. However, natural gas production was relatively unchanged on a net basisdue to a decrease in royalties attributable to decreased natural gasprices.  Dunvegan contributedapproximately 47% of Barnwell’s net natural gas production in fiscal 2002.

 

Infiscal 2002, net production after royalties for oil averaged 400 barrels perday, a decrease of 17% from 480 barrels per day in fiscal 2001.  This decrease was due to natural declines inproduction from certain of Barnwell’s older oil properties.

 

Infiscal 2002, net production after royalties for natural gas liquids averaged260 barrels per day, a decrease of 4% from 270 barrels per day in fiscal2001.  This decrease was due to declinesin production from the Dunvegan and Pembina areas.

 

The following table sets forth the gross and netnumber of productive wells Barnwell has an interest in as of September 30,2003.

 

Productive Wells

 
|              |   | **Productive  Wells*** |   |
|-------------------|--------|------------------------|--------|
|              |   | **Gross****            |   | **Net**** |   |
| **Location**      |   | **Oil**                |   | **Gas** |   | **Oil** |   | **Gas** |   |
| **Canada**        |   |                   |   |   |   |   |   |   |   |
| Alberta           |   | 175                    |   | 470 |   | 29.0 |   | 51.9 |   |
| Saskatchewan      |   | 2                      |   | 26 |   | 0.2 |   | 4.3 |   |
| British  Columbia |   | —                 |   | 1 |   | — |   | 0.5 |   |
| Total             |   | 177                    |   | 497 |   | 29.2 |   | 56.7 |   |

 

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*                                         Seventy-twogross natural gas wells have dual or multiple completions and six gross oilwells have dual completions.

**                                  Pleasesee note (2) on the following table.

 

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Developed Acreage and Undeveloped Acreage

 

The following table setsforth certain information with respect to oil and natural gas properties ofBarnwell as of September 30, 2003:

 
|              |   | **Developed  Acreage(1)** |   | **Undeveloped  Acreage(1)** |   | **Developed  and  Undeveloped  Acreage(1)** |   |
|-------------------|--------|---------------------------|--------|-----------------------------|--------|---------------------------------------------|--------|
| **Location**      |   | **Gross(2)**              |   | **Net(2)**                  |   | **Gross(2)**                                |   | **Net(2)** |   | **Gross(2)** |   | **Net(2)** |   |
| **Canada**        |   |                      |   |                        |   |                                        |   |   |   |   |   |   |   |
| Alberta           |   | 250,832                   |   | 35,670                      |   | 152,831                                     |   | 39,717 |   | 403,663 |   | 75,387 |   |
| British  Columbia |   | 1,753                     |   | 555                         |   | 4,401                                       |   | 1,653 |   | 6,154 |   | 2,208 |   |
| Saskatchewan      |   | 3,336                     |   | 530                         |   | —                                      |   | — |   | 3,336 |   | 530 |   |
| Total             |   | 255,921                   |   | 36,755                      |   | 157,232                                     |   | 41,370 |   | 413,153 |   | 78,125 |   |

 

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(1)                                  “DevelopedAcreage” includes the acres covered by leases upon which there are one or moreproducing wells.  “Undeveloped Acreage”includes acres covered by leases upon which there are no producing wells andwhich are maintained in effect by the payment of delay rentals or thecommencement of drilling thereon.

 

(2)                                  “Gross”also refers to the total number of acres in which Barnwell owns an interest,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 figures include interests owned of record byBarnwell and, in addition, the portion owned by others.

 

Barnwell’sleasehold interests in its undeveloped acreage expire over the next five fiscalyears, if not developed, as follows: 18% expire during fiscal 2004; 5% expireduring fiscal 2005; 11% expire during fiscal 2006; 15% expire during fiscal2007 and 51% expire during fiscal 2008. There can be no assurance that Barnwell will be successful in renewingits leasehold interests in the event of expiration.

 

Barnwell’s undevelopedacreage includes major concentrations in Alberta, at Thornbury (5,842 netacres), Swalwell (4,045 net acres), Red Earth (2,411 net acres), Pouce CoupeSouth (1,920 net acres), Gere (1,676 net acres), Bonanza (1,520 net acres),Foley Lake (1,200 net acres), and Progress (1,120 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 developed producing reservesand proved developed reserves of crude oil (including condensate and naturalgas liquids) and natural gas as of September 30, 2003, 2002 and 2001 onall properties in which Barnwell has an interest.  These reserves are before deductions for indebtedness secured bythe properties and are based on constant dollars.  No estimates of total proved net oil or natural gas reserves havebeen filed with or included in reports to any federal authority or agency sinceOctober 1, 2001.

 

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Proved ProducingReserves

 
|                                                                      |   | **September 30,** |   |
|---------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                      |   | **2003**               |   | **2002** |   | **2001** |   |
| Oil  – barrels (BBLS) (including condensate and natural gas liquids) |   | **1,262,000**          |   | 1,303,000 |   | 1,327,000 |   |
| Natural  gas – thousand cubic feet (MCF)                             |   | **21,463,000**         |   | 19,612,000 |   | 21,847,000 |   |

 

Total Proved Reserves

  (IncludesProved Producing Reserves)

 
|                                                                      |   | **September 30,** |   |
|---------------------------------------------------------------------------|--------|------------------------|--------|
|                                                                      |   | **2003**               |   | **2002** |   | **2001** |   |
| Oil  – barrels (BBLS) (including condensate and natural gas liquids) |   | **1,401,000**          |   | 1,527,000 |   | 1,536,000 |   |
| Natural  gas – thousand cubic feet (MCF)                             |   | **27,639,000**         |   | 27,166,000 |   | 28,371,000 |   |

 

As of September 30,2003, essentially all of Barnwell’s proved producing and total proved reserveswere located in the Province of Alberta, with minor volumes located in theProvinces of Saskatchewan and British Columbia.

 

During fiscal 2003, Barnwell’s total net provedreserves, including proved producing reserves, of oil, condensate and naturalgas liquids decreased by 126,000 barrels, and total net proved reserves ofnatural gas increased by 473,000 MCF. The change in oil, condensate and natural gas liquids reserves was thenet result of production during the year of 227,000 barrels, the addition of136,000 barrels from the drilling of productive wells, and the independentengineer’s 35,000 barrel downward revision of Barnwell’s oil reserves.  The change in natural gas reserves was thenet result of production during the year of 3,175,000 MCF, the addition of4,683,000 MCF from the drilling of productive natural gas wells, and the independentengineer’s 1,035,000 MCF downward revision of Barnwell’s natural gas reserves.

 

Barnwell’s workinginterest in the Dunvegan area accounted for approximately 58% and 66% of itstotal proved natural gas reserves at September 30, 2003 and 2002,respectively, and approximately 40% and 41% of total proved oil and condensatereserves at September 30, 2003 and 2002, respectively.

 

Thefollowing table sets forth Barnwell’s oil and natural gas reserves atSeptember 30, 2003, by property name, based on information prepared byPaddock Lindstrom & Associates Ltd. Gross reserves are before the deduction of royalties; net reserves areafter the deduction of royalties net of the Alberta Royalty Tax Credit.  This table is based on constant dollarswhere reserve estimates are based on sales prices, costs and statutory taxrates in existence at the date of the projection.  Oil, which includes natural gas liquids, is shown in thousands ofbarrels (“MBBLS”) and natural gas is shown in millions of cubic feet (“MMCF”).

 

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OIL AND NATURAL GAS RESERVES AT SEPTEMBER 30,2003

 

 
|                             |   | **Total  Proved Producing** |   | **Total  Proved** |   |
|----------------------------------|--------|-----------------------------|--------|-------------------|--------|
|                             |   | **Oil &  NGL’s**   |   | **Gas**           |   | **Oil &  NGL’s** |   | **Gas** |   |
| **Property Name**                |   | **Gross**                   |   | **Net**           |   | **Gross** |   | **Net** |   | **Gross** |   | **Net** |   | **Gross** |   | **Net** |   |
|                             |   | **(MBBLS)**                 |   | **(MMCF)**        |   | **(MBBLS)** |   | **(MMCF)** |   |
|                             |   |                        |   |              |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Dunvegan                         |   | 663                         |   | 479               |   | 16,980 |   | 13,598 |   | 784 |   | 559 |   | 20,171 |   | 16,095 |   |
| Red  Earth                       |   | 446                         |   | 393               |   | 30 |   | 30 |   | 469 |   | 412 |   | 30 |   | 30 |   |
| Pouce  Coupe                     |   | 14                          |   | 11                |   | 1,537 |   | 1,221 |   | 18 |   | 14 |   | 2,578 |   | 2,030 |   |
| Thornbury                        |   | —                      |   | —            |   | 1,249 |   | 1,041 |   | — |   | — |   | 1,496 |   | 1,254 |   |
| Hillsdown                        |   | 18                          |   | 13                |   | 738 |   | 589 |   | 36 |   | 28 |   | 904 |   | 724 |   |
| Medicine  River                  |   | 58                          |   | 42                |   | 1,192 |   | 750 |   | 58 |   | 42 |   | 1,192 |   | 750 |   |
| Armada                           |   | —                      |   | —            |   | — |   | — |   | — |   | — |   | 48 |   | 45 |   |
| Barrhead                         |   | —                      |   | —            |   | 237 |   | 268 |   | — |   | — |   | 237 |   | 268 |   |
| Bashaw                           |   | 2                           |   | 1                 |   | 79 |   | 52 |   | 2 |   | 1 |   | 79 |   | 52 |   |
| Belloy                           |   | —                      |   | —            |   | 102 |   | 78 |   | — |   | — |   | 153 |   | 119 |   |
| Bonanza                          |   | 53                          |   | 42                |   | 813 |   | 624 |   | 53 |   | 42 |   | 813 |   | 624 |   |
| Charlotte  Lake                  |   | —                      |   | —            |   | 302 |   | 275 |   | — |   | — |   | 703 |   | 619 |   |
| Chauvin                          |   | 153                         |   | 135               |   | 15 |   | 13 |   | 153 |   | 135 |   | 15 |   | 13 |   |
| Clive                            |   | —                      |   | —            |   | 7 |   | 7 |   | — |   | — |   | 7 |   | 7 |   |
| Coyote                           |   | —                      |   | —            |   | — |   | 11 |   | — |   | — |   | — |   | 11 |   |
| Doris                            |   | —                      |   | —            |   | — |   | — |   | — |   | — |   | 442 |   | 340 |   |
| Drumheller                       |   | —                      |   | —            |   | 59 |   | 49 |   | — |   | — |   | 59 |   | 49 |   |
| Faith  South                     |   | —                      |   | —            |   | — |   | — |   | — |   | — |   | 1,011 |   | 792 |   |
| Gilby                            |   | 7                           |   | 5                 |   | 121 |   | 105 |   | 7 |   | 5 |   | 121 |   | 105 |   |
| Highvale                         |   | 6                           |   | 5                 |   | 2 |   | 2 |   | 6 |   | 5 |   | 2 |   | 2 |   |
| Hilda                            |   | —                      |   | —            |   | 59 |   | 56 |   | — |   | — |   | 59 |   | 56 |   |
| Leduc                            |   | 24                          |   | 17                |   | 1,036 |   | 800 |   | 24 |   | 17 |   | 1,092 |   | 850 |   |
| Malmo                            |   | 1                           |   | 1                 |   | 28 |   | 27 |   | 1 |   | 1 |   | 28 |   | 27 |   |
| Manyberries                      |   | 15                          |   | 14                |   | 3 |   | 2 |   | 15 |   | 14 |   | 3 |   | 2 |   |
| Mikwan                           |   | —                      |   | —            |   | 17 |   | 15 |   | — |   | — |   | 17 |   | 15 |   |
| Mitsue                           |   | —                      |   | —            |   | 47 |   | 41 |   | — |   | — |   | 47 |   | 41 |   |
| Pembina                          |   | 36                          |   | 28                |   | 370 |   | 312 |   | 36 |   | 28 |   | 370 |   | 312 |   |
| Pine  Creek, Alberta             |   | —                      |   | —            |   | 218 |   | 154 |   | — |   | — |   | 218 |   | 154 |   |
| Pollockville                     |   | —                      |   | —            |   | 244 |   | 151 |   | — |   | — |   | 244 |   | 151 |   |
| Progress                         |   | 10                          |   | 7                 |   | 1,036 |   | 768 |   | 10 |   | 7 |   | 1,036 |   | 768 |   |
| Staplehurst                      |   | 15                          |   | 13                |   | — |   | — |   | 16 |   | 14 |   | — |   | — |   |
| Wizard  Lake                     |   | 48                          |   | 40                |   | 21 |   | 17 |   | 48 |   | 40 |   | 21 |   | 17 |   |
| Wood  River                      |   | 7                           |   | 7                 |   | 233 |   | 205 |   | 7 |   | 7 |   | 1,008 |   | 819 |   |
| Zama                             |   | 8                           |   | 7                 |   | 120 |   | 81 |   | 10 |   | 9 |   | 404 |   | 275 |   |
| Rigel,  British Columbia         |   | —                      |   | —            |   | 10 |   | 8 |   | — |   | — |   | 10 |   | 8 |   |
| Boundary  Lake, British Columbia |   | —                      |   | —            |   | — |   | — |   | 19 |   | 19 |   | 108 |   | 102 |   |
| Hatton,  Saskatchewan            |   | —                      |   | —            |   | 158 |   | 113 |   | — |   | — |   | 158 |   | 113 |   |
| Webb-Beverley,  Saskatchewan     |   | 2                           |   | 2                 |   | — |   | — |   | 2 |   | 2 |   | — |   | — |   |
| TOTAL                            |   | 1,586                       |   | 1,262             |   | 27,063 |   | 21,463 |   | 1,774 |   | 1,401 |   | 34,884 |   | 27,639 |   |

 

Properties arelocated in Alberta, Canada unless otherwise noted.

 

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Estimated Future Net Revenues

 

The following table setsforth Barnwell’s “Estimated Future Net Revenues” from total proved oil, naturalgas and condensate reserves and the present value of Barnwell’s “EstimatedFuture Net Revenues” (discounted at 10%). Estimated future net revenues for total proved reserves are net ofestimated development costs.  Netrevenues have been calculated using current sales prices and costs, afterdeducting all royalties net of the Alberta Royalty Tax Credit, operating costs,future estimated capital expenditures, and income taxes.

 
|                                                           |   | **Proved  Producing  Reserves** |       | **Total  Proved  Reserves** |   |
|----------------------------------------------------------------|--------|---------------------------------|------------|-----------------------------|--------|
| Year ending  September 30,                                |   |                            |       |                        |   |
|                                                           |   |                            |       |                        |   |
| 2004                                                           |   | $                               | 9,978,000  |                        | $      | 10,582,000 |   |
| 2005                                                           |   | 8,658,000                       |       | 9,972,000                   |   |
| 2006                                                           |   | 7,250,000                       |       | 8,358,000                   |   |
| Thereafter                                                     |   | 34,320,000                      |       | 41,623,000                  |   |
|                                                           |   | $                               | 60,206,000 |                        | $      | 70,535,000 |   |
|                                                           |   |                            |       |                        |   |
| Present  value (discounted at 10%)  at September 30, 2003 |   | $                               | 42,282,000 |                        | $      | 49,537,000 |   |

 

Marketing of Oil and Natural Gas

 

Barnwell sellssubstantially all of its oil and condensate production under short-termcontracts between itself and marketers of oil. The price of oil is freely 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 freelynegotiated between buyers and sellers. In 2003, 2002 and 2001, Barnwell took virtually all of its oil andnatural gas “in kind” where Barnwell markets the products instead of having theoperator of a producing property market the products on Barnwell’s behalf.

 

Infiscal 2003, natural gas production from the Dunvegan Unit was responsible forapproximately 41% of Barnwell’s natural gas revenues, as compared to 45% infiscal 2002.  In fiscal 2003, Barnwellhad four individually significant customers that accounted for 64% ofBarnwell’s oil and natural gas revenues. A substantial portion of Barnwell’s Dunvegan natural gas production andnatural gas production from other properties is sold to aggregators andmarketers under various short-term and long-term contracts, with the price ofnatural gas determined by negotiations between the aggregators and the finalpurchasers.  In fiscal 2003, Barnwellcontinued to increase the volumes of natural gas sold into spot markets,reaching approximately 46% of natural gas volumes, to take advantage of newpipeline access to premium markets and higher prices.

 

# Governmental Regulation

 

The jurisdictions inwhich the oil and natural gas properties of Barnwell are located haveregulatory provisions relating to permits for the drilling of wells, thespacing of wells, the prevention of

 

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oil and natural gaswaste, allowable rates of production and other matters.  The amount of oil and natural gas producedis subject to control by regulatory agencies in each province and state thatperiodically assign allowable rates of production.  The Province of Alberta and Government of Canada also monitor andregulate the volume of natural gas that may be removed from the province andthe conditions of removal.

 

There is no currentgovernment regulation of the price that may be charged on the sale of Canadianoil or natural gas production.  Canadiannatural gas production destined for export is priced by market forces subjectto export contracts meeting certain criteria prescribed by Canada’s NationalEnergy Board and the Government of Canada.

 

The right to explore forand develop oil and natural gas on lands in Alberta, Saskatchewan and BritishColumbia is controlled by the governments of each of those provinces.  Changes in royalties and other terms ofprovincial leases, permits and reservations may have a substantial effect onBarnwell’s operations.  In addition tothe foregoing, in the future, Barnwell’s Canadian operations may be affected fromtime to time by political developments in Canada and by Canadian Federal,provincial and local laws and regulations, such as restrictions on productionand export, oil and natural gas allocation and rationing, price controls, taxincreases, expropriation of property, modification or cancellation of contractrights, and environmental protection controls. Furthermore, operations may also be affected by United States importfees and restrictions.

 

Different royalty ratesare imposed by the provincial governments, the Government of Canada and privateinterests with respect to the production and sale of crude oil, natural gas andliquids.  In addition, provincialgovernments receive additional revenue through the imposition of taxes on crudeoil and natural gas owned by private interests within the province.  Essentially, provincial royalties arecalculated as a percentage of revenue, and vary depending on productionvolumes, selling prices and the date of discovery.

 

In fiscal 2001 and 2002,Canadian taxpayers were not permitted to deduct royalties, taxes, rentals andsimilar levies paid to the Federal or provincial governments in connection withoil and natural gas production in computing income for purposes of CanadianFederal income tax.  However, they wereallowed to deduct a “Resource Allowance” which is 25% of the taxpayer’s“Resource Profits for the Year” (essentially, net income from the production ofoil, natural gas or minerals) in computing their taxable income.

 

In October 2003, theParliament of Canada held first and second readings on a bill to reduceCanada’s corporate tax rate on “resource” income (income derived from oil andnatural gas operations) over a four-year period beginning January 1, 2003from 29% to 21% beginning January 1, 2007.  Additionally, the bill phases in over the same four-year periodtax deductions for royalties, which previously were not tax deductible, andphases out the Resource Allowance deduction along with other changes.  In November 2003, the bill passed onthird reading, received Royal Assent and was enacted into law.  The reduction in the tax will reduceBarnwell’s deferred income tax liabilities by approximately $1,500,000 in thequarter ending December 31, 2003, Barnwell’s fiscal 2004 first quarter.

 

In Alberta, a producer ofoil or natural gas is entitled to a credit against the royalties payable to theCrown by virtue of the Alberta Royalty Tax Credit program.  The Alberta Royalty Tax Credit rate is basedon a price-sensitive formula and varies between 75% at prices below a specifiedroyalty tax credit reference price and 25% at prices above a specified royaltytax credit reference price.  The Alberta

 

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Royalty Tax Credit will be applied to a maximum annual amount of$2,000,000 Canadian dollars of Alberta Crown royalties payable for eachproducer or associated group of producers. Crown royalties on production from producing properties acquired fromcorporations claiming maximum entitlements to Alberta Royalty Tax Credit willgenerally not be eligible for Alberta Royalty Tax Credit.  The rate is established quarterly based onthe average royalty tax credit reference price, as determined by the AlbertaDepartment of Energy.  The royalty taxcredit reference price is based 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 2003,Barnwell’s Alberta Royalty Tax Credit totaled approximately $342,000.  If the Alberta Royalty Tax Credit is notcontinued, it will have an adverse effect on Barnwell.

 

Competition

 

The majority ofBarnwell’s natural gas sales take place in Alberta, Canada.  Natural gas prices in Alberta are generallycompetitive with other major North American areas due to increased pipelinecapacity into the United States. Barnwell’s oil and natural gas liquids are sold in Alberta with pricesdetermined by the world price for oil.

 

Barnwell competes in thesale of oil and natural gas on the basis of price, and on the ability todeliver products.  The oil and naturalgas industry is intensely competitive in all phases, including the explorationfor new production and reserves and the acquisition of equipment and labornecessary to conduct drilling activities. The competition comes from numerous major oil companies as well asnumerous other independent operators. There is also competition between the oil and natural gas industry andother industries in supplying the energy and fuel requirements of industrial,commercial and individual consumers. Barnwell is a minor participant in the industry and competes in its oiland natural gas activities with many other companies having far greaterfinancial and other resources.

 

CONTRACT DRILLING OPERATIONS

 

Barnwellowns 100% of Water Resources International, Inc. which drills water andexploratory wells and installs and repairs water pumping systems inHawaii.  Water Resources International,Inc. owns and operates four Spencer-Harris portable rotary drill rigs rangingin drilling capacity from 3,500 feet to 7,000 feet, and leases an IDECO H-35rotary drill/workover rig to an oil company. Additionally, Water Resources International, Inc. owns a two acre parcelof real estate in an industrial park 11 miles south of Hilo, Hawaii, leases athree-quarter of an acre maintenance facility in Honolulu and a one acre maintenanceand storage facility with 2,800 square feet of interior space in Kawaihae,Hawaii, and maintains an inventory of drilling and pump supplies.  As of September 30, 2003, WaterResources International, Inc. employed ten drilling, pump and administrativeemployees, none of whom are union members.

 

Water ResourcesInternational, Inc. drills water, water monitoring and geothermal wells ofvarying depths in Hawaii and also installs and repairs water pumps and is theState of Hawaii’s

 

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distributor for Floway pumps and equipment.  The demand for Water Resources International, Inc.’s services isprimarily dependent upon land development activities in Hawaii.  Water Resources International, Inc. marketsits services to land developers and government agencies, and identifiespotential contracts through public notices, its officers’ involvement incommunity activities and referrals. Contracts are usually fixed price per lineal foot or day rate contractsand are negotiated with private entities or obtained through competitivebidding with private entities or with local, state and Federal agencies.  Contract revenues are not dependent upon thediscovery of water, geothermal production zones or other, similar targets, andcontracts are not subject to renegotiation of profits or termination at theelection of the governmental entities involved.  Contracts provide for arbitration in the event of disputes.

 

Barnwell’scontract drilling subsidiary derived 66%, 70% and 49% of its contract drillingrevenues in fiscal 2003, 2002 and 2001, respectively, pursuant to Federal,State of Hawaii and county contracts. At September 30, 2003, Barnwell had accounts receivable from theState of Hawaii and county entities totaling approximately $177,000.  Barnwell has lien rights on wells drilledand pumps installed for Federal, State of Hawaii, county and private entities.

 

Barnwell’s contractdrilling segment currently operates in Hawaii and is not subject to seasonalfluctuations.

 

Activity

 

Infiscal 2003, Water Resources International, Inc. started five well drillingcontracts and five pump installation contracts and completed six well drillingcontracts and nine pump installation contracts.  Two of the six completed well contracts and four of the ninecompleted pump contracts were started in the prior year.  Eighty-two percent (82%) of well drillingand pump installation jobs, representing 66% of total contract drillingrevenues in fiscal 2003, have been pursuant to government contracts.

 

AtSeptember 30, 2003, Water Resources International, Inc. had a backlog oftwo well drilling contracts and three pump installation and repair contracts,one of which was in progress as of September 30, 2003.

 

The dollar amount ofBarnwell’s backlog of firm well drilling and pump installation and repaircontracts at November 30, 2003 and 2002 is as follows:

 
|                          |   | **2003**    |          | **2002** |   |
|-------------------------------|--------|-------------|---------------|----------|--------|
| Well  drilling                |   | **$**       | **1,470,000** |     | $      | 1,700,000 |   |
| Pump  installation and repair |   | **880,000** |          | 100,000  |   |
|                          |   | **$**       | **2,350,000** |     | $      | 1,800,000 |   |

 

All ofthe contracts in backlog at November 30, 2003 are expected to be completedwithin fiscal year 2004.

 

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# Competition

 

Water ResourcesInternational, Inc. utilizes rotary drill rigs and competes with other drillingcontractors in Hawaii which use cable tool rigs, which require less labor tooperate but generally drill slower, rotary drill rigs similar to WaterResources International, Inc.’s drilling rigs, and top head rotary drillingrigs that drill as quickly as Water Resources International, Inc.’s equipmentbut require less labor.  Thesecompetitors are also capable of installing and repairing vertical turbine andsubmersible water pumping systems in Hawaii. These contractors compete actively with Water Resources International,Inc. for government and private contracts. Pricing is Barnwell’s major method of competition; reliability ofservice is also a significant factor.

 

Thenumber of available water well drilling jobs has not changed significantly fromthe prior year.  Barnwell expectscompetitive pressures within the industry to remain high as demand for welldrilling and pump installation in Hawaii is not expected to increase in fiscalyear 2004 and may decrease.

 

LAND INVESTMENT OPERATIONS

 

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 Kona District of the Island of Hawaii. In previous years, between 1986 and 1989, Kaupulehu Developmentsobtained the state and county zoning changes necessary to permit development ofthe Four Seasons Resort Hualalai at Historic Ka’upulehu and Hualalai Golf Club,which opened in 1996, a second golf course, and single and multiple familyresidential units.  These projects weredeveloped on land acquired from Kaupulehu Developments by Kaupulehu MakaiVenture, an unrelated entity that is an affiliate of Kajima Corporation ofJapan.

 

Activity

 

The leasehold land interests held by KaupulehuDevelopments are for approximately 870 acres of land zoned forresort/residential development and another approximately 1,000 acres of landzoned conservation district.  These approximately1,870 acres are located adjacent to and north of the Four Seasons ResortHualalai at Historic Ka’upulehu,between the Queen Kaahumanu Highway and the Pacific Ocean.

 

Kaupulehu Developments is negotiating with anindependent third party interested in developing the approximately 870leasehold acres zoned for resort/residential development, of whichapproximately 186 acres were designated by the State Land Use Commission aspreservation areas with no residential or golf course development.  The independent third party and KaupulehuDevelopments have made significant progress in negotiation of a reviseddevelopment agreement and residential fee simple purchase prices with thelessor of the 870 acres.  Managementcannot predict the outcome of these negotiations.

 

The development rights held by Kaupulehu Developmentsare for residentially zoned leasehold land within and adjacent to the HualalaiGolf Club and are under option to Kaupulehu Makai Venture.  On December 31, 2002, Kaupulehu MakaiVenture exercised the portion of its development rights option due on that dateand paid Kaupulehu Developments $2,125,000, reducing the amount of acreage

 

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originally under option to approximately 110 acres at September 30,2003.  Barnwell accounts for sales ofdevelopment rights under option by use of 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 development rights sold.  Accordingly, in consolidation, $1,277,000 of the proceeds fromthe sales of development rights were applied to reduce the carrying value ofthe underlying development rights recorded on the Condensed ConsolidatedBalance Sheets under the caption “Investment in land” to zero.  Additionally, sales of development rightswere further reduced by $128,000 representing fees paid to Nearco, Inc., (a company controlled by Mr. Terry Johnston,a director of Barnwell and an indirect 21.8% owner of Kaupulehu Developments)related to the sale.  The remaining$720,000 of sales proceeds is recorded in the Consolidated Statements ofOperations for fiscal 2003 as “Sale of development rights, net.”  The total amount of the remaining optionproceeds, if fully exercised, was $21,250,000 at September 30, 2003,comprised of eight payments of $2,656,250 due on each December 31 of years2003 to 2010.  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.

 

Competition

 

Barnwell’s landinvestment segment is subject to intense competition in all phases of itsoperations including the acquisition of new properties, the securing ofapprovals necessary for land rezoning, and the search for potential buyers ofproperty interests presently owned.  Thecompetition comes from numerous independent land development companies andother industries involved in land investment activities.  The principal factors affecting competitionare the location of the project and pricing. Kaupulehu Developments is a minor participant in the land developmentindustry and competes in its land investment activities with many otherentities having far greater financial and other resources.

 

For the past severalyears, Hawaii’s economy has experienced little or no growth.  However, the South Kohala/North Kona area ofthe island of Hawaii, the area in which Kaupulehu Developments’ property islocated, has experienced strong demand for residential real estate in recentyears.  This trend continued throughfiscal 2003 and is not expected to decline significantly in the near term,although there can be no assurance this trend will in fact continue.

 

CORPORATE OFFICE

 

In December 2003,Barnwell purchased the space it was leasing for its corporate offices locatedat 1100 Alakea Street, Suite 2900, Honolulu, Hawaii 96813 for $1,104,000.  The seller was A&B Alakea LLC, an independentthird party.  This purchase was fundedby $221,000 of cash and long-term debt of $883,000.  The long-term debt was financed by First Hawaiian Bank and ispayable in monthly principal payments of approximately $3,000, plus interest atthe three-month London Interbank Offer Rate, 1.25% at the time of closing, plus2%, and is due in full in December 2006. The space purchased has 4,662 useable square feet on the 28th floor of a31-story office building built in 1993 in downtown Honolulu.

 

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Item3.            LegalProceedings

 

Barnwell is occasionallyinvolved in routine litigation and is subject to governmental and regulatorycontrols that are incidental to the business. Barnwell’s management believes that routine claims and litigation involvingBarnwell are not likely to have a material adverse effect on its financialposition, results of operations or liquidity.

 

Item4.            Submission of Matters to a Vote ofSecurity Holders

 

None.

 

PART II

 

Item5.            Market For Common Equity and RelatedStockholder Matters

 

The principal market onwhich Barnwell’s common stock is being traded is the American StockExchange.  The following tables presentthe quarterly high and low sales prices, on the American Stock Exchange, forBarnwell’s common stock during the periods indicated:

 
| **Quarter Ended**        |   | **High** |   | **Low** |   | **Quarter  Ended**       |   | **High**               |   | **Low** |   |
|--------------------------|--------|----------|--------|---------|--------|--------------------------|--------|------------------------|--------|---------|--------|
| December 31, 2001   |   | $        | 20.75  |    | $      | 17.90                    |   | December 31, 2002 |   | $       | 20.45  |   | $ | 19.75 |   |
| March 31, 2002      |   | 20.60    |   | 19.75   |   | March 31, 2003      |   | 22.80                  |   | 20.01   |   |
| June 30,  2002      |   | 20.75    |   | 20.00   |   | June 30,  2003      |   | 25.05                  |   | 22.25   |   |
| September 30,  2002 |   | 20.05    |   | 19.40   |   | September 30,  2003 |   | 25.15                  |   | 24.00   |   |
|                          |        |          |        |         |        |                          |        |                        |        |         |        |  |  |  |  |

 

As of December 2,2003, there were 1,314,510 shares of common stock, par value $0.50,outstanding.  There were approximately400 holders of the common stock of the registrant as of December 2, 2003.

 

In March 2001,Barnwell declared a dividend of $0.20 per share payable March 30, 2001, tostockholders of record as of March 16, 2001.

 

In September 2001,Barnwell declared a dividend of $0.15 per share payable October 17, 2001,to stockholders of record as of October 2,2001.

 

In November 2001, Barnwell declared a dividend of$0.15 per share payable January 2, 2002, to stockholders of record as ofDecember 17, 2001.

 

In December 2003, Barnwell declared a dividend of$0.20 per share payable January 6, 2004 to stockholders of record as ofDecember 22, 2003.

 

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Item 6.            MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OFOPERATION

 

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, 2003 and 2002, and the related consolidated statements ofoperations, stockholders’ equity and comprehensive income (loss), and cashflows for each of the years in the three-year period ended September 30,2003.  This discussion should be read inconjunction with the Consolidated Financial Statements and related Notes ToConsolidated Financial Statements included in this report.

 

USE OF ESTIMATES IN THEPREPARATION OF FINANCIAL STATEMENTS

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues and expenses and the disclosure of contingent assets andliabilities.  Actual results coulddiffer significantly from those estimates.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

In response to U.S. Securities and Exchange CommissionRelease No. 33-8040, “Cautionary Advice Regarding Disclosure AboutCritical Accounting Policies,” Barnwell has identified certain of its policiesas being of particular importance to the understanding of its financialposition and results of operations and which require the application ofsignificant judgment by management.

 

Oil and natural gasproperties

 

Barnwell uses the fullcost method of accounting under which all costs incurred in the acquisition,exploration and development of oil and natural gas reserves, includingunsuccessful wells, are capitalized until such time as the aggregate of suchcosts, on a country-by-country basis, equals the discounted present value (at10%) of Barnwell’s estimated future net cash flows from estimated production ofproved oil and natural gas reserves, from such country, as determined byindependent petroleum engineers, less related income tax effects.  Any capitalized costs, net of oil and gas relateddeferred income taxes, in excess of the discounted present value of provedproperties and the lower of cost or estimated fair value of unproved propertiesare charged to expense.  Depletion ofall such costs, except costs related to major development projects, is providedby the unit-of-production method based upon proved oil and natural gas reservesof all properties on a country-by-country basis.  Investments in major development projects are not amortized untileither proved reserves are associated with the projects or impairment has beendetermined.  At September 30, 2003,Barnwell had no investments in major oil and natural gas development projectsthat were not being amortized.  Generaland administrative costs related to oil and natural gas operations are expensedas incurred.  Estimated future siterestoration and abandonment costs are capitalized as part of the carryingamount of oil and natural gas properties and depleted over the life of therelated reserves.  Proceeds from thedisposition of minor producing oil and natural gas properties are credited tothe cost of oil and natural gas properties. Gains or losses are recognized on the disposition of significant oil andnatural gas properties.

 

Investment in land andrevenue recognition

 

Barnwell’sinvestment in land is comprised of development rights under option andleasehold land interests in land zoned resort/residential and land zonedconservation, both of which are not under

 

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option.  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, and the acquisition of interests in development rights under optionare included in the consolidated balance sheets under the caption “Investmentin Land.”

 

Sales of developmentrights under option 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 estimated futurecosts related to the development rights sold.

 

Contract drilling

 

Revenues, costs andprofits applicable to contract drilling contracts are included in theconsolidated statements of operations using the percentage of completionmethod, principally measured by the percentage of labor dollars incurred todate for each contract to total estimated labor dollars for each contract.  Contract losses are recognized in full inthe period the losses are identified. The performance of drilling contracts may extend over more than one yearand, in the interim periods, estimates of total contract costs and profits areused to determine revenues and profits earned for reporting the results of thecontract drilling operations.  Revisionsin the estimates required by subsequent performance and final contractsettlements are included as adjustments to the results of operations in theperiod such revisions and settlements occur. Contracts are normally less than one year in duration.

 

Income taxes

 

Deferred income taxes aredetermined using the asset and liability method.  Deferred tax assets and liabilities are recognized for theestimated future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  Deferredtax assets and liabilities are measured using enacted tax rates in effect forthe year 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.

 

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.

 

AtSeptember 30, 2003, net deferred tax assets of $2,865,000 consistedprimarily of $1,535,000 of deferred tax assets related to the excess of thecost basis of investment in land for tax purposes over the cost basis ofinvestment in land for book purposes. This deferred tax asset will be realized through the deduction of thecost basis of investment in land for tax purposes against future proceeds fromsales of interests in leasehold land and development rights under option.  The amount of deferred income tax assetsconsidered realizable may be reduced if estimates of future taxable income arereduced.

 

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###### 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 accounts for its defined benefitpension plan in accordance with Statement of Financial Accounting Standards No.87, “Employers’ Accounting for Pensions,” which requires that amountsrecognized in financial statements be determined on an actuarial basis.  Statement of Financial Accounting StandardsNo. 87 requires that the effects of the performance of the pension plan’sassets and changes in pension liability discount rates on Barnwell’scomputation of pension income (expense) be amortized over future periods.  Any variances in the future between theassumed rates utilized for actuarial purposes and the actual rates experiencedby the plan may materially affect Barnwell’s results of operations or financialcondition.

 

Duringand as of the end of fiscal 2003 and fiscal 2002, Barnwell assumed an expectedlong-term rate of return on plan assets of 8%. The expected rate of future annual compensation increases utilizedduring and as of the end of fiscal 2003 was 5%.

 

Atthe end of each year, Barnwell determines the discount rate to be used tocalculate the present value of plan liabilities.  The discount rate is an estimate of the current interest rate atwhich the pension liabilities could be effectively settled at the end of theyear.  In estimating this rate, Barnwelllooks to rates of return on high-quality, fixed-income investments.  At September 30, 2003, Barnwelldetermined this rate to be 6%.

 

AtSeptember 30, 2003, Barnwell’s accrued benefit cost was $324,000.  For the year ended September 30, 2003,Barnwell recognized a net periodic benefit cost of $172,000.

 

CONTRACTUAL OBLIGATIONS

 

The following table lists the scheduled maturities oflong-term debt, estimating that Barnwell’s credit facility with the Royal Bankof Canada will be renewed on each annual renewal date, currently April 29,and scheduled minimum rental payments of non-cancelable operating leases foroffice space and leasehold land:

 
|                         |   | **Payments Due by Fiscal Year** |    |
|------------------------------|--------|---------------------------------|---------|
| **Contractual  Obligations** |   | **2004**                        |    | **2005-2006** |   | **2007-2008** |   | **After 2008** |   | **Total** |   |
| Long-term  debt              |   | $                               | —  |   | $ | — |   | $ | — |   | $ | 10,477,000 |   | $ | 10,477,000 |   |
| Operating  leases            |   | 443,000                         |    | 726,000 |   | 743,000 |   | 2,678,000 |   | 4,590,000 |   |
|                         |   |                            |    |   |   |   |   |   |   |   |   |
| Total                        |   | $                               | 443,000 |   | $ | 726,000 |   | $ | 743,000 |   | $ | 13,155,000 |   | $ | 15,067,000 |   |

 

There is no assurance that the bank will in fact extend the term of thefacility on each renewal date or that the facility will be renewed at itscurrent amount.  The following tablelists the scheduled maturities of long-term debt assuming that the facilitywill not be renewed on the next renewal date and that Barnwell then elects toconvert the revolving facility to term status, and scheduled minimum rentalpayments of non-cancelable operating leases for office space and leaseholdland:

 

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|                         |   | **Payments Due by Fiscal Year** |    |
|------------------------------|--------|---------------------------------|---------|
| **Contractual  Obligations** |   | **2004**                        |    | **2005-2006** |   | **2007-2008** |   | **After 2008** |   | **Total** |   |
| Long-term  debt              |   | $                               | 524,000 |   | $ | 9,953,000 |   | $ | — |   | $ | — |   | $ | 10,477,000 |   |
| Operating  leases            |   | 443,000                         |    | 726,000 |   | 743,000 |   | 2,678,000 |   | 4,590,000 |   |
|                         |   |                            |    |   |   |   |   |   |   |   |   |
| Total                        |   | $                               | 967,000 |   | $ | 10,679,000 |   | $ | 743,000 |   | $ | 2,678,000 |   | $ | 15,067,000 |   |

 

The lease payments for land are subject torenegotiation after December 31, 2005; the future rental paymentdisclosures above assume the minimum lease payments for land in effect atDecember 31, 2005 remain unchanged through 2025, the end of the leaseterm.  In December 2003, Barnwellpurchased the space it was leasing for its corporate office in Honolulu,Hawaii.  The future minimum rentalpayments reflected above have been adjusted accordingly.

 

RESULTS OF OPERATIONS

 

Summary

 

Barnwell had net earnings of $2,320,000 in fiscal2003, a $2,280,000 increase from net earnings of $40,000 in fiscal 2002.  The increase is largely attributable tosignificant increases in petroleum prices. In addition, land segment operating profit increased in fiscal 2003, ascompared to fiscal 2002, as revenues from the sale of development rights infiscal 2003 (accounted for under the cost recovery method) exceeded associatedcosts, whereas revenues from the sale of development rights in fiscal 2002 werefully offset by associated costs (after consideration of minority interest inearnings).

 

The fiscal year average exchange rate of the Canadiandollar to the U.S. dollar increased 8% in fiscal 2003, as compared to fiscal2002, and the exchange rate of the Canadian dollar to the U.S. dollar increased17% at September 30, 2003, as compared to September 30, 2002.  This increase in the value of the Canadiandollar in U.S. dollars increased Barnwell’s reported assets and liabilities andrevenues and expenses.

 

Barnwell had net earnings of $40,000 in fiscal 2002, a$3,790,000 (99%) decrease from net earnings of $3,830,000 in fiscal 2001.  The decrease is largely attributable tosignificant decreases in petroleum prices and lower oil production in fiscal2002, as compared to fiscal 2001.  Netearnings for fiscal 2002 includes an oil and natural gas operating expensecredit recorded in the fourth quarter for the settlement of overcharges ofoperating expenses for fiscal years 1998 through 2001 from the operator of theDunvegan property that contributed $250,000, net of income taxes, tooperations.  There were no significantoperating expense credits recorded in fiscal 2003 or 2001.

 

##### Oil and Natural Gas Revenues

 

Selected OperatingStatistics

 

The following tables setforth Barnwell’s annual net production and annual average price per unit ofproduction for fiscal 2003 as compared to fiscal 2002, and fiscal 2002 ascompared to fiscal 2001.  Productionamounts reported are net of royalties and the Alberta Royalty Tax Credit.

 

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Fiscal 2003 - Fiscal 2002

 

|                 |   | **Annual Net  Production** |   |
|----------------------|--------|----------------------------|--------|
|                 |   |                       |   |   |   | **Decrease** |   |
|                 |   | **2003**                   |   | **2002** |   | **Units** |   | **%** |   |
| Liquids  (Bbl)*      |   | **85,000**                 |   | 94,000 |   | (9,000 | ) | (10 | )% |
| Oil  (Bbl)*          |   | **142,000**                |   | 148,000 |   | (6,000 | ) | (4 | )% |
| Natural  gas (MCF)** |   | **3,175,000**              |   | 3,277,000 |   | (102,000 | ) | (3 | )% |

 

|                 |   | **Annual  Average Price Per Unit** |      |
|----------------------|--------|------------------------------------|-----------|
|                 |   |                               |      |   |   | **Increase** |   |
|                 |   | **2003**                           |      | **2002** |   | **$** |   | **%** |   |
| Liquids  (Bbl)*      |   | **$**                              | **21.50** |   | $ | 12.46 |   | $ | 9.04 |   | 73 | % |
| Oil  (Bbl)*          |   | **$**                              | **27.69** |   | $ | 21.28 |   | $ | 6.41 |   | 30 | % |
| Natural  gas (MCF)** |   | **$**                              | **4.27**  |   | $ | 2.12 |   | $ | 2.15 |   | 101 | % |

 

Fiscal 2002 - Fiscal 2001

 

|                 |   | **Annual Net  Production** |   |
|----------------------|--------|----------------------------|--------|
|                 |   |                       |   |   |   | **Increase  (Decrease)** |   |
|                 |   | **2002**                   |   | **2001** |   | **Units** |   | **%** |   |
| Liquids  (Bbl)*      |   | 94,000                     |   | 98,000 |   | (4,000 | ) | (4 | )% |
| Oil  (Bbl)*          |   | 148,000                    |   | 174,000 |   | (26,000 | ) | (15 | )% |
| Natural  gas (MCF)** |   | 3,277,000                  |   | 3,269,000 |   | 8,000 |   | — |   |

 

|                 |   | **Annual  Average Price Per Unit** |   |
|----------------------|--------|------------------------------------|--------|
|                 |   |                               |   |   |   | **Decrease** |   |
|                 |   | **2002**                           |   | **2001** |   | **$** |   | **%** |   |
| Liquids  (Bbl)*      |   | $                                  | 12.46  |   | $ | 22.60 |   | $ | (10.14 | ) | (45 | )% |
| Oil  (Bbl)*          |   | $                                  | 21.28  |   | $ | 25.44 |   | $ | (4.16 | ) | (16 | )% |
| Natural  gas (MCF)** |   | $                                  | 2.12   |   | $ | 4.02 |   | $ | (1.90 | ) | (47 | )% |

 

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  *Bbl = stocktank barrel equivalent to 42 U.S. gallons

**MCF = 1,000 cubic feet

 

Oil and natural gasrevenues increased $8,030,000 (71%) from $11,320,000 in fiscal 2002 to$19,350,000 in fiscal 2003, due to 101%, 30%, and 73% increases in natural gas,oil, and natural gas liquids prices, respectively.  The increase was partially offset by 3%, 4%, and 10% declines innet natural gas, oil, and natural gas liquids production, respectively, due tonatural declines in production from some of Barnwell’s more mature properties,which were partially offset by an increase in production from new wells.  In addition, natural gas liquids productiondecreased due to a fire in early October 2002 at a Dunvegan gas plant thatprevented stripping of natural gas liquids from the natural gas, resulting inan approximately 6,000 barrel decline in liquids net production in fiscal2003.  Barnwell did, however, receive ahigher price for its natural gas than it would have if the liquids had been

 

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removed, thereby mitigating some of the impact of the liquidsproduction decline.  The damage to thegas plant was repaired and the plant resumed operations in lateDecember 2002.

 

Oil and natural gas revenues decreased $8,550,000(43%) from $19,870,000 in fiscal 2001 to $11,320,000 in fiscal 2002, dueprimarily to 47%, 45%, and 16% decreases in natural gas, natural gas liquids,and oil prices, respectively.  Netnatural gas production increased less than one percent, however gross naturalgas production declined 6% as gas production declines at Barnwell’s more matureproperties were only partially offset by production from recentdevelopment.  However, a decrease inroyalty rates, due to decreased natural gas prices, mitigated this decline andleft natural gas production relatively unchanged on a net basis.  Net oil production decreased 15% due todeclines in production from some of Barnwell’s more mature oil properties.

 

Oil and Natural GasOperating Expenses

 

Operating expenses increased $1,084,000 (35%) to$4,192,000 in fiscal 2003, as compared to $3,108,000 in fiscal 2002.  The increase is partly attributable to anoil and natural gas operating expense credit recorded in the fourth quarter offiscal 2002 for the settlement of overcharges of operating expenses for fiscalyears 1998 through 2001 from the operator of the Dunvegan property that reducedfiscal 2002 operating expenses by approximately $470,000.  Also contributing to the increase wereincreases in well repair and maintenance, electricity, fuel, insurance, andgeneral maintenance costs.  Operatingexpenses in fiscal 2003 also include $85,000 of accretion of the assetretirement obligation due to implementation of Statement of FinancialAccounting Standards No. 143, “Accounting for Asset Retirement Obligations,” onOctober 1, 2002 (see Note 6 “Property and Equipment and Asset RetirementObligation” in the Notes to Consolidated Financial Statements).

 

Operating expenses decreased to $3,108,000 in fiscal2002, a $401,000 (11%) decrease from $3,509,000 in fiscal 2001, due to an oiland natural gas operating expense credit recorded in the fourth quarter offiscal 2002 for the settlement of overcharges of operating expenses for fiscalyears 1998 through 2001 from the operator of the Dunvegan property totaling$470,000.  Partially offsetting thiscredit were higher gathering and processing fees in fiscal 2002.

 

Sale of DevelopmentRights and Minority Interest in Earnings

 

Thedevelopment rights held by Kaupulehu Developments are for residentially zonedleasehold land within and adjacent to the Hualalai Golf Club and are under optionto Kaupulehu Makai Venture, an unrelated entity that is an affiliate of KajimaCorporation of Japan.  OnDecember 31, 2002, Kaupulehu Makai Venture exercised the portion of itsdevelopment rights option due on that date and paid Kaupulehu Developments $2,125,000,reducing the amount of acreage originally under option to approximately 110acres.  Barnwell accounts for sales ofdevelopment rights under option by use of 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 development rights sold.  Accordingly, in consolidation, $1,277,000 of the proceeds fromthe sales of development rights were applied to reduce the carrying value ofthe underlying development rights recorded on the Consolidated Balance Sheetsunder the caption “Investment in land” to zero.  Additionally, sales of development rights were further reduced by$128,000 of fees related to the sale. The remaining $720,000 of sales proceeds is recorded in the ConsolidatedStatements of Operations for fiscal 2003 as “Sale of development rights,net.”  The total amount of the remainingoption proceeds, if fully exercised, was $21,250,000 at September 30,2003, comprised of eight payments of $2,656,250 due on each December

 

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31 of years 2003to 2010.  If any annual option paymentis not made, the then remaining development right options will expire.  There is no assurance that any portion ofthe remaining options will be exercised.

 

The aforementioned $128,000in fees ($89,000, net of minority interest) on the $2,125,000 developmentrights proceeds were paid in January 2003 to Nearco, Inc., a companycontrolled by Mr. Terry Johnston, a director of Barnwell and an indirect 21.8%owner of Kaupulehu Developments.  Underan agreement entered into in 1987, prior to Mr. Johnston’s election toBarnwell’s Board of Directors, Barnwell is obligated to pay Nearco, Inc. 2% ofKaupulehu Developments’ gross receipts from the sale of real estateinterests.  In addition, CambridgeHawaii Limited Partnership, a 49.9% owner of Kaupulehu Developments, in whichBarnwell purchased a 55.2% interest in April 2001, is obligated under anagreement entered into in 1987 to pay Nearco, Inc. 4% of KaupulehuDevelopments’ gross receipts from the sale of real estate interests.  The fees represent compensation forpromotion and marketing of Kaupulehu Developments’ property and were determinedbased on the estimated fair value of such services.  Barnwell believes the fees are fair and reasonable compensationfor such services.

 

Feeswere also paid to Nearco, Inc. for consulting services related to KaupulehuDevelopments’ leasehold land.  Forfiscal 2003 and fiscal 2002, such fees totaled $218,000 and $95,000,respectively, and were included in general and administrative expenses.  Barnwell believes the fees are fair andreasonable compensation for such services.

 

On December 31, 2001 Kaupulehu Makai Ventureexercised the portion of its development rights option due on that date andpaid Kaupulehu Developments $2,125,000. Under the cost recovery method, $1,877,000 of investment in land wasexpensed as a result of this option exercise in fiscal 2002, reducing operatingprofit, after minority interest, to zero.

 

Kaupulehu Developments is negotiating with anindependent party interested in developing the approximately 870 acres ofresort/residential leasehold acreage (of which approximately 186 acres weredesignated by the State Land Use Commission as preservation areas with noresidential or golf course development). The independent third party and Kaupulehu Developments have madesignificant progress in negotiation of a revised development agreement andresidential fee simple purchase prices with the lessor.  Management cannot predict the outcome ofthese negotiations.

 

Contract Drilling

 

Contract drilling revenues and costs are associatedwith water well, geothermal well and exploratory well drilling, and water pumpinstallation, replacement and repair in Hawaii.

 

Contract drilling revenues decreased $1,430,000 (41%)to $2,050,000 in fiscal 2003, as compared to $3,480,000 in fiscal 2002, andcontract drilling operating expenses decreased $893,000 (32%) to $1,928,000 infiscal 2003, as compared to $2,821,000 in fiscal 2002.  Operating profit before depreciationdecreased $537,000 (81%) from $659,000 in fiscal 2002 to $122,000 in fiscal2003.  The decreases were due to adecreased number of available water well drilling and pump installationcontracts and lower contract margins resulting from higher competition forthose contracts.

 

At September 30, 2003, Water ResourcesInternational, Inc., a wholly-owned subsidiary of Barnwell, had a backlog oftwo well drilling contracts and three pump installation and repair contracts,

 

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one of which was in progress as of September 30, 2003.  The backlog of contract drilling revenues asof November 30, 2003 was approximately $2,350,000.

 

Contractdrilling revenues and operating expenses remained relatively constant in fiscal2002, as compared to fiscal 2001. Contract drilling revenues increased $190,000 (6%) to $3,480,000 infiscal 2002, as compared to $3,290,000 in fiscal 2001, and contract drillingoperating expenses decreased $85,000 (3%) to $2,821,000 in fiscal 2002, ascompared to $2,906,000 in fiscal 2001. Operating profit before depreciation increased $275,000 (72%) from$384,000 in fiscal 2001 to $659,000 in fiscal 2002 due to an increase in welldrilling activity, partially offset by a decrease in pump installationactivity; well drilling contracts generally have higher margins than pumpinstallation contracts.

 

Gas Processing and OtherIncome

 

Gas processing and otherincome increased $600,000 (63%) to $1,560,000 in fiscal 2003, as compared to$960,000 in fiscal 2002, due principally to the receipt by KaupulehuDevelopments of $500,000 in income related to negotiations on the developmentof Kaupulehu Developments’ resort/residential acreage during fiscal 2003, ascompared to $100,000 in fiscal 2002. Interest income in fiscal 2003 also increased due to $102,000 ofinterest on an income tax refund from the Canadian government relating toBarnwell’s fiscal 1994 tax return and a $61,000 increase in interest income ona note receivable (interest on the note began in February 2002, thereforethere were only eight months of interest earned in fiscal 2002, as compared toa full twelve months of interest earned in fiscal 2003).

 

Gasprocessing and other income was relatively unchanged in fiscal 2002 (increased$30,000 or 3%), as compared to fiscal 2001.

 

General and Administrative Expenses

 

General and administrative expenses increased$1,627,000 (37%) to $5,971,000 in fiscal 2003, as compared to $4,344,000 infiscal 2002, due primarily to costs incurred related to sales negotiations withinterested parties and other costs related to maintaining KaupulehuDevelopments’ leasehold land.  Suchcosts, totaling approximately $887,000, consisted of legal, consulting, traveland other costs; in fiscal 2002 these costs totaled $1,066,000, of which$324,000 was expensed and $742,000 of which was capitalized.  Attainment of zoning and developmententitlements for Kaupulehu Developments’ leasehold land interests inapproximately 870 acres of land zoned for resort/residential development wasdetermined to be substantially complete in December 2002.  Accordingly, effective January 1, 2003,Barnwell no longer capitalizes expenditures related to the 870 acres.  The increase was also attributable toincreases in personnel and pension plan costs of $495,000, increased oil andnatural gas segment incentive plan costs for the Vice President of CanadianOperations of $214,000, increased stock appreciation rights expense of$177,000, and increases in professional services of approximately $121,000(primarily related to compliance with the Sarbanes-Oxley Act of 2002 andrestatement of the Barnwell Industries, Inc. Employees’ Pension Plan to complywith Internal Revenue Service rulings), as compared to fiscal 2002.  Additionally, other general andadministrative costs increased by a net of $57,000.

 

General and administrative expenses include fees paidto Nearco, Inc., an entity controlled by Mr. Terry Johnston, a director ofBarnwell and an indirect 21.8% owner of Kaupulehu Developments, for consultingservices related to Kaupulehu Developments’ leasehold land.  In fiscal 2003 and 2002,

 

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fees paid to Nearco, Inc. totaled $218,000 and $95,000,respectively.  Barnwell believes thefees are fair and reasonable compensation for such services.

 

General and administrative expenses increased $223,000(5%) to $4,344,000 in fiscal 2002, as compared to $4,121,000 in fiscal 2001,due to legal and consulting costs related to land segment sales negotiations infiscal 2002; there were no such costs in fiscal 2001.

 

Depreciation, Depletionand Amortization

 

Depletion,depreciation and amortization increased $685,000 (19%) to $4,333,000 in fiscal2003, as compared to $3,648,000 in fiscal 2002, due to an 18% increase in thedepletion rate and an 8% increase in the fiscal year average exchange rate ofthe Canadian dollar to the U.S. dollar, partially offset by a 4% decrease inproduction (in MCF equivalents where one barrel of oil and natural gas liquidsare converted to 5.8 MCF equivalents). The higher depletion rate is the result of increased costs of findingand developing proven reserves in fiscal 2003, as compared fiscal 2002.

 

Depreciation, depletion and amortization expensedecreased $106,000 (3%) to $3,648,000 in fiscal 2002, as compared to $3,754,000in fiscal 2001, due to decreased production, partially offset by a slightlyhigher depletion rate per MCF equivalent in fiscal 2002, as compared to fiscal2001.

 

Interest Expense

 

Interestexpense increased $146,000 (49%) to $442,000 in fiscal 2003, as compared tointerest expense of $296,000 in fiscal 2002. The increase was due primarily to decreased capitalized interest.  Attainment of zoning and developmententitlements for Kaupulehu Developments’ leaseholdland interests in approximately 870 acres of land zoned for resort/residentialdevelopment was substantially complete as of the end ofDecember 2002.  Accordingly,effective January 1, 2003, Barnwell no longer capitalizes interest on theaccumulated development costs of the property.

 

Interest costs for theyears ended September 30, 2003, 2002 and 2001 are summarized as follows:

 
|                                                   |   | **2003**   |        | **2002** |   | **2001** |   |
|--------------------------------------------------------|--------|------------|-------------|----------|--------|----------|--------|
| Interest costs incurred                                |   | **$**      | **487,000** |     | $      | 498,000  |   | $ | 665,000 |   |
| Less  interest costs capitalized on investment in land |   | **45,000** |        | 202,000  |   | 278,000  |   |
| Interest  expense                                      |   | **$**      | **442,000** |     | $      | 296,000  |   | $ | 387,000 |   |

 

The average interest rate incurred during fiscal 2003on Barnwell’s borrowings from the Royal Bank of Canada decreased to 3.84%, ascompared to 4.24% in fiscal 2002, and the weighted average balance ofoutstanding borrowings from the Royal Bank of Canada decreased fromapproximately $10,300,000 in fiscal 2002 to approximately $10,100,000 in fiscal2003.  The convertible debentures, whichbore interest at 10% per annum in fiscal 2002 and the nine months endedJune 30, 2003, were fully repaid in June 2003.

 

Interest expense decreased $91,000 (24%) to $296,000in fiscal 2002, as compared to interest expense of $387,000 in fiscal2001.  The decrease was due to loweraverage interest rates, partially offset by higher average outstandingborrowings and a decrease in capitalized interest.  The average interest rate incurred during fiscal 2002 on Barnwell’sborrowings from the Royal Bank of Canada decreased to

 

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4.24%, as compared to 6.62% in fiscal 2001, whereasthe weighted average balance of outstanding borrowings from the Royal Bank ofCanada increased from approximately $8,300,000 in fiscal 2001 to approximately$10,300,000 in fiscal 2002.  The averageoutstanding debentures balance decreased from $950,000 in fiscal 2001 to$507,000 in fiscal 2002 while the average interest rate on the debentures remainedessentially unchanged.  Capitalizedinterest decreased $76,000 from $278,000 in fiscal 2001 to $202,000 in fiscal2002 primarily due to lower interest rates, partially offset by an increase inthe capitalization base as Barnwell carried a 77.6% interest in KaupulehuDevelopments’ leasehold interest in land under development for a full year infiscal 2002, as compared to approximately one-half year in fiscal 2001 (theadditional 27.5% interest in Kaupulehu Developments was purchased inApril 2001).

 

Foreign Currency Fluctuations

 

Inaddition to U.S. operations, Barnwell conducts foreign operations inCanada.  Consequently, Barnwell issubject to foreign currency translation and transaction gains and losses due tofluctuations of the exchange rates between the Canadian dollar and the U.S.dollar.

 

The fiscal year average exchange rate of the Canadiandollar to the U.S. dollar increased 8% in fiscal 2003, as compared to fiscal2002, and the exchange rate of the Canadian dollar to the U.S. dollar increased17% at September 30, 2003, as compared to September 30, 2002.  Accordingly, the assets, liabilities,stockholders’ equity and revenues and expenses of Barnwell’s subsidiariesoperating in Canada have increased. Barnwell’s Canadian dollar assets are greater than its Canadian dollarliabilities; therefore, increases in value of the Canadian dollar to the U.S.dollar generate other comprehensive income. Other comprehensive income due to foreign currency translation adjustmentsfor fiscal 2003 was $2,392,000, a $2,478,000 increase from an othercomprehensive loss of $86,000, due to foreign currency translation adjustments,in fiscal 2002.

 

Foreigncurrency transaction gains and losses were not material in fiscal 2003, 2002and 2001 and are reflected in general and administrative expenses.

 

Theimpact of fluctuations of the exchange rates between the Canadian dollar andthe U.S. dollar may be material from period to period.  Barnwell cannot accurately predict futurefluctuations between the Canadian and U.S. dollars.

 

Income Taxes

 

Includedin the provision for deferred income taxes for the years endedSeptember 30, 2003 and 2002 is a U.S. deferred tax benefit of $320,000 and$376,000, respectively, related to the sale of land development rights inDecember 2002 and 2001, respectively. The sales of land development rights created temporary differences dueto the excess of expenses recognized under the cost recovery method for booksover expenses deductible for tax purposes. There was no deferred income tax benefit related to land sales in theyear ended September 30, 2001.

 

In October 2003, theParliament of Canada held first and second readings on a bill to reduceCanada’s corporate tax rate on “resource” income (income derived from oil andnatural gas operations) over a four-year period beginning January 1, 2003from 29% to 21% beginning January 1, 2007.  Additionally, the bill phases in over the same four-year periodtax deductions for royalties, which previously were not tax deductible, andphases out the Resource Allowance deduction along with other changes.  In November 2003, the bill passed onthird reading, received Royal Assent and was enacted

 

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into law.  The reduction in thetax will reduce Barnwell’s deferred income tax liabilities by approximately$1,500,000 in the quarter ending December 31, 2003, Barnwell’s fiscal 2004first quarter.

 

In May 2003, thelegislative assembly of the Province of Alberta held a first reading on a billto reduce the province’s corporate tax rate from 13.0% to 12.5%, effectiveApril 1, 2003.  OnNovember 20, 2003, the bill passed on third reading and will become lawupon Royal Assent.  If enacted into lawthe reduction in the tax rate would reduce Barnwell’s current income taxliabilities by approximately $20,000 and Barnwell’s deferred income taxesliabilities by approximately $100,000.

 

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 inthe tax rate reduced Canadian deferred income tax liabilities by approximately$75,000 in the year ended September 30, 2003.  There was no such reduction recorded in the year endedSeptember 30, 2002.  During fiscal2001, the Province of Alberta reduced the province’s corporate tax rate from15.5% to 13.5% effective April 1, 2001. As a result of this reduction, Barnwell recorded an approximately$300,000 deferred income tax benefit in fiscal 2001.

 

In fiscal 2003, 2002 and 2001, the provision for income taxes did notbear a normal relationship to earnings because Canadian taxes were payable onCanadian operations and losses from U.S. operations provide no foreign taxbenefits.

 

Environmental Matters

 

Federal, state, andCanadian governmental agencies issue rules and regulations and enforce laws toprotect the environment which are often difficult and costly to comply with andwhich carry substantial penalties for failure to comply, particularly in regardto the discharge of materials into the environment.  The regulatory burden on the oil and gas industry increases itscost of doing business.  These laws,rules and regulations affect the operations of Barnwell and could have amaterial adverse effect upon the earnings or competitive position ofBarnwell.  Although Barnwell’sexperience has been to the contrary, there is no assurance that this willcontinue to be the case.

 

Inflation

 

The effect of inflationon Barnwell has generally been to increase its cost of operations, interestcost (as a substantial portion of Barnwell’s debt is at variable short-termrates of interest which tend to increase as inflation increases), general andadministrative costs and direct costs associated with oil and natural gasproduction and contract drilling operations. In the case of contract drilling, Barnwell has not been able to increaseits contract revenues to fully compensate for increased costs.  In the case of 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 AccountingPronouncements

 

In June 2001, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 143, “Accounting for Asset Retirement Obligations,” which requiresthat the fair value of a liability for an asset retirement obligation berecognized in the period in which it is incurred if a reasonable estimate offair value can be made.  The associatedasset retirement costs are to be capitalized as part of the carrying amount ofthe long-lived asset and depreciated over the

 

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life of the asset.  Theliability is accreted at the end of each period through charges to operatingexpense.  If the obligation is settledfor other than the carrying amount of the liability, Barnwell will recognize again or loss on settlement.  Theprovisions of SFAS No. 143 are effective for fiscal years beginning afterJune 15, 2002.  Barnwell adoptedSFAS No. 143 on October 1, 2002. 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.  Prior to the adoption of SFAS No. 143,obligations for asset retirements were charged to earnings at the rate ofdepletion and were included in accumulated depletion.  The impact of applying SFAS No. 143 on fiscal 2002 and 2001 netearnings would not have resulted in a material difference, and the assetretirement obligation would not have been materially different from the amountreported at September 30, 2003.

 

InNovember 2002, the FASB issued FASB Interpretation (“FIN”) No. 45,“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others.”  FIN No. 45 elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at theinception of a guarantee, a liability for the fair value of the obligationundertaken in issuing the guarantee. The initial recognition and initial measurement provisions of FIN No. 45are applicable on a prospective basis to guarantees issued or modified afterDecember 31, 2002, irrespective of the guarantor’s fiscal year-end.  The disclosure requirements are effectivefor financial statements of interim or annual periods ending afterDecember 15, 2002.  The adoption ofFIN No. 45 did not have a material effect on Barnwell’s financial condition, resultsof operations or liquidity.

 

In January 2003, theFASB issued FIN No. 46, “Consolidation of Variable Interest Entities,” whichaddresses the consolidation of variable interest entities (“VIE”) asdefined.  FIN No. 46 appliesimmediately to variable interests in VIEs created after January 31, 2003,and to variable interests in VIEs obtained after January 31, 2003.  For a variable interest in a VIE acquiredbefore February 1, 2003, FIN No. 46 can be applied no later than thebeginning of the first interim or annual reporting period beginning after June 15,2003.  The application of FIN No. 46 didnot have a material effect on Barnwell’s financial condition, results ofoperations or liquidity.

 

In December 2002,the FASB issued SFAS No. 148, “Accountingfor Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accountingfor Stock-Based Compensation,”to provide alternative methods of transition for a voluntary change to the fairvalue based method of accounting for stock-based employee compensation.  In addition, SFAS No. 148 amends thedisclosure requirements of SFAS No. 123 to require prominent disclosures inboth annual and interim financial statements about the method of accounting forstock-based employee compensation and the effect of the method used on reportedresults.  The amendments to SFAS No. 123are effective for financial statements for fiscal years ending afterDecember 15, 2002.  The requireddisclosures for interim financial statements are effective for financialreports containing condensed financial statements for interim periods beginningafter December 15, 2002.  Theadoption of SFAS No. 148 did not have a material effect on Barnwell’s financialcondition, results of operations or liquidity.

 

In April 2003, theFASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities.”  SFAS No. 149amends and clarifies accounting for derivative instruments, including certainderivative instruments embedded in other contracts, and for hedging activitiesunder SFAS No. 133.  In particular, SFASNo. 149 clarifies under what circumstances a contract with an initial netinvestment meets the characteristics of a derivative and when a derivative

 

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contains a financingcomponent that warrants special reporting in the statement of cash flows.  SFAS No. 149 is effective for contractsentered into or modified after June 30, 2003 and for hedging relationshipsdesignated after June 30, 2003. The adoption of SFAS No. 149 did not have a material impact onBarnwell’s financial condition, results of operations or liquidity.

 

In May 2003, the FASB issued SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity.”  SFAS No. 150clarifies the accounting for certain financial instruments with characteristicsof both liabilities and equity and requires that those instruments beclassified as liabilities in statements of financial position.  Previously, many of those financialinstruments were classified as equity. SFAS No. 150 is generally effective for financial instruments enteredinto or modified after May 31, 2003 and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003.  The adoption of SFAS No. 150 did not have amaterial impact on Barnwell’s financial condition, results of operations orliquidity.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash Flows, Debt and Available Credit

 

Cash flows from operations were $8,515,000 in fiscal2003, as compared to $1,448,000 in fiscal 2002, an increase of $7,067,000.  This increase was primarily due to$6,235,000 of higher operating profit generated by Barnwell’s oil and naturalgas segment as a result of higher petroleum prices, and a decrease in incometaxes paid in fiscal 2003, as compared to fiscal 2002.  Income taxes of $3,812,000 were paid infiscal 2002 (primarily related to Canadian income taxes for the year endedSeptember 30, 2001, which were paid, when due, in the first quarter offiscal 2002), as compared to $2,961,000 in fiscal 2003.

 

Cashflows used in investing activities totaled $7,749,000 in fiscal 2003, a$4,202,000 increase from $3,547,000 of cash flows used in investing activitiesin fiscal 2002.  The increase is dueprimarily to higher oil and natural gas capital expenditures in fiscal 2003, ascompared to fiscal 2002.  Payments forsuch capital expenditures increased $4,960,000 (108%) to $9,541,000 in fiscal2003, as compared to $4,581,000 in fiscal 2002.  The increase was partially offset by an $899,000 decrease incapital expenditures for investment in land project planning anddevelopment.  In fiscal 2002, $944,000of costs were capitalized for land planning and development, as compared to$45,000 in fiscal 2003.  Attainment ofzoning and development entitlements for Kaupulehu Developments’ leasehold landinterests in approximately 870 acres of land zoned for resort/residentialdevelopment was substantially complete as of the end ofDecember 2002.  Accordingly,Barnwell capitalized $45,000 of interest during the quarter endedDecember 31, 2002 and, effective January 1, 2003, Barnwell no longercapitalizes Kaupulehu Developments’ expenditures.

 

Cashflows used in financing activities amounted to $635,000 in fiscal 2003, a$905,000 decrease from $1,540,000 of cash flows used in fiscal 2002.  In fiscal 2002, Barnwell paid the $2,209,000of notes payable due on the acquisition of an additional 27.5% interest inKaupulehu Developments, borrowed $1,711,000 under the Royal Bank of Canadafacility, paid $394,000 in dividends, paid $370,000 on its convertibledebentures, and distributed $278,000 to Kaupulehu Developments’ minorityinterest partners.  In fiscal 2003,Barnwell repaid in full the remaining $360,000 of its convertible debenturesand distributed $275,000 to Kaupulehu Developments’ minority interest partners;there were

 

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no note payments related to the acquisition of anadditional 27.5% interest in Kaupulehu Developments, long-term debt borrowingsor dividend payments in fiscal 2003.

 

While Barnwell had no long-term debt borrowings infiscal 2003, a 17% increase in the exchange rate of the Canadian dollar to theU.S. dollar increased the amount of Canadian dollar denominated debt by U.S.$516,000 at September 30, 2003, as compared to September 30, 2002.

 

At September 30, 2003, Barnwell had consolidatedcash and cash equivalents of $1,648,000, a working capital deficit of$3,637,000, and available credit under the Royal Bank of Canada’s revolvingcredit facility of approximately $3,500,000.

 

TheRoyal Bank of Canada renewed Barnwell’s credit facility unchanged at$19,000,000 Canadian dollars, or approximately $14,000,000 U.S. dollars atSeptember 30, 2003, and extended the revolving period one year toApril 29, 2004.  If the loan isconverted to a term loan, the term period payments are as follows: first yearof the term period – 20% (5% per quarter), and in the second year of the termperiod – 80% (5% per quarter for the first three quarters and 65% in the finalquarter). Outstanding borrowings under this facility were $10,477,000 and$9,961,000 at September 30, 2003 and 2002, respectively, and are includedin long-term debt.

 

The bank represented that it will not require anyrepayments under the facility before October 1, 2004.  Accordingly, Barnwell has classifiedoutstanding borrowings under the facility as long-term debt.

 

Barnwellbelieves its current cash balances, future cash flows from operations, landsegment sales, collection of receivables, and available credit will besufficient to fund its estimated capital expenditures and meet the repaymentschedule on its long-term debt. However, if oil and natural gas production remains at or declines fromcurrent levels or oil and natural gas prices decline from current levels,current working capital balances and cash flows generated by operations may notbe sufficient to fund Barnwell’s current projected level of oil and natural gascapital expenditures, in which case Barnwell may fund capital expenditures withfunds generated by land segment sales, long-term debt borrowings, or it mayreduce future oil and natural gas capital expenditures.  Additionally, if Barnwell’s credit facilitywith a Canadian bank is reduced below the current level of borrowings under thefacility after the April 2004 review, Barnwell may be required to reduceexpenditures or seek alternative sources of financing to make any requiredpayments under the facility.

 

Partial Exercise of Development Rights Option

 

On December 31, 2002 and 2001, Kaupulehu MakaiVenture exercised the portion of its development rights option due on thosedates and paid Kaupulehu Developments $2,125,000 on each date.  Barnwell accounts for sales of developmentrights under option under the cost recovery method where no operating profit isrecognized until cash received exceeds costs and estimated future costsassociated with the development rights. In fiscal 2003, the remaining $1,277,000 balance of investment in landassociated with development rights was reduced to zero and net revenues fromthe sale of development rights exceeded the amount of investment in landexpensed and resulted in $280,000 of operating profit, after minority interest,as a result of the option exercise.  Infiscal 2002, $1,877,000 of investment in land was expensed as a result of thisoption exercise, reducing operating profit, after minority interest, to zero.

 

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The total amount of the remaining option proceeds, iffully exercised, was $21,250,000 at September 30, 2003, comprised of eightpayments of $2,656,250 due on each December 31 of years 2003 to 2010.  If any annual option payment is not made,the then remaining development right options will expire.  There is no assurance that any portion ofthe remaining options will be exercised.

 

Leasehold Land Interests

 

Kaupulehu Developments isnegotiating with an independent party interested in developing theapproximately 870 acres of resort/residential leasehold acreage (of whichapproximately 186 acres were designated by the State Land Use Commission aspreservation areas with no residential or golf course development).  The independent third party and KaupulehuDevelopments have made significant progress in negotiation of a reviseddevelopment agreement and residential fee simple purchase prices with thelessor.  Management cannot predict the outcome of these negotiations.

 

Acquisition of Additional Interest In KaupulehuDevelopments

 

On January 31, 2002, Barnwell paid the remaining$2,209,000 due on the April 2001 purchase of the additional 27.5% interestin Kaupulehu Developments.  Also, onJanuary 31, 2002, Nearco, Inc. repaid $100,000 of its notes payable toBarnwell and Barnwell extended the due date of the $1,381,000 balance of itsoriginal $1,481,000 receivable to December 31, 2002.  Nearco, Inc. paid all interest due andpayable at December 31, 2002 of $58,000 and repaid approximately $70,000of principal on its note payable to Barnwell in January 2003 leaving anunpaid principal balance of approximately $1,311,000, which is outstanding asof the date of this filing.  Under theterms of the note, the note is in default and the rate of interest increasedfrom 10% to 12% on January 1, 2003. Nearco, Inc. has paid interest on the note through September 30,2003.  Management believes that Nearco,Inc. will repay its note and any interest due in full.  The note is secured by Nearco, Inc.’s entireinterest in Cambridge Hawaii Limited Partnership, with its principal assetbeing a 49.9% interest in Kaupulehu Developments.  Management estimates that the current value of Nearco, Inc.’spledged interest in Kaupulehu Developments is significantly in excess of thecombined value of its note to Barnwell and Nearco, Inc.’s $450,000 note to athird party to which Barnwell’s note is subordinated.

 

Capital Expenditures

 

The following table setsforth Barnwell’s capital expenditures, including accrued capital expenditurecommitments, for each of the last three fiscal years:

 
|                                                                               |   | **2003**    |           | **2002** |   | **2001**  |   |
|------------------------------------------------------------------------------------|--------|-------------|----------------|----------|--------|-----------|--------|
| Oil  and natural gas                                                               |   | **$**       | **11,059,000** |     | $      | 4,581,000 |   | $ | 4,240,000 |   |
| Land  investment                                                                   |   | **45,000**  |           | 944,000  |   | 5,954,000 |   |
| Contract  drilling                                                                 |   | **72,000**  |           | 77,000   |   | 84,000    |   |
| Other                                                                              |   | **158,000** |           | 42,000   |   | 180,000   |   |
| Total  capital expenditures                                                        |   | **$**       | **11,334,000** |     | $      | 5,644,000 |   | $ | 10,458,000 |   |
|                                                                               |   |        |           |     |   |      |   |
| Increase  (decrease) in oil  and natural gas capital  expenditures from prior year |   | **$**       | **6,478,000**  |     | $      | 341,000   |   | $ | (763,000 | ) |

 

 

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Oiland natural gas properties also increased $648,000 in fiscal 2003 due to the adoption of SFAS No. 143 effectiveOctober 1, 2002.  The effect ofadoption of SFAS No. 143 is not included in the $11,059,000 of fiscal 2003 oiland natural gas capital expenditures shown above.

 

Landinvestment capital expenditures in 2001 include $5,000,000 for the purchase ofthe additional 27.5% interest in Kaupulehu Developments.  Barnwell paid $2,791,000 in cash and issued$2,209,000 in non-interest bearing promissory notes.

 

Infiscal 2003, Barnwell’s oil and natural gas capital expenditures increased$6,478,000 (141%) from $4,581,000 in fiscal 2002 to $11,059,000 in fiscal2003.  Barnwell participated in drilling65 (14.7 net) wells, 53 (11.1 net) of which were successful, and therecompletion of 10 wells (1.8 net wells), and replaced 44% of oil production(including natural gas liquids) and 115% of natural gas production. The majorareas of investments and commitments in fiscal 2003 were in the Leduc, Bonanza,Dunvegan, Progress, Pouce Coupe South, and Bashaw areas of Alberta.  In these areas, Barnwell drilled successfulwells that have been tied in and commenced production during the year endedSeptember 30, 2003.  In theDunvegan area, Barnwell participated in the drilling of 12 gross developmentwells (one net development well) as part of the operator’s objective ofincreasing production from the area. Barnwell operated and supervised the drilling of six wells in 2003 andsix wells in 2002.  Of the $11,059,000total oil and natural gas properties investments and commitments for fiscal2003, $1,390,000 was for acquisition of leases and lease rentals, $917,000 wasfor geological and geophysical costs, $5,857,000 was for intangible drillingcosts, and $2,895,000 was for well equipment.

 

The following table sets forth the gross and netnumbers of oil and natural gas wells Barnwell participated in drilling andpurchased for each of the last three fiscal years:

 
|                                            |   | **2003**  |       | **2002**  |   | **2001**  |   |
|-------------------------------------------------|--------|-----------|------------|-----------|--------|-----------|--------|
|                                            |   | **Gross** |       | **Net**   |   | **Gross** |   | **Net** |   | **Gross** |   | **Net** |   |
| Exploratory  oil and natural  gas wells drilled |   | **13**    | ** ** | **3.60**  |   | 5         |   | 0.94 |   | 4 |   | 1.40 |   |
|                                            |   |      |       |      |   |      |   |   |   |   |   |   |   |
| Development  oil and natural  gas wells drilled |   | **52**    | ** ** | **11.10** |   | 11        |   | 4.52 |   | 26 |   | 4.40 |   |
|                                            |   |      |       |      |   |      |   |   |   |   |   |   |   |
| Successful  oil and natural  gas wells drilled  |   | **53**    | ** ** | **11.10** |   | 12        |   | 4.19 |   | 23 |   | 3.20 |   |

 

Barnwell estimates that oil and natural gas capitalexpenditures for fiscal 2004 will range from $9,500,000 to $12,500,000.  This estimated amount may increase ordecrease as dictated by management’s assessment of the oil and gas environmentand prospects.

 

In fiscal 2003, $45,000 of Barnwell’s capitalexpenditures were applicable to capitalized interest on development ofKaupulehu Developments’ leasehold land interests in approximately 870 acres ofland zoned for resort/residential development. Attainment of zoning and development entitlements for the approximately870 acres was substantially complete as of the end of December 2002,therefore, effective January 1, 2003, Barnwell no longer capitalizesKaupulehu Developments’ expenditures and no longer capitalizes interest on theaccumulated development costs of the property. In fiscal 2002, $944,000 of Barnwell’s capital expenditures wereapplicable to investment in land project planning and development.  These expenditures were primarily comprisedof legal, consulting, and planning fees and capitalized interest.

 

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Item 7.            FINANCIAL STATEMENTS

 

**Independent Auditors’ Report**

** **

The Board of DirectorsBarnwell Industries, Inc.:

 

We have auditedthe consolidated balance sheets of Barnwell Industries, Inc. and subsidiariesas of September 30, 2003 and 2002, and the related consolidated statementsof operations, stockholders’ equity and comprehensive income (loss), and cashflows for each of the years in the three-year period ended September 30,2003. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

 

We conducted our auditsin accordance with auditing standards generally accepted in the United Statesof America. Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Barnwell Industries, Inc. andsubsidiaries as of September 30, 2003 and 2002, and the results of theiroperations and their cash flows for each of the years in the three-year periodended September 30, 2003, in conformity with accounting principles generallyaccepted in the United States of America.

 

As discussed in note 2 tothe consolidated financial statements, effective October 1, 2002, theCompany changed its method of accounting for asset retirement obligations.

 
|  /s/KPMG LLP                                    |   |   |
|------------------------------------------------------|--------|--------|
|                                                 |   |
| Honolulu, Hawaii                                     |   |
| December 2, 2003,  except as to notes 11 and 16 |   |
| which  are as of December 23, 2003              |   |

 

 

37

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS

 
|                                                                                   |   | **September 30,** |           |
|----------------------------------------------------------------------------------------|--------|------------------------|----------------|
|                                                                                   |   | **2003**               |           | **2002** |   |
| ASSETS                                                                                 |   |                   |           |   |   |
| CURRENT ASSETS:                                                                        |   |                   |           |   |   |
| Cash  and cash equivalents                                                             |   | **$**                  | **1,648,000**  | ** ** | $ | 1,489,000 |   |
| Accounts  receivable, net (Notes 3 and 14)                                             |   | **2,866,000**          | ** **     | 3,031,000 |   |
| Note  receivable (Note 4)                                                              |   | **1,311,000**          | ** **     | 1,381,000 |   |
| Costs  and estimated earnings in excess of billings on uncompleted contracts (Note  3) |   | **166,000**            | ** **     | 174,000 |   |
| Deferred  income taxes (Note 8)                                                        |   | **215,000**            | ** **     | 210,000 |   |
| Prepaid  expenses and other current assets                                             |   | **675,000**            | ** **     | 821,000 |   |
| TOTAL  CURRENT ASSETS                                                                  |   | **6,881,000**          | ** **     | 7,106,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| INVESTMENT  IN LAND (Notes 5 and 7)                                                    |   | **6,508,000**          | ** **     | 7,740,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| PROPERTY  AND EQUIPMENT, NET (Notes 6, 7 and 16)                                       |   | **38,948,000**         | ** **     | 25,828,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| TOTAL  ASSETS                                                                          |   | **$**                  | **52,337,000** | ** ** | $ | 40,674,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                             |   |                   | ** **     |   |   |
| CURRENT  LIABILITIES:                                                                  |   |                   | ** **     |   |   |
| Accounts  payable                                                                      |   | **$**                  | **3,357,000**  | ** ** | $ | 2,995,000 |   |
| Accrued  liabilities                                                                   |   | **6,082,000**          | ** **     | 3,367,000 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts (Note 3)  |   | **29,000**             | ** **     | 114,000 |   |
| Payable  to joint interest owners                                                      |   | **608,000**            | ** **     | 727,000 |   |
| Income  taxes payable (Note 8)                                                         |   | **442,000**            | ** **     | — |   |
| Current  portion of long-term debt (Note 7)                                            |   | **—**             | ** **     | 360,000 |   |
| TOTAL  CURRENT LIABILITIES                                                             |   | **10,518,000**         | ** **     | 7,563,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| LONG-TERM  DEBT (Notes 7 and 16)                                                       |   | **10,477,000**         | ** **     | 9,961,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| ASSET  RETIREMENT OBLIGATION                                                           |   | **1,432,000**          | ** **     | — |   |
|                                                                                   |   |                   | ** **     |   |   |
| DEFERRED  INCOME TAXES (Notes 8 and 16)                                                |   | **9,443,000**          | ** **     | 7,429,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| MINORITY  INTEREST (Note 5)                                                            |   | **834,000**            | ** **     | 800,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| COMMITMENTS  AND CONTINGENCIES                                                         |   |                   | ** **     |   |   |
| (Notes  5, 9, 10, 11 and 16)                                                           |   |                   | ** **     |   |   |
|                                                                                   |   |                   | ** **     |   |   |
| STOCKHOLDERS’  EQUITY (Notes 7, 10 and 16):                                       |   |                   | ** **     |   |   |
| Common  stock, par value $0.50 per share:                                              |   |                   | ** **     |   |   |
| Authorized,  4,000,000 shares; issued, 1,642,797 shares; outstanding, 1,314,510 shares |   | **821,000**            | ** **     | 821,000 |   |
| Additional  paid-in capital                                                            |   | **3,139,000**          | ** **     | 3,139,000 |   |
| Retained  earnings                                                                     |   | **22,018,000**         | ** **     | 19,698,000 |   |
| Accumulated  other comprehensive loss - foreign currency translation adjustments       |   | **(1,491,000**         | **)**          | (3,883,000 | ) |
| Treasury  stock, at cost, 328,287 shares                                               |   | **(4,854,000**         | **)**          | (4,854,000 | ) |
| TOTAL  STOCKHOLDERS’ EQUITY                                                       |   | **19,633,000**         | ** **     | 14,921,000 |   |
|                                                                                   |   |                   | ** **     |   |   |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                       |   | **$**                  | **52,337,000** | ** ** | $ | 40,674,000 |   |

 

See Notes toConsolidated Financial Statements

 

38

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BARNWELLINDUSTRIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTSOF OPERATIONS

 
|                                                   |   | **Year ended September 30,** |           |
|--------------------------------------------------------|--------|---------------------------------------------|----------------|
|                                                   |   | **2003**                                    |           | **2002** | ** ** | **2001** | ** ** |
| Revenues:                                              |   |                                        |           |   |   |   |   |
| Oil  and natural gas                                   |   | **$**                                       | **19,350,000** |   | $ | 11,320,000 |   | $ | 19,870,000 |   |
| Contract  drilling                                     |   | **2,050,000**                               |           | 3,480,000 |   | 3,290,000 |   |
| Gas  processing and other                              |   | **1,560,000**                               |           | 960,000 |   | 930,000 |   |
| Sale  of development rights, net (Note 5)              |   | **720,000**                                 |           | 120,000 |   | — |   |
|                                                   |   | **23,680,000**                              |           | 15,880,000 |   | 24,090,000 |   |
|                                                   |   |                                        |           |   |   |   |   |
| Costs  and expenses:                                   |   |                                        |           |   |   |   |   |
| Oil  and natural gas operating                         |   | **4,192,000**                               |           | 3,108,000 |   | 3,509,000 |   |
| Contract  drilling operating                           |   | **1,928,000**                               |           | 2,821,000 |   | 2,906,000 |   |
| General  and administrative                            |   | **5,971,000**                               |           | 4,344,000 |   | 4,121,000 |   |
| Depreciation,  depletion and amortization              |   | **4,333,000**                               |           | 3,648,000 |   | 3,754,000 |   |
| Interest  expense, net (Note 7)                        |   | **442,000**                                 |           | 296,000 |   | 387,000 |   |
| Minority  interest in earnings (Note 5)                |   | **309,000**                                 |           | 62,000 |   | 8,000 |   |
|                                                   |   |                                        |           |   |   |   |   |
|                                                   |   | **17,175,000**                              |           | 14,279,000 |   | 14,685,000 |   |
|                                                   |   |                                        |           |   |   |   |   |
| Earnings  before income taxes                          |   | **6,505,000**                               |           | 1,601,000 |   | 9,405,000 |   |
|                                                   |   |                                        |           |   |   |   |   |
| Provision  for income taxes (Note 8)                   |   | **4,185,000**                               |           | 1,561,000 |   | 5,575,000 |   |
|                                                   |   |                                        |           |   |   |   |   |
| NET  EARNINGS                                          |   | **$**                                       | **2,320,000**  |   | $ | 40,000 |   | $ | 3,830,000 |   |
|                                                   |   |                                        |           |   |   |   |   |
| BASIC  EARNINGS PER COMMON SHARE                       |   | **$**                                       | **1.76**       |   | $ | 0.03 |   | $ | 2.92 |   |
| DILUTED  EARNINGS PER COMMON SHARE                     |   | **$**                                       | **1.69**       |   | $ | 0.03 |   | $ | 2.82 |   |
|                                                   |   |                                        |           |   |   |   |   |
| WEIGHTED  AVERAGE NUMBER OF COMMON SHARES OUTSTANDING: |   |                                        |           |   |   |   |   |
| BASIC                                                  |   | **1,314,510**                               |           | 1,313,915 |   | 1,310,952 |   |
|                                                   |   |                                        |           |   |   |   |   |
| DILUTED                                                |   | **1,369,595**                               |           | 1,357,181 |   | 1,390,798 |   |

 

See Notes toConsolidated Financial Statements

 

39

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BARNWELLINDUSTRIES, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTSOF CASH FLOWS

 
|                                                                                                                       |   | **Year ended September 30,** |          |
|----------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------|---------------|
|                                                                                                                       |   | **2003**                                    |          | **2002** | ** ** | **2001** | ** ** |
| Cash  flows from operating activities:                                                                                     |   |                                        | ** **    |   |   |   |   |
| Net  earnings                                                                                                              |   | **$**                                       | **2,320,000** | ** ** | $ | 40,000 |   | $ | 3,830,000 |   |
| Adjustments  to reconcile net earnings to net cash provided by operating activities:                                       |   |                                        | ** **    |   |   |   |   |
| Depreciation,  depletion and amortization                                                                                  |   | **4,333,000**                               | ** **    | 3,648,000 |   | 3,754,000 |   |
| Deferred income taxes                                                                                            |   | **709,000**                                 | ** **    | 405,000 |   | 154,000 |   |
| Minority  interest in earnings                                                                                             |   | **309,000**                                 | ** **    | 62,000 |   | 8,000 |   |
| Accretion  of asset retirement obligation                                                                                  |   | **85,000**                                  | ** **    | — |   | — |   |
| Sale of development rights, net                                                                        |   | **(720,000**                                | **)**         | (120,000 | ) | — |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
|                                                                                                                       |   | **7,036,000**                               |          | 4,035,000 |   | 7,746,000 |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Increase (decrease) from changes in  current assets and liabilities (Note 15) |   | **1,479,000**                               | ** **    | (2,587,000 | ) | 2,412,000 |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Net cash provided by operating activities                                                         |   | **8,515,000**                               | ** **    | 1,448,000 |   | 10,158,000 |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Cash flows from investing activities:                                                                  |   |                                        | ** **    |   |   |   |   |
| Proceeds from sale of development rights, net                                                |   | **1,997,000**                               | ** **    | 1,997,000 |   | — |   |
| Proceeds  from collection of notes receivable                                                                              |   | **70,000**                                  | ** **    | 100,000 |   | — |   |
| Capital expenditures                                                                                                  |   | **(9,816,000**                              | **)**         | (5,644,000 | ) | (5,458,000 | ) |
| Investment  in Cambridge Hawaii Limited Partnership                                                                        |   | **—**                                  | ** **    | — |   | (2,791,000 | ) |
| Cash  advanced in exchange for notes receivable                                                                            |   | **—**                                  | ** **    | — |   | (1,481,000 | ) |
| Proceeds from sale of property and equipment                                                 |   | **—**                                  | ** **    | — |   | 8,000 |   |
| Decrease  in other assets                                                                                        |   | **—**                                  | ** **    | — |   | 57,000 |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Net cash used in  investing activities                                                                 |   | **(7,749,000**                              | **)**         | (3,547,000 | ) | (9,665,000 | ) |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Cash flows from financing activities:                                                                  |   |                                        | ** **    |   |   |   |   |
| Repayments of long-term debt                                                                                |   | **(360,000**                                | **)**         | (370,000 | ) | (400,000 | ) |
| Distribution to minority interest partners                                                             |   | **(275,000**                                | **)**         | (278,000 | ) | — |   |
| Payment of dividends                                                                                             |   | **—**                                  | ** **    | (394,000 | ) | (459,000 | ) |
| Repayments  of notes payable                                                                                               |   | **—**                                  | ** **    | (2,209,000 | ) | — |   |
| Long-term debt borrowings                                                                                        |   | **—**                                  | ** **    | 1,711,000 |   | — |   |
| Purchases of common stock for treasury                                                            |   | **—**                                  | ** **    | — |   | (20,000 | ) |
| Proceeds  from exercise of stock options                                                                                   |   | **—**                                  | ** **    | — |   | 13,000 |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Net cash used in financing activities                                                             |   | **(635,000**                                | **)**         | (1,540,000 | ) | (866,000 | ) |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                      |   | **28,000**                                  | ** **    | (26,000 | ) | (174,000 | ) |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Net increase (decrease) in  cash and cash equivalents                                        |   | **159,000**                                 | ** **    | (3,665,000 | ) | (547,000 | ) |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Cash and cash equivalents at beginning of year                                          |   | **1,489,000**                               | ** **    | 5,154,000 |   | 5,701,000 |   |
|                                                                                                                       |   |                                        | ** **    |   |   |   |   |
| Cash and cash equivalents at end of year                                                |   | **$**                                       | **1,648,000** | ** ** | $ | 1,489,000 |   | $ | 5,154,000 |   |

 

See Notes to Consolidated Financial Statements

 

40

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME(LOSS)

Years ended September 30, 2003,2002 and 2001

 
|                                                                                           |   | **Common  Stock** |    | **Additional  Paid-In  Capital** | ** ** | **Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** |      |
|------------------------------------------------------------------------------------------------|--------|-------------------|---------|----------------------------------|------------|---------------------------|------------|------------------------|------------|---------------------------------------------|------------|---------------------|------------|---------------------------------------|-----------|
| Balance at September 30, 2000                                                   |   | $                 | 821,000 |                             | $          | 3,103,000                 |       |                   |       | $                                           | 16,680,000 |                | $          | (3,048,000                            | )         | $ | (4,882,000 | ) | $ | 12,674,000 |   |
|                                                                                           |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
|                                                                                           |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
| Exercise of stock options, 1,000 shares                                                        |   |              |    | 2,000                            |       |                      |       |                   |       |                                        |       | 11,000              |       | 13,000                                |      |
|                                                                                           |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
| Purchase of 1,000 common shares for treasury                                                   |   |              |    |                             |       |                      |       |                   |       |                                        |       | (20,000             | )          | (20,000                               | )         |
|                                                                                           |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
| Dividends declared ($0.50 per share)                                                      |   |              |    |                             |       |                      |       | (655,000               | )          |                                        |       |                |       | (655,000                              | )         |
|                                                                                           |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
| Comprehensive income:                                                                          |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
| Net earnings                                                                                   |   |              |    |                             |       | $                         | 3,830,000  |                   | 3,830,000  |                                        |       |                |       |                                  | 3,830,000 |   |
| Other comprehensive loss, net of income taxes –  foreign currency translation adjustments |   |              |    |                             |       | (749,000                  | )          |                   |       | (749,000                                    | )          |                |       | (749,000                              | )         |
| Total comprehensive income                                                                     |   |              |    |                             |       | $                         | 3,081,000  |                   |       |                                        |       |                |       |                                  |      |   |
|                                                                                           |   |              |    |                             |       |                      |       |                   |       |                                        |       |                |       |                                  |      |
| At September 30, 2001                                                                     |   | $                 | 821,000 |                             | $          | 3,105,000                 |       |                   |       | $                                           | 19,855,000 |                | $          | (3,797,000                            | )         | $ | (4,891,000 | ) | $ | 15,093,000 |   |

 

(Continued on next page)

 

41

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME(LOSS)

Years ended September 30,2003, 2002 and 2001

(Continued from previouspage)

 
|                                                                                           |   | **Common  Stock** |    | **Additional  Paid-In  Capital** | ** ** | **Comprehensive  Loss** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Treasury  Stock** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|------------------------------------------------------------------------------------------------|--------|-------------------|---------|----------------------------------|------------|-------------------------|------------|------------------------|------------|---------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
| Balance at September 30, 2001                                                             |   | $                 | 821,000 |                             | $          | 3,105,000               |       |                   |       | $                                           | 19,855,000 |                | $          | (3,797,000                            | )          | $ | (4,891,000 | ) | $ | 15,093,000 |   |
|                                                                                           |   |              |    |                             |       |                    |       |                   |       |                                        |       |                |       |                                  |       |
| Conversion of debentures to common stock at $20.00  per share                                  |   |              |    | 34,000                           |       |                    |       |                   |       |                                        |       | 37,000              |       | 71,000                                |       |
|                                                                                           |   |              |    |                             |       |                    |       |                   |       |                                        |       |                |       |                                  |       |
| Dividends declared ($0.15 per share)                                                      |   |              |    |                             |       |                    |       | (197,000               | )          |                                        |       |                |       | (197,000                              | )          |
|                                                                                           |   |              |    |                             |       |                    |       |                   |       |                                        |       |                |       |                                  |       |
| Comprehensive loss:                                                                            |   |              |    |                             |       |                    |       |                   |       |                                        |       |                |       |                                  |       |
| Net earnings                                                                                   |   |              |    |                             |       | $                       | 40,000     |                   | 40,000     |                                        |       |                |       |                                  | 40,000     |   |
| Other comprehensive loss, net of income taxes –  foreign currency translation adjustments |   |              |    |                             |       | (86,000                 | )          |                   |       | (86,000                                     | )          |                |       | (86,000                               | )          |
| Total comprehensive loss                                                                       |   |              |    |                             |       | $                       | (46,000    | )                      |       |                                        |       |                |       |                                  |       |   |
|                                                                                           |   |              |    |                             |       |                    |       |                   |       |                                        |       |                |       |                                  |       |
| At September 30, 2002                                                                     |   | $                 | 821,000 |                             | $          | 3,139,000               |       |                   |       | $                                           | 19,698,000 |                | $          | (3,883,000                            | )          | $ | (4,854,000 | ) | $ | 14,921,000 |   |

 

See Notes to Consolidated Financial Statements

 

42

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BARNWELL INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME(LOSS)

Years ended September 30,2003, 2002 and 2001

(Continued from previouspage)

 
|                                                                                             |   | **Common  Stock** |        | **Additional  Paid-In  Capital** |   | **Comprehensive  Income** |       | **Retained  Earnings** |       | **Accumulated  Other  Comprehensive  Loss** |           | **Treasury  Stock** |   | **Total  Stockholders’  Equity** |      |
|--------------------------------------------------------------------------------------------------|--------|-------------------|-------------|----------------------------------|--------|---------------------------|------------|------------------------|------------|---------------------------------------------|----------------|---------------------|--------|---------------------------------------|-----------|
| Balance at September 30, 2002                                                               |   | $                 | 821,000     |                             | $      | 3,139,000                 |       |                   |       | $                                           | 19,698,000     |                | $      | (3,883,000                            | )         | $ | (4,854,000 | ) | $ | 14,921,000 |   |
|                                                                                             |   |              |        |                             |   |                      |       |                   |       |                                        |           |                |   |                                  |      |
| 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**                                                                   |   | **$**             | **821,000** | ** **                       | **$**  | **3,139,000**             | ** ** |                   | ** ** | **$**                                       | **22,018,000** |                | **$**  | **(1,491,000**                        | **)**     | **$** | **(4,854,000** | **)** | **$** | **19,633,000** | ** ** |

 

See Notes to Consolidated Financial Statements

 

43

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BARNWELL INDUSTRIES, INC.

 

AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

YEARS ENDED SEPTEMBER 30, 2003, 2002 AND 2001

 

1.             DESCRIPTION OF THE REPORTINGENTITY AND BUSINESS

 

The consolidated financial statements include theaccounts of Barnwell Industries, Inc. and all majority-owned subsidiaries,including an indirect 77.6%-owned land development general partnership,(collectively referred to herein as “Barnwell”).  All significant intercompany accounts and transactions have beeneliminated.

 

During its last three fiscal years, Barnwell wasengaged in exploring for, developing, producing and selling oil and natural gasin Canada, investing in leasehold land in Hawaii, and drilling wells andinstalling and repairing water pumping systems in Hawaii.  Barnwell’s oil and natural gas activitiescomprise its largest business segment. Approximately 82% of Barnwell’s revenues and 98% of Barnwell’s capitalexpenditures for the fiscal year ended September 30, 2003 wereattributable to its oil and natural gas activities.  Barnwell’s contract drilling activities accounted for 9% ofBarnwell’s fiscal 2003 revenues, land investment activities comprised 5% offiscal 2003 revenues, and gas processing and other revenues comprised 4% offiscal 2003 revenues.

 

2.             SIGNIFICANT ACCOUNTING POLICIES

 

Cash and cash equivalents

 

Cash and cash equivalentsinclude cash on hand, demand deposits and short-term investments with originalmaturities of three months or less.

 

Trade Accounts Receivable

 

Trade accounts receivable are recorded at the invoicedamount and do not bear interest.  Theallowance for doubtful accounts is Barnwell’s best estimate of the amount ofprobable credit losses in Barnwell’s existing accounts receivable and is basedon historical write-off experience. Account balances are charged off against the allowance after all meansof collection have been exhausted and the potential for recovery is consideredremote.  Barnwell does not have anyoff-balance sheet credit exposure related to its customers.

 

Oil and natural gasproperties

 

Barnwell uses the full cost method of accounting underwhich all costs incurred in the acquisition, exploration and development of oiland natural gas reserves, including unsuccessful wells, are capitalized untilsuch time as the aggregate of such costs, on a country-by-country basis, equalsthe discounted present value (at 10%) of Barnwell’s estimated future net cashflows from estimated production of proved oil and natural gas reserves, asdetermined by independent petroleum engineers, less related income taxeffects.  Any capitalized costs, net ofoil and gas related deferred income taxes,

 

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in excess of the discounted present value of proved properties and thelower of cost or estimated fair value of unproved properties are charged toexpense.  Depletion of all such costs,except costs related to major development projects, is provided by theunit-of-production method based upon proved oil and natural gas reserves of allproperties on a country-by-country basis. Investments in major development projects are not amortized until eitherproved reserves are associated with the projects or impairment has been determined.  At September 30, 2003, Barnwell had noinvestments in major oil and natural gas development projects that were notbeing amortized.  General andadministrative costs related to oil and natural gas operations are expensed asincurred.  Estimated future siterestoration and abandonment costs are capitalized as part of the carryingamount of oil and natural gas properties and depleted over the life of therelated reserves.  Proceeds from thedisposition of minor producing oil and natural gas properties are credited tothe cost of oil and natural gas properties. Gains or losses are recognized on the disposition of significant oil andnatural gas properties.

 

Investment in land andrevenue recognition

 

Barnwell’s investment inland is comprised of development rights under option and leasehold landinterests in land zoned resort/residential and land zoned conservation, both ofwhich are not under option.  Investmentin land is reported at the lower of the asset carrying value or fair value,less costs to sell, and is evaluated for impairment whenever events or changesin circumstances indicate that the recorded investment balance may not be fullyrecoverable.

 

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

 

Sales of developmentrights under option 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.

 

Contract drilling

 

Revenues, costs andprofits applicable to contract drilling contracts are included in theconsolidated statements of operations using the percentage of completionmethod, principally measured by the percentage of labor dollars incurred todate for each contract to total estimated labor dollars for each contract.  Contract losses are recognized in full inthe period the losses are identified. The performance of drilling contracts may extend over more than one yearand, in the interim periods, estimates of total contract costs and profits areused to determine revenues and profits earned for reporting the results of thecontract drilling operations.  Revisionsin the estimates required by subsequent performance and final contractsettlements are included as adjustments to the results of operations in theperiod such revisions and settlements occur. Contracts are normally less than one year in duration.

 

Long-lived assets

 

Long-lived assets to beheld and 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

 

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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, otherproperty and equipment are stated at cost. Depreciation is computed using the straight-line method based on estimateduseful lives ranging from three to ten years.

 

Inventories

 

Inventories are comprisedof drilling 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 thedisposal or 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 RetirementObligation

 

On October 1, 2002,Barnwell adopted Statement ofFinancial Accounting Standards (“SFAS”) No. 143, “Accounting for AssetRetirement Obligations,” which requires that the fair value of a liability foran asset retirement obligation be recognized in the period in which it isincurred if a reasonable estimate of fair value can be made.  Barnwell’s estimated site restoration andabandonment costs of its oil and natural gas properties are capitalized as partof the carrying amount of oil and natural gas properties and depleted over thelife of the related reserves.  Adoptionof SFAS No. 143 increased gross oil and natural gas properties by $564,000,decreased accumulated depletion by $546,000, and increased the asset retirementobligation by $1,110,000 on October 1, 2002.  The liability is accreted at the end of each period throughcharges to oil and natural gas operating expense.  If the obligation is settled for other than the carrying amountof the liability, Barnwell will recognize a gain or loss on settlement.

 

Priorto the adoption of SFAS No. 143, obligations for asset retirements were chargedto earnings at the rate of depletion and were included in accumulateddepletion.  The impact of applying SFASNo. 143 on fiscal 2002 and 2001 net earnings would not have resulted in amaterial difference, and the asset retirement obligation would not have beenmaterially different from the amount reported at September 30, 2003.

 

Following the initialimplementation of SFAS No. 143, the asset retirement obligation was increasedduring the year ended September 30, 2003 by $39,000 to reflect obligationsincurred on new wells drilled, by $85,000 for accretion of the asset retirementobligation, and by $198,000 for changes in foreign currency translation rates.

 

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Income taxes

 

Deferred income taxes aredetermined using the asset and liability method.  Deferred tax assets and liabilities are recognized for theestimated future tax consequences attributable to differences between thefinancial statement carrying amounts of existing assets and liabilities andtheir respective tax bases.  Deferredtax assets and liabilities are measured using enacted tax rates in effect forthe year 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

 

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.

 

Reconciliationsbetween the numerator and denominator of the basic and diluted earnings pershare computations for the years ended September 30, 2003, 2002 and 2001are as follows:

 
|                                                       |   | **September 30,  2003**   |          |
|------------------------------------------------------------|--------|--------------------------------|---------------|
|                                                       |   | **Net  Earnings  (Numerator)** |          | **Shares  (Denominator)** |   | **Per-Share  Amount** |   |
| Basic  earnings per share                                  |   | **$**                          | **2,320,000** | ** ** | **1,314,510** | ** ** | **$** | **1.76** |   |
| Effect  of dilutive securities – common stock options |   | **—**                     | ** **    | **55,085** | ** ** |   |   |
| Diluted  earnings per share                                |   | **$**                          | **2,320,000** | ** ** | **1,369,595** | ** ** | **$** | **1.69** |   |

 
|                                                       |   | **September 30,  2002**   |   |
|------------------------------------------------------------|--------|--------------------------------|--------|
|                                                       |   | **Net  Earnings  (Numerator)** |   | **Shares  (Denominator)** |   | **Per-Share  Amount** |   |
| Basic  earnings per share                                  |   | $                              | 40,000 |   | 1,313,915 |   | $ | 0.03 |   |
| Effect  of dilutive securities – common stock options |   | —                         |   | 43,266 |   |   |   |
| Diluted  earnings per share                                |   | $                              | 40,000 |   | 1,357,181 |   | $ | 0.03 |   |

 
|                            |   | **September 30,  2001**   |      |
|---------------------------------|--------|--------------------------------|-----------|
|                            |   | **Net  Earnings  (Numerator)** |      | **Shares  (Denominator)** |   | **Per-Share  Amount** |   |
| Basic  earnings per share       |   | $                              | 3,830,000 |   | 1,310,952 |   | $ | 2.92 |   |
| Effect  of dilutive securities: |   |                           |      |   |   |   |   |
| Common  stock options           |   | —                         |      | 39,846 |   |   |   |
| Convertible  debentures         |   | 98,000                         |      | 40,000 |   |   |   |
| Diluted  earnings per share     |   | $                              | 3,928,000 |   | 1,390,798 |   | $ | 2.82 |   |

 

Assumed conversion of convertible debentures to 6,750shares of common stock was excluded from the computation of diluted EPS for theperiod that the debentures were outstanding during the year

 

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endedSeptember 30, 2003 because the effect would be antidilutive (theconvertible debentures were repaid in full on June 30, 2003).  Assumed conversion of convertible debenturesto acquire 18,000 shares of common stock at September 30, 2002 and 20,000shares of common stock at September 30, 2001 were excluded from thecomputation of diluted earnings per share for the years endedSeptember 30, 2002 and 2001, respectively, because their inclusion would havebeen antidilutive.

 

# Stock-BasedCompensation

#  

Barnwellapplies the provisions of Accounting Principles Board Opinion No. 25 inaccounting for stock-based compensation and adopted the disclosure-onlyprovisions of Statement of Financial Accounting Standards No. 123, “Accountingfor Stock-Based Compensation,” as amended by Statement of Financial AccountingStandards No. 148, “Accounting for Stock-Based Compensation — Transition andDisclosure.”  Had compensation cost forstock options granted since October 1, 1995 been determined based on thefair value method of measuring stock-based compensation provisions of Statementof Financial Accounting Standards No. 123, Barnwell’s net earnings (loss) andbasic and diluted earnings (loss) per share would have been as follows:

 
|                                                                                                                       |   | **Year ended  September 30,** |          |
|----------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|---------------|
|                                                                                                                       |   | **2003**                           |          | **2002** | ** ** | **2001** | ** ** |
| Net  earnings, as reported                                                                                                 |   | **$**                              | **2,320,000** |   | $ | 40,000 |   | $ | 3,830,000 |   |
| Less  stock-based employee compensation expense determined under the fair value  based method, net of related income taxes |   | **(44,000**                        | )             | (95,000 | ) | (185,000 | ) |
| Pro-forma  net earnings (loss)                                                                                             |   | **$**                              | **2,276,000** |   | $ | (55,000 | ) | $ | 3,645,000 |   |
|                                                                                                                       |   |                               |          |   |   |   |   |
| Basic  Earnings (Loss) Per Share:                                                                                          |   |                               |          |   |   |   |   |
| As  reported                                                                                                               |   | **$**                              | **1.76**      |   | $ | 0.03 |   | $ | 2.92 |   |
| Pro  forma                                                                                                                 |   | **$**                              | **1.73**      |   | $ | (0.04 | ) | $ | 2.78 |   |
|                                                                                                                       |   |                               |          |   |   |   |   |
| Diluted  Earnings (Loss) Per Share:                                                                                        |   |                               |          |   |   |   |   |
| As  reported                                                                                                               |   | **$**                              | **1.69**      |   | $ | 0.03 |   | $ | 2.82 |   |
| Pro  forma                                                                                                                 |   | **$**                              | **1.66**      |   | $ | (0.04 | ) | $ | 2.69 |   |

 

Fair value measurement ofthe options was based on a Black-Scholes option-pricing model which includedassumptions of a weighted average expected life of 5.97 years, expectedvolatility of 30%, weighted average risk-free interest rate of 6.12%, and anexpected dividend yield of 0%.

 

The full impact ofstock-based compensation is not reflected in the pro-forma information abovebecause, under Statement of Financial Accounting Standards No. 123,compensation cost is reflected over the options’ vesting periods andcompensation cost for options granted prior to October 1, 1995 is notconsidered.

 

# Foreigncurrency translation

#  

Assetsand liabilities of foreign operations and subsidiaries are translated at theyear-end exchange rate and resulting translation gains or losses are accountedfor in a stockholders’ equity account entitled “accumulated other comprehensiveloss - foreign currency translation adjustments.”

 

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Operating resultsof foreign subsidiaries are translated at average exchange rates during theperiod. Realized foreign currency transaction gains or losses were not materialin fiscal years 2003, 2002 and 2001.

 

Use of Estimates in thePreparation of Financial Statements

 

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenues and expenses and the disclosure of contingent assets andliabilities.  Actual results coulddiffer significantly from those estimates. Significant assumptions are required in the valuation of deferred taxassets and proved oil and natural gas reserves, and such assumptions may impactthe amount at which deferred tax assets and oil and natural gas properties arerecorded.

 

**3.             ACCOUNTS RECEIVABLE AND CONTRACTCOSTS**

 

Accountsreceivable, current, are net of allowances for doubtful accounts of $10,000 and$17,000 as of September 30, 2003 and 2002, respectively.  Included in accounts receivable are contractretainage balances of $96,000 and $129,000 as of September 30, 2003 and2002, respectively.  These balances areexpected to be collected within one year, generally within 45 days after therelated contracts have received final acceptance and approval.

 

Costs and estimatedearnings on uncompleted contracts are as follows:

 

 
|                                     |   | **September 30,** |          |
|------------------------------------------|--------|------------------------|---------------|
|                                     |   | **2003**               |          | **2002** | ** ** |
| Costs  incurred on uncompleted contracts |   | **$**                  | **1,667,000** |   | $ | 2,200,000 |   |
| Estimated  earnings                      |   | **109,000**            |          | 309,000 |   |
|                                     |   | **1,776,000**          |          | 2,509,000 |   |
| Less  billings to date                   |   | **1,639,000**          |          | 2,449,000 |   |
|                                     |   | **$**                  | **137,000**   |   | $ | 60,000 |   |

 

Costs and estimatedearnings on uncompleted contracts are included in the consolidated balancesheets under the following captions:

 

 
|                                                                         |   | **September 30,** |        |
|------------------------------------------------------------------------------|--------|------------------------|-------------|
|                                                                         |   | **2003**               |        | **2002** | ** ** |
|                                                                         |   |                   |        |   |   |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |   | **$**                  | **166,000** |   | $ | 174,000 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |   | **(29,000**            | )           | (114,000 | ) |
|                                                                         |   | **$**                  | **137,000** |   | $ | 60,000 |   |

 

**4.             NOTE RECEIVABLE**

 

Nearco, Inc.’s note payable to Barnwell was due in full onDecember 31, 2002.  Nearco, Inc. paidall interest due and payable at December 31, 2002 of $58,000 and repaidapproximately $70,000 of principal on its note payable to Barnwell inJanuary 2003 leaving an unpaid principal balance of

 

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$1,311,000, which is outstanding as of the date of this filing.  Under the terms of the note, the note is indefault and the rate of interest increased from 10% to 12% on January 1,2003.  Nearco, Inc. has paid interest onthe note through September 30, 2003. Management believes that Nearco, Inc. will repay its note and anyinterest due in full.  The note issecured by Nearco, Inc.’s entire interest in Cambridge Hawaii Limited Partnership,with its principal asset being a 49.9% interest in Kaupulehu Developments.  Management estimates that the current valueof Nearco, Inc.’s pledged interest in Kaupulehu Developments is significantlyin excess of the combined value of its note to Barnwell and Nearco, Inc.’s$450,000 note to a third party to which Barnwell’s note is subordinated.

 

**5.             INVESTMENT IN LAND**

 

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 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 and multiple 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.

 

In 1993, Kaupulehu Developments submitted a rezoning petition to theState Land Use Commission and in 1998, filed an Application for a ProjectDistrict zoning ordinance and a Special Management Area Use Permit Petitionwith the County of Hawaii to reclassify approximately 1,100 leasehold acres ofits approximately 2,100 leasehold acres zoned conservation forresort/residential development.  InOctober 2001, the 1,100 leasehold acres received final approval forreclassification for resort/residential development.

 

InNovember 2001, Kaupulehu Developments restructured the option held byKaupulehu Makai Venture to acquire Kaupulehu Developments’ development rightsand transferred approximately 230 leasehold acres of its 1,100 acres ofresort/residential zoned land to Kaupulehu Makai Venture.  Thedevelopment rights held by Kaupulehu Developments are for residentially zonedleasehold land within and adjacent to the Hualalai Golf Club.  On December 31, 2001 and 2002,Kaupulehu Makai Venture exercised the portion of its development rights optiondue on those dates and paid Kaupulehu Developments $2,125,000 on bothDecember 31, 2001 and 2002, reducing the amount of acreage under option toapproximately 110 acres at September 30, 2003.  Barnwell accounts for sales of development rights under option byuse of 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 development rightssold.  In fiscal 2002, approximately $1,877,000 of the proceeds from the salesof development rights were applied to reduce the carrying value of theunderlying investment in land.  Sales ofdevelopment rights were further reduced in fiscal 2002 by $128,000 of feesrelated to the sale, and the remaining $120,000 of sales proceeds is recordedin the Consolidated Statements of Operations for fiscal 2002 as “Sale ofdevelopment rights, net.”   Infiscal 2003, $1,277,000 of the proceeds from the sales of development rightswere applied to reduce the carrying value of the underlying development rightsrecorded on the Condensed Consolidated Balance Sheets under the caption“Investment in land” to zero.  Sales ofdevelopment rights were further reduced in fiscal 2003 by $128,000 of feesrelated to the sale and the remaining $720,000 of sales proceeds is recorded inthe Consolidated Statements of Operations for fiscal 2003 as “Sale ofdevelopment rights, net.”

 

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Thetotal amount of the remaining option proceeds, if fully exercised, was$21,250,000 at September 30, 2003, comprised of eight payments of$2,656,250 due on each December 31 of years 2003 to 2010.  If any annual option payment is not made,the then remaining development right options will expire.  There is no assurance that any portion ofthe remaining options will be exercised.

 

The aforementioned $128,000 in fees ($89,000, net ofminority interest) on the $2,125,000 development rights proceeds were paid inJanuary 2003 to Nearco, Inc., a company controlled by Mr. Terry Johnston,a director of Barnwell and an indirect 21.8% owner of KaupulehuDevelopments.  Under an agreemententered into in 1987, prior to Mr. Johnston’s election to Barnwell’s Board ofDirectors, Barnwell is obligated to pay Nearco, Inc. 2% of KaupulehuDevelopments’ gross receipts from the sale of real estate interests.  In addition, Cambridge Hawaii Limited Partnership,a 49.9% owner of Kaupulehu Developments, in which Barnwell purchased a 55.2%interest in April 2001, is obligated under an agreement entered into in1987 to pay Nearco, Inc. 4% of Kaupulehu Developments’ gross receipts from thesale of real estate interests.  The feesrepresent compensation for promotion and marketing of Kaupulehu Developments’property and were determined based on the estimated fair value of suchservices.  Barnwell believes the feesare fair and reasonable compensation for such services.

 

Fees were also paid to Nearco, Inc. for consultingservices related to Kaupulehu Developments’ leasehold land.  In fiscal 2003 and 2002, fees paid toNearco, Inc. totaled $218,000 and $95,000, respectively.  Barnwell believes the fees are fair andreasonable compensation for such services.

 

The remaining leasehold land interests held byKaupulehu Developments at September 30, 2003 are for approximately 870acres of land zoned for resort/residential development and anotherapproximately 1,000 acres of land zoned conservation.  These approximately 1,870 acres are located adjacent to and northof the Four Seasons Resort Hualalai at Historic Ka’upulehu, between the QueenKaahumanu Highway and the Pacific Ocean.

 

Kaupulehu Developments is negotiating with anindependent third party interested in developing the approximately 870 acres ofresort/residential leasehold acreage, of which approximately 186 acres weredesignated by the State Land Use Commission as preservation areas with noresidential or golf course development. The independent third party and Kaupulehu Developments have madesignificant progress in negotiation of a revised development agreement andresidential fee simple purchase prices with the lessor.  Management cannot predict the outcome ofthese negotiations.

 

Attainment of zoning anddevelopment entitlements for the approximately 870 acres of leasehold landzoned for resort/residential development was determined to be substantiallycomplete in December 2002. Accordingly, effective January 1, 2003, Barnwell no longercapitalizes expenditures related to the 870 acres.  Activities to improve the leasehold land interests in theapproximately 1,000 acres of conservation-zoned land have not yet commenced.

 

Barnwell’s cost,including capitalized interest, of leasehold land interests and developmentrights under option is included in the consolidated balance sheets under thecaption “Investment in Land” and consisted of the following amounts:

 

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|                                      |   | **September 30,** |          |
|-------------------------------------------|--------|------------------------|---------------|
|                                      |   | **2003**               |          | **2002** |   |
| Leasehold  land interests:                |   |                   |          |   |   |
| Zoned  for resort/residential development |   | **$**                  | **6,458,000** |   | $ | 6,413,000 |   |
| Zoned  conservation                       |   | **50,000**             |          | 50,000 |   |
|                                      |   | **6,508,000**          |          | 6,463,000 |   |
| Development  rights under option          |   | **—**             |          | 1,277,000 |   |
| Total  investment in land                 |   | **$**                  | **6,508,000** |   | $ | 7,740,000 |   |

 

**6.****             PROPERTY ANDEQUIPMENT AND ASSET RETIREMENT OBLIGATION**

 

Barnwell’s property andequipment is detailed as follows:

 
|                                                   |   | **Gross  Property and  Equipment** |           | **Accumulated  Depreciation,  Depletion and  Amortization** |       | **Net  Property and  Equipment** |       |
|--------------------------------------------------------|--------|------------------------------------|----------------|-------------------------------------------------------------|------------|----------------------------------|------------|
| At  September 30, 2003:                           |   |                               |           |                                                        |       |                             |       |
| Land                                                   |   | $                                  | 465,000        |                                                        | $          | —                           |       | $ | 465,000 |   |
| Oil  and natural gas properties (full cost accounting) |   | 80,863,000                         |           | (43,404,000                                                 | )          | 37,459,000                       |       |
| Drilling  rigs and equipment                           |   | 4,094,000                          |           | (3,841,000                                                  | )          | 253,000                          |       |
| Other  property and equipment                          |   | 3,077,000                          |           | (2,306,000                                                  | )          | 771,000                          |       |
| Total                                                  |   | **$**                              | **88,499,000** | ** **                                                  | **$**      | **(49,551,000**                  | **)**      | **$** | **38,948,000** | ** ** |
|                                                   |   |                               | ** **     |                                                        | ** ** |                             | ** ** |
| At  September 30, 2002:                           |   |                               |           |                                                        |       |                             |       |
| Land                                                   |   | $                                  | 465,000        |                                                        | $          | —                           |       | $ | 465,000 |   |
| Oil  and natural gas properties (full cost accounting) |   | 58,108,000                         |           | (33,796,000                                                 | )          | 24,312,000                       |       |
| Drilling  rigs and equipment                           |   | 4,340,000                          |           | (4,081,000                                                  | )          | 259,000                          |       |
| Other  property and equipment                          |   | 2,783,000                          |           | (1,991,000                                                  | )          | 792,000                          |       |
| Total                                                  |   | $                                  | 65,696,000     |                                                        | $          | (39,868,000                      | )          | $ | 25,828,000 |   |

 

Adoptionof SFAS No. 143 increased gross oil and natural gas properties by $564,000,decreased accumulated depletion by $546,000, and increased the asset retirementobligation by $1,110,000 on October 1, 2002.  The liability is accreted at the end of each period throughcharges to oil and natural gas operating expense.  If the obligation is settled for other than the carrying amountof the liability, Barnwell will recognize a gain or loss on settlement.

 

Following the initialimplementation of SFAS No. 143, the asset retirement obligation was increasedduring the year ended September 30, 2003 by $39,000 to reflect obligationsincurred on new wells drilled, by $85,000 for accretion of the asset retirementobligation, and by $198,000 for changes in foreign currency translation rates.

 

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**7.****             LONG-TERM DEBT**

 

Barnwell has a creditfacility at the Royal Bank of Canada, a Canadian bank, for approximately$14,000,000 at September 30, 2003. Borrowings under this facility were $10,477,000 and $9,961,000 atSeptember 30, 2003 and 2002, respectively, and are included in long-termdebt.  At September 30, 2003,Barnwell had unused credit available under this facility of approximately$3,500,000.

 

The facility is availablein U.S. dollars at the London Interbank Offer Rate plus 1-3/4%, at U.S. primeplus 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 2004.  Subject tothat review, the facility may be extended one year with no required debtrepayments for one year 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 thethen outstanding loan balance:  firstyear of the term period – 20% (5% per quarter), and in the second year of theterm period  – 80% (5% per quarter forthe first 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 30,2003, Barnwell paid interest at rates ranging from 2.81% to 6.00%.  The weighted average interest rate on thefacility at September 30, 2003 was 3.74%. The facility is collateralized by Barnwell’s interests in its major oiland natural gas properties and a negative pledge on its remaining oil andnatural gas properties.  The facility isreviewed annually with a primary focus on the future cash flows that will begenerated by Barnwell’s Canadian oil and natural gas properties.  No compensating bank balances are requiredfor this facility.

 

The bank represented thatit will not require any repayments under the facility before October 1,2004.  Accordingly, Barnwell hasclassified outstanding borrowings under the facility as long-term debt.

 

InJune 1995, Barnwell issued $2,000,000 of convertible notes dueJuly 1, 2003.  $1,950,000 ofsuch notes were purchased by an officer/shareholder, a director/shareholder,and certain other shareholders of Barnwell. The notes were payable in 20 consecutive equal quarterly installmentsbeginning October 1998.  Interestwas payable quarterly at a rate adjusted each quarter to the greater of 10% perannum or 1% over the prime rate of interest. Barnwell paid interest on these convertible notes at an average rate of10.00% per annum in 2003, 10.00% per annum in 2002 and 10.28% per annum in2001.  The notes were unsecured andconvertible at any time at the holder’s option into shares of Barnwell’s commonstock at a price of $20.00 per share, subject to adjustment for certain events,and were redeemable, at the option of Barnwell, without premium.  In December 2001, approximately $71,000of convertible debentures, including accrued interest, were converted to 3,558shares of Barnwell’s stock at $20 per share; these shares were issued fromBarnwell’s treasury stock.  The remainingconvertible notes were repaid in full on June 30, 2003.

 

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Barnwell capitalizesinterest on costs related to its investment in land.  Interest costs for the years ended September 30, 2003, 2002and 2001 are summarized as follows:

 
|                                                   |   | **2003**   |        | **2002** |   | **2001** |   |
|--------------------------------------------------------|--------|------------|-------------|----------|--------|----------|--------|
| Interest costs incurred                                |   | **$**      | **487,000** |     | $      | 498,000  |   | $ | 665,000 |   |
| Less  interest costs capitalized on investment in land |   | **45,000** |        | 202,000  |   | 278,000  |   |
| Interest  expense                                      |   | **$**      | **442,000** |     | $      | 296,000  |   | $ | 387,000 |   |

 

**8.****             TAXES ON INCOME**

 

The components of earningsbefore income taxes are as follows:

 
|                                     |   | **Year ended  September 30,** |           |
|------------------------------------------|--------|------------------------------------|----------------|
|                                     |   | **2003**                           |           | **2002** |   | **2001** |   |
| Earnings  (loss) before income taxes in: |   |                               |           |   |   |   |   |
| United  States                           |   | **$**                              | **(2,499,000** | **)** | $ | (1,811,000 | ) | $ | (1,586,000 | ) |
| Canada                                   |   | **9,004,000**                      | ** **     | 3,412,000 |   | 10,991,000 |   |
|                                     |   | **$**                              | **6,505,000**  |   | $ | 1,601,000 |   | $ | 9,405,000 |   |

 

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

 
|                          |   | **Year ended  September 30,** |          |
|-------------------------------|--------|------------------------------------|---------------|
|                          |   | **2003**                           |          | **2002** |   | **2001** |   |
| Current  provision:           |   |                               |          |   |   |   |   |
| United  States – Federal |   | **$**                              | **143,000**   | ** ** | $ | 21,000 |   | $ | 160,000 |   |
| Canadian                      |   | **3,333,000**                      | ** **    | 1,135,000 |   | 5,261,000 |   |
| Total  current                |   | **3,476,000**                      | ** **    | 1,156,000 |   | 5,421,000 |   |
|                          |   |                               | ** **    |   |   |   |   |
| Deferred  provision:          |   |                               | ** **    |   |   |   |   |
| United  States                |   | **(191,000**                       | **)**         | 42,000 |   | 44,000 |   |
| Canadian                      |   | **900,000**                        | ** **    | 363,000 |   | 110,000 |   |
| Total  deferred               |   | **709,000**                        | ** **    | 405,000 |   | 154,000 |   |
|                          |   | **$**                              | **4,185,000** |   | $ | 1,561,000 |   | $ | 5,575,000 |   |

 

Barnwell’s Canadiandeferred tax provision for the years ended September 30, 2003, 2002 and2001 were primarily due to Barnwell’s Canadian tax deductions related to its oiland natural gas properties exceeding Barnwell’s depletion of its oil andnatural gas properties for book purposes.

 

Includedin the provision for deferred income taxes for the years endedSeptember 30, 2003 and 2002 is a U.S. deferred tax benefit of $320,000 and$376,000, respectively, related to the sale of land development rights inDecember 2002 and 2001, respectively. The sales of land development rights created temporary differences dueto the excess of expenses recognized under the cost recovery method for booksover expenses deductible for tax purposes. There was no deferred income tax benefit related to land sales in theyear ended September 30, 2001.

 

54

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In October 2003, theParliament of Canada held first and second readings on a bill to reduceCanada’s corporate tax rate on “resource” income (income derived from oil andnatural gas operations) over a four-year period beginning January 1, 2003from 29% to 21% beginning January 1, 2007.  Additionally, the bill phases in over the same four-year periodtax deductions for royalties, which previously were not tax deductible, andphases out the Resource Allowance deduction along with other changes.  In November 2003, the bill passed onthird reading, received Royal Assent and was enacted into law.  The reduction in the tax will reduceBarnwell’s deferred income tax liabilities by approximately $1,500,000 in thequarter ending December 31, 2003, Barnwell’s fiscal 2004 first quarter.

 

In May 2003, thelegislative assembly of the Province of Alberta held a first reading on a billto reduce the province’s corporate tax rate from 13.0% to 12.5%, effectiveApril 1, 2003.  OnNovember 20, 2003, the bill passed on third reading and will become lawupon Royal Assent.  If enacted into lawthe reduction in the tax rate would reduce Barnwell’s current income taxliabilities by approximately $20,000 and Barnwell’s deferred income taxesliabilities by approximately $100,000.

 

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 inthe tax rate reduced Canadian deferred income tax liabilities by approximately$75,000 in the year ended September 30, 2003.  There was no such reduction recorded in the year endedSeptember 30, 2002.  During fiscal2001, the Province of Alberta reduced the province’s corporate tax rate from15.5% to 13.5% effective April 1, 2001. As a result of this reduction, Barnwell recorded an approximately$300,000 deferred income tax benefit in fiscal 2001.

 

A reconciliation betweenthe reported provision for income taxes and the amount computed by multiplyingthe earnings before income taxes by the U.S. federal tax rate of 35% is asfollows:

 
|                                                            |   | **Year ended  September 30,** |          |
|-----------------------------------------------------------------|--------|------------------------------------|---------------|
|                                                            |   | **2003**                           |          | **2002** |   | **2001** |   |
| Tax  expense computed by applying statutory rate                |   | **$**                              | **2,277,000** | ** ** | $ | 560,000 |   | $ | 3,292,000 |   |
|                                                            |   |                               | ** **    |   |   |   |   |
| Effect  of the foreign tax provision on the total tax provision |   | **1,967,000**                      | ** **    | 1,060,000 |   | 2,264,000 |   |
| State  net operating losses (generated) utilized                |   | **(39,000**                        | **)**         | (22,000 | ) | 18,000 |   |
| Other                                                           |   | **(20,000**                        | **)**         | (37,000 | ) | 1,000 |   |
|                                                            |   | **$**                              | **4,185,000** |   | $ | 1,561,000 |   | $ | 5,575,000 |   |

 

55

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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, 2003and 2002 are as follows:

 
|                                                                                                         |   | **2003**        |           | **2002**   |   |
|--------------------------------------------------------------------------------------------------------------|--------|-----------------|----------------|------------|--------|
| Deferred  income tax assets:                                                                                 |   |            | ** **     |       |   |
| U.S.  tax effect of deferred Canadian taxes                                                                  |   | **$**           | **3,139,000**  | ** ** | $      | 2,391,000 |   |
| Foreign  tax credit carryforwards                                                                            |   | **5,286,000**   | ** **     | 4,313,000  |   |
| Tax  basis in investment in land in excess of book basis                                                     |   | **1,535,000**   | ** **     | 1,263,000  |   |
| Write-down  of assets not deducted for tax                                                                   |   | **178,000**     | ** **     | 355,000    |   |
| Alternative  minimum tax credit carryforwards                                                                |   | **514,000**     | ** **     | 372,000    |   |
| State  of Hawaii net operating loss carryforwards                                                            |   | **304,000**     | ** **     | 264,000    |   |
| Expenses  accrued for books but not for tax                                                                  |   | **801,000**     | ** **     | 547,000    |   |
| Asset  retirement obligation                                                                                 |   | **487,000**     | ** **     | —     |   |
| Other                                                                                                        |   | **6,000**       | ** **     | —     |   |
| Total  gross deferred tax assets                                                                             |   | **12,250,000**  | ** **     | 9,505,000  |   |
| Less-valuation  allowance                                                                                    |   | **(9,385,000**  | **)**          | (7,595,000 | )      |
| Net  deferred income tax assets                                                                              |   | **2,865,000**   | ** **     | 1,910,000  |   |
|                                                                                                         |   |            | ** **     |       |   |
| Deferred  income tax liabilities:                                                                            |   |            | ** **     |       |   |
| Property  and equipment accumulated tax depreciation and depletion in excess of book  under Canadian tax law |   | **(9,233,000**  | **)**          | (7,033,000 | )      |
| Property  and equipment accumulated tax depreciation and depletion in excess of book  under U.S. tax law     |   | **(2,524,000**  | **)**          | (1,768,000 | )      |
| Other                                                                                                        |   | **(336,000**    | **)**          | (328,000   | )      |
| Total  deferred income tax liabilities                                                                       |   | **(12,093,000** | **)**          | (9,129,000 | )      |
|                                                                                                         |   |            | ** **     |       |   |
| Net  deferred income tax liability                                                                           |   | **$**           | **(9,228,000** | **)**      | $      | (7,219,000 | ) |

 

Thetotal valuation allowance increased $1,790,000, $730,000 and $1,849,000, forthe years ended September 30, 2003, 2002 and 2001, respectively.  The increases relate primarily to foreigntax credit carryforwards for which it is more likely than not that suchcarryforwards will not be utilized to reduce Barnwell’s U.S. tax obligation.

 

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.

 

Net deferred tax assetsof $2,865,000 consists primarily of $1,535,000 of deferred tax assets relatedto the excess of the cost basis of investment in land for tax purposes over thecost basis of investment in land for book purposes.  This deferred tax asset will be realized through the deduction ofthe cost basis of investment in land for tax purposes against future proceedsfrom sales of interests in leasehold land and land development rights.  The amount of deferred income tax assetsconsidered realizable may be reduced if estimates of future taxable income arereduced.

 

56

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At September 30, 2003, Barnwell had alternativeminimum tax credit carryforwards of $514,000 which are available to reducefuture U.S. federal regular income taxes, if any, over an indefinite period.

 

**9.****             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.  The planassets at September 30, 2003 were invested as follows: 7% in cash and cashequivalents, 34% listed government mortgages and 59% common stocks and equitymutual funds.

 

The funded status of thepension plan and the amounts recognized in the consolidated financialstatements are as follows:

 
|                                           |   | **September 30,** |          |
|------------------------------------------------|--------|------------------------|---------------|
|                                           |   | **2003**               |          | **2002** |   |
| Change  in Benefit Obligation                  |   |                   | ** **    |   |   |
| Benefit obligation at beginning of year        |   | **$**                  | **2,753,000** | ** ** | $ | 2,197,000 |   |
| Service  cost                                  |   | **128,000**            | ** **    | 94,000 |   |
| Interest  cost                                 |   | **171,000**            | ** **    | 161,000 |   |
| Actuarial  loss                                |   | **182,000**            | ** **    | 421,000 |   |
| Benefits  paid                                 |   | **(148,000**           | **)**         | (120,000 | ) |
|                                           |   |                   | ** **    |   |   |
| Benefit  obligation at end of year             |   | **3,086,000**          | ** **    | 2,753,000 |   |
|                                           |   |                   | ** **    |   |   |
| Change  in Plan Assets                         |   |                   | ** **    |   |   |
| Fair value of plan assets at beginning of year |   | **1,855,000**          | ** **    | 2,146,000 |   |
| Actual  return on plan assets                  |   | **228,000**            | ** **    | (171,000 | ) |
| Employer contribution                          |   | **92,000**             | ** **    | — |   |
| Benefits  paid                                 |   | **(148,000**           | **)**         | (120,000 | ) |
|                                           |   |                   | ** **    |   |   |
| Fair  value of plan assets at end of year      |   | **2,027,000**          | ** **    | 1,855,000 |   |
|                                           |   |                   | ** **    |   |   |
| Funded status                                  |   | **(1,059,000**         | **)**         | (898,000 | ) |
| Unrecognized  prior service cost               |   | **12,000**             | ** **    | 18,000 |   |
| Unrecognized  actuarial loss                   |   | **723,000**            | ** **    | 636,000 |   |
|                                           |   |                   | ** **    |   |   |
| Accrued  benefit cost                          |   | **$**                  | **(324,000**  | **)** | $ | (244,000 | ) |

 
|                                  |   | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------|--------|----------|------------|----------|------------|
| Assumptions  as of September 30, |   |     |       |     |       |
| Discount rate                         |   | **6.00** | **%**      | 6.50     | %          |
| Expected  return on plan assets       |   | **8.00** | **%**      | 8.00     | %          |
| Rate  of compensation increase        |   | **5.00** | **%**      | 5.00     | %          |

 

57

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|                                       |   | **Year ended  September 30,** |        |
|--------------------------------------------|--------|------------------------------------|-------------|
|                                       |   | **2003**                           |        | **2002** |   | **2001** |   |
| Net Periodic Benefit Cost for the Year     |   |                               |        |   |   |   |   |
| Service cost                               |   | **$**                              | **128,000** | ** ** | $ | 94,000 |   | $ | 94,000 |   |
| Interest  cost                             |   | **171,000**                        | ** **  | 161,000 |   | 152,000 |   |
| Expected  return on plan assets            |   | **(144,000**                       | **)**       | (167,000 | ) | (195,000 | ) |
| Amortization  of net asset                 |   | **(1,000**                         | **)**       | (1,000 | ) | (1,000 | ) |
| Amortization  of prior service cost        |   | **6,000**                          | ** **  | 6,000 |   | 6,000 |   |
| Amortization  of net actuarial loss (gain) |   | **12,000**                         | ** **  | — |   | (13,000 | ) |
|                                       |   |                               | ** **  |   |   |   |   |
| Net  periodic benefit cost                 |   | **$**                              | **172,000** |   | $ | 93,000 |   | $ | 43,000 |   |

 

**10.****          STOCK OPTIONS**

 

In March 1995,Barnwell granted 20,000 stock options to an officer of Barnwell under anon-qualified plan at a purchase price of $19.625 per share (market price ondate of grant), with 4,000 of such options vesting annually commencing one yearfrom the date of grant.  These optionshave stock appreciation rights that permit the holder to receive stock, cash ora combination thereof equal to the amount by which the fair market value, atthe time of exercise of the option, exceeds the option price.  The options expire ten years from the dateof grant.  Barnwell recognized $101,000and $6,000 of compensation cost relating to these options in the years endedSeptember 30, 2003 and 2002, respectively.  No compensation cost was recognized for these options in the yearended September 30, 2001.

 

InJune 1998, Barnwell granted 30,000 stock options to an officer ofBarnwell’s oil and gas segment under a non-qualified plan at a purchase priceof $15.625 per share (market price on date of grant), with 6,000 of suchoptions vesting annually commencing one year from the date of grant.  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.  Theoptions expire ten years from the date of grant.  Barnwell recognized $125,000, $43,000 and $38,000 of compensationcosts relating to these options in the years ended September 30, 2003,2002 and 2001, respectively.

 

In December 1999,Barnwell granted qualified stock options to certain employees of Barnwell toacquire 68,000 shares and 29,000 shares of Barnwell’s common stock with anexercise price per share of $11.875 (market price at date of grant) and $13.063(110% of market price at date of grant), respectively.  These options vest annually over four yearscommencing one year from the date of grant. The $11.875 per share options expire ten years from the date of grant,and the $13.063 per share options expire five years from the date ofgrant.  No compensation cost wasrecognized for these options for the years ended September 30, 2003, 2002and 2001.  36,000 shares were availablefor grant under this plan at September 30, 2003.

 

During the year endedSeptember 30, 2002, 3,000 options to acquire Barnwell’s stock at $11.875per share were forfeited.  During theyear ended September 30, 2001, 1,000 options to acquire Barnwell’s stockat $11.875 per share were exercised.

 

58

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Stock options atSeptember 30, 2003 were as follows:

 
|                          |   | **Options  outstanding** |   | **Options  exercisable**                            |   |
|-------------------------------|--------|--------------------------|--------|-----------------------------------------------------|--------|
| **Range of  exercise prices** |   | **Number of  Shares**    |   | **Weighted  Average  Remaining  Contractual  Life** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
| $11.875 - $15.625             |   | 123,000                  |   | 4.6 years                                           |   | $ | 13.07 |   | 99,750 |   | $ | 13.26 |   |
| $19.625                       |   | 20,000                   |   | 1.4 years                                           |   | $ | 19.63 |   | 20,000 |   | $ | 19.63 |   |
|                          |   |                     |   |                                                |   |   |   |   |   |   |   |
| $11.875 - $19.625             |   | 143,000                  |   | 4.2 years                                           |   | $ | 13.99 |   | 119,750 |   | $ | 14.32 |   |

 

Stock options atSeptember 30, 2002 were as follows:

 
|                          |   | **Options  outstanding** |   | **Options  exercisable**                            |   |
|-------------------------------|--------|--------------------------|--------|-----------------------------------------------------|--------|
| **Range of  exercise prices** |   | **Number of  Shares**    |   | **Weighted  Average  Remaining  Contractual  Life** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
| $11.875 - $15.625             |   | 123,000                  |   | 5.6 years                                           |   | $ | 13.07 |   | 70,500 |   | $ | 13.40 |   |
| $19.625                       |   | 20,000                   |   | 2.4 years                                           |   | $ | 19.63 |   | 20,000 |   | $ | 19.63 |   |
|                          |   |                     |   |                                                |   |   |   |   |   |   |   |
| $11.875 - $19.625             |   | 143,000                  |   | 5.2 years                                           |   | $ | 13.99 |   | 90,500 |   | $ | 14.77 |   |

 

Stock options atSeptember 30, 2001 were as follows:

 
|                          |   | **Options  outstanding** |   | **Options  exercisable**                            |   |
|-------------------------------|--------|--------------------------|--------|-----------------------------------------------------|--------|
| **Range of  exercise prices** |   | **Number of  Shares**    |   | **Weighted  Average  Remaining  Contractual  Life** |   | **Weighted  Average  Exercise  Price** |   | **Number of  Shares** |   | **Weighted  Average  Exercise  Price** |   |
| $11.875 - $15.625             |   | 126,000                  |   | 6.7 years                                           |   | $ | 13.04 |   | 41,250 |   | $ | 13.72 |   |
| $19.625                       |   | 20,000                   |   | 3.4 years                                           |   | $ | 19.63 |   | 20,000 |   | $ | 19.63 |   |
|                          |   |                     |   |                                                |   |   |   |   |   |   |   |
| $11.875 - $19.625             |   | 146,000                  |   | 6.2 years                                           |   | $ | 13.94 |   | 61,250 |   | $ | 15.65 |   |

 

InDecember 2001, approximately $71,000 of convertible debentures, includingaccrued interest, was converted to 3,558 shares of Barnwell’s stock at $20 pershare; these shares were issued from Barnwell’s treasury stock.  During the year ended September 30,2001, Barnwell repurchased 1,000 shares of its common stock from an employee arisingfrom the exercise of stock options for $19,750 at the then prevailing marketprice under a March 2000 stock buyback plan authorizing the repurchase ofup to 100,000 shares.  There were noconversions or repurchases of Barnwell’s stock in the year endedSeptember 30, 2003.  Barnwell plansto repurchase additional shares from time to time in the open market or inprivately negotiated transactions, depending on market conditions.  At September 30, 2003, Barnwell couldpurchase an additional 93,000 shares under the March 2000 repurchaseauthorization.

 

59

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**11.****          COMMITMENTS ANDCONTINGENCIES**

 

Barnwellhas committed to compensate its Vice President of Canadian Operations pursuantto an incentive compensation plan, the value of which directly relates toBarnwell’s oil and natural gas segment’s net income and the change in the valueof Barnwell’s oil and gas reserves since 1998 with adjustments for changes innatural gas and oil prices and subject to other terms and conditions.  Barnwell recognized $166,000 of compensationexpense pursuant to this incentive plan in fiscal 2003.  In fiscal 2002, Barnwell recognized a$48,000 benefit, a reduction in compensation expense, pursuant to thisincentive plan; there was no compensation expense or benefit recognized infiscal 2001.

 

Barnwellhas also committed to compensate certain Canadian personnel pursuant to anincentive compensation plan, the value of which directly relates to Barnwell’soil and natural gas segment’s net income and the value of Barnwell’s oil andgas reserves discovered, commencing in fiscal 2002, for projects developed bysuch personnel.  Barnwell recognizedapproximately $80,000 of compensation costs pursuant to this plan in fiscal2003, of which approximately $30,000 was expensed and approximately $50,000,the portion related to in-house geologists, was capitalized as oil and naturalgas capital expenditures.  Barnwellrecognized no compensation expense pursuant to this plan in fiscal 2002.

 

Barnwell has several non-cancelable operating leasesfor office space and leasehold land. Rental expense was $474,000 in 2003, $467,000 in 2002 and $460,000 in2001.  Barnwell is committed under theseleases for minimum rental payments summarized by fiscal year as follows: 2004 -$443,000, 2005 - $363,000, 2006 - $363,000, 2007 - $371,000, 2008 - $372,000and thereafter through 2026 an aggregate of $2,678,000.  The lease payments for land are subject torenegotiation after December 31, 2005; the future rental paymentdisclosures above assume the minimum lease payments for land in effect atDecember 31, 2005 remain unchanged through 2025, the end of the leaseterm.  In December 2003, Barnwellpurchased the space it was leasing for its corporate office in Honolulu, Hawaii.  The future minimum rental payments reflectedabove have been adjusted accordingly.

 

Barnwellis occasionally involved in routine litigation and is subject to governmentaland regulatory controls that are incidental to the ordinary course of business.  Barnwell’s management believes that allclaims and litigation involving Barnwell are not likely to have a materialadverse effect on its financial statements taken as a whole.

 

**12.****          SEGMENT ANDGEOGRAPHIC INFORMATION**

 

Barnwelloperates three segments: exploring for, developing, producing and selling oiland natural gas (oil and natural gas); investing in leasehold land in Hawaii(land investment); and drilling wells and installing and repairing waterpumping systems 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 different geographicallocations.

 

Barnwell does notallocate general and administrative expenses, interest expense, interest incomeor income taxes to segments, and there are no transactions between segmentsthat affect segment profit or loss.

 

60

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|                                                                   |   | **Year ended  September 30,** |           |
|------------------------------------------------------------------------|--------|------------------------------------|----------------|
|                                                                   |   | **2003**                           |           | **2002** |   | **2001** |   |
| Revenues:                                                              |   |                               | ** **     |   |   |   |   |
| Oil and natural gas                                                    |   | **$**                              | **19,350,000** | ** ** | $ | 11,320,000 |   | $ | 19,870,000 |   |
| Contract  drilling                                                     |   | **2,050,000**                      | ** **     | 3,480,000 |   | 3,290,000 |   |
| Land  investment                                                       |   | **1,220,000**                      | ** **     | 220,000 |   | — |   |
| Other                                                                  |   | **720,000**                        | ** **     | 598,000 |   | 601,000 |   |
| Total before interest income                                           |   | **23,340,000**                     | ** **     | 15,618,000 |   | 23,761,000 |   |
| Interest income                                                        |   | **340,000**                        | ** **     | 262,000 |   | 329,000 |   |
| Total revenues                                                         |   | **$**                              | **23,680,000** | ** ** | $ | 15,880,000 |   | $ | 24,090,000 |   |
|                                                                   |   |                               | ** **     |   |   |   |   |
| Depreciation,  depletion and amortization:                             |   |                               | ** **     |   |   |   |   |
| Oil and natural gas                                                    |   | **$**                              | **4,026,000**  | ** ** | $ | 3,315,000 |   | $ | 3,416,000 |   |
| Contract  drilling                                                     |   | **88,000**                         | ** **     | 118,000 |   | 116,000 |   |
| Other                                                                  |   | **219,000**                        | ** **     | 215,000 |   | 222,000 |   |
| Total                                                                  |   | **$**                              | **4,333,000**  | ** ** | $ | 3,648,000 |   | $ | 3,754,000 |   |
|                                                                   |   |                               | ** **     |   |   |   |   |
| Operating  profit (loss) (before general and administrative expenses): |   |                               | ** **     |   |   |   |   |
| Oil and natural gas                                                    |   | **$**                              | **11,132,000** | ** ** | $ | 4,897,000 |   | $ | 12,945,000 |   |
| Contract  drilling                                                     |   | **34,000**                         | ** **     | 541,000 |   | 268,000 |   |
| Land  investment, net of minority interest                             |   | **669,000**                        | ** **     | — |   | (8,000 | ) |
| Other                                                                  |   | **501,000**                        | ** **     | 483,000 |   | 379,000 |   |
| Total                                                                  |   | **12,336,000**                     | ** **     | 5,921,000 |   | 13,584,000 |   |
| General and administrative expenses, net of minority  interest         |   | **(5,729,000**                     | **)**          | (4,286,000 | ) | (4,121,000 | ) |
| Interest  income                                                       |   | **340,000**                        | ** **     | 262,000 |   | 329,000 |   |
| Interest  expense                                                      |   | **(442,000**                       | **)**          | (296,000 | ) | (387,000 | ) |
| Earnings  before income taxes                                          |   | **$**                              | **6,505,000**  | ** ** | $ | 1,601,000 |   | $ | 9,405,000 |   |
|                                                                   |   |                               | ** **     |   |   |   |   |
| Capital  expenditures:                                                 |   |                               | ** **     |   |   |   |   |
| Oil and natural gas                                                    |   | **$**                              | **11,059,000** | ** ** | $ | 4,581,000 |   | $ | 4,240,000 |   |
| Land  investment                                                       |   | **45,000**                         | ** **     | 944,000 |   | 5,954,000 |   |
| Contract  drilling                                                     |   | **72,000**                         | ** **     | 77,000 |   | 84,000 |   |
| Other                                                                  |   | **158,000**                        | ** **     | 42,000 |   | 180,000 |   |
| Total                                                                  |   | **$**                              | **11,334,000** | ** ** | $ | 5,644,000 |   | $ | 10,458,000 |   |

 

Depletion per 1,000 cubicfeet (“MCF”) of natural gas and natural gas equivalent (“MCFE”), converted at arate of one barrel of oil and natural gas liquids to 5.8 MCFE, was $0.90 infiscal 2003, $0.71 in fiscal 2002 and $0.70 in fiscal 2001.  The higher depletion rate in fiscal 2003 isthe result of increased costs of finding and developing proven reserves, ascompared to prior years.

 

Landinvestment capital expenditures in 2001 include $5,000,000 for the purchase ofthe additional 27.5% interest in Kaupulehu Developments.  Barnwell paid $2,791,000 in cash and issued$2,209,000 in non-interest bearing promissory notes.

 

61

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ASSETS BY SEGMENT:

 
|                       |   | **September 30,** |           |
|----------------------------|--------|------------------------|----------------|
|                       |   | **2003**               |           | **2002** |   | **2001** |   |
| Oil  and natural gas (1)   |   | **$**                  | **40,338,000** | ** ** | **77** | **%** | $ | 27,113,000 |   | 66 | % | $ | 24,973,000 |   | 57 | % |
| Contract  drilling (2)     |   | **1,380,000**          | ** **     | **3** | **%** | 1,931,000 |   | 5 | % | 2,128,000 |   | 5 | % |
| Land  investment (2)       |   | **6,508,000**          | ** **     | **12** | **%** | 7,740,000 |   | 19 | % | 8,677,000 |   | 20 | % |
| Other:                     |   |                   |           |   | ** ** |   |   |   |   |   |   |   |   |
| Cash  and cash equivalents |   | **1,648,000**          | ** **     | **3** | **%** | 1,489,000 |   | 4 | % | 5,154,000 |   | 12 | % |
| Corporate  and other       |   | **2,463,000**          | ** **     | **5** | **%** | 2,401,000 |   | 6 | % | 2,739,000 |   | 6 | % |
| Total                      |   | **$**                  | **52,337,000** | ** ** | **100** | **%** | $ | 40,674,000 |   | 100 | % | $ | 43,671,000 |   | 100 | % |

 

----

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

 

LONG-LIVED ASSETS BYGEOGRAPHIC AREA:

 
|           |   | **September 30,** |           |
|----------------|--------|------------------------|----------------|
|           |   | **2003**               |           | **2002** |   | **2001** |   |
| United  States |   | **$**                  | **7,640,000**  | ** ** | **17** | **%** | $ | 8,962,000 |   | 27 | % | $ | 10,075,000 |   | 30 | % |
| Canada         |   | **37,816,000**         | ** **     | **83** | **%** | 24,606,000 |   | 73 | % | 23,494,000 |   | 70 | % |
| Total          |   | **$**                  | **45,456,000** | ** ** | **100** | **%** | $ | 33,568,000 |   | 100 | % | $ | 33,569,000 |   | 100 | % |

 

REVENUE BY GEOGRAPHICAREA:

 
|                               |   | **Year ended  September 30,** |           |
|------------------------------------|--------|------------------------------------|----------------|
|                               |   | **2003**                           |           | **2002** |   | **2001** |   |
| United States                      |   | **$**                              | **3,420,000**  |   | $ | 3,766,000 |   | $ | 3,397,000 |   |
| Canada                             |   | **19,920,000**                     |           | 11,852,000 |   | 20,364,000 |   |
| Total  (excluding interest income) |   | **$**                              | **23,340,000** |   | $ | 15,618,000 |   | $ | 23,761,000 |   |

 

**13.****          FAIR VALUE OFFINANCIAL INSTRUMENTS**

 

The carrying amounts ofcash and cash equivalents, accounts receivable, notes receivable, accountspayable and notes payable approximate fair value because of the short maturityof these instruments.  The carryingvalue of long-term debt approximates fair value as the terms approximatecurrent market terms for similar debt instruments of comparable risk andmaturities.

 

The differences betweenthe estimated fair values and carrying values of Barnwell’s financialinstruments are not material.

 

62

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**14.****          CONCENTRATIONS OFCREDIT RISK**

 

Barnwell’soil and natural gas segment derived 64% of its oil and natural gas revenues infiscal 2003 from four individually significant customers, ProGas Limited, CoralEnergy Canada Inc., Plains Marketing Canada, L.P., and Petrogas MarketingLtd.  At September 30, 2003,Barnwell had a total of $1,100,000 in receivables from these fourcustomers.  In fiscal 2002 Barnwellderived 76% of its oil and natural gas revenues from five individuallysignificant customers.

 

Barnwell’scontract drilling subsidiary derived 66%, 70% and 49% of its contract drillingrevenues in fiscal 2003, 2002 and 2001, respectively, pursuant to Federal,State of Hawaii and county contracts. At September 30, 2003, Barnwell had accounts receivables from theFederal, State of Hawaii and county entities totaling approximately$177,000.  Barnwell has lien rights onwells drilled and pumps installed for Federal, State of Hawaii, and countygovernments.

 

Historically, Barnwellhas not incurred significant credit related losses on its trade receivables,and management does not believe significant credit risk related to these tradereceivables exists at September 30, 2003.

 

63

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**15.****          SUPPLEMENTALSTATEMENTS OF CASH FLOWS 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,** |          |
|------------------------------------------------------------------------------|--------|------------------------------------|---------------|
|                                                                         |   | **2003**                           |          | **2002** |   | **2001** |   |
| Increase  (decrease) from changes in:                                        |   |                               | ** **    |   |   |   |   |
|                                                                         |   |                               | ** **    |   |   |   |   |
| Receivables                                                                  |   | **$**                              | **548,000**   | ** ** | $ | (622,000 | ) | $ | 80,000 |   |
| Costs  and estimated earnings in excess of billings on uncompleted contracts |   | **8,000**                          | ** **    | 206,000 |   | 116,000 |   |
| Other  current assets                                                        |   | **210,000**                        | ** **    | (338,000 | ) | (214,000 | ) |
| Accounts  payable                                                            |   | **(84,000**                        | **)**         | 148,000 |   | 551,000 |   |
| Accrued  liabilities                                                         |   | **679,000**                        | ** **    | 21,000 |   | 667,000 |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |   | **(85,000**                        | **)**         | (94,000 | ) | (142,000 | ) |
| Payable  to joint interest owners                                            |   | **(198,000**                       | **)**         | 403,000 |   | (436,000 | ) |
| Income  taxes payable                                                        |   | **401,000**                        | ** **    | (2,311,000 | ) | 1,790,000 |   |
| Increase  (decrease) from changes in current assets and liabilities          |   | **$**                              | **1,479,000** | ** ** | $ | (2,587,000 | ) | $ | 2,412,000 |   |
|                                                                         |   |                               |          |   |   |   |   |
| Supplemental  disclosure of cash flow information:                           |   |                               |          |   |   |   |   |
|                                                                         |   |                               |          |   |   |   |   |
| Cash paid during the year  for:                                              |   |                               |          |   |   |   |   |
| Interest  (net of amounts capitalized)                                       |   | **$**                              | **454,000**   | ** ** | $ | 303,000 |   | $ | 423,000 |   |
|                                                                         |   |                               | ** **    |   |   |   |   |
| Income  taxes                                                                |   | **$**                              | **2,961,000** | ** ** | $ | 3,812,000 |   | $ | 3,705,000 |   |

 

Supplemental disclosureof Non-cash Investing and Financing Activities:

 

Barnwell accrued anadditional $1,518,000 in capital expenditures at September 30, 2003, ascompared to September 30, 2002; accordingly, capital expenditures forfiscal 2003, including accrued capital expenditures, totaled $11,334,000.  Incremental accrued capital expenditures infiscal 2002 and 2001 were not material.

 

On October 1, 2002,net oil and natural gas properties and the asset retirement obligationincreased $1,110,000 as a result of adoption of Statement of FinancialAccounting Standards No. 143.   Duringthe remainder of fiscal 2003, net oil and natural gas properties increased$39,000 to reflect asset retirement obligations incurred on new wells drilledand by $191,000 for changes in foreign currency translation rates; the assetretirement obligation increased $39,000 to reflect asset retirement obligationsincurred on new wells drilled, $85,000 for accretion of the asset retirementobligation, and by $198,000 for changes in foreign currency translation rates.

 

In December 2001,approximately $71,000 of convertible debentures, including accrued interest,was converted to 3,558 shares of Barnwell’s stock at $20 per share; theseshares were issued from Barnwell’s treasury stock.

 

In April 2001,Barnwell purchased 55.2% of Cambridge Hawaii Limited Partnership for$5,000,000.  $2,791,000 was paid uponclosing, and the remaining balance of $2,209,000 was financed by non-interestbearing notes payable.  The $2,209,000of notes payable was paid in fiscal 2002.

 

64

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**16.****          SUBSEQUENT EVENTS**

 

In October 2003, theParliament of Canada held first and second readings on a bill to reduceCanada’s corporate tax rate on “resource” income (income derived from oil andnatural gas operations) over a four-year period beginning January 1, 2003from 29% to 21% beginning January 1, 2007.  Additionally, the bill phases in over the same four-year periodtax deductions for royalties, which previously were not tax deductible, andphases out the Resource Allowance deduction along with other changes.  In November 2003, the bill passed onthird reading, received Royal Assent and was enacted into law.  The reduction in the tax will reduceBarnwell’s deferred income tax liabilities by approximately $1,500,000 in thequarter ending December 31, 2003, Barnwell’s fiscal 2004 first quarter.

 

In December 2003, Barnwell declared a dividend of $0.20 per sharepayable January 6, 2004 to stockholders of record as of December 22,2003.

 

In December 2003,Barnwell purchased the space it was leasing for its corporate offices inHonolulu, Hawaii for $1,104,000.  Thispurchase was funded by $221,000 of cash and long-term debt of $883,000.  The long-term debt is payable in monthlyprincipal payments of approximately $3,000, plus interest at the three-monthLondon Interbank Offer Rate, 1.25% at the time of closing, plus 2%, and is duein full in December 2006.  Thespace purchased has 4,662 useable square feet on the 28th floor of a 31-storyoffice building built in 1993 in downtown Honolulu.

 

As these transactionswere effective in November or December 2003, their impact will bereflected in Barnwell’s quarterly financial statements for the period endedDecember 31, 2003.

 

**17.****          SUPPLEMENTARY OIL ANDNATURAL GAS INFORMATION (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. Proveddeveloped producing oil and natural gas reserves are reserves that can beexpected to be recovered through existing wells with existing equipment andoperating methods. The estimated net interests in total proved developed andproved developed producing reserves are based upon subjective engineeringjudgments and may be affected by the 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 suchestimates will not be materially revised in subsequent periods.

 

(A)          Oil and Natural GasReserves

 

The following table,based on information prepared by independent petroleum engineers, PaddockLindstrom & Associates Ltd., summarizes changes in the estimates ofBarnwell’s net interests in total proved reserves of crude oil and condensateand natural gas (“MCF” means 1,000 cubic feet of natural gas) which are all inCanada:

 

65

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|                                         |   | **OIL  (Barrels)** |       | **GAS  (MCF)** |       |
|----------------------------------------------|--------|--------------------|------------|----------------|------------|
| Balance  at September 30, 2000          |   | 1,781,000          |       | 29,796,000     |       |
|                                         |   |               |       |           |       |
| Decrease  in royalty rates*                  |   | 104,000            |       | 2,482,000      |       |
| Revisions  of previous estimates             |   | (111,000           | )          | (1,695,000     | )          |
| Extensions,  discoveries and other additions |   | 34,000             |       | 1,057,000      |       |
| Less  production                             |   | (272,000           | )          | (3,269,000     | )          |
| Balance  at September 30, 2001          |   | 1,536,000          |       | 28,371,000     |       |
|                                         |   |               |       |           |       |
| Revisions  of previous estimates             |   | 184,000            |       | 985,000        |       |
| Extensions,  discoveries and other additions |   | 49,000             |       | 1,087,000      |       |
| Less  production                             |   | (242,000           | )          | (3,277,000     | )          |
| 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** | ** ** |

 

----

*                 The deduction oraddition of reserve units due to royalty rates is the result of Alberta’sroyalties being calculated on a sliding scale basis, with the royaltypercentage increasing as prices increase. The Province of Alberta takes its royalty share of production based oncommodity prices; as all commodity prices were significantly lower atSeptember 30, 2001, as compared to September 30, 2000, significantlyless reserves were deducted for royalty volumes at September 30, 2001, ascompared to September 30, 2000.

 
|                           |   | **OIL  (Barrels)** |       | **GAS  (MCF)** |       |
|--------------------------------|--------|--------------------|------------|----------------|------------|
| Proved producing reserves  at: |   |               |       |           |       |
| September 30,  2000       |   | 1,508,000          |       | 20,594,000     |       |
| September 30,  2001       |   | 1,327,000          |       | 21,847,000     |       |
| September 30,  2002       |   | 1,303,000          |       | 19,612,000     |       |
| **September 30, 2003**    |   | **1,262,000**      | ** ** | **21,463,000** | ** ** |

 

(B)           Capitalized CostsRelating to Oil and Natural Gas Producing Activities

 
|                                         |   | **September 30,** |           |
|----------------------------------------------|--------|------------------------|----------------|
|                                         |   | **2003**               |           | **2002** |   | **2001** |   |
| Proved  properties                           |   | **$**                  | **77,913,000** |   | $ | 56,959,000 |   | $ | 51,668,000 |   |
| Unproved  properties                         |   | **2,950,000**          |           | 1,149,000 |   | 2,152,000 |   |
| Total  capitalized costs                     |   | **80,863,000**         |           | 58,108,000 |   | 53,820,000 |   |
| Accumulated  depletion and depreciation |   | **43,404,000**         |           | 33,796,000 |   | 30,663,000 |   |
| Net  capitalized costs                       |   | **$**                  | **37,459,000** |   | $ | 24,312,000 |   | $ | 23,157,000 |   |

 

66

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(C)                                CostsIncurred in Oil and Natural Gas Property Acquisition, Exploration andDevelopment

 
|                         |   | **Year ended  September 30,** |          |
|------------------------------|--------|------------------------------------|---------------|
|                         |   | **2003**                           |          | **2002** |   | **2001** |   |
| Acquisition  of properties:  |   |                               |          |   |   |   |   |
| Unproved,  Canadian          |   | **$**                              | **715,000**   |   | $ | 262,000 |   | $ | 468,000 |   |
| Proved,  Canadian            |   | **$**                              | **635,000**   |   | — |   | — |   |
|                         |   |                               |          |   |   |   |   |
| Exploration costs:           |   |                               |          |   |   |   |   |
| Canadian                     |   | **$**                              | **2,567,000** |   | $ | 1,007,000 |   | $ | 431,000 |   |
| United  States               |   | **—**                         |          | — |   | 172,000 |   |
|                         |   | **$**                              | **2,567,000** |   | $ | 1,007,000 |   | $ | 603,000 |   |
|                         |   |                               |          |   |   |   |   |
| Development  costs, Canadian |   | **$**                              | **7,142,000** |   | $ | 3,312,000 |   | $ | 3,169,000 |   |

 

(D)                               TheResults of Operations of Barnwell’s Oil and Natural Gas Producing Activities

 
|                            |   | **Year ended  September 30,** |          |
|---------------------------------|--------|------------------------------------|---------------|
|                            |   | **2003**                           |          | **2002** |   | **2001** |   |
| Gross  revenues                 |   | **26,234,000**                     |          | 14,896,000 |   | 27,695,000 |   |
| Royalties,  net of credit       |   | **6,884,000**                      |          | 3,576,000 |   | 7,825,000 |   |
| Net  revenues                   |   | **19,350,000**                     |          | 11,320,000 |   | 19,870,000 |   |
| Production  costs               |   | **4,192,000**                      |          | 3,108,000 |   | 3,509,000 |   |
| Depletion  and depreciation     |   | **4,026,000**                      |          | 3,315,000 |   | 3,416,000 |   |
| Pre-tax  results of operations* |   | **11,132,000**                     |          | 4,897,000 |   | 12,945,000 |   |
| Estimated  income tax expense   |   | **5,665,000**                      |          | 2,450,000 |   | 6,398,000 |   |
| Results  of operations*         |   | **$**                              | **5,467,000** |   | $ | 2,447,000 |   | $ | 6,547,000 |   |
|                                 |        |                                    |               |  |  |  |  |  |  |  |

 

----

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

 

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

 

The following tables havebeen developed pursuant to procedures prescribed by Statement of FinancialAccounting Standards No. 69, and utilize reserve and production data estimatedby petroleum engineers. The information may be useful for certain comparisonpurposes but should not be solely relied upon in evaluating Barnwell or itsperformance. Moreover, the projections should not be construed as realisticestimates of future cash flows, nor should the standardized measure be viewedas representing current value.

 

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 reserveestimates may occur in the future, development and production of the oil andnatural gas reserves may not occur in the periods assumed and actual pricesrealized and actual costs incurred are expected to vary significantly fromthose used. Management does not rely upon this information in making investmentand operating 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.

 

67

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Standardized Measure ofEstimated Discounted Future Net Cash Flows

 
|                                                                |   | **As of  September 30,** |            |
|---------------------------------------------------------------------|--------|-------------------------------|-----------------|
|                                                                |   | **2003**                      |            | **2002** |   | **2001** |   |
| Future  cash inflows                                                |   | **$**                         | **141,809,000** | ** ** | $ | 101,448,000 |   | $ | 82,347,000 |   |
|                                                                |   |                          | ** **      |   |   |   |   |
| Future  production costs                                            |   | **(37,439,000**               | **)**           | (30,537,000 | ) | (28,883,000 | ) |
|                                                                |   |                          | ** **      |   |   |   |   |
| Future  development costs                                           |   | **(1,231,000**                | **)**           | (1,263,000 | ) | (1,216,000 | ) |
| Future  net cash flows before income taxes                          |   | **103,139,000**               | ** **      | 69,648,000 |   | 52,248,000 |   |
|                                                                |   |                          | ** **      |   |   |   |   |
| Future  income tax expenses                                         |   | **(32,604,000**               | **)**           | (17,442,000 | ) | (18,783,000 | ) |
|                                                                |   |                          | ** **      |   |   |   |   |
| Future  net cash flows                                              |   | **70,535,000**                | ** **      | 52,206,000 |   | 33,465,000 |   |
|                                                                |   |                          | ** **      |   |   |   |   |
| 10%  annual discount for timing of cash flows                       |   | **(20,998,000**               | **)**           | (19,587,000 | ) | (12,192,000 | ) |
|                                                                |   |                          | ** **      |   |   |   |   |
| Standardized  measure of estimated discounted future net cash flows |   | **$**                         | **49,537,000**  | ** ** | $ | 32,619,000 |   | $ | 21,273,000 |   |

 

68

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Changes in theStandardized Measure of Estimated Discounted Future Net Cash Flows

 
|                                                                             |   | **Year ended  September 30,** |           |
|----------------------------------------------------------------------------------|--------|------------------------------------|----------------|
|                                                                             |   | **2003**                           |           | **2002** |   | **2001** |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Beginning  of year                                                               |   | **$**                              | **32,619,000** | ** ** | $ | 21,273,000 |   | $ | 42,500,000 |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Sales  of oil and natural gas produced, net of production costs                  |   | **(15,107,000**                    | **)**          | (8,210,000 | ) | (16,281,000 | ) |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Net  changes in prices and production costs, net of royalties and wellhead taxes |   | **18,878,000**                     | ** **     | 12,469,000 |   | (25,205,000 | ) |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Extensions  and discoveries                                                      |   | **12,673,000**                     | ** **     | 1,989,000 |   | 1,438,000 |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Purchases  of properties                                                         |   | **971,000**                        | ** **     | — |   | — |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Revisions  of previous quantity estimates                                   |   | **771,000**                        | ** **     | 2,657,000 |   | 29,000 |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Net  change in Canadian dollar translation rate                                  |   | **4,441,000**                      | ** **     | (41,000 | ) | (1,640,000 | ) |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Changes  in the timing of future production and other                            |   | **(711,000**                       | **)**          | (1,224,000 | ) | (1,152,000 | ) |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Net  change in income taxes                                                      |   | **(7,680,000**                     | **)**          | 1,957,000 |   | 18,178,000 |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Accretion  of discount                                                           |   | **2,682,000**                      | ** **     | 1,749,000 |   | 3,406,000 |   |
|                                                                             |   |                               | ** **     |   |   |   |   |
| Net  change                                                                      |   | **16,918,000**                     | ** **     | 11,346,000 |   | (21,227,000 | ) |
|                                                                             |   |                               | ** **     |   |   |   |   |
| End  of year                                                                     |   | **$**                              | **49,537,000** | ** ** | $ | 32,619,000 |   | $ | 21,273,000 |   |

 

Item 7A.                       Quantitativeand Qualitative Disclosures About Market Risk

 

Barnwell’s primary marketrisk exposure is interest rate risk. Barnwell’s exposure to market risk for changes in interest rates relatesto its debt obligations under a floating interest rate loan.  Assuming variable rate debt atSeptember 30, 2003, a change of one hundred basis points in interest rateswould impact annual net interest payments by $105,000.  Barnwell does not use derivative financialinstruments to manage interest rate risk.

 

Item 8.                                 Changesin and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

69

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Item 8A.**                      **Controlsand Procedures

 

As of September 30,2003, an evaluation was carried out by Barnwell’s Chief Executive Officer andChief Financial Officer of the effectiveness of Barnwell’s disclosure controlsand procedures.  Based on thatevaluation, the Chief Executive Officer and Chief 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.  Subsequent to the date of their evaluation,there were no significant changes in Barnwell’s internal controls or in otherfactors that could significantly affect the disclosure controls, including anycorrective actions with regard to significant deficiencies and materialweaknesses.

 

PART III

 

Item 9.                                 Directors,Executive Officers, Promoters and Control Persons, Compliance WithSection 16(a) of the Exchange Act 

 

The information requiredis omitted pursuant to General Instruction E.3. of Form 10-KSB, since theRegistrant will file its definitive proxy statement for the 2003 Annual Meetingof Stockholder no later than 120 days after the close of its fiscal year endedSeptember 30, 2003, which proxy statement is incorporated herein byreference.

 

Item 10.                           ExecutiveCompensation

 

The information requiredis omitted pursuant to General Instruction E.3. of Form 10-KSB, since theRegistrant will file its definitive proxy statement for the 2003 Annual Meetingof Stockholder no later than 120 days after the close of its fiscal year endedSeptember 30, 2003, which proxy statement is incorporated herein byreference.

 

Item 11.                           SecurityOwnership of Certain Beneficial Owners and Management

 

The information requiredis omitted pursuant to General Instruction E.3. of Form 10-KSB, since theRegistrant will file its definitive proxy statement for the 2003 Annual Meetingof Stockholder no later than 120 days after the close of its fiscal year endedSeptember 30, 2003, which proxy statement is incorporated herein byreference.

 

70

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#### **Equity Compensation PlanInformation**

#### ** **

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, 2003:

 
| **Plan Category**                                           |   | **(a)  Number of  securities  to be issued  upon exercise  of outstanding  options, warrants  and rights** |   | **(b)  Weighted-  average  price of  outstanding  options,  warrants  and rights** |   | **(c)  Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column (a))** |   |
|-------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| Equity  compensation plans approved by security holders     |   | 93,000                                                                                                     |   | $                                                                                  | 12.25  |                                                                                                                                                       | 36,000 |   |
| Equity  compensation plans not approved by security holders |   | 50,000                                                                                                     |   | $                                                                                  | 17.23  |                                                                                                                                                       | — |   |
| Total                                                       |   | 143,000                                                                                                    |   | $                                                                                  | 13.99  |                                                                                                                                                       | 36,000 |   |

 

Equity compensation plansnot approved by security holders are comprised of the following plans:

 

In March 1995,Barnwell granted 20,000 stock options to an officer of Barnwell under anon-qualified plan at a purchase price of $19.625 per share (market price ondate of grant), with 4,000 of such options vesting annually commencing one yearfrom the date of grant.  These optionshave stock appreciation rights that permit the holder to receive stock, cash ora combination thereof equal to the amount by which the fair market value, atthe time of exercise of the option, exceeds the option price.  The options expire ten years from the dateof grant.

 

In June 1998,Barnwell granted 30,000 stock options to an officer of Barnwell’s oil and gassegment under a non-qualified plan at a purchase price of $15.625 per share(market price on date of grant), with 6,000 of such options vesting annuallycommencing one year from the date of grant. These options have stock appreciation rights that permit the holder toreceive stock, cash or a combination thereof equal to the amount by which thefair market value, at the time of exercise of the option, exceeds the optionprice.  The options expire ten yearsfrom the date of grant.

 

Item 12.                           CertainRelationships and Related Transactions

 

The information requiredis omitted pursuant to General Instruction E.3. of Form 10-KSB, since theRegistrant will file its definitive proxy statement for the 2003 Annual Meetingof Stockholder no later than 120 days after the close of its fiscal year endedSeptember 30, 2003, which proxy statement is incorporated herein byreference.

 

71

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Item 13.                           Exhibits,List and Reports on Form 8-K

 
| (A) |   | Financial Statements |
|-----|--------|----------------------|

 

The following consolidated financial statements ofBarnwell Industries, Inc. and its subsidiaries are included in Part II, Item 7:

 
| Independent  Auditors’ Report - KPMG LLP                                                                                                                           |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                    |   |
| Consolidated Balance Sheets  - September 30, 2003 and 2002                                                                                                         |   |
|                                                                                                                                                                    |   |
| Consolidated  Statements of Operations – for the three years ended September 30, 2003                                                                         |   |
|                                                                                                                                                                    |   |
| Consolidated  Statements of Cash Flows – for the three years ended September 30, 2003                                                                         |   |
|                                                                                                                                                                    |   |
| Consolidated  Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the  three years ended September 30, 2003                                |   |
|                                                                                                                                                                    |   |
| Notes to  Consolidated Financial Statements                                                                                                                             |   |
|                                                                                                                                                                    |   |
| Schedules have been  omitted because they were not applicable, not required, or the information is  included in the consolidated financial statements or notes thereto. |   |

 
| (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.(6) |
|   |   |                |   |   |
|   |   | 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 |
|        |        |                     |  |  |  |  |

 

----

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

(2)                                  Incorporatedby reference to the registration statement on Form S-1 originally filed by theRegistrant January 29, 1957 and as amended February 15, 1957 andFebruary 19, 1957.

(3)                                  Incorporatedby reference to Form 10-K for the year ended September 30, 1989.

(4)                                  Incorporatedby reference to Form 10-K for the year ended September 30, 1992.

(5)                                  Incorporatedby reference to Form 10-KSB for the year ended September 30, 2000.

(6)                                  Incorporatedby reference to Form 10-KSB for the year ended September 30, 1998.

 

72

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Item 14.                           PrincipalAccountant Fees and Services

 

The information requiredis omitted pursuant to General Instruction E.3. of Form 10-KSB, since theRegistrant will file its definitive proxy statement for the 2003 Annual Meetingof Stockholder no later than 120 days after the close of its fiscal year endedSeptember 30, 2003, which proxy statement is incorporated herein byreference.

 

73

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SIGNATURES

 

 

In accordance withSection 13 or 15(d) of the Securities Act, the registrant has this reportto be signed on its behalf by the undersigned, thereunto duly authorized.

 

 
| BARNWELL INDUSTRIES,  INC.                                                               |                       |
|------------------------------------------------------------------------------------------|----------------------------|
| (Registrant)                                                                             |                       |
|                                                                                     |                       |
|                                                                                     |                       |
|            /s/Russell  M. Gifford |                       |   |
| By:                                                                                      | Russell M. Gifford         |   |
|                                                                                     | Chief Financial  Officer,  |   |
|                                                                                     | Executive Vice  President, |   |
|                                                                                     | Treasurer and Secretary    |   |
| Date:                                                                                    | December 23, 2003     |   |
|                                                                                          |                            |  |  |  |  |

 

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 23,  2003                                                           |                                 |
|                                                                                    |                                 |
|            /s/Martin  Anderson   |                                 |            /s/Daniel  Jacobson      |   |
| MARTIN ANDERSON,  Director                                                              | DANIEL JACOBSON,  Director           |
| Date: December 23,  2003                                                           | Date: December 23,  2003        |
|                                                                                    |                                 |
|            /s/Murray  C. Gardner |                                 |            /s/Terry  Johnston       |   |
| MURRAY C. GARDNER,  Director                                                            | TERRY JOHNSTON,  Director            |
| Date: December 23,  2003                                                           | Date: December 23,  2003        |
|                                                                                    |                                 |
|                                                                                    |                                 |            /s/Alexander  C. Kinzler |   |
| ERIK  HAZELHOFF-ROELFZEMA                                                               | ALEXANDER C. KINZLER                 |
| Director                                                                                | President, Chief  Operating Officer, |
|                                                                                    | General Counsel and  Director        |
|                                                                                    | Date: December 23,  2003        |
|                                                                                    |                                 |
|            /s/Alan  D. Hunter    |                                 |            /s/Russell  M. Gifford   |   |
| ALAN D. HUNTER,  Director                                                               | RUSSELL M. GIFFORD                   |
| Date: December 23,  2003                                                           | Executive Vice  President,           |
|                                                                                    | Chief Financial  Officer, Treasurer  |
|                                                                                    | Secretary and Director               |
|                                                                                    | Date: December 23,  2003        |
|                                                                                         |                                      |                                                                                            |  |  |  |  |

 

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