<PAGE>
PROSPECTUS
$100,000,000
[LOGO]
COSTILLA ENERGY, INC.
10 1/4% SENIOR NOTES DUE 2006
---------------------
The 10 1/4% Senior Notes due 2006 (the "Notes") are being offered (the
"Notes Offering") by Costilla Energy, Inc., a Delaware corporation ("Costilla"
or the "Company"). The net proceeds of the Notes Offering, together with the net
proceeds of the other financing described herein, will be used by the Company to
refinance existing indebtedness, to pay certain costs in connection with the
Corporate Reorganization (as defined herein) and for general corporate purposes.
The Notes mature on October 1, 2006, unless previously redeemed. Interest on
the Notes is payable semiannually on April 1 and October 1, commencing April 1,
1997. The Notes will be redeemable at the option of the Company, in whole or in
part, on or after October 1, 2001, at the redemption prices set forth herein,
plus accrued and unpaid interest, if any, to the redemption date.
Notwithstanding the foregoing, at any time on or before October 1, 1999,
Costilla may redeem up to 30% of the original aggregate principal amount of the
Notes with the net proceeds of an Equity Offering (as defined herein) at a
redemption price equal to 110.25% of the principal amount thereof, plus accrued
and unpaid interest thereon, if any, to the redemption date. Upon a Change of
Control (as defined herein), the Company will be required to make an offer to
repurchase all outstanding Notes at 101% of the aggregate principal amount
thereof plus accrued and unpaid interest, if any, to the date of repurchase. See
"Description of Notes."
Concurrently with the Notes Offering, the Company is offering 4,800,000
shares (5,520,000 shares if the underwriters' over-allotment option is exercised
in full) of its Common Stock (the "Common Stock Offering" and together with the
Notes Offering, the "Offerings") pursuant to an underwritten public offering.
The Notes Offering and the Common Stock Offering are each conditioned on the
consummation of the other.
The Notes will be general unsecured senior obligations of the Company and
will rank equally in right of payment with all other Senior Indebtedness (as
defined herein) of the Company, which will include borrowings under the Credit
Facility (as defined herein), but will be effectively subordinated to any
existing or future secured Senior Indebtedness. The Credit Facility is expected
to be secured by substantially all of the assets of the Company. As of June 30,
1996, on a pro forma basis after giving effect to the Corporate Reorganization,
the Offerings and the application of the proceeds therefrom, as described under
"Use of Proceeds," the Company would have had $0.4 million of secured Senior
Indebtedness. No indebtedness of the Company is expressly subordinated to the
Notes. Initially, both the Notes and the Credit Facility will be effectively
subordinated to liabilities of the Company's subsidiaries. On a pro forma basis,
the total liabilities of the Company's subsidiaries were $6.5 million at June
30, 1996, all of which were operating liabilities. See "Risk Factors,"
"Capitalization" and "Description of Notes."
The Notes will be represented by a Global Certificate registered in the name
of the nominee of The Depository Trust Company, which will act as the Depositary
(the "Depositary"). Beneficial interests in the Global Certificate will be shown
on, and transfers thereof will be effected only through, records maintained by
the Depositary and its participants. Except as described herein, Notes in
definitive form will not be issued. See "Description of Notes-- Book-Entry,
Delivery and Form."
The Company does not intend to list the Notes on any national securities
exchange. See "Risk Factors-- Absence of Public Market." The Common Stock has
been approved for listing on The Nasdaq Stock Market's National Market ("Nasdaq
National Market") under the symbol COSE.
SEE "RISK FACTORS" BEGINNING ON PAGE 10 FOR A DISCUSSION OF FACTORS THAT
SHOULD BE CONSIDERED IN EVALUATING AN INVESTMENT IN THE NOTES.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THE PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<TABLE>
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------
<CAPTION>
Price to Underwriting Proceeds to
Public (1) Discounts (2) Company (1)(3)
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------
Per Note........................................... 100% 3.25% 96.75%
Total.............................................. $100,000,000 $3,250,000 $96,750,000
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(1) Plus accrued interest, if any, from October 8, 1996.
(2) The Company has agreed to indemnify the Underwriters (as defined herein)
against certain liabilities, including liabilities under the Securities Act
of 1933, as amended. See "Underwriting."
(3) Before deducting expenses payable by the Company, estimated at $600,000.
The Notes are being offered, subject to prior sale, by the Underwriters
when, as and if issued to and accepted by the Underwriters, and subject to
various prior conditions. The Underwriters reserve the right to withdraw, cancel
or modify such offer and to reject orders in whole or in part. It is expected
that delivery of the Global Certificate will be made on or about October 8, 1996
in book-entry form through the facilities of the Depositary, against payment
therefor.
NATIONSBANC CAPITAL MARKETS, INC. PRUDENTIAL SECURITIES INCORPORATED
The date of this Prospectus is October 2, 1996
<PAGE>
PRIMARY OPERATING AREAS
[A GEOGRAPHICAL MAP INDICATING WHERE THE COMPANY HAS
OIL AND GAS PROPERTIES AND OFFICES]
IN CONNECTION WITH THIS NOTES OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR
EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE NOTES AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED IN THE OPEN MARKET OR OTHERWISE. SUCH
STABILIZATION, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE DETAILED
INFORMATION, FINANCIAL STATEMENTS AND OTHER DATA APPEARING ELSEWHERE IN THIS
PROSPECTUS. THE PRO FORMA INFORMATION GIVES EFFECT TO THE CONVERSION OF COSTILLA
FROM A LIMITED LIABILITY COMPANY TO A CORPORATION, CERTAIN MATERIAL ACQUISITIONS
AND THE OFFERINGS AND THE APPLICATION OF THE ESTIMATED NET PROCEEDS THEREFROM.
SEE "-- SIGNIFICANT ACQUISITIONS," "THE COMPANY -- CORPORATE REORGANIZATION,"
AND "USE OF PROCEEDS." AS USED HEREIN, REFERENCES TO THE COMPANY OR TO COSTILLA
ARE TO COSTILLA ENERGY, INC. AND ITS SUBSIDIARIES. UNLESS OTHERWISE INDICATED,
THE INFORMATION IN THIS PROSPECTUS ASSUMES THE UNDERWRITERS' OVER-ALLOTMENT
OPTION WITH RESPECT TO THE COMMON STOCK OFFERING WILL NOT BE EXERCISED. CERTAIN
OIL AND GAS TERMS USED IN THIS PROSPECTUS ARE DEFINED IN THE "GLOSSARY" INCLUDED
HEREIN. CERTAIN TERMS USED IN CONNECTION WITH THE NOTES ARE DEFINED UNDER
"DESCRIPTION OF NOTES -- CERTAIN DEFINITIONS." "ADJUSTED EBITDA," AS USED
HEREIN, MEANS NET INCOME (LOSS), PLUS INTEREST, INCOME TAXES, DEPRECIATION,
DEPLETION AND AMORTIZATION, EXPLORATION AND ABANDONMENT COSTS AND EXTRAORDINARY
LOSS FROM EXTINGUISHMENT OF DEBT.
THE COMPANY
Costilla is an independent energy company engaged in the exploration,
acquisition and development of oil and gas properties. The Company's primary
operations are in the Permian Basin area of Texas and New Mexico, the Gulf Coast
and the Rocky Mountain regions. The Company's strategy focuses on increasing
reserves through a targeted exploration program, the exploitation of its
existing properties and selective property acquisitions. In addition, the
Company recently acquired an interest in an entity which has a concession for
the development of mineral interests in the Republic of Moldova, in Eastern
Europe. The Company also has minor interests in the domestic gas gathering and
transmission business.
The Company's predecessor began operating in 1988 with the strategy of
acquiring and exploiting undervalued oil and gas properties, and at December 31,
1992 had net proved reserves of 4.7 MMBOE. Since January 1, 1993, the Company
has successfully closed seven transactions for an aggregate purchase price of
approximately $101 million. As of April 1, 1996, the Company had total estimated
net proved reserves of 16.5 Mmbbls of oil and 112.9 Bcf of gas, aggregating 35.3
MMBOE, with a PV-10 Value of approximately $179.5 million, assuming the 1996
Acquisition (as defined below) had occurred at April 1, 1996. The Company also
has a substantial undeveloped acreage position consisting of 180,704 gross
(165,166 net) acres at June 30, 1996. The Company has identified in excess of
185 drilling locations of which 64 are included in its proved reserves.
Costilla has in-house exploration expertise which uses 3-D seismic
technology as a primary tool to identify drilling opportunities and has
experienced high rates of success in each of its first two major 3-D seismic
drilling programs. Since 1994, the Company has drilled 37 wells based on these
3-D surveys, 31 of which have been productive. The Company has recently
completed two additional 3-D surveys and intends to commence drilling on one of
these acreage blocks in the second half of 1996. The Company currently plans to
drill 63 wells through 1997 based on its 3-D surveys.
Since 1993, Costilla has generated significant growth in reserves and
production. The Company increased its estimated proved reserves from 6.0 MMBOE
at December 31, 1993 to 35.3 MMBOE at April 1, 1996 (pro forma for the 1996
Acquisition), representing a compound annual growth rate of 114%. This reserve
growth has been achieved at an average all-in finding cost of $3.60 per BOE over
such period, a level which the Company believes is lower than industry averages.
Concurrently, the Company increased its average net daily production from 827
BOE for the year ended December 31, 1993 to 10,231 BOE for the three months
ended March 31, 1996 (pro forma for the 1996 Acquisition), representing a
compound annual growth rate of 190%.
3
<PAGE>
BUSINESS STRATEGY
The Company's strategy is to increase its oil and gas reserves, production
and cash flow from operations through a two-pronged approach which combines an
active exploration program using 3-D seismic and other technological advances
with the acquisition and exploitation of producing properties. The Company seeks
to reduce its operating and commodity risks by holding a geographically diverse
portfolio of properties, the reserves attributable to which are approximately
balanced between oil and gas. The Company also seeks to manage the elements of
its business strategy through the operation of a significant portion of its
properties, the use of a rate of return analysis and the direct marketing and
hedging of its oil and gas production. The elements of the Company's strategy
may be further described as follows:
- - EXPLORATION EFFORTS. The Company uses extensive geological and
geophysical analysis to carefully focus its 3-D seismic surveys. This
focus allows the Company to successfully direct the size and scope of its
exploration program in order to improve the likelihood of success while
managing overall exploration costs. The Company's exploration efforts are
concentrated currently on known producing regions. The Company plans to
drill 24 exploratory wells during the last half of 1996 and 36 exploratory
wells in 1997. Capital budgeted for exploration activities is $8.1 million
for the last six months of 1996 and $10.8 million for 1997.
- - EXPLOITATION ACTIVITIES. The Company is actively pursuing numerous
exploitation opportunities within its existing properties, including areas
where no proved reserves are currently assigned. Exploitation activities
currently in progress include a carbon dioxide flood, recompletions,
workovers, infill and horizontal drilling and a secondary recovery
project. The Company's capital budget for such activities is $8.4 million
for the last six months of 1996 and $9.2 million for 1997, which includes
the drilling of 12 development wells in 1996 and 13 development wells in
1997.
- - PROPERTY ACQUISITIONS. The Company seeks to acquire producing properties
where it has identified opportunities to increase production and reserves
through both exploitation and exploration activities. The Company has
increased the value of its acquisitions by aggressively managing the
operations of existing proved properties and by successfully identifying
and developing previously unproved reserves on acquired acreage. The
Company seeks to acquire reserves which will fit its existing portfolio,
are generally not being actively marketed and where a negotiated sale
would be the method of purchase. The Company does not rely on major oil
company divestitures or property auctions.
- - PROPERTY DIVERSIFICATION. The Company holds a portfolio of oil and gas
properties located in the Permian Basin, the Gulf Coast and the Rocky
Mountain regions. The Company believes that by conducting its activities
in distinct regions it is able to reduce commodity price and other
operational risks. The Company's Moldovan interest is an extension of this
strategy and can be characterized by low initial costs, significant
reserve potential and the availability of technical data that may be
further developed by the Company.
- - CONTROL OF OPERATIONS. The Company prefers to operate and own the
majority working interest in its properties. This allows the Company
greater control over future development, drilling, completing and lifting
costs and marketing of production. At April 1, 1996, the Company operated
wells constituting approximately 72% of its total PV-10 Value (pro forma
for the 1996 Acquisition).
4
<PAGE>
SIGNIFICANT ACQUISITIONS
1995 ACQUISITION. In a $46.6 million acquisition completed in June 1995,
the Company acquired a group of oil and gas properties located in the Permian
Basin, Gulf Coast and Rocky Mountain regions. At the date of acquisition, the
net proved reserves included 7.1 Mmbbls of oil and 44.1 Bcf of gas, aggregating
14.4 MMBOE. From the date of acquisition until March 31, 1996, the Company
produced 1.5 MMBOE from the acquired properties and sold a portion of the
acquired properties for approximately $3.6 million. At April 1, 1996, the net
proved reserves of the remaining properties were 13.4 MMBOE. The acquired
properties also included 103,010 gross (93,787 net) undeveloped acres.
1996 ACQUISITION. In June 1996, the Company acquired a group of oil and gas
properties located primarily in the Permian Basin and Gulf Coast regions for
approximately $42.5 million. This acquisition included properties with net
proved reserves at April 1, 1996 of 5.0 Mmbbls of oil and 33.5 Bcf of gas,
aggregating 10.6 MMBOE. The acquired properties also included 42,855 gross
(16,646 net) undeveloped acres and a pipeline located in Pennsylvania which had
an allocated purchase price of $3.5 million.
DRILLING ACTIVITIES
Exploration efforts since January 1, 1996 include the drilling of eight
wells located on the Company's Edwards/McElroy Ranch Prospect in the Permian
Basin. While one of such wells is being drilled, the remaining seven wells have
been completed as producers. Three of the productive wells have resulted in
separate field discoveries which have confirmed the Company's seismic
interpretation of a significant trend. Since beginning operations on this
prospect, the Company has drilled 11 producing wells and one dry hole. As a
result, the Company has identified up to 68 additional drilling locations, none
of which are included in the Company's proved reserves.
The Company has also continued drilling in the McGyver-Green Acres 3-D
Prospect. Since commencing activity in this prospect in July 1994 the Company
has drilled 17 wells, of which 14 have been successful. During June 1996, the
average daily capacity from the producing wells in this prospect was
approximately 83 BOE per well. The Company has identified 34 additional drilling
locations in the McGyver-Green Acres Prospect, nine of which are included in the
Company's proved reserves.
The Company has also drilled and completed seven development wells in the
Permian Basin and Gulf Coast regions since the beginning of 1996. Currently, the
Company's principal exploitation activities include a carbon dioxide flood in
the East Goldsmith Unit, infill drilling primarily in the Permian Basin and
horizontal drilling in the Susan Peak Field.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Securities Offered.......................... $100,000,000 aggregate principal amount of
10 1/4% Senior Notes due 2006 of the Company
(the "Notes").
Maturity Date............................... October 1, 2006.
Interest Payment Dates...................... April 1 and October 1, commencing April 1,
1997.
Optional Redemption......................... On or after October 1, 2001, the Company may
redeem the Notes, in whole or in part, at the
redemption prices set forth herein, plus
accrued and unpaid interest, if any, to the
date of redemption. Notwithstanding the
foregoing, at any time on or before October 1,
1999, the Company may redeem up to 30% of the
original aggregate principal amount of the
Notes with the net proceeds of an Equity
Offering (as defined herein) at a redemption
price equal to 110.25% of the principal amount
thereof, plus accrued and unpaid interest, if
any, to the date of redemption, provided that
at least 70% of the original aggregate
principal amount of the Notes remain
outstanding immediately after such redemption.
See "Description of Notes -- Optional
Redemption."
Mandatory Redemption........................ None, except at maturity on October 1, 2006.
Ranking..................................... The Notes will be general unsecured senior
obligations of the Company, and will rank
equally in right of payment with all other
Senior Indebtedness of the Company (including
the Credit Facility) and senior in right of
payment to all existing and future
Subordinated Indebtedness of the Company.
Borrowings under the Credit Facility are
expected to be secured by substantially all of
the assets of the Company and any subsidiary
of the Company that guarantees such
borrowings. Initially, none of the Company's
subsidiaries will guarantee the obligations of
the Company under the Credit Facility. To the
extent of pledged collateral, such
Indebtedness will have priority over the
Notes. At June 30, 1996, on a pro forma basis
after giving effect to the Corporate
Reorganization, the Offerings and the
application of the net proceeds therefrom, the
Company would have had $0.4 million of secured
Senior Indebtedness and no other unsecured
Senior Indebtedness. The Notes also will be
effectively subordinated to all indebtedness
and other liabilities of the Company's
subsidiaries until such subsidiaries (the
'Subsidiaries Guarantors") deliver Subsidiary
Guarantees to fully and unconditionally
guarantee the Notes on a senior basis (the
"Subsidiary Guarantees"). At June 30, 1996,
the subsidiaries' total liabilities were
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
$6.5 million, all of which were operating
liabilities. The Indenture pursuant to which
the Notes will be issued (the "Indenture")
requires each Subsidiary to deliver a
Subsidiary Guarantee as a condition to its
incurrence of Indebtedness (other than
intercompany Indebtedness). At the date of the
Indenture, there will be no Subsidiary
Guarantees. See "Description of Notes --
Ranking" and "-- Subsidiary Guarantees."
Change of Control........................... Upon a Change of Control (as defined herein),
the Company will be required to make an offer
to repurchase all outstanding Notes at 101% of
the principal amount thereof plus accrued and
unpaid interest thereon, if any, to the date
of repurchase. See "Description of Notes --
Repurchase at the Option of Holders -- Change
of Control."
Covenants................................... The Indenture will restrict, among other
things, the Company's ability to incur
additional indebtedness, pay dividends or make
certain other restricted payments, incur
liens, engage in any sale and leaseback
transaction, sell stock of subsidiaries, apply
net proceeds from certain asset sales, merge
or consolidate with any other person, sell,
assign, transfer, lease, convey or otherwise
dispose of substantially all of the assets of
the Company, or enter into certain
transactions with affiliates.
Common Stock Offering....................... Concurrently with the Notes Offering, the
Company is offering 4,800,000 shares of Common
Stock to the public. See "Common Stock
Offering." The closings of the Notes Offering
and the Common Stock Offering are each
conditioned upon the consummation of the
other.
Use of Proceeds............................. The Company intends to use the net proceeds of
the Notes Offering, together with the net
proceeds of the Common Stock Offering (i) to
repay existing indebtedness, (ii) to pay
certain costs incurred in connection with the
Corporate Reorganization (as defined herein),
including redeeming certain membership
interests of the Company's predecessor and
(iii) for general corporate purposes. See "Use
of Proceeds."
</TABLE>
RISK FACTORS
See "Risk Factors" for a discussion of certain factors that should be
considered in evaluating an investment in the Notes.
7
<PAGE>
SUMMARY FINANCIAL INFORMATION
The following table sets forth certain summary historical and pro forma
financial data of the Company. The historical information should be read in
conjunction with the Consolidated Financial Statements and the notes thereto
included elsewhere in this Prospectus. The Company acquired significant
producing oil and gas properties in certain of the periods presented which
affect the comparability of the historical financial and operating data for the
periods presented. The pro forma information should be read in conjunction with
the Pro Forma Condensed Financial Statements and notes thereto included
elsewhere in this Prospectus. Neither the historical results nor the pro forma
results are necessarily indicative of the Company's future operations or
financial results.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
------------------------------------------ -------------------------------
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
------------------------------- --------- -------------------- ---------
1993 1994 1995 1995(1) 1995 1996 1996(1)
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT RATIOS AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................................ $ 4,397 $ 7,836 $ 21,816 $ 52,637 $ 5,573 $ 19,525 $ 28,748
Expenses:
Oil and gas production............................ 1,688 2,351 10,355 26,937 2,413 8,278 13,295
General and administrative........................ 952 1,184 3,571 4,850 1,008 2,809 3,010
Compensation related to option settlement......... -- -- 656 656 656 -- --
Exploration and abandonments...................... 218 793 1,650 2,761 1,007 308 555
Depreciation, depletion and amortization.......... 884 1,847 5,958 14,176 1,367 4,620 6,981
Interest.......................................... 605 1,458 4,591 10,635 1,046 4,156 5,317
Other............................................. -- -- 2 2 -- -- --
Net income (loss) before income taxes and
extraordinary item................................. 50 203 (4,967) (7,380) (1,924) (646) (410)
Net income (loss)................................... 73 163 (4,970) (7,383) (1,924) (2,286) (410)
Pro forma earnings (loss) per common share.......... -- -- -- (0.75) -- -- (0.04)
Pro forma weighted average common shares
outstanding........................................ -- -- -- 9,861 -- -- 10,000
STATEMENT OF CASH FLOWS DATA:
Net cash provided by (used in):
Operating activities.............................. $ 322 $ 1,527 $ 6,366 -- $ (3,040) $ (122) --
Investing activities.............................. (6,731) (12,146) (62,467) -- (57,773) (49,723) --
Financing activities.............................. 6,315 10,618 58,830 -- 62,094 48,143 --
OTHER FINANCIAL DATA:
Capital expenditures................................ $ 6,862 $ 11,868 $ 62,220 -- $ 57,773 $ 49,723 --
Adjusted EBITDA (2)................................. 1,757 4,301 7,232 $ 20,192 1,496 8,438 $ 12,443
Adjusted EBITDA/interest expense (2)................ 2.9x 2.9x 1.6x 1.9x 1.4x 2.0x 2.3x
Ratio of earnings to fixed charges (3).............. 1.0 1.1 -- -- -- -- --
BALANCE SHEET DATA (AS OF PERIOD END):
Working capital..................................... $ 1,612 $ 1,081 $ 2,496 -- -- $ 4,266 $ 13,757
Total assets........................................ 13,290 24,904 87,367 -- -- 135,047 146,434
Total debt.......................................... 12,034 23,613 71,494 -- -- 122,365 100,365
Redeemable members' capital......................... -- -- 11,576 -- -- 13,171 --
Members' capital.................................... 51 (747) (7,445) -- -- (11,326) --
Pro forma stockholders' equity...................... -- -- -- -- -- -- 35,232
ACNTA (4)........................................... 200,923
Ratio of ACNTA to total debt........................ -- -- -- -- -- -- 2.0x
</TABLE>
- ------------------------------
(1) Assumes that the 1995 Acquisition, the 1996 Acquisition, the Corporate
Reorganization (as defined in "The Company-- Corporate Reorganization") and
the Offerings and the application of proceeds therefrom had taken place on
June 30, 1996 for purposes of the Balance Sheet Data (to the extent not
already reflected) and as of January 1, 1995 for purposes of Statement of
Operations Data and Other Financial Data.
(2) Adjusted EBITDA and the ratio of Adjusted EBITDA to interest expense are
presented because of their wide acceptance as financial indicators of a
company's ability to service or incur debt. Adjusted EBITDA (as used
herein) is calculated by adding interest, income taxes, depreciation,
depletion and amortization, exploration and abandonment costs and
extraordinary loss resulting from extinguishment of debt to net income
(loss). The ratio of Adjusted EBITDA to interest expense is calculated by
dividing Adjusted EBITDA by interest. Interest includes interest expense
accrued and amortization of deferred financing costs. Adjusted EBITDA and
the ratio of Adjusted EBITDA to interest expense should not be considered
as alternatives to earnings (loss), or operating earnings (loss), as
defined by generally accepted accounting principles, as indicators of the
Company's financial performance or to cash flow as a measure of liquidity.
(3) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" are net income (loss) before extraordinary loss resulting from
extinguishment of debt, plus income taxes and fixed charges. Fixed charges
are comprised of interest on indebtedness, amortization of deferred
financing costs, and that portion of operating lease expense which is
deemed to be representative of an interest factor. Earnings were
insufficient to cover fixed charges by $4,967,000, $1,924,000 and $646,000
for the historical periods ended December 31, 1995, June 30, 1995 and June
30, 1996, respectively, and $7,380,000 and $410,000 for the pro forma
periods ended December 31, 1995 and June 30, 1996, respectively.
(4) ACNTA means Adjusted Consolidated Net Tangible Assets as defined in the
Indenture. See "Description of Notes-- Certain Definitions."
8
<PAGE>
SUMMARY RESERVE DATA
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF APRIL 1, 1996
------------------------------- ------------------------
1993 1994 1995 ACTUAL PRO FORMA(1)
--------- --------- --------- --------- -------------
<S> <C> <C> <C> <C> <C>
ESTIMATED PROVED RESERVES (2):
Oil (MBbls)............................................ 2,365 4,009 10,788 11,479 16,477
Gas (Mmcf)............................................. 21,619 27,512 78,152 79,420 112,921
MBOE................................................... 5,968 8,594 23,813 24,716 35,297
Percent of proved developed reserves................... 67.0% 62.3% 76.1% 73.9% 78.2%
Present value of estimated future net cash flow, before
income taxes, discounted at 10% (in thousands)........ $ 26,377 $ 36,779 $ 113,296 $ 129,091 $ 179,527
Reserve life index (in years) (3)...................... 19.8 14.4 13.6 -- --
RESERVE REPLACEMENT DATA:
Production replacement ratio (4)....................... 513% 540% 969% -- --
All-in finding costs per BOE (5)....................... $ 4.31 $ 3.67 $ 3.43 $ 2.84 $ 3.72
</TABLE>
- ------------------------------
(1) Gives effect to the 1996 Acquisition as if such transaction had occurred as
of April 1, 1996.
(2) Estimates of net proved oil and gas reserves at April 1, 1996 are based on
reports prepared by Williamson Petroleum Consultants, Inc. ("Williamson"),
independent petroleum engineers. The 1995 reserve estimates were prepared by
the Company and such estimates of gross reserves with respect to certain of
the Company's producing properties were subject to a limited review by
Williamson. Prior reserve estimates are based on information compiled by the
Company. See "Risk Factors -- Uncertainty of Estimates of Proved Reserves
and Future Net Revenues" and "Business and Properties -- Oil and Gas
Reserves."
(3) Calculated by dividing year-end proved reserves by annual production for the
most recent year.
(4) Calculated by dividing reserve additions through acquisitions of reserves,
extensions and discoveries and revisions during the year by production for
such year.
(5) The average all-in finding costs over the period January 1, 1993 through
March 31, 1996 (pro forma for the 1996 Acquisition) was $3.60 per BOE.
SUMMARY OPERATING DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------
SIX MONTHS ENDED JUNE 30,
HISTORICAL PRO FORMA(1) 1996
------------------------------- ------------- --------------------------
1993 1994 1995 1995 ACTUAL PRO FORMA(1)
--------- --------- --------- ------------- --------- ---------------
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PRODUCTION DATA:
Oil (MBbls)................................... 158 330 950 2,085 709 990
Gas (Mmcf).................................... 865 1,600 4,806 11,984 3,504 5,345
MBOE.......................................... 302 597 1,751 4,083 1,293 1,881
AVERAGE SALES PRICE PER UNIT:
Oil (per Bbl)................................. $ 16.93 $ 15.25 $ 15.53 $ 15.75 $ 18.93 $ 18.26
Gas (per Mcf)................................. 1.82 1.63 1.45 1.59 1.91 1.87
COSTS PER BOE:
Production costs, including severance taxes
(2).......................................... $ 5.59 $ 3.94 $ 5.91 $ 6.60 $ 6.40 $ 7.07
Depreciation, depletion and amortization...... 2.93 3.09 3.40 3.47 3.57 3.71
</TABLE>
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(1) Gives effect to the 1995 Acquisition and the 1996 Acquisition as if such
transactions had occurred as of January 1, 1995.
(2) Production costs per BOE in 1995 and for the six months ended June 30, 1996
were unusually high as a result of relatively high workover expenses with
respect to properties acquired in the 1995 Acquisition which did not produce
related production improvements until subsequent periods. Additionally, the
Company's 1995 production costs were adversely affected by expenses incurred
in connection with plugging wells to comply with applicable regulatory
requirements.
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RISK FACTORS
PRIOR TO MAKING AN INVESTMENT DECISION, PROSPECTIVE INVESTORS SHOULD
CONSIDER FULLY, TOGETHER WITH THE OTHER INFORMATION CONTAINED IN THIS
PROSPECTUS, THE FOLLOWING FACTORS.
SIGNIFICANT LEVERAGE AND DEBT SERVICE
As of June 30, 1996, as adjusted for the Corporate Reorganization, the
Offerings and the application of the net proceeds therefrom, the Company's total
debt and stockholders' equity would have been $100.4 million and $35.2 million,
respectively. See "Capitalization." In addition, the Company may currently incur
additional indebtedness under its Credit Facility (as defined under "Description
of Other Indebtedness"). Immediately following the consummation of the
Offerings, the Credit Facility will afford the Company $50.0 million of
available borrowing capacity, none of which is expected to be necessary to
finance the Company's existing business plan. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources" and "Description of Other Indebtedness."
The Company's level of indebtedness will have several important effects on
its future operations, including (i) a substantial portion of the Company's cash
flow from operations must be dedicated to the payment of interest on its
indebtedness and will not be available for other purposes, (ii) covenants
contained in the Credit Facility and the Indenture governing the Notes will
require the Company to meet certain financial tests, and other restrictions may
limit its ability to borrow additional funds or to dispose of assets and may
affect the Company's flexibility in planning for, and reacting to, changes in
its business, including possible acquisition activities and (iii) the Company's
ability to obtain additional financing in the future for working capital,
capital expenditures, acquisitions, general corporate purposes or other purposes
may be impaired. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
The Company's ability to meet its debt service obligations and to reduce its
total indebtedness will be dependent upon the Company's future performance,
which will be subject to general economic conditions and to financial, business
and other factors affecting the operations of the Company, many of which are
beyond its control. Earnings were insufficient to cover fixed charges by $5.0
million and $0.6 million for the year ended December 31, 1995 and six months
ended June 30, 1996, respectively, and $7.4 million and $0.4 million for the pro
forma year ended December 31, 1995 and six months ended June 30, 1996,
respectively. Based upon the current and anticipated level of operations, the
Company believes, however, that its cash flow from operations, together with
amounts available under its Credit Facility and its other sources of liquidity,
will be adequate to meet its anticipated requirements in the foreseeable future
for working capital, capital expenditures, interest payments and scheduled
principal payments. There can be no assurance, however, that the Company's
business will continue to generate cash flow at or above current levels. If the
Company is unable to generate sufficient cash flow from operations in the future
to service its debt, it may be required to refinance all or a portion of its
existing debt, including the Notes, or to obtain additional financing. There can
be no assurance that any such refinancing would be possible or that any
additional financing could be obtained. The inability to obtain additional
financing could have a material adverse effect on the Company. For example, a
default by the Company under the terms of the Indenture could result in a
default under the terms of the Credit Facility.
EFFECTIVE SUBORDINATION OF NOTES
The obligations of the Company and any subsidiary of the Company that
guarantees the obligations of the Company under the Credit Facility are expected
to be secured by substantially all of the assets of the Company and such
subsidiary. Holders of secured Indebtedness of the Company and its subsidiaries,
including the lenders under the Credit Facility, have claims with respect to the
assets constituting collateral for such Indebtedness that are prior to the
claims of holders of the Notes. In the event of a default on such Indebtedness,
or a bankruptcy, liquidation or reorganization of the Company and its
subsidiaries, such assets will be available to satisfy obligations with respect
to the
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Indebtedness secured thereby before any payment therefrom could be made on the
Notes. Accordingly, the Notes will be effectively subordinated to claims of
secured creditors of the Company and its subsidiaries to the extent of such
pledged collateral. As of June 30, 1996, after giving pro forma effect to the
Corporate Reorganization, the Offerings and the application of the net proceeds
therefrom, the Company would have had $0.4 million of secured Senior
Indebtedness outstanding and will have $50.0 million available under the Credit
Facility. See "Description of Notes -- Ranking."
The Indenture does not require the Subsidiaries to guarantee the payment of
the Notes unless the Subsidiaries incur Indebtedness (other than intercompany
Indebtedness). The Indenture prohibits Subsidiaries that are not Subsidiary
Guarantors from incurring Indebtedness. The Notes will be effectively
subordinated to claims of creditors (other than the Company) of the Subsidiaries
that are not Subsidiary Guarantors, including trade creditors, taxing
authorities and tort claimants. Such creditors generally will have priority as
to the assets of such Subsidiaries over the claims and equity interests of the
Company and, thereby indirectly, the holders of indebtedness of the Company,
including the Notes. At June 30, 1996, on a pro forma basis, the Company's
Subsidiaries had $6.5 million of liabilities, all of which were operating
liabilities. Any Subsidiary Guarantees will be effectively subordinated in right
of payment to all existing and future secured Senior Indebtedness of the
Subsidiary Guarantors. On the date of the Indenture there will be no Subsidiary
Guarantees. See "Description of Notes -- Ranking," "-- Subsidiary Guarantees"
and "-- Incurrence of Indebtedness and Preferred Stock."
SUBSIDIARY GUARANTEES MAY TERMINATE; FRAUDULENT CONVEYANCE CONSIDERATIONS
RELATING TO SUBSIDIARY GUARANTEES
The Indenture does not require any Subsidiary to guarantee the Notes unless
such Subsidiary incurs Indebtedness (other than intercompany Indebtedness). On
the date of the Indenture there will be no Subsidiary Guarantees. Various
fraudulent conveyance laws have been enacted for the protection of creditors and
may be used by a court of competent jurisdiction to subordinate or avoid any
Subsidiary Guarantee that may be delivered. To the extent that a court were to
find that (x) a Subsidiary Guarantee was incurred with the intent to hinder,
delay or defraud any present or future creditor or that such Subsidiary
Guarantor contemplated insolvency with a design to favor one or more creditors
to the exclusion in whole or in part of others or (y) a Subsidiary Guarantor did
not receive fair consideration or reasonably equivalent value for issuing its
Subsidiary Guarantee and, at the time it issued the Subsidiary Guarantee, such
Subsidiary Guarantor (i) was insolvent or rendered insolvent by reason of the
issuance of the Subsidiary Guarantee, (ii) was engaged or about to engage in a
business or transaction for which the remaining assets of such Subsidiary
Guarantor constituted unreasonably small capital or (iii) intended to incur, or
believed that it would incur, debts beyond its ability to pay such debts as they
matured, a court could avoid or subordinate the Subsidiary Guarantee in favor of
such Subsidiary Guarantor's other creditors. Among other things, a legal
challenge of the Subsidiary Guarantee issued by such Subsidiary Guarantor on
fraudulent conveyance grounds may focus on the benefits, if any, realized by
such Subsidiary Guarantor as a result of the issuance by the Company of the
Notes. To the extent the Subsidiary Guarantee was avoided as a fraudulent
conveyance or held unenforceable for any other reason, the holders of the Notes
would cease to have any claim against such Subsidiary Guarantor and would be
creditors solely of the Company and any Subsidiary Guarantors whose Subsidiary
Guarantees were not avoided or held unenforceable. In such event, the claims of
the holders of the Notes against the issuer of an invalid Subsidiary Guarantee
would be subject to the prior payment of all liabilities of such Subsidiary
Guarantor. There can be no assurance that, after providing for all prior claims,
there would be sufficient assets to satisfy the claims of the holders of the
Notes relating to any avoided portions of any of the Subsidiary Guarantees.
The measure of insolvency for purposes of the foregoing considerations will
vary depending upon the law applied in any such proceeding. Generally, however,
a Subsidiary Guarantor may be considered insolvent if the sum of its debts,
including contingent liabilities, was greater than the fair market value of all
of its assets at a fair valuation, if the present fair market value of its
assets was less than
11
<PAGE>
the amount that would be required to pay its probable liability on its existing
debts, including contingent liabilities, as they become absolute and mature, or
if it had insufficient capital to carry on its business.
POTENTIAL INABILITY TO FUND A CHANGE OF CONTROL OFFER AND ASSET SALE OFFER
The Company must offer to purchase the Notes upon the occurrence of certain
events. The Indenture provides that upon the occurrence of a Change of Control,
the Company is required to offer to repurchase any or all of the outstanding
Notes at a price equal to 101% of the aggregate principal amount thereof,
together with accrued and unpaid interest, if any, to the date of purchase.
Generally, a "Change of Control" includes any person or group other than Cadell
S. Liedtke, Michael J. Grella and Henry G. Musselman, the Chairman of the Board,
President and Executive Vice President of the Company, respectively, acquiring
50% or more of the voting securities of the Company, and certain other events.
In the event of certain asset dispositions, the Company will be required under
certain circumstances to use the Excess Proceeds (as defined) to offer to
purchase the Notes at 100% of the principal amount thereof, plus accrued and
unpaid interest to the date of purchase. See "Description of Notes -- Repurchase
at the Option of Holders."
The Credit Facility prohibits the Company from prepaying the Notes,
including prepayments pursuant to a Change of Control or Asset Sale. Prior to
commencing such an offer to purchase, the Company may be required to (i) repay
in full all indebtedness of the Company that would prohibit the repurchase of
the Notes including that under the Credit Facility, or (ii) obtain any requisite
consent to permit the repurchase. If the Company is unable to repay all of such
indebtedness or is unable to obtain the necessary consents, then the Company
will be unable to offer to purchase the Notes, and such failure will constitute
an Event of Default under the Indenture. It is unlikely that the Company would
have sufficient internally generated funds available at the time of any Change
of Control or Asset Sale Offer to satisfy all of its debt obligations (including
repurchases of the Notes and payment of the Credit Facility) simultaneously
without refinancing the indebtedness.
The events that constitute a Change of Control or require an Asset Sale
Offer under the Indenture may also be events of default under the Credit
Facility or other senior indebtedness of the Company and the Subsidiaries. Such
events may permit the lenders under such debt instruments to accelerate the debt
and, if the debt is not paid, to enforce security interests on substantially all
the assets of the Company and the Subsidiaries, thereby limiting the Company's
ability to raise cash to repurchase the Notes, and reducing the practical
benefit of the offer to purchase provisions to the holders of the Notes. In
addition, the Change of Control covenant in the Indenture could have the effect
of discouraging a takeover of the Company by making such an attempt potentially
more expensive.
UNCERTAINTY OF ESTIMATES OF PROVED RESERVES AND FUTURE NET CASH FLOWS
There are numerous uncertainties in estimating quantities of proved reserves
and in projecting future rates of production and the timing of development
expenditures, including many factors beyond the control of the Company. The
reserve data set forth in this Prospectus are estimates only. Although the
Company believes such estimates to be reasonable, reserve estimates are
imprecise and should be expected to change as additional information becomes
available. Furthermore, estimates of oil and gas reserves, of necessity, are
projections based on engineering data, and there are uncertainties inherent in
the interpretation of such data as well as the projection of future rates of
production and the timing of development expenditures. Reserve engineering is a
subjective process of estimating underground accumulations of oil and gas that
cannot be exactly measured, and the accuracy of any reserve estimate is a
function of the quality of available data and of engineering and geological
interpretation and judgment. Accordingly, estimates of the economically
recoverable quantities of oil and gas attributable to any particular group of
properties, classifications of such reserves based on risk of recovery, and
estimates of the future net cash flows expected therefrom prepared by different
engineers or by the same engineers at different times may vary substantially.
Moreover, there can be no assurance that the reserves set forth herein will
ultimately be produced or that the proved undeveloped reserves will be developed
within the periods anticipated. Variances from the estimates contained herein
could be material. In addition, the estimates of future net revenues from proved
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<PAGE>
reserves of the Company and the present value thereof are based upon certain
assumptions about production levels, prices and costs, which may not be correct.
The Company emphasizes with respect to such estimates that the discounted future
net cash flows should not be construed as representative of the fair market
value of the proved oil and gas properties belonging to the Company, because
discounted future net cash flows are based upon projected cash flows that do not
provide for changes in oil and gas prices or for escalation of expenses and
capital costs. The meaningfulness of such estimates is highly dependent upon the
accuracy of the assumptions upon which they were based. Actual results may
differ materially from the results estimated. Prospective purchasers of Notes
are cautioned not to place undue reliance on the reserve data included in this
Prospectus.
ACQUISITION RISKS
The Company's rapid growth in recent years has been largely the result of
acquisitions of producing properties. The Company expects to continue to
evaluate and pursue acquisition opportunities available on terms management
considers favorable to the Company. The successful acquisition of producing
properties requires an assessment of recoverable reserves, future oil and gas
prices, operating costs, potential environmental and other liabilities and other
factors beyond the Company's control. Such an assessment is necessarily inexact
and its accuracy is inherently uncertain. In connection with such an assessment,
the Company performs a review of the subject properties it believes to be
generally consistent with industry practices. Such a review, however, will not
reveal all existing or potential problems, nor will it permit a buyer to become
sufficiently familiar with the properties fully to assess their deficiencies and
capabilities. Inspections may not be performed on every well, and structural and
environmental problems are not necessarily observable even when an inspection is
undertaken. The Company is generally not entitled to contractual indemnification
for preclosing liabilities, including environmental liabilities, and generally
acquires interests in the properties on an "as is" basis.
VOLATILITY OF OIL AND GAS PRICES
The Company's financial results and, therefore, its ability to service its
debt, including the Notes, are significantly affected by the price received for
the Company's oil and gas production. Historically, the markets for oil and gas
have been volatile and may continue to be volatile in the future. Prices of oil
and gas are subject to wide fluctuations in response to market uncertainty,
changes in supply and demand and a variety of additional factors, all of which
are beyond the control of the Company. These factors include domestic and
foreign political conditions, the overall level of supply of and demand for oil
and gas, the price of imported oil and gas, weather conditions, the price and
availability of alternative fuels and overall economic conditions. The Company's
future financial condition and results of operations will be dependent, in part,
upon the prices received for the Company's oil and gas production, as well as
the costs of acquiring, finding, developing and producing reserves. To reduce
its exposure to price risks in the sale of its oil and gas, the Company enters
into hedging arrangements from time to time. Although the Company hedges a
significant portion of its production, any substantial or extended decline in
the price of oil and gas would have a material adverse effect on the Company's
financial condition and results of operations, as well as reduce the amount of
the Company's oil and gas that could be produced economically. Moreover, if oil
and gas prices fall materially below their current levels, the availability of
funds and the Company's ability to repay outstanding amounts under its Credit
Facility and the Notes could be materially adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
CONFLICTS OF INTEREST
The Company has a continuing relationship with A&P Meter Sales and Services,
Inc. ("A&P"), a corporation in which Messrs. Liedtke, Grella and Musselman own
60.0% of the outstanding common stock. A&P owes the Company $437,000 (including
accrued interest through December 31, 1995) pursuant to a promissory note under
which the Company is not entitled to any principal or interest payments until
December 31, 2004. A&P also owes the Company $247,000, which is represented by a
promissory note payable upon demand. See "Certain Transactions."
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<PAGE>
Under the Company's current credit arrangements, Messrs. Liedtke, Grella and
Musselman are each liable for a portion of the Company's existing debt (see
"Description of Other Indebtedness") pursuant to limited guaranties. However,
these individuals will not be liable for, or guarantee amounts due under, the
Credit Facility or the indebtedness represented by the Notes.
DEPENDENCE ON KEY PERSONNEL
The Company depends to a large extent on the services of Messrs. Liedtke,
Grella and Musselman. The loss of the services of any of Messrs. Liedtke, Grella
or Musselman could have a material adverse effect on the Company's operations.
Pursuant to employment agreements which are to be effective upon the
consummation of the Offerings, Messrs. Liedtke, Grella and Musselman have agreed
not to compete with the Company for a one-year period should they voluntarily
leave the Company's employment or should their employment be terminated for
cause within the initial three-year term of each employment agreement. The
Company believes that its success is also dependent upon its ability to continue
to employ and retain skilled technical personnel. See "Management."
CONTROL OF THE COMPANY
If the Offerings are completed, Messrs. Liedtke, Grella and Musselman will
own directly and indirectly, in the aggregate, 42.6% of the outstanding Common
Stock (or 39.8% if the underwriters' over-allotment option in the Common Stock
Offering is exercised in full). Accordingly, Messrs. Liedtke, Grella and
Musselman may be able to exercise significant influence over the election of
directors of the Company and the control of the Company's management, operations
and affairs. See "Security Ownership of Certain Beneficial Owners and
Management."
FOREIGN INVESTMENT
The Company's investment in Moldova involves risks typically associated with
investments in emerging markets such as foreign exchange restrictions and
currency fluctuations, foreign taxation, changing political conditions, foreign
and domestic monetary and tax policies, expropriation, nationalization,
nullification, modification or renegotiation of contracts, war and civil
disturbances and other risks that may limit or disrupt markets. In addition, if
a dispute arises in its Moldovan operations, the Company may be subject to the
exclusive jurisdiction of foreign courts or may not be successful in subjecting
foreign persons to the jurisdiction of the United States. The Company attempts
to conduct its business and financial affairs so as to protect against political
and economic risks applicable to operations in Moldova, but there can be no
assurance the Company will be successful in so protecting itself.
DRILLING RISKS
Drilling involves numerous risks, including the risk that no commercially
productive oil or gas will be encountered. The cost of drilling, completing and
operating wells is often uncertain, and drilling operations may be curtailed,
delayed or cancelled as a result of a variety of factors, including unexpected
drilling conditions, pressure or irregularities in formations, equipment
failures or accidents, adverse weather conditions and shortages or delays in the
delivery of equipment. The Company's future drilling activities may not be
successful and, if unsuccessful, such failure may have a material adverse effect
on the Company's future results of operations and financial condition.
OPERATING HAZARD AND UNINSURED RISKS
The Company's operations are subject to hazards and risks inherent in the
drilling for and production and transportation of oil and gas, including fires,
natural disasters, explosions, encountering formations with abnormal pressures,
blowouts, cratering, pipeline ruptures, and spills, any of which can result in
loss of hydrocarbons, environmental pollution, personal injury or loss of life,
severe damage to and destruction of properties of the Company and others, and
suspension of operations. Although the Company maintains insurance coverage that
it considers to be adequate and customary in the industry, it is not fully
insured against certain of these risks, either because such insurance is not
available or because of high premium costs. The occurrence of a significant
event not fully covered by insurance could have a material adverse effect on the
Company's financial condition and results of operations.
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COMPETITION
The Company encounters substantial competition in acquiring properties,
marketing oil and gas and securing trained personnel. Many competitors have
substantially larger financial resources, staffs and facilities. See "Business
and Properties -- Competition and Markets."
GOVERNMENT LAWS AND REGULATIONS
The Company's operations are affected from time to time in varying degrees
by political developments and federal, state and local laws and regulations. In
particular, oil and gas production, operations and economics are or have been
significantly affected by price controls, taxes and other laws relating to the
oil and gas industry, by changes in such laws and by changes in administrative
regulations. The Company cannot predict how existing laws and regulations may be
interpreted by enforcement agencies or court rulings, whether additional laws
and regulations will be adopted, or the effect such changes may have on its
business, financial condition or results of operations. See "Business and
Properties -- Regulation."
ENVIRONMENTAL REGULATIONS
The Company's operations are subject to complex and constantly changing
environmental laws and regulations adopted by federal, state and local
governmental authorities. The Company believes that compliance with such laws
has had no material adverse effect upon the Company's operations to date and
that the cost of such compliance has not been material. Nevertheless, the
discharge of oil, gas or other pollutants into the air, soil or water may give
rise to significant liabilities on the part of the Company to the government and
third parties and may require the Company to incur substantial costs of
remediation. Moreover, the Company has agreed to indemnify sellers of producing
properties from whom the Company has acquired reserves against certain
liabilities for environmental claims associated with the properties being
purchased by the Company, including, without limitation, in connection with both
the 1995 Acquisition and the 1996 Acquisition. No assurance can be given that
existing environmental laws or regulations, as currently interpreted or
reinterpreted in the future, or future laws or regulations, will not materially
adversely affect the Company's results of operations and financial condition or
that material indemnity claims will not arise against the Company with respect
to properties acquired by the Company. See "Business and Properties --
Environmental Matters."
ABSENCE OF PUBLIC MARKET
There is no existing public market for the Notes and the Company does not
intend to list the Notes on any national securities exchange. Although the
Underwriters have advised the Company that they currently intend to make a
market in the Notes, the Underwriters are not obligated to do so and may
discontinue such market-making at any time. Accordingly, there can be no
assurance that an active market will develop upon completion of this Notes
Offering or, if developed, that such market will be sustained. The initial
offering price of the Notes will be determined through negotiations between the
Company and the Underwriters, and may bear no relationship to the market price
of the Notes after the Notes Offering. Factors such as quarterly or cyclical
variations in the Company's financial condition and results of operations,
variations in interest rates, future announcements concerning the Company or its
competitors, government regulation, general economic and other conditions and
developments affecting the oil and gas industry could cause the market price of
the Notes to fluctuate substantially.
FORWARD-LOOKING STATEMENTS
Certain statements contained in this Prospectus, including without
limitation, statements containing the words "believes," "anticipates,"
"intends," "expects," and words of similar import, constitute "forward-looking
statements". Such forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements of the Company or industry to be materially different from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Certain of these factors are discussed in more
detail elsewhere in this Prospectus, including without limitation under
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"Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and "Business and Properties".
Given these uncertainties, prospective investors are cautioned not to place
undue reliance on such forward-looking statements. The Company disclaims any
obligation to update any such factors or to publicly announce the result of any
revisions to any of the forward-looking statements contained herein to reflect
future events or developments.
THE COMPANY
GENERAL
The Company is an independent energy company that is engaged in the
acquisition, exploration, exploitation and development of oil and gas
properties. The Company's primary operations are in the Permian Basin, the Gulf
Coast and the Rocky Mountain regions. The Company recently acquired an interest
in an entity which has a concession for the development of mineral interests in
the Republic of Moldova, in Eastern Europe. The Company also has minor interests
in the domestic gas gathering and transmission business.
CORPORATE REORGANIZATION
Costilla was incorporated in Delaware in June 1996 to consolidate and
continue the activities previously conducted by Costilla Energy, L.L.C., a Texas
limited liability company (the "LLC"), and its wholly owned subsidiaries, to
acquire the assets of CSL Management Corporation ("CSL") (which owns certain
office equipment used by the Company), and to acquire the stock of Valley
Gathering Company ("Valley"). Costilla has been formed solely for the purpose of
conducting the Offerings, and has not commenced operations. Both CSL and Valley
are owned by Messrs. Liedtke, Grella and Musselman. See "Certain Transactions."
Contemporaneously with the closings of the Offerings: (1) the redeemable
membership interests of NationsBanc Capital Corp. ("NBCC") in the LLC will be
redeemed for $15.5 million; (2) the LLC will be merged into Costilla (the
"Merger") and an aggregate of 5,200,000 shares of Common Stock will be issued to
the four members of the LLC; (3) Costilla will acquire all of the issued and
outstanding stock of Valley and the assets of CSL for $0.7 million; and (4) $4.3
million in distributions will be made to the members of the LLC, $3.5 million of
which, in the case of Messrs. Liedtke, Grella and Musselman, will be provided to
such persons for certain estimated income tax effects of the Merger. These
transactions are referred to throughout this Prospectus as the "Corporate
Reorganization." As a result of the Corporate Reorganization, Costilla will have
four wholly owned subsidiaries: (i) Costilla Petroleum Corporation, a Texas
corporation ("CPC"), which operates properties owned by Costilla and owns minor
interests in the same properties; (ii) Statewide Minerals, Inc., a Texas
corporation ("Statewide"), which is engaged in the purchase of small royalty and
mineral interests; (iii) Valley, which owns several small gas gathering systems,
a small gas processing plant, certain salt water disposal systems and gas
compressors; and (iv) Costilla Pipeline Corporation, a Texas corporation
("Pipeline") which owns a gas pipeline in Pennsylvania held for resale. CSL will
be dissolved. Costilla and CPC are the sole members of two Texas limited
liability companies through which the Company's Moldovan operations are
conducted. Costilla also owns a 40.5% interest in a Delaware limited liability
company which owns and operates a gas pipeline and associated facilities in
Louisiana.
The Company's executive offices are located at 400 West Illinois, Suite
1000, Midland, Texas, 79701 and its telephone number is (915) 683-3092.
COMMON STOCK OFFERING
Concurrent with the Notes Offering, the Company is offering 4,800,000 shares
of its Common Stock. The Notes Offering and the Common Stock Offering are each
conditioned upon the consummation of the other.
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USE OF PROCEEDS
The net proceeds of the Offerings are estimated to be $151.5 million ($159.8
million if the underwriters' over-allotment option with respect to the Common
Stock Offering is exercised). Approximately $125.8 million of such proceeds,
including all the net proceeds of the Notes Offering, will be used to repay all
of the existing senior indebtedness of the Company (the "Existing Debt")
incurred in connection with the 1996 Acquisition, and to refinance its previous
credit facility. The Existing Debt matures in June 1999. Approximately $30.0
million of the Existing Debt currently bears interest at 14.0% per annum
(increasing to 14.5% on September 13, 1996) and the balance currently bears
interest at a rate selected by the Company equal to a base rate (generally the
prime rate established by NationsBank, N.A.) plus 0.75% or LIBOR plus 3.0%. See
"Description of Other Indebtedness." In addition, $20.5 million of the net
proceeds will be used to pay certain amounts incurred in connection with the
Corporate Reorganization, including $15.5 million to redeem certain membership
interests of NBCC in the LLC prior to the Merger, $0.7 million to acquire the
stock of Valley and the assets of CSL and $4.3 million in distributions to the
members of the LLC, $3.5 million of which, in the case of Messrs. Liedtke,
Grella and Musselman, will be provided to such persons for certain estimated
federal income tax effects of the Merger. See "Certain Transactions." The
remaining estimated net proceeds of $5.1 million will be used by the Company for
general corporate purposes. Pending such uses, the remaining net proceeds will
be invested in short-term, investment grade, interest-bearing securities.
The following is a description of sources and uses of proceeds from the
Offerings, assuming the underwriters' over-allotment option in connection with
the Common Stock Offering is not exercised (in millions):
<TABLE>
<S> <C>
Sources:
Notes Offering................................................... $ 100.0
Common Stock Offering............................................ 60.0
---------
$ 160.0
---------
---------
Uses:
Refinance Existing Debt.......................................... $ 125.8
Redeem membership interests...................................... 15.5
Distributions to individual members to pay estimated income tax
liability of such members....................................... 3.5
Pro rata distribution to remaining member........................ 0.8
Purchase of stock of Valley and assets of CSL.................... 0.7
Working capital.................................................. 5.1
Estimated fees, commissions, underwriting discounts and expenses
related to the Offerings........................................ 8.6
---------
$ 160.0
---------
---------
</TABLE>
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CAPITALIZATION
The following table sets forth the unaudited capitalization of the Company
as of June 30, 1996, on an historical basis and on a pro forma basis giving
effect to the Corporate Reorganization and the Offerings and the application of
the net proceeds therefrom, as if such transactions had been consummated as of
June 30, 1996. The following table should be read in conjunction with the
Consolidated Financial Statements of the LLC, the unaudited Pro Forma Condensed
Financial Statements, the related notes, and the other information contained
elsewhere in this Prospectus, including the information set forth in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." For further information regarding the terms of the long-term debt
reflected in the following table, see "Description of Other Indebtedness" and
Note 7 and Note 12 of the Notes to Consolidated Financial Statements.
<TABLE>
<CAPTION>
JUNE 30, 1996
------------------------
HISTORICAL PRO FORMA
----------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt:
Existing debt......................................................................... $ 122,365 $ 365
Credit Facility....................................................................... -- --
10 1/4% Senior Notes due 2006......................................................... -- 100,000
----------- -----------
Total long-term debt.................................................................... 122,365 100,365
----------- -----------
Redeemable members' capital............................................................. 13,171 --
----------- -----------
Members' capital and stockholders' equity:
Members' capital...................................................................... (11,326) --
Preferred stock, $.10 par value (3,000,000 shares authorized; no shares issued or
outstanding)......................................................................... -- --
Common Stock, $.10 par value (20,000,000 shares authorized; no shares outstanding
actual, 10,000,000 shares outstanding pro forma)..................................... -- 1,000
Paid-in capital....................................................................... -- 34,232
----------- -----------
Total members' capital and stockholders' equity......................................... (11,326) 35,232
----------- -----------
Total capitalization.................................................................... $ 124,210 $ 135,597
----------- -----------
----------- -----------
</TABLE>
18
<PAGE>
PRO FORMA CONDENSED FINANCIAL STATEMENTS
The unaudited Pro Forma Condensed Financial Statements of the Company have
been prepared to give effect to the 1995 Acquisition and the 1996 Acquisition,
the Corporate Reorganization, and the Offerings and the application of the
estimated net proceeds therefrom as if such transactions (to the extent not
already reflected) had taken place on June 30, 1996 for purposes of the Pro
Forma Condensed Balance Sheet and as if the transactions had taken place on
January 1, 1995 for purposes of the Pro Forma Condensed Statements of
Operations. The Pro Forma Condensed Financial Statements of the Company are not
necessarily indicative of the results for the periods presented had the 1995
Acquisition and the 1996 Acquisition, the Corporate Reorganization, and the
Offerings and the application of the estimated net proceeds therefrom taken
place on January 1, 1995. In addition, future results may vary significantly
from the results reflected in the accompanying Pro Forma Condensed Financial
Statements because of normal production declines, changes in product prices, and
the success of future exploration and development activities, among other
factors. This information should be read in conjunction with the Consolidated
Financial Statements of Costilla Energy, L.L.C. and subsidiaries, and the
Statements of Revenues and Direct Operating Expenses with respect to the
properties acquired in the 1995 Acquisition and the 1996 Acquisition, all
included elsewhere herein.
19
<PAGE>
COSTILLA ENERGY, INC.
PRO FORMA CONDENSED BALANCE SHEET -- UNAUDITED
JUNE 30, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA
PRO FORMA COSTILLA
COSTILLA OFFERING ENERGY,
ASSETS L.L.C. ADJUSTMENTS INC.
- ----------------------------------------------------------------------- ------------- ------------ -----------
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents............................................ $ 1,164 $ (700)(1) $ 10,655
151,450(3)
(141,259)(4)
Accounts receivable.................................................. 8,785 8,785
Prepaid and other current assets..................................... 2,629 2,629
------------- -----------
Total current assets............................................. 12,578 22,069
Oil and gas properties, using the successful efforts method of
accounting:
Proved properties.................................................... 126,809 126,809
Unproved properties.................................................. 4,615 4,615
Accumulated depreciation, depletion and amortization................. (13,933) (13,933)
------------- -----------
117,491 117,491
Other property and equipment, net...................................... 1,640 700(1) 2,340
Deferred charges (Note 2).............................................. 2,654 3,850(3) 3,850
(2,654)(4)
Note receivable -- affiliate........................................... 684 684
------------- -----------
$ 135,047 $ 146,434
------------- -----------
------------- -----------
<CAPTION>
LIABILITIES, REDEEMABLE MEMBERS' CAPITAL AND EQUITY
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Current liabilities:
Current maturities of long-term debt................................. $ 98 $ 98
Trade accounts payable............................................... 4,587 4,587
Undistributed revenue................................................ 1,524 1,524
Other current liabilities............................................ 2,103 2,103
------------- -----------
Total current liabilities........................................ 8,312 8,312
Long-term debt, less current maturities................................ 122,267 100,000(3) 100,267
(122,000)(4)
Deferred income........................................................ 2,623 2,623
------------- -----------
Total liabilities................................................ 133,202 111,202
Redeemable members' capital............................................ 13,171 (13,171)(4) --
Members' capital and stockholders' equity:
Members' capital..................................................... (11,326) 11,326(2) --
Preferred stock, $.10 par value (3,000,000 shares authorized; no
shares outstanding)................................................. -- --
Common Stock, $.10 par value (20,000,000 shares authorized; no shares
outstanding historical, 10,000,000 shares outstanding pro forma).... -- 1,000(3) 1,000
Paid-in capital...................................................... -- (2,654)(4) 34,232
(1,829)(4)
(4,259)(4)
54,300(3)
(11,326)(2)
------------- -----------
Total members' capital and stockholders' equity...................... (11,326) 35,232
------------- -----------
$ 135,047 $ 146,434
------------- -----------
------------- -----------
</TABLE>
See accompanying notes to unaudited pro forma condensed financial statements.
20
<PAGE>
COSTILLA ENERGY, INC.
PRO FORMA CONDENSED STATEMENT OF OPERATIONS -- UNAUDITED
YEAR ENDED DECEMBER 31, 1995
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRE OFFERING PRO FORMA
COSTILLA 1995 1996 PRO FORMA COSTILLA OFFERING
L.L.C. ACQUISITION ACQUISITION ADJUSTMENTS L.L.C. ADJUSTMENTS
------------- ----------- ----------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Revenues............................... $ 21,816 $ 10,930 $ 19,891 $ 52,637
------------- ----------- ----------- -------------
Expenses:
Oil and gas production............... 10,355 5,473 11,409 $ (300)(1) 26,937
General and administrative........... 3,571 -- -- (172)(1) 4,850
1,451(5)
Compensation related to option
settlement.......................... 656 656
Exploration and abandonments......... 1,650 109 1,002 2,761
Depreciation, depletion and
amortization........................ 5,958 -- -- 100(1) 14,176
8,118(6)
Interest............................. 4,591 -- -- 10,046(7) 14,637 $ (14,637)(8)
10,635(8)
Other................................ 2 -- -- 2
------------- ----------- ----------- -------------
26,783 5,582 12,411 64,019
------------- ----------- ----------- -------------
Net income (loss) before federal income
taxes................................. (4,967) 5,348 7,480 (11,382)
Provision for federal income taxes..... 3 -- -- 3
------------- ----------- ----------- -------------
Net income (loss)...................... $ (4,970) $ 5,348 $ 7,480 $ (11,385)
------------- ----------- ----------- -------------
------------- ----------- ----------- -------------
Net loss per share.....................
<CAPTION>
PRO FORMA
COSTILLA
ENERGY,
INC.
-----------
<S> <C>
Revenues............................... $ 52,637
-----------
Expenses:
Oil and gas production............... 26,937
General and administrative........... 4,850
Compensation related to option
settlement.......................... 656
Exploration and abandonments......... 2,761
Depreciation, depletion and
amortization........................ 14,176
Interest............................. 10,635
Other................................ 2
-----------
60,017
-----------
Net income (loss) before federal income
taxes................................. (7,380)
Provision for federal income taxes..... 3
-----------
Net income (loss)...................... $ (7,383)
-----------
-----------
Net loss per share..................... $ (.75)
-----------
-----------
</TABLE>
See accompanying notes to unaudited pro forma condensed financial statements.
21
<PAGE>
COSTILLA ENERGY, INC.
PRO FORMA CONDENSED STATEMENT OF OPERATIONS -- UNAUDITED
SIX MONTHS ENDED JUNE 30, 1996
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRO FORMA
PRE OFFERING PRO FORMA COSTILLA
COSTILLA 1996 PRO FORMA COSTILLA OFFERING ENERGY,
L.L.C. ACQUISITION ADJUSTMENTS L.L.C. ADJUSTMENTS INC.
------------- ----------- -------------- ------------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
Revenues................................. $ 19,525 $ 9,223 $ 28,748 $ 28,748
Expenses:
Oil and gas production................. 8,278 5,167 $ (150)(1) 13,295 13,295
General and administrative............. 2,809 (86)(1) 3,010 3,010
287(5)
Exploration and abandonments........... 308 247 555 555
Depreciation, depletion and
amortization.......................... 4,620 50(1) 6,981 6,981
2,311(6)
Interest............................... 4,156 2,832(7) 6,988 $ (6,988)(8) 5,317
5,317(8)
------------- ----------- ------------- -----------
20,171 5,414 30,829 29,158
------------- ----------- ------------- -----------
Net income (loss) before federal income
taxes................................... (646) 3,809 (2,081) (410)
------------- ----------- ------------- -----------
Net income (loss)........................ $ (646) $ 3,809 $ (2,081) $ (410)
------------- ----------- ------------- -----------
------------- ----------- ------------- -----------
Net income (loss) per share.............. $ (0.04)
-----------
-----------
</TABLE>
See accompanying notes to unaudited pro forma condensed financial statements.
22
<PAGE>
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS
NOTE 1. -- BASIS OF PRESENTATION
The Pro Forma Condensed Financial Statements of the Company have been
prepared to give effect to the 1995 Acquisition and the 1996 Acquisition, the
Corporate Reorganization and the Offerings and the application of estimated net
proceeds therefrom, as if such transactions had taken place on June 30, 1996 for
purposes of the Pro Forma Condensed Balance Sheet (with the exception of the
1995 Acquisition which was previously reflected in the balance sheet of Costilla
Energy, L.L.C.), and as if each of the transactions had taken place on January
1, 1995 for purposes of the Pro Forma Condensed Statements of Operations. The
1995 Acquisition and 1996 Acquisition are accounted for by the purchase method.
Costilla L.L.C. -- Represents the consolidated balance sheet of
Costilla Energy, L.L.C. and subsidiaries as of June 30, 1996 and the
related consolidated statements of operations for the year ended
December 31, 1995 and the six months ended June 30, 1996.
1995 Acquisition -- Represents the revenues and direct operating
expenses of the properties acquired in the 1995 Acquisition for the
period from January 1, 1995 to June 12, 1995 (date of the 1995
Acquisition).
1996 Acquisition -- Represents the revenues and direct operating
expenses of the properties acquired in the 1996 Acquisition for the
period from January 1, 1995 to June 14, 1996 (date of the 1996
Acquisition).
NOTE 2. -- PRO FORMA ENTRIES
(1) To record the acquisition of Valley Gathering Company and CSL Management
Corporation from certain members of Costilla Energy, L.L.C. and to record the
related additional depreciation and amortization, and reduction in oil and gas
production and general and administrative expenses.
(2) To reflect the Corporate Reorganization including the transfer of
members' capital to stockholders' equity.
(3) To reflect the issuance of 4,800,000 shares of Common Stock at a price
of $12.50 per share for estimated proceeds of $55,300,000, net of estimated
expenses of the Common Stock Offering, and issuance of the Notes at
$100,000,000; and to reflect payment of related debt issuance expenses of
$3,850,000.
(4) To record the repayment of the Existing Debt and the write-off of
related debt issuance costs, the distribution of cash to certain members, and
the repurchase of redeemable members capital for approximately $15,000,000 from
proceeds of the Offerings.
The redemption amount is composed of the following:
<TABLE>
<S> <C>
Redeemable members' interest subject to preferred return...... $11,000,000
Redeemable members' interest not subject to preferred
return....................................................... 1,500,000
Accrued 15% preferred return including associated 10%
redemption premium........................................... 2,500,000
-----------
$15,000,000
-----------
-----------
</TABLE>
(5) Estimated incremental general and administrative expenses necessary to
administer the properties acquired in the 1995 and 1996 acquisitions and
increased public reporting and administration costs include salary and benefits
for one executive level employee and revised compensation arrangements for the
remaining executives, approximately 29 additional administrative personnel (the
majority of which were added prior to December 31, 1995), directors' fees,
insurance coverage and estimated costs to administer shareholder communications.
23
<PAGE>
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. -- PRO FORMA ENTRIES (CONTINUED)
(6) To record estimated incremental depletion expense for the properties
acquired in the 1995 Acquisition from January 1, 1995 through June 12, 1995
(date of the 1995 Acquisition) and for the properties acquired in the 1996
Acquisition from January 1, 1995 through June 14, 1996 (date of the 1996
Acquisition).
(7) To adjust interest expense to reflect additional borrowings for the
properties acquired in the 1995 Acquisition from January 1, 1995 to June 12,
1995 (date of the 1995 Acquisition) and for the properties acquired in the 1996
Acquisition from January 1, 1995 to June 14, 1996 (date of the 1996
Acquisition). The adjustment also reflects adjusted interest expense due to the
Existing Debt. Also included is the amortization of estimated debt issuance
costs of $2,728,000 over a three-year period.
Incremental interest expense includes the following components:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1995 JUNE 30, 1996
----------------- -----------------
<S> <C> <C>
Additional interest on borrowings associated with the
1995 Acquisition for the period of January 1 to June
12, 1995 (Average rate 10.0%).......................... $ 2,350 $ --
Additional interest on borrowings for the 1996
Acquisition through June 14, 1996 (including Tranche B
interest ranging from 14% to 16.5%).................... 6,750 2,300
Adjustment of average interest rate on previously
existing debt and amortization of loan fees............ 946 532
-------- -------
$ 10,046 $ 2,832
-------- -------
-------- -------
</TABLE>
(8) To reverse interest on the Existing Debt and to adjust interest expense
to reflect issuance of the Notes at 10.25% plus the amortization of estimated
debt issuance costs over 10 years ($385,000 annually).
NOTE 3. -- INCOME TAXES
Upon consummation of the Corporate Reorganization, the Company intends to
account for income taxes pursuant to the provisions of SFAS 109. At June 30,
1996, the pro forma tax basis of the Company's assets and liabilities exceeded
the pro forma book basis by approximately $5,000,000. The pro forma temporary
differences are primarily related to the differences in book and tax basis of
oil and gas properties due to the expensing of intangible development costs for
tax purposes and other income tax differences arising from the tax treatment of
oil and gas producing activities.
NOTE 4. -- NET LOSS PER SHARE
Net loss per share is calculated based on the pro forma weighted average
shares outstanding during the respective periods. Weighted average shares
reflect the pro forma issuance of 936,000 shares of Common Stock to NBCC on
February 17, 1995 and the pro forma issuance of 4,264,000 shares of Common Stock
to the remaining holders prior to January 1, 1995. In addition, the issuance of
4,800,000 shares in the Common Stock Offering is assumed to have taken place on
January 1, 1995 and assumes that the Underwriters' over-allotment option is not
exercised.
NOTE 5. -- SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
The estimates of proved oil and gas reserves, which are located in the
United States, were prepared by the Company as of December 31, 1993, 1994 and
1995, and Williamson as of April 1, 1996.
24
<PAGE>
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. -- SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (CONTINUED)
Reserves were estimated in accordance with guidelines established by the
Securities and Exchange Commission and FASB which require that reserve estimates
be prepared under existing economic and operating conditions with no provision
for price and cost escalations, except by contractual arrangements. The Company
has presented the pro forma reserve estimates utilizing an oil price of $17.79
per Bbl and a gas price of $2.03 per Mcf as of December 31, 1995, and an oil
price of $20.91 per Bbl and a gas price of $2.02 per Mcf as of April 1, 1996.
The pro forma information assumes that both the 1995 Acquisition and the 1996
Acquisition took place on January 1, 1995.
OIL AND GAS PRODUCING ACTIVITIES
Oil and gas reserve quantity estimates are subject to numerous uncertainties
inherent in the estimation of quantities of proved reserves and in the
projection of future rates of production and the timing of development
expenditures. The accuracy of such estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Results of subsequent drilling, testing and production may cause either upward
or downward revision of previous estimates. Further, the volumes considered to
be commercially recoverable fluctuate with changes in prices and operating
costs. The Company emphasizes that reserve estimates are inherently imprecise
and that estimates of new discoveries are more imprecise that those of currently
producing oil and gas properties. Accordingly, these estimates are expected to
change as additional information becomes available in the future.
<TABLE>
<CAPTION>
OIL AND GAS
CONDENSATE (MBBLS) (MMCF)
------------------- -----------
<S> <C> <C>
Balance, January 1, 1995.............................................. 17,990 115,281
Revisions of previous estimates..................................... (570) 425
Extensions and discoveries.......................................... 605 8,922
Production.......................................................... (2,085) (11,984)
------- -----------
Balance, December 31, 1995............................................ 15,940 112,644
Revisions of previous estimates..................................... 437 2,615
Extensions and discoveries.......................................... 592 296
Production.......................................................... (492) (2,634)
------- -----------
Balance, April 1, 1996................................................ 16,477 112,921
------- -----------
------- -----------
Proved Developed Reserves:
December 31, 1995................................................... 13,235 87,345
April 1, 1996....................................................... 13,552 84,369
</TABLE>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL
AND GAS RESERVES
The standardized measure of discounted future net cash flows is computed by
applying period-end prices of oil and gas (with consideration of price changes
only to the extent provided by contractual arrangements) to the estimated future
production of proved oil and gas reserves less estimated future production of
proved oil and gas reserves less estimated future expenditures (based on period-
end costs) to be incurred in developing and producing the proved reserves, less
estimated future income tax expenses (based on period-end statutory tax rates,
with consideration of future tax rates already legislated) to be incurred on
pretax net cash flows less tax basis of properties and available credits, and
assuming continuation of existing economic conditions. The estimated future net
cash flows are then discounted using a rate of 10% per year to reflect the
estimated timing of the future cash flows.
Discounted future cash flow estimates like those shown below are not
intended to represent estimates of the fair value of oil and gas properties.
Estimates of fair value should also consider
25
<PAGE>
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. -- SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (CONTINUED)
probable reserves, anticipated future oil and gas prices, interest rates,
changes in development and production costs and risks associated with future
production. Because of these and other considerations, any estimate of fair
value is necessarily subjective and imprecise.
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1995 1996
------------ --------------
(IN THOUSANDS)
<S> <C> <C>
Future cash flows........................................................ $ 516,515 $ 572,426
Future costs:
Production............................................................. (239,388) (253,348)
Development............................................................ (20,907) (22,076)
------------ --------------
Future net cash flows before income taxes (a)............................ 256,220 297,002
Future income taxes...................................................... (48,735) (63,418)
------------ --------------
Future net cash flows.................................................... 207,485 233,584
10% annual discount for estimated timing of cash flows................... (66,851) (76,359)
------------ --------------
Standardized measure of discounted net cash flows........................ $ 140,634 $ 157,225
------------ --------------
------------ --------------
</TABLE>
- ------------------------
(a) Present value of estimated future net cash flows, before income taxes would
be $155,984 and $179,527 as of December 31, 1995 and March 31, 1996,
respectively.
Changes in Standardized Measure of Discounted Future Net Cash Flows From Proved
Reserves:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS
DECEMBER 31, ENDED MARCH 31,
1995 1996
------------ ---------------
(IN THOUSANDS)
<S> <C> <C>
Increase (decrease):
Extensions and discoveries and improved recovery, net of future
production and development costs..................................... $ 9,598 $ 6,002
Accretion of discount................................................. 14,147 3,516
Net change in sales prices, net of production costs................... 2,992 20,807
Changes in estimated future development costs......................... (1,651) (238)
Revisions of quantity estimates....................................... (2,392) 4,694
Net change in income taxes............................................ 1,633 (9,563)
Sales, net of production costs........................................ (27,055) (7,264)
Changes of production rates (timing) and other........................ 1,893 (1,363)
------------ ---------------
Net increase (decrease)............................................. (835) 16,591
Standardized measure of discounted future net cash flows:
Beginning of period................................................... 141,469 140,634
------------ ---------------
End of period......................................................... $ 140,634 $ 157,225
------------ ---------------
------------ ---------------
</TABLE>
26
<PAGE>
SELECTED FINANCIAL INFORMATION
The following table sets forth selected financial data of Costilla Energy,
L.L.C. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations." The historical information should be read in conjunction
with the Consolidated Financial Statements and the notes thereto included
elsewhere in this Prospectus. Costilla Energy, L.L.C. acquired significant
producing oil and gas properties in certain of the periods presented which
affect the comparability of the historical financial and operating information.
The historical results are not necessarily indicative of the Company's future
operations or financial results.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------------- --------------------
1991 1992 1993 1994 1995 1995 1996
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT RATIOS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues..................... $ 1,623 $ 2,362 $ 4,231 $ 7,637 $ 21,693 $ 5,568 $ 19,445
Total revenues......................... 2,134 2,887 4,397 7,836 21,816 5,573 19,525
Expenses:
Oil and gas production............... 769 1,340 1,688 2,351 10,355 2,413 8,278
General and administrative........... 354 388 952 1,184 3,571 1,008 2,809
Compensation related to option
settlement.......................... -- -- -- -- 656 656 --
Exploration and abandonments......... 106 4 218 793 1,650 1,007 308
Depreciation, depletion and
amortization........................ 494 404 884 1,847 5,958 1,367 4,620
Interest............................. 179 365 605 1,458 4,591 1,046 4,156
Other................................ -- -- -- -- 2 -- --
--------- --------- --------- --------- --------- --------- ---------
Income (loss) before income taxes and
extraordinary item.................... 232 386 50 203 (4,967) (1,924) (646)
Net income (loss)...................... 234 368 73 163 (4,970) (1,924) (2,286)
STATEMENT OF CASH FLOWS DATA:
Net cash provided by (used in):
Operating activities................. $ 276 $ 140 $ 322 $ 1,527 $ 6,366 $ (3,040) $ (122)
Investing activities................. (2,659) (1,432) (6,731) (12,146) (62,467) (57,773) (49,723)
Financing activities................. 2,440 1,450 6,315 10,618 58,830 62,094 48,143
OTHER FINANCIAL DATA:
Capital expenditures................... $ 3,092 $ 3,720 $ 6,862 $ 11,868 $ 62,220 $ 57,773 $ 49,723
Distributions to members............... -- -- 456 961 55 55 --
Adjusted EBITDA (1).................... 1,011 1,159 1,757 4,301 7,232 1,496 8,438
Adjusted EBITDA/interest expense (1)... 5.6x 3.2x 2.9x 2.9x 1.6x 1.4x 2.0x
Ratio of earnings to fixed charges
(2)................................... 1.3 1.5 1.0 1.1 -- -- --
BALANCE SHEET DATA (AS OF PERIOD END):
Working capital........................ $ (580) $ 185 $ 1,612 $ 1,081 $ 2,496 -- $ 4,266
Total assets........................... 4,602 6,675 13,290 24,904 87,367 -- 135,047
Total debt............................. 3,610 5,352 12,034 23,613 71,494 -- 122,365
Redeemable members' capital............ -- -- -- -- 11,576 -- 13,171
Members' capital....................... 504 434 51 (747) (7,445) -- (11,326)
</TABLE>
- ------------------------------
(1) Adjusted EBITDA and the ratio of Adjusted EBITDA to interest expense are
presented because of their wide acceptance as financial indicators of a
company's ability to service or incur debt. Adjusted EBITDA (as used herein)
is calculated by adding interest, income taxes, depreciation, depletion and
amortization, exploration and abandonment costs and extraordinary loss
resulting from extinguishment of debt to net income (loss). The ratio of
Adjusted EBITDA to interest expense is calculated by dividing Adjusted
EBITDA by interest. Interest includes interest expense accrual and
amortization of deferred financing costs. Adjusted EBITDA and the ratio of
Adjusted EBITDA to interest expense should not be considered as alternatives
to earnings (loss), or operating earnings (loss), as defined by generally
accepted accounting principles, as indicators of the Company's financial
performance or to cash flow as a measure of liquidity.
(2) For purposes of calculating the ratio of earnings to fixed charges,
"earnings" are net income (loss) before extraordinary loss resulting from
extinguishment of debt, plus income taxes and fixed charges. Fixed charges
are comprised of interest on indebtedness, amortization of deferred
financing costs, and that portion of operating lease expense which is deemed
to be representative of an interest factor. Earnings were insufficient to
cover fixed charges by $4,967,000, $1,924,000 and $646,000 for the
historical periods ended December 31, 1995, June 30, 1995 and June 30, 1996,
respectively.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Costilla is an independent energy company engaged in the exploration,
acquisition and development of oil and gas properties. The Company's predecessor
began operating in 1988 and through mid-1995 had grown primarily through a
series of small acquisitions of oil and gas properties and the exploitation of
those properties. In June 1995, Costilla consummated the 1995 Acquisition for a
purchase price of approximately $46.6 million, and in June 1996, the 1996
Acquisition was consummated for a purchase price of approximately $42.5 million.
To date, the Company has achieved its high rate of growth primarily through
acquisitions. This has impacted its reported financial results in a number of
ways. Properties sold by others frequently have not received focused attention
prior to sale. After acquisition, certain of these properties are in need of
maintenance, workovers, recompletions and other remedial activity not
constituting capital expenditures, which substantially increase lease operating
expenses. The increased production and revenue resulting from these expenditures
is predominately realized in periods subsequent to the period of expense. In
addition, the rapid growth of the Company has required it to develop operating,
accounting and administrative personnel compatible with its increased size. The
Company believes it has now achieved a sufficient size to expand its reserve
base without a corresponding increase in its general and administrative expense.
The Company also believes it now has a sufficient inventory of prospects and the
professional staff necessary to follow a more balanced program of exploration
and exploitation activities to complement its acquisition efforts.
Costilla's strategy is to increase its oil and gas reserves, production and
cash flow from operations through a two-pronged approach which combines an
active exploration program with the acquisition and exploitation of proved
reserves. In addition, Costilla continues to evaluate the acquisition of
undeveloped acreage for its exploration efforts. Costilla has in-house
exploration expertise using 3-D seismic technology to identify new drilling
opportunities as well as for the exploitation of acquired properties.
Costilla has shown a significant increase in its oil and gas reserves and
production, especially due to the 1995 Acquisition and the 1996 Acquisition. The
following table sets forth certain operating data of Costilla for the periods
presented:
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
OIL AND GAS PRODUCTION:
Oil (MBbls)....................................... 158 330 950 233 709
Gas (Mmcf)........................................ 865 1,600 4,806 1,233 3,504
MBOE.............................................. 302 597 1,751 438 1,293
AVERAGE SALES PRICES (1):
Oil (per Bbl)..................................... $ 16.93 $ 15.25 $ 15.53 $ 16.12 $ 18.93
Gas (per Mcf)..................................... 1.82 1.63 1.45 1.46 1.91
PRODUCTION COST (2):
Per BOE (3)....................................... $ 5.59 $ 3.94 $ 5.91 $ 5.51 $ 6.40
Per dollar of sales............................... 0.40 0.31 0.48 0.43 0.43
DEPRECIATION, DEPLETION AND AMORTIZATION:
Per BOE........................................... $ 2.93 $ 3.09 $ 3.40 $ 3.12 $ 3.57
Per dollar of sales............................... 0.21 0.24 0.27 0.25 0.24
</TABLE>
- ------------------------------
(1) Before deduction of production taxes and net of hedging results.
(2) Excludes depreciation, depletion and amortization. Production cost includes
lease operating expenses and production and ad valorem taxes, if
applicable.
(3) Production costs per BOE in 1995 and for the six months ended June 30, 1996
were unusually high as a result of relatively high workover expenses with
respect to properties acquired in the 1995 Acquisition which did not
produce related production improvement until subsequent periods.
Additionally, the Company's 1995 production costs were adversely affected
by expenses incurred in connection with plugging wells to comply with
applicable regulatory requirements.
28
<PAGE>
Costilla uses the successful efforts method of accounting for its oil and
gas activities. Costs to acquire mineral interests in oil and gas properties, to
drill and equip exploratory wells that result in proved reserves, and to drill
and equip development wells are capitalized. Costs to drill exploratory wells
that do not result in proved reserves, geological, geophysical and seismic
costs, and costs of carrying and retaining unproved properties are expensed.
Capitalized costs of producing oil and gas properties, after considering
estimated dismantlement and abandonment costs and estimated salvage values, are
depreciated and depleted using the unit-of-production method. Unproved oil and
gas properties that are individually significant are periodically reviewed for
impairment of value, and a loss is recognized at the time of impairment by
providing an impairment allowance. Other unproved properties are amortized based
on the Company's experience of successful drilling and average holding period.
The Company utilizes option contracts to hedge the effect of price changes
on a portion of its future oil and gas production. Premiums paid and amounts
receivable under the option contracts are amortized and accrued to oil and gas
sales, respectively. If market prices of oil and gas exceed the strike price of
put options, the options will expire unexercised, therefore, reducing the
effective price received for oil and gas sales by the cost of the related
option. Conversely, if market prices of oil and gas decline below the strike
price of put options, the options will be exercised, therefore, increasing the
effective price received for oil and gas sale by the proceeds received from the
related option. The net effect of the Company's commodity hedging activities
reduced oil and gas revenues by $9,000, $80,000, $80,000 and $854,000,
respectively, for the years ended December 31, 1994 and 1995, and the six months
ended June 30, 1995 and 1996 and increased oil and gas revenues by $71,000 for
the year ended December 31, 1993. See "Business and Properties -- Risk
Management."
The Company utilizes interest rate swap agreements to reduce the potential
impact of increases in interest rates on floating-rate, long term debt. If
market rates of interest experienced during the applicable swap term are below
the rate of interest effectively fixed by the swap agreement, the rate of
interest incurred by the Company will exceed the rate that would have been
experienced under the Credit Agreement. The net effect of the Company's interest
rate hedging activities increased interest expense by $8,000 for the year ended
December 31, 1995 and $359,000 for the six months ended June 30, 1996.
The Company's predecessors were classified as partnerships for federal
income tax purposes. Therefore, no income taxes were paid or provided for by the
Company prior to the Offerings. Future tax amounts, if any, will be dependent
upon several factors, including but not limited to the Company's results of
operations.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1996 COMPARED TO SIX MONTHS ENDED JUNE 30, 1995
The Company's total oil and gas revenues for the six months ended June 30,
1996 were $19,445,000, representing an increase of $13,877,000 (249%) over
revenues of $5,568,000 for the comparable period in 1995. This increase was
primarily due to the 1995 Acquisition which accounted for approximately
$11,046,000 of the revenue increase. Prior to accounting for the impact of the
1995 Acquisition and the 1996 Acquisition, the Company's total oil and gas
revenues for the six months ended June 30, 1996 increased by $1,912,000 (45%)
over the same period in 1995.
Oil and gas production was 1,293 MBOE in the 1996 period compared to 438
MBOE in the 1995 period. Of the 855 MBOE increase, approximately 800 MBOE was
due to the properties acquired in the 1995 Acquisition. The remainder of the
increase was due to a combination of successful drilling activities and the
enhancement of existing production.
Interest and other revenues were $40,000 for the six months ended June 30,
1996 compared to $5,000 for the comparable period in 1995, representing an
increase of $35,000, which was primarily
29
<PAGE>
comprised of an increase in interest income of $33,000 in 1996 due to increased
funds earning interest. Also in the 1996 period, the Company realized gains of
$40,000 on various transactions for which there were no comparable transactions
for the six months ended June 30, 1995.
Oil and gas production costs in the 1996 period were $8,278,000 ($6.40 per
BOE), compared to $2,413,000 in 1995 ($5.51 per BOE), representing an increase
of $5,865,000 (243%), due principally to the 1995 Acquisition. On a per BOE
basis, production costs increased $0.89 due primarily to costs incurred to
exploit the properties acquired in the 1995 Acquisition which did not produce
related production improvement for the full period.
General and administrative expense for the six months ended June 30, 1996
was $2,809,000, representing an increase of $1,801,000 (179%) from the
comparable period in 1995 of $1,008,000. The increase is primarily due to an
increase in personnel and related costs necessary to accommodate the increased
activities of the Company due to the 1995 Acquisition and in anticipation of the
1996 Acquisition.
Results of operations for the six months ended June 30, 1995 include
non-cash compensation expense of $656,000 deemed to have been accrued to a
minority owner of the Company who was deemed to have benefited from the
cancellation of an option to purchase an additional interest in the Company held
by the other minority owner.
Exploration and abandonment expense decreased to $308,000 in the 1996 period
compared to $1,007,000 in 1995. The Company incurred $4,000 of seismic costs for
the six months ended June 30, 1996, compared to $514,000 which were incurred for
the comparable period in 1995. Dry hole costs decreased from $493,000 to
$304,000 for the comparable periods in 1995 and 1996, respectively.
Depreciation, depletion and amortization expense for the 1996 period was
$4,620,000 compared to $1,367,000 for the 1995 period, representing an increase
of $3,253,000 (238%). During 1996, depreciation, depletion and amortization on
oil and gas production was provided at an average rate of $3.57 per BOE compared
to $3.12 per BOE for 1995. The increase was due primarily to the 1995
Acquisition.
Interest expense was $4,156,000 in the 1996 period, compared to $1,046,000
for the comparable period in 1995. The $3,110,000 (297%) increase was
attributable primarily to increased levels of debt which the Company used to
finance the 1995 Acquisition. The average amounts of applicable interest-bearing
debt for the comparable periods in 1996 and 1995 were $77,646,000 and
$25,145,000, respectively.
Results of operations for the six months ended June 30, 1996 include an
extraordinary charge of $1,640,000 related to the early extinguishment of the
Company's previous credit agreement. The charge consisted of previously
capitalized debt issuance costs. The previous credit agreement was replaced by
the Existing Debt.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
The Company's total oil and gas revenues for 1995 were $21,693,000,
representing an increase of $14,056,000 (184%) over revenues of $7,637,000 in
1994. This increase was primarily due to the 1995 Acquisition which accounted
for approximately $13,373,000 of the revenue increase.
Oil and gas production was 1,751 MBOE in 1995 and 597 MBOE in 1994. Of the
1,154 MBOE increase, 1,099 MBOE was due to the properties acquired in the 1995
Acquisition.
Interest and other revenues were $123,000 in 1995 compared to $87,000 in
1994, representing an increase of $36,000 (41%), which was comprised of an
increase in interest income of $59,000 in 1995 due to an increased amount of
funds earning interest, partially offset by a decrease of other income of
$23,000. In 1994, the Company realized a gain of $112,000 on the sale of various
properties for which there were no comparable gains in 1995.
Oil and gas production costs in 1995 were $10,355,000 ($5.91 per BOE),
compared to $2,351,000 in 1994 ($3.94 per BOE), representing an increase of
$8,004,000 (340%). The major portion of the
30
<PAGE>
increase was due to increased production associated with the 1995 Acquisition.
In addition, certain acquired properties required remedial workovers and other
activity immediately following acquisition resulting in unusual operating costs
of approximately $600,000 during 1995. In addition, $1,605,000 of operating
costs were incurred in connection with properties acquired in late 1994.
General and administrative expense for 1995 was $3,571,000, representing an
increase of $2,387,000 (202%) from 1994 expense of $1,184,000. The increase is
primarily due to an increase in personnel and related costs necessary to
accommodate the increased activities of the Company due to the 1995 Acquisition.
Results of operations for the year ended December 31, 1995 include non-cash
compensation expense of $656,000 deemed to have been accrued to a minority owner
of the Company in connection with the cancellation of an option to purchase an
additional interest in the Company held by the other minority owner.
Exploration and abandonment expense increased to $1,650,000 in 1995 compared
to $793,000 in 1994. The increase of $857,000 (108%) was comprised principally
of $790,000 of seismic costs.
Depreciation, depletion and amortization expense for 1995 was $5,958,000
compared to $1,847,000 for 1994, representing an increase of $4,111,000 (233%).
During 1995, depreciation, depletion and amortization on oil and gas production
was provided at an average rate of $3.40 per BOE compared to $3.09 per BOE for
1994. The increase was due primarily to the 1995 Acquisition.
Interest expense was $4,591,000 in 1995 compared to $1,458,000 in 1994. The
$3,133,000 (215%) increase was attributable to increased levels of debt which
the Company used to finance the 1995 Acquisition. The average amounts of
applicable interest-bearing debt in 1995 and 1994 were $49,972,000 and
$17,632,000, respectively.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
The Company's total oil and gas revenues for 1994 were $7,637,000,
representing an increase of $3,406,000 (81%) over revenues of $4,231,000 in
1993. The primary reason for the increase in revenues was due to two
acquisitions of properties in 1994, one of which occurred in January 1994 and
the other in October 1994.
Oil and gas production was 597 MBOE in 1994 and 302 MBOE in 1993. The
increase in production of 295 MBOE was principally due to properties acquired
during 1994.
Interest and other revenues were $87,000 in 1994 compared to $56,000 in
1993. The increase of $31,000 was comprised of an increase in interest income of
$26,000 in 1994, due to increased funds earning interest, and an additional
$5,000 in other income.
Oil and gas production costs in 1994 were $2,351,000 ($3.94 per BOE),
compared to $1,688,000 in 1993 ($5.59 per BOE), representing an increase of
$663,000. The increase in production costs is primarily attributable to two
acquisitions in 1994.
In 1994, general and administrative expense was $1,184,000, representing an
increase of $232,000 (24%) from 1993 expense of $952,000. The increase is due to
an increase in personnel and costs related primarily to acquisitions made in
1994.
Exploration and abandonment expense increased to $793,000 in 1994 compared
to $218,000 in 1993. The increase of $575,000 (264%) was due to an increase in
non-productive wells drilled in 1994 compared to 1993.
Depreciation, depletion and amortization expense for 1994 was $1,847,000
compared to $884,000 for 1993, representing an increase of $963,000 (109%),
primarily due to increased production. During 1994, depreciation, depletion and
amortization expense on oil and gas production was provided at an average rate
of $3.09 per BOE compared to $2.93 per BOE for 1993. The increase was due to
increased drilling and development, and the acquisition of additional
properties.
31
<PAGE>
Interest expense was $1,458,000 in 1994 compared to $605,000 in 1993. The
$853,000 increase was attributable to increased debt levels related primarily to
the Company's acquisition of additional oil and gas properties in 1994. The
average amount of applicable interest-bearing debt in 1994 and 1993 was
$17,632,000 and $8,258,000, respectively.
LIQUIDITY AND CAPITAL RESOURCES
NET CASH USED IN OPERATING ACTIVITIES
For the six months ended June 30, 1996, net cash used in operating
activities decreased to $0.1 million from $3.0 million for the comparable period
in 1995. Cash provided by operations, before changes in operating assets and
liabilities, increased to $4.2 million from $0.1 million for the comparable
period in 1995 due primarily to the 1995 Acquisition and the increase in results
of operations therefrom.
NET CASH USED IN INVESTING ACTIVITIES
Net cash used in investing activities for the six months ended June 30, 1996
was $49.7 million. Approximately $42.5 million was used for the 1996
Acquisition, $5.2 million was used for other oil and gas expenditures and $2.0
million was used for other property and equipment. For the year ended December
31, 1995, net cash used in investing activities was $62.5 million. Approximately
$46.6 million was used for the 1995 Acquisition, $14.9 million for additional
acquisitions of producing oil and gas properties and exploration and development
activities and $1.0 million primarily for other property and equipment.
NET CASH PROVIDED BY FINANCING ACTIVITIES
The Company entered into a $125.0 million senior credit agreement in June
1996, against which $122.0 million was initially funded. Approximately $74.5
million was for the extension and refinancing of prior debt, $42.5 million was
used for the 1996 Acquisition and approximately $5.0 million was used for
general corporate purposes.
CAPITAL SOURCES
Funding for the Company's business activities has historically been provided
by bank financings, cash flow from operations, private equity sales, property
divestitures and joint ventures with industry participants. The Company
completed a $10.0 million private equity placement in February 1995.
Subsequently, the 1995 Acquisition and the 1996 Acquisition were substantially
funded by bank financings. The Company plans to finance its continuing
operations and execute its business strategy with cash flow from operations, net
proceeds from the Offerings and borrowings under the Credit Facility.
While the Company regularly engages in discussions relating to potential
acquisitions, the Company has no present agreement, commitment or understanding
with respect to any such acquisition, other than the acquisition of undeveloped
acreage and royalty and overriding royalty interests in its normal course of
business. Any future acquisition may require additional financing and will be
dependent upon financing arrangements available at the time.
The Company believes that cash flow from operations will be sufficient for
anticipated operating and capital expenditure requirements. However, because
future cash flows and the availability of financing are subject to a number of
variables beyond the Company's control, there can be no assurance that the
Company's capital resources will be sufficient to maintain currently planned
levels of capital expenditures. The Company's historical and pro forma earnings
for the year ended December 31, 1995 and the six months ended June 30, 1996 were
insufficient to cover fixed charges. Although the Company's earnings were
insufficient to cover fixed charges for these periods, the Company does not have
covenants in the Indenture or the Credit Facility requiring the Company to
maintain a specific ratio of earnings to fixed charges. However, if the Company
is unable to generate sufficient cash flow from operations to service its debt,
it may be required to refinance all or a portion of its debt, including the
Notes, or to obtain additional financing. There can be no assurance that any
such refinancing would be possible or that any additional financing could be
obtained. See "Risk Factors -- Significant Leverage and Debt Service."
32
<PAGE>
The Company has received a commitment from NationsBank of Texas, N.A. (the
"Bank") to provide the Credit Facility to the Company following the Offerings.
The Credit Facility will provide for a revolving line of credit with the
availability of funds and letters of credit being subject to a borrowing base
determination at least semiannually. The borrowing base will provide for a
maximum availability of $50.0 million (which amount is also expected to be the
initial borrowing base), none of which is expected to be outstanding immediately
following the Offerings. Availability under the borrowing base is initially
limited to $20.0 million for working capital and $30.0 million for acquisitions
of oil and gas properties meeting certain criteria established by the Bank.
Borrowings under the Credit Facility will bear interest at the Company's option
at a floating rate which is at or above the NationsBank, N.A. prime rate or the
LIBOR rate, depending on the percentage of committed funds which have been
borrowed. Interest will be payable quarterly and principal will be amortized in
twelve equal installments commencing two years following the execution of
definitive loan documents. Under the Credit Facility, the Company will be
obligated to pay certain fees to the Bank, including a commitment fee based on
the unused portion of the commitment. The Credit Facility will contain customary
restrictive covenants (including restrictions on the payment of dividends and
the incurrence of additional indebtedness) and will require the Company to
maintain a current ratio of not less than 1.0 to 1.0, a ratio of Adjusted EBITDA
to interest expense of not less than 2.0 to 1.0 and a minimum tangible net
worth. At June 30, 1996, on a pro forma basis, the Company's current ratio would
have been 2.7 to 1.0, the ratio of Adjusted EBITDA to interest expense would
have been 2.3 to 1.0 and the Company would have exceeded the tangible net worth
test by $1.4 million. The Company believes it will be in compliance with such
covenants on the date of closing of the Offerings. Borrowings under the Credit
Facility will be secured by substantially all of the assets of the Company and
any subsidiary of the Company that guarantees the Company's obligations under
the Credit Facility. Initially, none of the Company's subsidiaries will
guarantee the Company's obligations under the Credit Facility. The Bank's
commitment is subject to certain conditions, including completion of the
Offerings and the Corporate Reorganization and application of the net proceeds
therefrom to repay the Company's prior secured indebtedness. See "Use of
Proceeds."
Although certain of the Company's costs and expenses may be affected by
inflation, inflationary costs have not had a significant effect on the Company's
results of operations.
CAPITAL EXPENDITURES
The Company requires capital primarily for the exploration, development and
acquisition of oil and gas properties, the repayment of indebtedness and general
working capital needs.
The following table sets forth costs incurred by the Company in its
development, exploration and acquisition activities during the periods
indicated.
<TABLE>
<CAPTION>
SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED
------------------------------- JUNE 30,
1993 1994 1995 1996
--------- --------- --------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Development costs...................................... $ -- $ -- $ 158 $ 607
Exploration costs...................................... 2,017 2,167 5,627 3,881
Acquisition costs:
Unproved properties.................................. 829 1,232 1,742 1,712
Proved properties.................................... 4,665 9,649 52,470 41,791
--------- --------- --------- -------------
Total.................................................. $ 7,511 $ 13,048 $ 59,997 $ 47,991
--------- --------- --------- -------------
--------- --------- --------- -------------
</TABLE>
The Company anticipates that costs incurred for 1996 will be approximately
$64.8 million, of which approximately $42.5 million was expended for the 1996
Acquisition, and approximately $5.2 million was expended for acquisition,
exploration and development activities during the six months ended June 30,
1996.
DELIVERY COMMITMENT
In November 1995, the Company entered into gas sales agreements whereby it
committed to delivery of a total of 2,379,000 Mmbtu, from December 1, 1995
through December 1, 1996, for a total fixed price of $3,429,610. Income from the
agreements is recognized in the period of delivery.
33
<PAGE>
BUSINESS AND PROPERTIES
GENERAL
Costilla is an independent energy company engaged in the exploration,
acquisition and development of oil and gas properties. The Company's primary
operations are in the Permian Basin area of Texas and New Mexico, the Gulf Coast
and the Rocky Mountain regions. The Company's strategy focuses on increasing
reserves through targeted exploration programs, the exploitation of its existing
properties and selective property acquisitions. In addition, the Company
recently acquired an interest in an entity which has a concession for the
development of mineral interests in the Republic of Moldova, in Eastern Europe.
The Company also has minor interests in the domestic gas gathering and
transmission business.
The Company's predecessor began operating in 1988 with the strategy of
acquiring and exploiting undervalued oil and gas properties, and at December 31,
1992 had net proved reserves of 4.7 MMBOE. Since January 1, 1993, the Company
has successfully closed seven transactions for an aggregate purchase price of
approximately $101 million. As of April 1, 1996, the Company had total estimated
net proved reserves (as defined below) of 16.5 Mmbbls of oil and 112.9 Bcf of
gas, aggregating 35.3 MMBOE, with a PV-10 Value of approximately $179.5 million,
assuming the 1996 Acquisition (as defined below) had occurred at April 1, 1996.
The Company also has a substantial undeveloped acreage position consisting of
180,704 gross (165,166 net) acres at June 30, 1996. The Company has identified
in excess of 185 drilling locations of which 64 are included in its proved
reserves.
Costilla has in-house exploration expertise which uses 3-D seismic
technology as a primary tool to identify drilling opportunities and has
experienced high rates of success in each of its first two major 3-D seismic
drilling programs. Since 1994, the Company has drilled 37 wells based on these
3-D surveys, 31 of which have been productive. The Company has recently
completed two additional 3-D surveys and intends to commence drilling on one of
these acreage blocks in the second half of 1996. The Company currently plans to
drill 63 wells through 1997 based on its 3-D surveys.
Since 1993, Costilla has generated significant growth in reserves and
production. The Company increased its estimated proved reserves from 6.0 MMBOE
at December 31, 1993 to 35.3 MMBOE at April 1, 1996 (pro forma for the 1996
Acquisition), representing a compound annual growth rate of 114%. This reserve
growth has been achieved at an average all-in finding cost of $3.60 per BOE over
such period, a level which the Company believes is lower than industry averages.
Concurrently, the Company increased its average net daily production from 827
BOE for the year ended December 31, 1993 to 10,231 BOE for the three months
ended March 31, 1996 (pro forma for the 1996 Acquisition), representing a
compound annual growth rate of 190%.
BUSINESS STRATEGY
The Company's strategy is to increase its oil and gas reserves, production
and cash flow from operations through a two-pronged approach which combines an
active exploration program using 3-D seismic and other technological advances
with the acquisition and exploitation of producing properties. The Company seeks
to reduce its operating and commodity risks by holding a geographically diverse
portfolio of properties, the reserves attributable to which are approximately
balanced between oil and gas. The Company also seeks to manage the elements of
its business strategy through the operation of a significant portion of its
properties, the use of a rate of return analysis and the direct marketing and
hedging of its oil and gas production. The elements of the Company's strategy
may be further described as follows:
- - EXPLORATION EFFORTS. The Company uses extensive geological and geophysical
analysis to carefully focus its 3-D seismic surveys. This focus allows the
Company to successfully direct the size and scope of its exploration program
in order to improve the likelihood of success while managing overall
exploration costs. The Company's exploration efforts are concentrated
currently on
34
<PAGE>
known producing regions. The Company plans to drill 24 exploratory wells
during the last half of 1996 and 36 exploratory wells in 1997. Capital
budgeted for exploration activities is $8.1 million for the last six months
of 1996 and $10.8 million for 1997.
- - EXPLOITATION ACTIVITIES. The Company is actively pursuing numerous
exploitation opportunities within its existing properties, including areas
where no proved reserves are currently assigned. Exploitation activities
currently in progress include a carbon dioxide flood, recompletions,
workovers and infill and horizontal drilling and a secondary recovery
project. The Company's capital budget for such activities is $8.4 million
for the last six months of 1996 and $9.2 million for 1997, which includes
the drilling of 12 development wells in 1996 and 13 development wells in
1997.
- - PROPERTY ACQUISITIONS. The Company seeks to acquire producing properties
where it has identified opportunities to increase production and reserves
through both exploitation and exploration activities. The Company has
increased the value of its acquisitions by aggressively managing the
operations of existing proved properties and by successfully identifying and
developing previously unproved reserves on acquired acreage. The Company
seeks to acquire reserves which will fit its existing portfolio, are
generally not being actively marketed and where a negotiated sale would be
the method of purchase. The Company does not rely on major oil company
divestitures or property auctions.
- - PROPERTY DIVERSIFICATION. The Company holds a portfolio of oil and gas
properties located in the Permian Basin, the Gulf Coast and the Rocky
Mountain regions. The Company believes that by conducting its activities in
distinct regions it is able to reduce commodity price and other operational
risks. The Company's Moldovan interest is an extension of this strategy and
can be characterized by low initial costs, significant reserve potential and
the availability of technical data that may be further developed by the
Company.
- - CONTROL OF OPERATIONS. The Company prefers to operate and own the majority
working interest in its properties. This allows the Company greater control
over future development, drilling, completing and lifting costs and
marketing of production. At April 1, 1996, the Company operated wells
constituting approximately 72% of its total PV-10 Value (pro forma for the
1996 Acquisition).
SIGNIFICANT ACQUISITIONS
1995 ACQUISITION. In a $46.6 million acquisition completed in June 1995,
the Company acquired a group of oil and gas properties located in the Permian
Basin, Gulf Coast and Rocky Mountain regions. At the date of acquisition, the
net proved reserves included 7.1 Mmbbls of oil and 44.1 Bcf of gas, aggregating
14.4 MMBOE. From the date of acquisition until March 31, 1996, the Company
produced 1.1 MMBOE from the acquired properties and sold a portion of the
acquired properties for approximately $3.6 million. At April 1, 1996, the net
proved reserves of the remaining properties were 13.4 MMBOE. The acquired
properties also included 103,010 gross (93,787 net) undeveloped acres.
1996 ACQUISITION. In June 1996, the Company acquired a group of oil and gas
properties located primarily in the Permian Basin and Gulf Coast regions for
approximately $42.5 million. This acquisition included properties with net
proved reserves at April 1, 1996 of 5.0 Mmbbls of oil and 33.5 Bcf of gas,
aggregating 10.6 MMBOE. The acquired properties also included 42,855 gross
(16,646 net) undeveloped acres and a pipeline located in Pennsylvania which had
an allocated purchase price of $3.5 million.
35
<PAGE>
PRINCIPAL PROPERTIES
The following table sets forth certain information, as of April 1, 1996 (pro
forma for the 1996 Acquisition), which relates to the principal oil and gas
properties owned by the Company.
<TABLE>
<CAPTION>
PROVED RESERVES
----------------------------------------------------------
TOTAL OIL PERCENT OF
GROSS OIL GAS EQUIVALENT TOTAL OIL
REGION WELLS (MBBLS) (MMCF) (MBOE) EQUIVALENT
- ---------------------------------------------------------- --------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Permian Basin............................................. 1,890 9,200 55,200 18,400 52.1%
Gulf Coast................................................ 968 2,054 38,440 8,461 24.0
Rocky Mountain............................................ 236 4,526 12,886 6,674 18.9
Other..................................................... 428 697 6,395 1,762 5.0
--------- --------- --------- ----------- -----
Total..................................................... 3,522 16,477 112,921 35,297 100.0%
--------- --------- --------- ----------- -----
--------- --------- --------- ----------- -----
</TABLE>
PERMIAN BASIN. At April 1, 1996, 52.1% of the Company's proved reserves
were concentrated in the Permian Basin, an approximately 70-county region in
West Texas and Southeast New Mexico. The Company's production comes from well
known fields such as the Spraberry Trend, Sawyer Canyon, Goldsmith Unit and
Susan Peak. The majority of the Company's producing intervals in the Permian
Basin range from 4,500 feet to 9,500 feet in depth.
The Company has several exploratory projects in the Permian Basin based
primarily on 3-D seismic surveys. The most significant include:
EDWARDS/MCELROY RANCH PROSPECT, ECTOR AND CRANE COUNTIES, TEXAS. Costilla
has identified 68 drilling locations on the Company's 11,513 gross (5,066 net)
acres in this prospect based on 3-D seismic data. Since January 1, 1996, the
Company has drilled seven successful wells on this prospect, three of which have
resulted in three separate field discoveries. In addition, these wells have
confirmed the Strawn and Wolfcamp trends defined by the Company's extensive
approximate 50-square mile 3-D seismic project undertaken jointly with Texaco
Exploration and Production Inc. ("Texaco"). One additional well is being drilled
on seismic delineated features. The Company plans to drill 21 wells in this
trend through 1997. The Company's working interest in this prospect is
approximately 44%.
Costilla and Texaco are also developing a Queen Sand field identified from
the Edwards/McElroy Ranch seismic program. The four producing wells drilled
through June 30, 1996 are producing an aggregate of approximately 80 Bbls of oil
per day and the Company has participated in the drilling of two additional
productive wells subsequent to June 30, 1996. Drilling of six additional Queen
Sand wells is anticipated through 1997, with the field ultimately being
developed on a planned waterflood pattern in order to maximize recovery of the
oil in place.
MCGYVER-GREEN ACRES PROSPECT, HOWARD COUNTY, TEXAS. The Company has
identified 34 drilling locations in this prospect based on information derived
from approximately 30 square miles of 3-D seismic data that the Company acquired
on the area in 1994. The Talbot Fuller well was the first well drilled by the
Company on this prospect and was completed in the Canyon Lime formation at 8,200
feet in August 1994. From completion to June 30, 1996, the well produced 61
MBbls of oil and 238 Mmcf of gas, and had average capacity of 71 Bbls of oil per
day and 278 Mcf of gas per day during June 1996. Subsequent to the first well,
16 additional wells have been drilled on this prospect of which 13 are
productive. The Company is drilling or intends to drill five additional wells
during the balance of 1996 on its 9,801 gross (7,057 net) acres. The Company's
working interest in this prospect averages approximately 72%.
The following two 3-D programs currently being undertaken by the Company in
the Permian Basin are expected to provide additional drilling locations:
WILSON RANCH 3-D PROJECT, PECOS COUNTY, TEXAS. The Wilson Ranch is located
in northeastern Pecos County, approximately 10 miles west of the Yates field.
The Company recently completed an
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<PAGE>
approximate 17-square mile seismic survey on the project. A second phase will be
initiated in the first quarter of 1997. The project presents several potential
exploration targets, including the Queen, San Andres, Wolfcamp, Devonian and
Ellenberger formations, found at depths ranging from 1,600 to 8,000 feet. The
Company has agreed to lease 3,750 gross acres on this 50,000 acre ranch. Upon
acquiring the lease, the Company intends to sell up to one-half of its
approximate 75% working interest. The Company believes that there is significant
additional potential in this area.
DAVAN UNIT 3-D PROJECT, STONEWALL COUNTY, TEXAS. The Company has completed
another 3-D seismic project with Texaco to further develop the Company-operated
Davan Unit. The project involves a 3-D seismic evaluation of approximately 3,200
gross acres adjacent to a Company-operated waterflood which has produced in
excess of three Mmbbls of oil. An exploratory well is scheduled on this prospect
for the first quarter of 1997.
Two examples of the Company's current exploitation efforts in the Permian
Basin include:
EAST GOLDSMITH FIELD C02 PROJECT, ECTOR COUNTY, TEXAS. The Company owns
3,053 gross (2,656 net) acres in this field located 20 miles northwest of
Midland, Texas. Since its discovery, the field has produced in excess of 20
Mmbbls of oil from seven formations. The most productive zones in the East
Goldsmith Field have been the San Andres and Holt formations, both of which have
been subject to secondary recovery by waterflooding. The Company has been
analyzing a tertiary recovery project in those formations using CO2, and intends
to initiate the project in the fourth quarter of 1996. The Company's working
interest in this project averages approximately 87%.
SUSAN PEAK FIELD WORKOVER AND HORIZONTAL DRILLING PROGRAM, TOM GREEN COUNTY,
TEXAS. The Company recently completed the first horizontal well in this field
located south of San Angelo, Texas, in which it owns a 100% working interest
until payout. Production from this well drilled in the Strawn formation was
approximately 68 Bbls of oil per day and 225 Mcf of gas per day in July 1996.
With only two workovers and the new horizontal well, the Company has increased
Susan Peak production from approximately 31 Bbls of oil per day and 760 Mcf of
gas per day in the last half of 1995 to an average rate of approximately 126
Bbls of oil per day and 1,330 Mcf of gas per day in July 1996. Two possible
horizontal drilling locations and additional workover candidates remain on this
7,461 gross (3,730 net) acre lease. The Company's working interest in this
project is 50%.
GULF COAST. At April 1, 1996, 24.0% of the Company's proved reserves were
concentrated in the Gulf Coast region. The Company's production in this region
primarily comes from known formations such as Frio, Yegua, Austin Chalk and
Wilcox.
The Company plans to use its expertise in aggressively developing 3-D
opportunities on the extensive acreage position it holds in the region. Examples
of such exploration projects in progress include:
SEALY PROSPECT, AUSTIN COUNTY, TEXAS. The Sealy Field, consisting of 3,534
gross and net acres, was acquired in the 1995 Acquisition. The Wilcox formation
in this field has produced over 66 Bcf of gas and there are subsurface
indications of the presence of several fault blocks that lie untested. The
Company's working interest in this prospect is 100%. The Company is currently
attempting to acquire additional acreage in this prospect prior to initiating a
3-D survey in late 1996 or 1997.
SOUTHWEST SPEAKS, LAVACA COUNTY, TEXAS. This project, consisting of 5,078
gross (2,539 net) acres, was also acquired in the 1995 Acquisition and is held
by several shallow Company-operated wells. Multiple producing horizons from
shallow depths to below 14,000 feet have produced over 122 Bcf of gas from this
highly faulted field. A recent well was completed in the Rainbow Wilcox sand on
acreage adjoining Costilla's lease. A well, in which Costilla holds a 5%
interest as a result of a farmout, has also been completed on Costilla's lease.
The Company's plans are to conduct a 3-D survey in the Speaks area in late 1996
or 1997. The Company's working interest in this prospect is approximately 50%.
37
<PAGE>
BORCHERS FIELD, LAVACA COUNTY, TEXAS. This field was acquired by the
Company in the 1996 Acquisition. The property is on trend with the Speaks
project and is also a highly faulted field providing opportunity for further
development. The Company's lease in the Borchers Field area has produced a total
of 21.2 Bcf of gas from two Wilcox sands. Costilla has a 100% working interest
in this field consisting of 1,322 gross and net acres. The Company plans to
conduct a 3-D survey in the Borchers Field in 1997.
Examples of exploitation activities in this region include:
JOSEY RANCH LEASE, HARRIS COUNTY, TEXAS. Two examples of the Company's
production enhancement of Gulf Coast properties were undertaken on this
prospect. When the lease was acquired in the 1995 Acquisition, production had
nearly ceased. Through a series of workovers, the Company has improved daily
capacity, as of June 30, 1996, to 63 Bbls of oil per day and 73 Mcf of gas per
day. In addition, Costilla has participated in a 10,900 foot test well on the
Josey Ranch lease to test the Wilcox formation. The well was completed in April
1996 and has consistently produced approximately 1,000 Mcf of gas per day. The
Josey Ranch lease covers 1,661 gross (650 net) acres, and the Company's working
interest in this prospect is approximately 39%.
PERSONVILLE, LIMESTONE COUNTY, TEXAS. The Company has recently completed an
11,000 foot Cotton Valley well, which is producing 2.8 Mmcf of gas per day. The
Company is currently drilling an additional well on this prospect. Costilla
leases 411 gross (119 net) acres in this prospect, and has identified one
additional drilling location. The Company is the operator of this prospect and
its working interest is approximately 29%.
AUSTIN CHALK, BRAZOS, BURLESON, FAYETTE AND LEE COUNTIES, TEXAS. Costilla
acquired the majority of the working interest in nine gross Austin Chalk wells
in the 1995 Acquisition and an additional 80 gross Austin Chalk wells were
included in the 1996 Acquisition. The Company intends to enhance production on
certain of these wells through stimulation and workover activities, and analyze
further development potential. Costilla has 30,414 gross (20,985 net) acres in
the Austin Chalk area, and its working interest in this area averages
approximately 69%.
ROCKY MOUNTAIN. At April 1, 1996, 18.9% of the Company's proved reserves
were concentrated in the Rocky Mountain region, which includes Montana, North
Dakota, Wyoming, Colorado and Utah.
The Company has a number of opportunities in the Rocky Mountain region
involving 3-D seismic surveys, exploratory drilling and exploitation activities.
Examples of each of these opportunities are:
RAYMOND FIELD, SHERIDAN COUNTY, MONTANA. Since its discovery in 1972, the
Raymond Field has produced over five Mmbbls of oil from five different
formations. Daily production from the field has increased from 179 Bbls of oil
per day since its acquisition in June 1995 to 368 Bbls of oil per day in June
1996 primarily as a result of the Company's improved operations. The Company
plans a 3-D program on its 960 gross and net acres in this field. The Company
owns a 100% working interest in this prospect.
OUTLOOK FIELD, SHERIDAN COUNTY, MONTANA. The Company undertook its first
Rocky Mountain 3-D seismic survey in the Outlook area to further develop the
field. Three drilling locations were identified from the data. The Company
anticipates commencing an Outlook test well in October 1996 that will be drilled
to 10,500 feet, a depth sufficient to test several different formations.
Costilla leases 5,169 gross (1,292 net) acres in the Outlook prospect, and owns
an approximate 25% working interest in this prospect.
NATURAL BUTTES FIELD, UINTAH COUNTY, UTAH. The Company owns a 100% working
interest in 4,640 gross and net acres in this prospect. Development by prior
owners was on 640-acre spacing while offset acreage has been developed on
80-acre spacing. Low gas prices in the area have precluded the assignment of
proved reserves to any undeveloped acres. As gas prices improve, the Company
plans to drill additional wells on the prospect.
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<PAGE>
The Company owns an interest in significant acreage positions in the Rocky
Mountain region which are operated by third parties and are the subject of
active exploitation efforts. The most significant property is:
CIRCLE RIDGE FIELD, FREMONT COUNTY, WYOMING. The Circle Ridge Field, in
which the Company has an approximate 18% working interest, is operated by
Marathon Oil Company. This field is an approximate 1,100 acre waterflood located
in the Wind River Basin of Wyoming, approximately 30 miles north of Riverton,
Wyoming. There are 97 active producing wells and 10 active injection wells in
the field. Production originates from the Phosphoria, Tensleep and Amsden
formations that are present at depths ranging from 500 to 2,000 feet. Since
January 1995, 45 projects have been completed in the field. These projects
include recompletions, stimulation treatments and reactivations, which have
increased production from 1,469 Bbls of oil per day in January 1995 to a rate of
1,778 Bbls of oil per day for June 1996. The operator has several other projects
scheduled for the remainder of 1996 and is evaluating various different methods
of enhanced oil recovery for the field.
MARKETING ARRANGEMENTS
The Company utilizes an active marketing program for a portion of its crude
oil production in order to enhance the net price it receives. The Company sells
its crude oil production from operated properties in North Dakota, Montana and
Wyoming, at the lease level to an oil transportation company for the posted
price, plus an agreed upon bonus, with a corresponding agreement to repurchase
this production at its delivery point (typically, Cushing, Oklahoma) for a price
equal to the then posted price for West Texas Intermediate crude oil less an
agreed upon deduction for transportation and quality differentials, if any,
between the repurchased crude oil and West Texas Intermediate crude oil. The
Company then employs a broker to resell its crude oil to end users (such as
refineries) on a month-to-month basis. The lease level sales and repurchase
contracts are typically of six months duration. With respect to its other
operated oil production (primarily located in Texas), the Company employs a
similar price enhancement strategy, although the repurchase feature is absent.
Instead, the lease level purchaser resells the crude oil to end users at the
delivery point for the account of the Company. While these arrangements have the
effect of increasing the net price the Company receives for its crude oil, such
arrangements do not have the effect of limiting the Company's exposure to
movements in crude oil prices. The Company markets its gas production at the
lease level pursuant to month-to-month contracts. Phibro Energy USA, Inc.'s
purchases of the Company's oil production for the year ended December 31, 1995
accounted for 17.7% of the Company's 1995 consolidated revenues. Because of the
number of crude oil purchasers, the Company does not anticipate any difficulty
in replacing Phibro Energy USA, Inc.
RISK MANAGEMENT
The Company typically employs a strategy of purchasing put options on a
portion of its anticipated oil and gas production. This strategy is designed to
protect the Company from significant downward movements in commodity prices
while preserving the benefit of rising prices. The Company does not establish
hedges in excess of its anticipated production. Upon consummation of the
Offerings, substantially all of the Company's debt will be fixed rate. The
Company's current position with regard to its 1996 commodity hedges is as
follows:
OIL SALES. The Company has purchased put options to provide a floor price
for 3,000 Bbls of oil per day of its oil production for August 1996 through
December 1996. These put options currently in place represent approximately 52%
of the Company's estimated oil production for August 1996 through December 1996.
The floor price the Company has an agreement to receive is $18.00 per Bbl,
irrespective of the prices actually paid by purchasers of the oil at the lease
level.
GAS SALES. The Company has purchased put options which provide a floor
price for 900,000 Mmbtu's per month of its gas production through October 1996.
The put options currently in place represent approximately 84% of the Company's
estimated gas production for July 1996 through October 1996. The floor prices
with respect to such put options varies from $1.65 to $1.75 per Mmbtu depending
on the area in which the gas is produced.
39
<PAGE>
OIL AND GAS RESERVES
The Company's estimated total proved and proved developed reserves of oil
and gas as of December 31, 1993, 1994 and 1995, and as of April 1, 1996 were as
follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------------------------ PRO FORMA
APRIL 1,
1993 1994 1995 1996 (1)
---------------------- -------------------- -------------------- --------------------
OIL GAS OIL GAS OIL GAS OIL GAS
(MBBLS) (MMCF) (MBBLS) (MMCF) (MBBLS) (MMCF) (MBBLS) (MMCF)
----------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Proved developed producing... 1,785 13,268 2,632 15,757 8,338 50,542 13,122 76,439
Proved developed non-
producing................... 0 0 0 583 228 6,851 430 7,930
Proved undeveloped........... 580 8,351 1,377 11,172 2,222 20,759 2,925 28,552
----- --------- --------- --------- --------- --------- --------- ---------
Total proved............... 2,365 21,619 4,009 27,512 10,788 78,152 16,477 112,921
----- --------- --------- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- --------- --------- ---------
</TABLE>
- ------------------------------
(1) Assumes that the 1996 Acquisition had been consummated at April 1, 1996.
The following table sets forth the future net cash flows from the Company's
estimated proved reserves:
<TABLE>
<CAPTION>
DECEMBER 31, PRO FORMA
--------------------------------- APRIL 1,
1993 1994 1995 1996(1)
--------- --------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Future net cash flows before income taxes....................... $ 47,213 $ 68,596 $ 188,337 $ 297,002
Future net cash flows before income taxes, discounted at 10%.... $ 26,377 $ 36,779 $ 113,296 $ 179,527
</TABLE>
- ------------------------------
(1) Assumes that the 1996 Acquisition had been consummated at April 1, 1996.
The reserve estimates reflected above for 1993, 1994 and 1995 were prepared
by the Company. The Company's 1995 estimates of gross reserves with respect to
certain of the Company's producing properties were subject to a limited review
by Williamson of the Company's engineering analysis covering approximately 54.0%
of the Company's proved reserves at such date. The pro forma estimates for April
1, 1996, including the properties acquired in the 1996 Acquisition, were
prepared by Williamson and are part of reports on the Company's oil and gas
properties prepared by Williamson, a summary of which is set forth herein as
Appendix A.
The reserve data set forth herein present estimates only. In general,
estimates of economically recoverable oil and gas reserves and of the future net
revenues therefrom are based upon an number of variable factors and assumptions,
such as historical production from the subject properties, the assumed effects
of regulation by governmental agencies and assumptions concerning future oil and
gas prices and future operating costs, all of which may vary considerably from
actual results. All such estimates are to some degree speculative, and
classifications of reserves are only attempts to define the degree of
speculation involved. For these reasons, estimates of the economically
recoverable oil and gas reserves attributable to any particular group of
properties, classifications of such reserves based on risk of recovery and
estimates of the future net revenues expected therefrom, prepared by different
engineers or by the same engineers at different times, may vary substantially.
The Company therefore emphasizes that the actual production, revenues, severance
and excise taxes, development and operating expenditures with respect to its
reserves will likely vary from such estimates, and such variances could be
material.
Estimates with respect to proved reserves that may be developed and produced
in the future are often based upon volumetric calculations and upon analogy to
similar types of reserves rather than
40
<PAGE>
actual production history. Estimates based on these methods are generally less
reliable than those based on actual production history. Subsequent evaluation of
the same reserves based upon production history will result in variations, which
may be substantial, in the estimated reserves.
In accordance with applicable requirements of the Securities and Exchange
Commission, the estimated discounted future net revenues from estimated proved
reserves are based on prices and costs as of the date of the estimate unless
such prices or costs are contractually determined at such date. Actual future
prices and costs may be materially higher or lower. Actual future net revenues
also will be affected by factors such as actual production, supply and demand
for oil and natural gas, curtailments or increases in consumption by natural gas
purchasers, changes in governmental regulations or taxation and the impact of
inflation on costs.
EXPLORATION AND DEVELOPMENT ACTIVITIES
The Company drilled, or participated in the drilling of, the following
number of wells during the periods indicated. At June 30, 1996, the Company was
in the process of drilling two gross (0.49 net) wells and was in the process of
completing three gross (1.22 net) wells as producers which are not reflected in
the following table.
<TABLE>
<CAPTION>
1993 1994 1995
---------------------- ---------------------- ----------------------
GROSS NET GROSS NET GROSS NET
----------- --------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Exploratory:
Productive....................................... 3 0.83 9 2.27 10 4.58
Dry.............................................. 2 1.06 10 3.73 6 2.57
--- --- --- --- --- ---
Total.......................................... 5 1.89 19 6.00 16 7.15
--- --- --- --- --- ---
--- --- --- --- --- ---
Development:
Productive....................................... -- -- -- -- 1 0.44
Dry.............................................. -- -- -- -- -- --
--- --- --- --- --- ---
Total.......................................... -- -- -- -- 1 0.44
--- --- --- --- --- ---
--- --- --- --- --- ---
Total:
Productive....................................... 3 0.83 9 2.27 11 5.02
Dry.............................................. 2 1.06 10 3.73 6 2.57
--- --- --- --- --- ---
Total.......................................... 5 1.89 19 6.00 17 7.59
--- --- --- --- --- ---
--- --- --- --- --- ---
<CAPTION>
SIX MONTHS ENDED JUNE
30, 1996
----------------------
GROSS NET
----------- ---------
<S> <C> <C>
Exploratory:
Productive....................................... 3 1.74
Dry.............................................. 1 0.72
--- ---
Total.......................................... 4 2.46
--- ---
--- ---
Development:
Productive....................................... 4 1.98
Dry.............................................. -- --
--- ---
Total.......................................... 4 1.98
--- ---
--- ---
Total:
Productive....................................... 7 3.72
Dry.............................................. 1 0.72
--- ---
Total.......................................... 8 4.44
--- ---
--- ---
</TABLE>
The Company does not own any drilling rigs and all of its drilling
activities are conducted by independent contractors under standard drilling
contracts.
PRODUCTIVE WELL SUMMARY
The following table sets forth the Company's gross and net interests in
productive oil and gas wells as of June 30, 1996. Productive wells are producing
wells and wells capable of production.
<TABLE>
<CAPTION>
ACTUAL (1)
--------------------
GROSS NET
--------- ---------
<S> <C> <C>
Oil wells...................................................................................... 2,248 678.54
Gas wells...................................................................................... 1,278 231.11
--------- ---------
Total...................................................................................... 3,526 909.65
--------- ---------
--------- ---------
</TABLE>
- ------------------------------
(1) Does not include royalty and overriding royalty interests owned by
Statewide or the Company. See "-- Other Activities -- Minerals Acquisition
Program." In addition, one well with multiple completions is counted as a
single well.
41
<PAGE>
ACREAGE
The following table sets forth certain information regarding the Company's
developed and undeveloped leasehold acreage as of June 30, 1996. Acreage in
which the Company's interest is limited to royalty, overriding royalty, mineral
and similar interests (such as all acreage owned by Statewide) is excluded.
<TABLE>
<CAPTION>
DEVELOPED UNDEVELOPED TOTAL
-------------------- -------------------- --------------------
REGION GROSS NET GROSS NET GROSS NET
- ------------------------------------------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Permian Basin.............................. 126,091 50,151 65,741 59,669 191,832 109,820
Gulf Coast................................. 197,650 65,547 46,040 39,713 243,690 105,260
Rocky Mountain............................. 8,534 6,126 24,757 24,650 33,291 30,776
Other...................................... 43,651 26,108 44,166 41,134 87,817 67,242
--------- --------- --------- --------- --------- ---------
Total.................................. 375,926 147,932 180,704 165,166 556,630 313,098
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
</TABLE>
OTHER ACTIVITIES
MOLDOVA CONCESSION AGREEMENT. In July 1995, the Republic of Moldova
(located in Eastern Europe between Romania and the Ukraine) granted a Concession
Agreement to Resource Development Company Limited, L.L.C. ("Redeco"), an entity
not affiliated with the Company. The Company has paid Redeco $90,000 and agreed
to bear the first $2.0 million of Concession expenses ($1.2 million of which had
been expended through June 30, 1996) in return for a 50.0% interest in Redeco.
After the initial $2.0 million expenditure, the Company and the other members of
Redeco are each responsible for bearing 50.0% of future expenses. The Concession
Agreement covers the entire country with respect to oil and gas and other
minerals and continues for various time periods depending on the nature of the
activity conducted. In connection with two previously producing but now
abandoned fields, Redeco's exclusive rights continue for 20 years. Redeco's
exclusive period to explore throughout the remainder of Moldova expires in 2005,
but Redeco will maintain exclusive development rights with respect to fields
discovered for a period of 20 years from the date of first production from such
field. The Company has no material fixed financial commitments with respect to
the Concession.
MINERALS ACQUISITION PROGRAM. Statewide, a Company subsidiary, was
organized for the purpose of acquiring overriding royalty interests and other
types of non cost-bearing mineral interests underlying producing oil and gas
fields primarily in Texas. The strategy of such acquisitions is to make blanket
offers to holders of small interests. From inception through June 30, 1996,
Statewide expended approximately $3.3 million in acquiring interests in
approximately 1,400 properties. Through June 30, 1996, Statewide had received
revenues from such interests aggregating approximately $1.4 million, as well as
proceeds from sales of such interests of approximately $102,000.
GAS GATHERING AND TRANSMISSION. In 1996, the Company purchased a 40.5%
membership interest (which reduces to 32.4% when the Company and certain other
members recoup their original investment) in Republic Gas Partners, L.L.C., a
Delaware limited liability company ("Republic"), for approximately $941,000.
Republic owns all of the stock of Mid Louisiana Gas Company, Mid Louisiana
Marketing Company and Mid Louisiana Gas Transmission Company (collectively, the
"Midla Companies"). The assets of the Midla Companies include 409 miles of
mainly 22-inch pipeline extending from the Monroe field area south of the city
of Baton Rouge, serving various Louisiana and Mississippi municipal and
industrial customers along its route. Mid Louisiana Gas Company's pipeline is
subject to the jurisdiction of the Federal Energy Regulatory Commission
("FERC").
Valley, a Company subsidiary, owns a small gas gathering system, several
small gas plants, 11 salt water disposal wells located in each of its three
principal regions and compressors used in the compression of gas located in the
Gulf Coast region. For the year ended December 31, 1995, Valley had revenues of
$553,000 and net income of $264,000, substantially all of which were related to
transactions with Costilla.
42
<PAGE>
In the 1996 Acquisition, Pipeline, a Company subsidiary, acquired a 120-mile
gas transportation pipeline in southwestern Pennsylvania for an allocated value
of $3.5 million. The Company regards this asset as non-strategic to its business
activities and is presently marketing the pipeline for sale.
COMPETITION AND MARKETS
Competition in all areas of the Company's operations is intense. Major and
independent oil and gas companies and oil and gas syndicates actively bid for
desirable oil and gas properties, as well as for the equipment and labor
required to operate and develop such properties. A number of the Company's
competitors have financial resources and acquisition, exploration and
development budgets that are substantially greater than those of the Company,
which may adversely affect the Company's ability to compete with these
companies. Many of the Company's competitors have been engaged in the energy
business for a much longer time than the Company. Such companies may be able to
pay more for productive oil and gas properties and exploratory prospects and to
define, evaluate, bid for and purchase a greater number of properties and
prospects than the Company's financial or human resources permit. The Company's
ability to acquire additional properties and to discover reserves in the future
will be dependent on its ability to evaluate and select suitable properties and
to consummate transactions in a highly competitive environment.
The market for oil, gas and natural gas liquids produced by the Company
depends on factors beyond its control, including domestic and foreign political
conditions, the overall level of supply of and demand for oil, gas and natural
gas liquids, the price of imports of oil and gas, weather conditions, the price
and availability of alternative fuels, the proximity and capacity of gas
pipelines and other transportation facilities and overall economic conditions.
The oil and gas industry as a whole also competes with other industries in
supplying the energy and fuel requirements of industrial, commercial and
individual consumers.
REGULATION
The Company's oil and gas exploration, production and related operations are
subject to extensive rules and regulations promulgated by federal, state and
local agencies. Failure to comply with such rules and regulations can result in
substantial penalties. The regulatory burden on the oil and gas industry
increases the Company's cost of doing business and affects its profitability.
Because such rules and regulations are frequently amended or reinterpreted, the
Company is unable to predict the future cost or impact of complying with such
laws.
The State of Texas and many other states require permits for drilling
operations, drilling bonds and reports concerning operations and impose other
requirements relating to the exploration and production of oil and gas. Such
states also have statutes or regulations addressing conservation matters,
including provisions for the unitization or pooling of oil and gas properties,
the establishment of maximum rates of production from oil and gas wells and the
regulation of spacing, plugging and abandonment of such wells. The statutes and
regulations of certain states limit the rate at which oil and gas can be
produced from the Company's properties.
FERC regulates interstate natural gas transportation rates and service
conditions, which affect the marketing of gas produced by the Company, as well
as the revenues received by the Company for sales of such production. Since the
mid-1980s, the FERC has issued a series of orders, culminating in Order Nos.
636, 636-A and 636-B ("Order 636"), that have significantly altered the
marketing and transportation of gas. Order 636 mandates a fundamental
restructuring of interstate pipeline sales and transportation service, including
the unbundling by interstate pipelines of the sales, transportation, storage and
other components of the city-gate sales services such pipelines previously
performed. One of the FERC's purposes in issuing the orders is to increase
competition within all phases of the gas industry. Order 636 and subsequent FERC
orders on rehearing have been appealed and are pending judicial review. Because
these orders may be modified as a result of the appeals, it is difficult to
predict the ultimate impact of the orders on the Company and its gas marketing
efforts. Generally,
43
<PAGE>
Order 636 has eliminated or substantially reduced the interstate pipelines'
traditional role as wholesalers of natural gas, and has substantially increased
competition and volatility in natural gas markets. While significant regulatory
uncertainty remains, Order 636 may ultimately enhance the Company's ability to
market and transport its gas, although it may also subject the Company to
greater competition and the more restrictive pipeline imbalance tolerances and
greater associated penalties for violation of such tolerances.
Sales of oil and natural gas liquids by the Company are not regulated and
are made at market prices. The price the Company receives from the sale of these
products is affected by the cost of transporting the products to market.
Effective as of January 1, 1995, the FERC implemented regulations establishing
an indexing system for transportation rates for oil pipelines, which, generally,
would index such rates to inflation, subject to certain conditions and
limitations. These regulations could increase the cost of transporting oil and
natural gas liquids by pipeline, although the most recent adjustment generally
decreased rates. These regulations are subject to pending petitions for judicial
review. The Company is not able to predict with certainty what effect, if any,
these regulations will have on it, but, other factors being equal, the
regulations may, over time, tend to increase transportation costs or reduce
wellhead prices for oil and natural gas liquids.
ENVIRONMENTAL MATTERS
Operations of the Company are subject to numerous and constantly changing
federal, state and local laws and regulations governing the discharge of
materials into the environment or otherwise relating to environmental
protection. These laws and regulations may require the acquisition of certain
permits, restrict or prohibit the types, quantities and concentration of
substances that can be released into the environment in connection with drilling
and production, restrict or prohibit drilling activities that could impact
wetlands, endangered or threatened species or other protected natural resources
and impose substantial liabilities for pollution resulting from the Company's
operations. Such laws and regulations may substantially increase the cost of
exploring for, developing or producing oil and gas and may prevent or delay the
commencement or continuation of a given project. In the opinion of the Company's
management, the Company is in substantial compliance with current applicable
environmental laws and regulations, and the cost of compliance with such laws
and regulations has not been material and is not expected to be material during
the next fiscal year. Nevertheless, changes in existing environmental laws and
regulations or in interpretations thereof could have a significant impact on the
operating costs of the Company, as well as the oil and gas industry in general.
For instance, legislation has been proposed in Congress from time to time that
would reclassify certain oil and gas production wastes as "hazardous wastes,"
which reclassification would make exploration and production wastes subject to
much more stringent handling, disposal and clean-up requirements. State
initiatives to further regulate the disposal of oil and gas wastes and naturally
occurring radioactive materials are also pending in certain states, including
Texas, and these various initiatives could have a similar impact on the Company.
The Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without regard
to fault or the legality of the original conduct, on certain classes of persons
that are considered to have contributed to the release of a "hazardous
substance" into the environment. These persons include the owner or operator of
the disposal site or the site where the release occurred and companies that
disposed or arranged for the disposal of the hazardous substances found at the
site. Persons who are or were responsible for releases of hazardous substances
found at the site and persons who are or were responsible for releases of
hazardous substances under CERCLA may be subject to joint and several liability
for the costs of cleaning up the hazardous substances that have been released
into the environment and for damages to natural resources, and it is not
uncommon for neighboring landowners and other third parties to file claims for
personal injury and property damage allegedly caused by the hazardous substances
released into the environment. The Company is able to control directly the
operation of only those wells with respect to which its acts as operator.
Notwithstanding the Company's lack of
44
<PAGE>
control over wells operated by others, the failure of the operator to comply
with applicable environmental regulations may, in certain circumstances, be
attributed to the Company. The Company has no material commitments for capital
expenditures to comply with existing environmental requirements.
EMPLOYEES
At June 30, 1996, the Company had 109 full-time employees. None of the
Company's employees is subject to a collective bargaining agreement. The Company
considers its relations with its employees to be good.
LEGAL PROCEEDINGS
The Company is a defendant or codefendant in minor lawsuits that have arisen
in the ordinary course of business. While the outcome of the these lawsuits
cannot be predicted with certainty, management does not expect any of these to
have a material adverse effect on the Company's consolidated financial condition
or results of operations.
TITLE TO PROPERTIES
The Company has obtained title opinions on substantially all of its
producing properties and believes that it has satisfactory title to such
properties in accordance with standards generally accepted in the oil and gas
industry. As is customary in the oil and gas industry, the Company performs a
minimal title investigation before acquiring undeveloped properties. A title
opinion is obtained prior to the commencement of drilling operations on such
properties. The Company's properties are subject to customary royalty interests,
liens incident to operating agreements, liens for current taxes and other
burdens which the Company believes do not materially interfere with the use of
or affect the value of such properties. Substantially all of the Company's oil
and gas properties are mortgaged to secure borrowings under the Company's
Existing Debt Facility and will continue to be mortgaged to secure borrowings
under the Credit Facility. See "Management's Discussion and Analysis of
Financial Conditions and Results of Operations -- Liquidity and Capital
Resources," and "Description of Other Indebtedness."
OPERATIONAL HAZARDS AND INSURANCE
The Company's operations are subject to the hazards and risks inherent in
drilling and production and transportation of oil and gas, including fires,
natural disasters, explosions, encountering formations with abnormal pressures,
blowouts, cratering, pipeline ruptures, and spills, any of which can result in
loss of hydrocarbons, environmental pollution, personal injury or loss of life,
severe damage to and destruction of properties of the Company and others, and
suspension of operations. See "Risk Factors -- Drilling Risks" and "Risk Factors
- -- Operating Hazards and Uninsured Risks."
The Company maintains insurance of various types to cover its operations.
The limits provided under its liability policies total $21 million. In addition,
the Company maintains operator's extra expense coverage which provides for care,
custody and control of all material wells drilled by the Company as operator.
The Company believes that its insurance is adequate and customary for companies
of a similar size engaged in operations similar to those of the Company, but
losses could occur for uninsurable or uninsured risks or in amounts in excess of
existing insurance coverage. The Company's general policy is to only engage
drilling contractors who provide substantial insurance coverage and name the
Company as an additional named insured. The occurrence of a significant adverse
event, the risks of which are not fully covered by insurance, could have a
material adverse effect on the Company's financial condition and results of
operations. Moreover, no assurances can be given that the Company will be able
to maintain adequate insurance in the future at rates it considers reasonable.
45
<PAGE>
MANAGEMENT
The executive officers and directors of the Company following completion of
the Corporate Reorganization are listed below, together with a description of
their experience and certain other information (ages provided are as of June 30,
1996). Executive officers are appointed by the Board of Directors.
<TABLE>
<CAPTION>
NAME AGE EMPLOYED SINCE POSITION WITH COMPANY
- --------------------------- --- ----------------- --------------------------------------------------------------
<S> <C> <C> <C>
Cadell S. Liedtke 41 1988 Chairman of the Board, Chief Executive Officer and Director
Michael J. Grella 47 1988 President, Chief Operating Officer and Director
Henry G. Musselman 42 1992 Executive Vice President and Director
Jerry J. Langdon 43 n/a Director
W.D. Kennedy 76 n/a Director
Bobby W. Page 53 1996 Senior Vice President, Treasurer and Chief Financial Officer
Clifford N. Hair, Jr. 49 1992 Vice President -- Land and Secretary
Roger J. Wetz 47 1992 Vice President -- Exploration (Geology)
Roger A. Freidline 46 1993 Vice President -- Exploration (Geophysics)
Brian K. Miller 36 1992 Vice President -- Reservoir Engineering
Sal J. Pagano 45 1995 Vice President -- Engineering and Operations
Keith Atwood 42 1992 Vice President -- Field Operations
Celia A. Zinn 48 1996 Controller
</TABLE>
Cadell S. Liedtke entered the oil and gas business in Midland, Texas in 1977
as an independent landman generating oil and gas prospects in the Permian Basin.
He founded the Company's predecessor with Michael J. Grella in 1988 and has
served as managing partner and/or chief executive officer since that time. Mr.
Liedtke has served on the Board of Directors of Texas Commerce Bank-Permian
Basin and has been appointed by Texas Governor George W. Bush to the Oil and Gas
Compact Commission. Mr. Liedtke is a member of the All-American Wildcatters
Association, the Permian Basin Petroleum Association, the Permian Basin Landmans
Association and the Independent Producer's Association of America. Mr. Liedtke
graduated from the University of Texas at Austin in 1977 with a B.A. degree in
economics.
Michael J. Grella has served as Chief Operating Officer of the Company and
its predecessor entities since their formation in 1988. He owned and operated an
independent oil and gas company and has invested in the oil and gas business
since 1982. Mr. Grella is a member of the Permian Basin Petroleum Association,
the Independent Producer's Association of America, the Texas Independent
Producers and Royalty Owners Association and the Permian Basin Landman
Association. Mr. Grella has a B.S. degree in computer science from the
University of California.
Henry G. Musselman began his oil and gas career in 1975 with Musselman
Petroleum and Land Company where he served as Vice President and a Director
until forming Musselman, Owen & King in 1982. For the 10 years until merging his
company into Costilla's predecessor in 1992, Mr. Musselman developed and
acquired oil and gas properties throughout the Permian Basin. Mr. Musselman is a
member and former director of the Independent Producer's Association of America.
Mr. Musselman graduated from the University of Texas at Austin in 1975 with a
B.B.A. degree.
Jerry J. Langdon has previously held positions with WP Corporation, Houston
Pipeline Company, Texas Oil & Gas Corporation and W. Wilson Corporation. In
1980, Mr. Langdon formed Texas IntraMark Gas Company, Inc., an intrastate gas
gathering company engaging in the business of constructing and operating natural
gas gathering, treating and processing facilities. In 1984, Mr. Langdon formed
Langdon & Associates, a natural gas consulting group advising petroleum
resource-oriented
46
<PAGE>
companies, financial institutions and law firms on a variety of technical,
commercial and regulatory issues. Mr. Langdon served as a member of the FERC
from 1988 to June 1993. Since leaving the FERC, Mr. Langdon formed Republic Gas
Corp. to acquire, construct and operate intrastate natural gas pipeline,
gathering, processing, treating and marketing facilities. Mr. Langdon is the
President of both Republic and the Midla Companies. Mr. Langdon is a 1975
graduate of the University of Texas at Austin with a B.S. degree.
W. D. Kennedy has been continually involved in the oil and gas business
since 1948. From 1953 until 1980, Mr. Kennedy was an executive officer and
director of C&K Petroleum, Inc., and its predecessor. C&K Petroleum, Inc. was a
publicly held corporation from 1971 until 1980, when the company was sold for in
excess of $200 million. Mr. Kennedy remains an active investor in the oil and
gas business. Mr. Kennedy is a graduate of the University of Texas, and a member
of the All-American Wildcatters Association, a past president of the Permian
Basin Petroleum Association, a former director of the Texas Mid-Continent Oil
and Gas Association, and an advisory director of Norwest Bank Texas, Midland.
Bobby W. Page began his oil and gas career with MGF Oil Corporation in 1967,
where he remained until 1988, ultimately serving as Executive Vice President,
Chief Financial Officer and a member of the Board of Directors. Following two
years as a self-employed financial consultant, Mr. Page joined Alta Energy
Corporation in 1990 as Executive Vice President, Treasurer and Chief Financial
Officer. From July 1993 until joining the Company, Mr. Page served as Vice
President, Chief Financial Officer and Secretary of Marcum Natural Gas Services,
Inc. Mr. Page graduated from the University of Oklahoma with a B.B.A. degree in
accounting in 1965.
Clifford N. Hair, Jr. has served in district and division landman roles, as
well as a corporate officer with Texas Gas Exploration Corporation, Samedan Oil
Corporation, Henry Petroleum Corporation and Donald C. Slawson Oil Producer. For
the two year period prior to joining the Company in 1992, Mr. Hair was an
independent landman involved in drilling projects in Texas and Oklahoma. Mr.
Hair is a Certified Petroleum Landman's and a member of the American Association
of Petroleum Landmen and the Petroleum Basin Landman Association. Mr. Hair
graduated with honors from the University of Houston in 1971 with a B.B.A.
degree in accounting.
Roger J. Wetz began his oil and gas career with IMCO Services, a division of
Halliburton, Inc. in 1974. He held a variety of geological positions with Gulf
Energy & Minerals Company, TXO Production Corporation and Terra Resources, Inc.
from 1976 to 1989. From 1989 until joining the Company in 1992, Mr. Wetz was an
independent geologist generating prospects in the Permian Basin. Mr. Wetz
graduated from St. Mary's University in 1973 with a B.S. degree in geology.
Roger A. Freidline began his industry career with Union Oil Company of
California. From 1976 until 1985, Mr. Freidline served in various geophysical
capacities with Forest Oil Corporation, Gifford, Mitchell and Wisenbaker and
Heritage Resources, Inc. Mr. Freidline was an independent geophysicist from 1985
until joining the Company, except for a period of employment as district
geologist for Hondo Oil & Gas Company prior to its sale. Mr. Freidline is a
Certified Petroleum Geologist, and a member of the Society of Exploration
Geophysicists, the Permian Basin Geophysical Society and the West Texas
Geological Society. He has co-authored papers which have appeared in Geology and
The Bulletin of the Seismological Society of America. Mr. Freidline received a
B.S. degree with highest honors from the New Mexico Institute of Mining and
Technology in 1972 and a Masters of Science degree in geophysics from the
University of Utah in 1974.
Brian K. Miller entered the oil and gas business as an operations engineer
for ARCO Oil and Gas Company. From 1984 to 1987, he was a reservoir engineer
with First City National Bank of Midland, Texas, and from 1987 to 1989, Mr.
Miller was an independent consulting engineer. Prior to joining the Company in
1992, Mr. Miller served as an oil and gas analyst under appointment to the
Federal Deposit Insurance Corporation. Mr. Miller is a member of the Society of
Petroleum Engineers.
47
<PAGE>
Mr. Miller received a B.S. degree with highest honors in petroleum engineering
from the University of Texas at Austin in 1982 and a Master of Business
Administration degree with honors in finance in 1984.
Sal J. Pagano began his oil and gas career with Amoco Production Company
where he was employed until 1978. From 1978 through 1989, Mr. Pagano was
employed by several independent oil and gas companies in Midland, Texas in a
variety of petroleum engineering capacities. Prior to joining the Company in
1995, Mr. Pagano was employed by Midland Resources Company from 1989 as a vice
president. Mr. Pagano is a registered petroleum engineer and a member of the
Society of Petroleum Engineers. Mr. Pagano graduated in 1973 from the University
of Missouri at Rolla with a B.S. degree in petroleum engineering.
Keith Atwood began his oil and gas career with Otis Engineering Corp. in
1974. Mr. Atwood worked as an independent consultant from 1979 to 1983 when he
joined Musselman, Owen & King Operating Co. to manage field operations. He
served in that capacity until joining the Company in 1992. Mr. Atwood attended
Southwest Texas State University and the University of Texas.
Celia A. Zinn joined the Company in 1996. From 1992 to 1996, she practiced
public accounting in Midland. Ms. Zinn has 18 years experience in the oil and
gas industry, including 12 years as Controller for Clayton W. Williams, Jr.,
Inc. from 1981 to 1992. Ms. Zinn is a certified public accountant. Ms. Zinn
graduated from the University of Texas-Arlington in 1978 with a B.A. in
mathematics.
48
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth the names and addresses of each of the
Company's stockholders who beneficially own more than five percent of the
Company's Common Stock, the number of shares beneficially owned by such
shareholders and the percentage of the Common Stock so owned at June 30, 1996,
assuming in each case the Corporate Reorganization had been consummated at June
30, 1996 and that the Common Stock Offering is consummated without the
underwriters' over-allotment option being exercised.
<TABLE>
<CAPTION>
AMOUNT AND NATURE OF
BENEFICIAL OWNERSHIP PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER (1) CLASS
- -------------------------------------- ---------------------- -------------
<S> <C> <C>
Cadell S. Liedtke .................... 2,302,560 23.0%
400 W. Illinois
Midland, Texas 79701
Michael J. Grella .................... 1,350,267 13.5%
400 W. Illinois
Midland, Texas 79701
NationsBanc Capital Corp. ............ 936,000 9.4%
100 North Tryon Street
Charlotte, North Carolina 28255
Henry G. Musselman ................... 611,173 6.1%
400 W. Illinois
Midland, Texas 79701
</TABLE>
- ------------------------------
(1) All persons own the listed shares of record.
The following table sets forth information as of June 30, 1996 (assuming the
Corporate Reorganization had been consummated on such date) with respect to the
shares of Common Stock beneficially owned by each of the Company's Directors,
the Chief Executive Officer and the three other most highly compensated
executive officers for 1996 (whose annualized compensation for such year based
on compensation levels following the Offering is expected to exceed $100,000)
and all Directors and executive officers as a group and the percent of the
outstanding Common Stock owned by each, assuming that the Common Stock Offering
is consummated without the underwriters' over-allotment option being exercised.
<TABLE>
<CAPTION>
DIRECTORS AND NAMED AMOUNT AND NATURE OF PERCENT OF
EXECUTIVE OFFICER BENEFICIAL OWNERSHIP CLASS (1)
- -------------------------------------- ---------------------- -------------
<S> <C> <C>
Cadell S. Liedtke..................... 2,302,560 23.0%
Michael J. Grella..................... 1,350,267 13.5%
Henry G. Musselman.................... 611,173 6.1%
Bobby W. Page......................... 75,000(2) 0.7%
All Officers and Directors as a group
(13 persons).......................... 4,814,000(3) 45.6%
</TABLE>
- ------------------------------
(1) For the sole purpose of calculating these percentages, the shares, which
the named person has the right to acquire within 60 days, by exercise of
the options described in these footnotes, are deemed outstanding shares
with respect to that person's percentage ownership and with respect to the
percentage ownership of all Officers and Directors as a group.
(2) Includes 75,000 shares issuable pursuant to an option granted under the
Company's 1996 Stock Option Plan which option will be immediately
exercisable upon closing of the Offerings at a price equal to the initial
public offering price of the Common Stock.
(3) Includes 550,000 shares issuable pursuant to options granted under the
Company's 1996 Stock Option Plan which options will be immediately
exercisable upon closing of the Offerings at a price equal to the initial
public offering price of the Common Stock.
49
<PAGE>
EXECUTIVE COMPENSATION AND OTHER INFORMATION
SUMMARY COMPENSATION TABLE
The following table sets forth information for the Company's Chief Executive
Officer and the three other most highly compensated executive officers whose
annual compensation for the fiscal year ending December 31, 1996 is expected to
exceed $100,000. Information is presented for 1995, and for 1996 on an
annualized basis based on salaries to be effective following consummation of the
Offerings. Information for 1994 and prior years is not comparable since the
Company's predecessor was a general partnership in which the partners received
periodic partnership distributions in lieu of salary.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
-------------
ANNUAL COMPENSATION SECURITIES
------------------------------------------------- UNDERLYING
OTHER ANNUAL OPTIONS/ ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY($) BONUS($) COMPENSATION($) SARS(#)(2) COMPENSATION($)
- ------------------------------- --------- --------- --------- ---------------- ------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Cadell S. Liedtke
Chairman of the Board and 1995 185,700 -- -- -- --
Chief Executive Officer 1996 300,000 -- -- -- --
Michael J. Grella
President and Chief Operating 1995 261,750 -- -- -- 656,000(3)
Officer 1996 300,000 -- -- -- --
Henry G. Musselman
1995 139,800 -- -- -- --
Executive Vice President 1996 215,000 -- -- -- --
Bobby W. Page
Senior Vice President,
Treasurer and Chief 1995(1) -- -- -- -- --
Financial Officer 1996 150,000 -- -- 75,000 --
</TABLE>
- ------------------------------
(1) Mr. Page joined the Company in June 1996.
(2) The amount shown represents the number of shares subject to a stock option
to be granted upon the closing of the Offerings pursuant to the Company's
1996 Stock Option Plan described under "-- Benefit Plans -- 1996 Stock
Option Plan." The option will be granted with an exercise price per share
equal to the initial public offering price of the Common Stock and will be
granted for a 10-year term.
(3) The amount shown represents non-cash compensation deemed to have been
accrued to Mr. Grella in connection with the cancellation of an option held
by a minority owner to purchase an additional interest in the Company. See
Note 11 of the Notes to the Consolidated Financial Statements.
DIRECTORS' COMPENSATION
Compensation for non-employee directors (Messrs. Langdon and Kennedy) will
consist of an annual retainer fee of $10,000, plus a $1,000 fee for each Board
meeting attended and a $1,000 fee for attending a committee meeting held on a
day other than the same day of a Board meeting. In addition, outside Directors
are participants in the Company's Outside Directors Stock Option Plan described
under "-- Benefit Plans -- Outside Directors Stock Option Plan." Employee
Directors do not receive compensation for serving on the Board or the Board's
committees.
EMPLOYMENT AGREEMENTS
Messrs. Liedtke, Grella and Musselman have entered into employment
agreements (the "Founders Employment Agreements") with the Company which will
become effective upon the closing of the Offerings and replace certain existing
agreements. The Founders Employment Agreements are each for three years,
commencing on the closing of the Offerings and each will automatically renew for
successive one-year periods thereafter unless the employee is notified to the
contrary. The Founders Employment Agreements provide for salary levels for
Messrs. Liedtke, Grella and Musselman of $300,000, $300,000 and $215,000,
respectively.
Each of Messrs. Liedtke, Grella and Musselman would receive his salary for
the remaining term of the applicable Founders Employment Agreement if the
Company were to terminate such person's
50
<PAGE>
employment other than for cause. If such person were to voluntarily leave his
employment with the Company prior to the second anniversary of the Agreement no
further payments would be required. If a voluntary termination were to occur
after the second anniversary of the Agreement, such person would be entitled to
one year's salary from the date of termination. Each Founders Employment
Agreement provides that the covered employee will not compete with the Company
for a one year period following his voluntary cessation of employment or
termination of employment for cause, in either case if such event occurs within
the initial three-year term of the Agreement. Competitive activities are defined
as engaging in the oil and gas business in any area in which the Company is then
active.
Bobby W. Page has entered into an employment agreement (the "Page Employment
Agreement") with the Company effective June 30, 1996. The Page Employment
Agreement is for a period of three years from June 30, 1996 and will
automatically renew for successive one-year periods thereafter unless Mr. Page
is notified to the contrary by the Company. The Page Employment Agreement
provides a $25,000 bonus (which includes Mr. Page's cost of relocation), plus a
base salary of $150,000 until January 1, 1997; $175,000 until January 1, 1998;
and $185,000 thereafter. In addition, Mr. Page will receive options to purchase
75,000 shares of Common Stock, certain insurance benefits and other benefits
generally available to the Company's employees. Mr. Page would receive his
salary for the remaining term of the Page Employment Agreement if the Company
were to terminate the Page Employment Agreement other than for cause. However,
if Mr. Page were to voluntarily leave his employment with the Company, no
further payments would be required.
BENEFIT PLANS
OUTSIDE DIRECTORS STOCK OPTION PLAN. The Outside Directors Stock Option
Plan provides for the issuance of stock options to the outside directors of the
Company. A total of 50,000 shares of Common Stock has been authorized and
reserved for issuance under the plan, subject to adjustments to reflect changes
in the Company's capitalization resulting from stock splits, stock dividends and
similar events. Only outside directors are eligible to participate in the plan.
Outside directors are those directors of the Company who are not executive
officers or regular salaried employees of the Company as of the date an option
is granted. Under the plan, an option for 1,000 shares of Common Stock will be
granted to each person who qualifies as an outside director each year that such
person is elected as a director of the Company. The exercise price of each
option granted under the plan will be the fair market value (as reported on the
Nasdaq National Market) of the Common Stock at the time the option is granted,
and may be paid either in cash, shares of Common Stock or a broker-assisted
cashless transaction. Each option will be exercisable immediately, and will
expire ten years from the date of grant. An option granted under the plan is not
transferrable other than by will or the laws of descent and distribution. In the
event a participant in the plan ceases to be an outside director, other than by
reason of death, such participant may exercise an outstanding option under the
plan within six months after such termination, to the extent the participant was
entitled to exercise the option on the date of termination. In the event of the
death of a participant under the plan, such participant's option(s) may be
exercised by the executors or administrators of the optionee's estate or by the
legatees of such participant within one year after his death, so long as the
term of the option has not expired. The Company does not receive any
consideration upon the grant of options under the plan. The options granted
under the plan are intended to be non-qualifying options for federal income tax
purposes. Because options under the plan are not generally transferrable, do not
appear to be subject to a substantial risk of forfeiture and the exercise price
will be the fair market value of the common stock on the date of grant, the
options should not be taxable to an optionee until the optionee exercises the
option, at which time the optionee would recognize income on the difference
between the exercise price and the fair market value of the shares on the date
of exercise. The grant of options under the plan should be treated as
compensation paid by the Company for purposes of the Company's federal income
tax considerations. The Board of Directors may amend the plan without the
approval of the stockholders of the Company in any respect other than any
amendment which requires stockholder
51
<PAGE>
approval by law and may only modify an outstanding option, including the
repricing of such options, with the consent of the option holder. The Company
currently has five directors, two of whom are eligible to participate in the
plan.
1996 STOCK OPTION PLAN. The 1996 Stock Option Plan provides for the grant
of both incentive stock options and non-qualifying stock options, as well as
limited stock appreciation rights and supplemental bonuses, to the employees of
the Company and its subsidiaries, including officers and directors who are
salaried employees. A total of 850,000 shares of Common Stock has been
authorized and reserved for issuance under the plan, subject to adjustment to
reflect changes in the Company's capitalization resulting from stock splits,
stock dividends and similar events. The plan is administered by the Board of
Directors. The Board of Directors has the sole authority to interpret the plan,
to determine the persons to whom options will be granted, to determine the basis
upon which the options will be granted, and to determine the exercise price,
duration and other terms of the options to be granted under the plan; provided
that (a) the exercise price of each option granted under the plan may not be
less than the fair market value of the Common Stock on the date the option is
granted (and for incentive stock options, 110% of fair market value if the
employee is the beneficial owner of 10% or more of the Company's voting
securities), (b) the exercise price must be paid in cash, by surrendering
previously owned shares of Common Stock upon the exercise of the option or by a
promissory note or broker-assisted cashless exercise approved by the Board of
Directors, (c) the term of the option may not exceed ten years, and (d) no
option is transferrable other than by will, the laws of descent and distribution
or pursuant to a qualified domestic relations order. Upon termination of an
optionee's employment (other than by death or disability), an incentive stock
option may be exercised prior to the expiration date of the option or within
three months after the date of such termination, whichever is earlier, but only
to the extent the optionee had the right to exercise the option upon the date of
such termination, while the rights of the holder of a non-qualifying stock
option will be set forth in each option agreement. In the event of the
disability of an optionee, the option may be exercised by such person or his
personal representative at any time within one year of the termination of such
person's employment, but only to the extent the optionee had the right to
exercise the option as of the date of his disability. In the event of death of
the optionee, the option may be exercised by his personal representative or
successor in interest at any time until the later of the expiration of the
option or one year after the optionee's death, to the extent the option was
exercisable at the time of the optionee's death. Incentive stock options may not
be granted under the plan to any individual if the effect of such grant would
permit that person to have the first opportunity to exercise such options, in
any calendar year, for the purchase of shares having a fair market value (at the
time of grant of the option) in excess of $100,000. Neither the Company nor any
of its subsidiaries will receive any consideration for the granting of options
under the plan. Limited stock appreciation rights may be granted under the plan
with respect to specified options, allowing the option holder to receive, in
cash, the difference between the exercise price and the market value in the
event of a change of control of the Company. The Board of Directors may also
grant supplemental bonuses under the plan which are cash bonuses not to exceed
the amount of income tax liability incurred by a plan participant upon the
exercise of a non-qualifying stock option or a limited stock appreciation right
with respect to which the bonus was granted. Incentive stock options granted
under the plan are intended to have the federal income tax consequences of a
qualified stock option. As a result, the exercise of an incentive stock option
will not be a taxable event; the taxable event occurs at the time the shares of
Common Stock acquired upon exercise of the option are sold. If the optionee
holds such shares for the later of two years from the date the option was
granted or one year from the date of exercise of the option, the difference
between the price paid for the shares at exercise and the price for which those
shares are sold will be treated as capital gains income. If the optionee does
not hold the shares for the required holding period, the income would be treated
as ordinary income rather than capital gains income. The non-qualifying stock
options granted under the plan should be taxable when the option is exercised,
at which time the optionee would recognize ordinary income the difference
between the exercise price and the fair market value of the shares on the date
of exercise. The grant of options under the plan will be treated as compensation
by the Company for federal income tax purposes. The Board of Directors may amend
52
<PAGE>
the plan, without stockholder approval, in any respect other than any amendment
that requires stockholder approval by law, and may modify an outstanding option,
including the repricing of non-qualifying options, with the consent of the
option holder. There are currently approximately 100 persons who are eligible to
participate under the plan.
BONUS INCENTIVE PLAN. The Company has adopted the Bonus Incentive Plan to
become effective upon the completion of the Offerings. The plan provides that
the Board of Directors each year may award bonuses in cash, Common Stock, or
some combination thereof, to those officers, directors, employees and advisors
of the Company or a subsidiary of the Company, who the Board of Directors
determines have contributed to the success of the Company. A total of 100,000
shares of Common Stock has been authorized and reserved for issuance under the
plan, subject to adjustments to reflect changes in the Company's capitalization
resulting from stock splits, stock dividends and similar events. All officers,
directors, employees and advisors of the Company or a subsidiary of the Company
who have completed a minimum of 180 days of service and are employed or retained
by the Company or such subsidiary on the last day of the plan year, other than
such persons who own ten percent or more of the outstanding shares of Common
Stock during that year are eligible to participate in the plan. Bonus awards
will be determined based on a number of factors, including performance and
salary level of the participant and the financial performance of the Company and
its subsidiaries. Bonuses will be awarded after review and upon approval of the
Board of Directors, subject to the terms and conditions of the plan.
CERTAIN TRANSACTIONS
A&P supplies meter reading services which measures gas production to the
Company, as well as to unaffiliated oil and gas companies. A&P is also engaged
in the sale of gas meter and regulating equipment, and in certain other oil
field related businesses. For the fiscal year ended December 31, 1995, the
Company accounted for approximately 27% of A&P's gross revenues. From time to
time, the Company has advanced funds to A&P for working capital needs. These
advances have been consolidated into two promissory notes. One note was executed
December 31, 1994 in the original principal amount of $370,000. The note bears
interest at a floating rate equal to the "prime rate" plus 1.0%. No principal or
interest payments are due until the maturity of the note at December 31, 2004.
The note is secured by a second lien on A&P's accounts receivable, inventory and
equipment. The second note is in the original principal amount of $247,000 and
is dated May 22, 1996. The note bears interest at 6.0% per annum, is unsecured
and is payable upon demand. During the fiscal year ended December 31, 1995, A&P
received $612,139 from the Company for meter reading, meter repair, calibration,
flow line installation and other related services provided to the Company. The
Company believes that the services and charges therefor are comparable to those
the Company could have obtained from unaffiliated third parties.
During 1995 the Company paid $440,884 to Valley for gas compression and salt
water disposal charges. During 1995, Valley paid the Company $109,399 for
operating costs of its salt water disposal wells and gas compressors. Also
during 1995, the Company paid CSL $592,920 for management fees and lease
payments on equipment.
During a portion of 1995, the Company leased office space from 511 Tex L.C.,
in which Messrs. Liedtke, Grella and Musselman are the sole members. The amount
of rental payments to 511 Tex L.C. during 1995 was $67,896. The Company no
longer leases office space from any affiliated party.
The Company has agreed that, upon the request of NBCC, on up to two
occasions, the Company will register under the Securities Act of 1933, as
amended (the "Securities Act"), and applicable state securities laws the sale of
the Common Stock owned by NBCC. The Company's obligation is subject to certain
limitations regarding the timing of registrations and certain other matters. The
Company is also obligated to offer to NBCC and Messrs. Liedtke, Grella and
Musselman (collectively, the "Affiliated Holders") the opportunity to include
shares of the Common Stock owned by them in certain
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registration statements filed by the Company. In addition, the Company has
agreed to indemnify the Affiliated Holders and their respective officers and
directors against securities law liabilities arising in connection with such
offerings, other than liabilities arising as a result of information furnished
to the Company by the Affiliated Holders participating in the registration. The
Company is obligated to pay all expenses incident to such registration, except
underwriters' discounts and commissions allocable to the sale of shares by
Affiliated Holders and any professional fees and expenses incurred by the
Affiliated Holders incident to such registration. The Affiliated Holders have
agreed that they will not sell any shares of Common Stock for a period of 180
days after the Offerings without the consent of Prudential Securities
Incorporated.
In 1995, non-cash compensation of $656,000 was deemed to have accrued to Mr.
Grella in connection with the cancellation of an option held by Mr. Musselman to
acquire an interest in the Company's predecessors. To effect such cancellation,
Mr. Liedtke agreed to transfer a portion of his ownership interest in the
Company's predecessors directly to Mr. Musselman. See Note 11 of the Notes to
the Consolidated Financial Statements.
Certain of the transactions comprising the Corporate Reorganization
represent transactions between the Company, or its predecessors, and its
affiliates. Messrs. Liedtke, Grella and Musselman, the shareholders of Valley
and CSL will sell the stock of Valley and the assets of CSL to the Company for
$0.7 million. The purchase price is based on negotiations between Messrs.
Liedtke, Grella and Musselman, on the one hand, and NBCC, considering the value
to the Company of the stock and assets being acquired. No third party conducted
an appraisal of either Valley or CSL.
Messrs. Liedtke, Grella and Musselman will receive an aggregate distribution
from the LLC of approximately $3.5 million which is estimated to be the federal
income tax liability (as well as the federal income tax liability on such
distribution) which will be owed by Messrs. Liedtke, Grella and Musselman as a
result of the Corporate Reorganization. However, the precise amount of such
liability will be dependent upon a number of factors which cannot be determined
with certainty until subsequent to December 31, 1996. While the amount to be
distributed has been determined in good faith by the Company's tax advisors,
there can be no assurance that the actual tax liability of any of Messrs.
Liedtke, Grella or Musselman will not be less or greater than the distributed
amounts. If the distributed amounts exceed the ultimate tax liabilities, none of
such persons will reimburse the Company. Correspondingly, if the tax liability
exceeds the amount of such distributions, the Company will not make any further
distributions to cover such short-fall. NBCC is also receiving a distribution of
$0.8 million, which represents its post-redemption ownership percentage of the
distribution made to Messrs. Liedtke, Grella and Musselman. However, NBCC has no
tax or other liability with respect to such distribution. In addition, Messrs.
Liedtke, Grella and Musselman and NBCC will receive an aggregate of 5,200,000
shares of Common Stock in the Merger in exchange for their interests in the LLC.
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DESCRIPTION OF NOTES
GENERAL
The Notes will be issued pursuant to an Indenture (the "Indenture") between
the Company and State Street Bank and Trust Company, as trustee (the "Trustee").
A copy of the Indenture in substantially the form in which it will be executed
has been filed as an Exhibit to the Registration Statement of which this
Prospectus is a part. The terms of the Notes include those stated in the
Indenture and those made part of the Indenture by reference to the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act"). The Notes are
subject to all such terms, and Holders of Notes are referred to the Indenture
and the Trust Indenture Act for a statement thereof. The following summary of
certain provisions of the Indenture does not purport to be complete and is
qualified in its entirety by reference to the Indenture, including the
definitions therein of certain terms used below and those terms that are made a
part of the Indenture by reference to the Trust Indenture Act. The definitions
of certain terms used in the following summary are set forth below under the
caption "Certain Definitions."
As of the date of the Indenture, Costilla Redeco Energy, L.L.C. and Costilla
Redeco Operating, L.L.C., through which the Company conducts its Moldovan
operations, will be Unrestricted Subsidiaries. However, under certain
circumstances, the Company will be able to designate additional Subsidiaries as
Unrestricted Subsidiaries. If so designated, such Subsidiaries will not be
subject to many of the restrictive covenants set forth in the Indenture. As used
herein, "Subsidiary" refers to any Subsidiary of the Company that is not an
Unrestricted Subsidiary.
PRINCIPAL, MATURITY AND INTEREST
The Notes will be general unsecured senior obligations of the Company,
limited in aggregate principal amount to $100.0 million and will mature on
October 1, 2006. Interest on the Notes will accrue at the rate of 10.25% per
annum and will be payable semiannually in arrears on April 1 and October 1
commencing on April 1, 1997, to Holders of record on the immediately preceding
March 15 and September 15. Interest on the Notes will accrue from the most
recent date to which interest has been paid or, if no interest has been paid,
from October 8, 1996. Interest will be computed on the basis of a 360-day year
comprised of twelve 30-day months. Principal, premium, if any, and interest on
the Notes will be payable at the office or agency of the Company maintained for
such purpose within the City and State of New York or, at the option of the
Company, payment of interest may be made by check mailed to the Holders of the
Notes at their respective addresses set forth in the register of Holders of
Notes; PROVIDED that all payments with respect to Global Notes and Certificated
Securities the Holders of which have given wire transfer instructions to the
Company will be required to be made by wire transfer of immediately available
funds to the accounts specified by the Holders thereof. Until otherwise
designated by the Company, the Company's office or agency in New York will be in
the office of the Trustee maintained for such purpose. The Notes will be issued
in denominations of $1,000 and integral multiples thereof.
RANKING
The Notes will be general unsecured senior obligations of the Company and
will rank equally in right of payment with all existing and future Senior
Indebtedness of the Company, and senior in right of payment to all existing and
future subordinated indebtedness of the Company. The Notes, however, will be
effectively subordinated to secured Senior Indebtedness of the Company and its
subsidiaries with respect to the assets securing such Indebtedness, including
indebtedness under the Credit Facility, which is expected to be secured by a
lien on substantially all of the assets of the Company and any subsidiary of the
Company that guarantees the Company's obligations under the Credit Facility. See
"Description of Other Indebtedness -- Credit Facility." On a pro forma basis,
after giving effect to the Corporate Reorganization, the Offerings and the
application of proceeds therefrom, the Company would have had no senior
unsecured indebtedness, other than the Notes and trade payables, and $0.4
million of secured Senior Indebtedness. On such a pro forma basis, no
Indebtedness was junior to the Notes. The Notes will also be effectively
subordinated to liabilities of the Company's subsidiaries that
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are not Subsidiary Guarantors. On a pro forma basis, the total liabilities of
the Company's Subsidiaries were $6.5 million at June 30, 1996, all of which were
operating liabilities. The Indenture will limit, subject to certain financial
tests, the amount of additional Indebtedness that the Company and its
Subsidiaries can incur. See "Certain Covenants -- Incurrence of Indebtedness and
Issuance of Preferred Stock." The Indenture will also limit the amount of such
Indebtedness that can be secured. See "Certain Covenants -- Liens."
SUBSIDIARY GUARANTEES
The Indenture does not require any Subsidiary to guarantee the payment of
the Notes unless each such Subsidiary incurs Indebtedness (other than its
Indebtedness existing on the date of the Indenture and certain intercompany
Indebtedness). The Indenture requires the Company to cause such Subsidiary to
fully and unconditionally, jointly and severally guarantee (the "Subsidiary
Guarantees") the Company's payment obligations under the Notes prior to the
incurrence of such Indebtedness. See "Certain Covenants -- Incurrence of
Indebtedness and Issuance of Preferred Stock." On the date of the Indenture,
there will be no Subsidiary Guarantors. So long as a Person is an Unrestricted
Subsidiary, such Person will not be required to become a Subsidiary Guarantor or
execute a Subsidiary Guarantee. See "Certain Covenants -- Unrestricted
Subsidiaries." As a result, claims of creditors against the Subsidiaries and the
Unrestricted Subsidiaries, including their trade creditors and tort claimants,
will effectively have priority to the property and earnings of such subsidiaries
over claims of creditors of the Company, including the Holders. The obligations
of each Subsidiary Guarantor under its Subsidiary Guarantee will be limited in a
manner intended to result in such Subsidiary Guarantee not constituting a
fraudulent conveyance under applicable law.
The Indenture will provide that no Subsidiary Guarantor may consolidate with
or merge with or into (whether or not such Subsidiary Guarantor is the surviving
Person) another Person whether or not affiliated with such Subsidiary Guarantor
(other than the consolidation or merger of a Wholly Owned Subsidiary of the
Company with another Wholly Owned Subsidiary of the Company or into the Company)
unless (i) subject to the provisions of the following paragraph, the Person
formed by or surviving any such consolidation or merger (if other than such
Subsidiary Guarantor) becomes a Subsidiary Guarantor pursuant to a supplemental
indenture or other agreement in form and substance reasonably satisfactory to
the Trustee, and (ii) immediately after giving effect to such transaction, (A)
no Default or Event of Default would exist or be continuing and (B) other than
in the case of the consolidation or merger of two or more Subsidiary Guarantors
or of one or more Subsidiary Guarantors with the Company, the Company would (A)
have Consolidated Net Worth immediately after the transaction equal to or
greater than the Consolidated Net Worth of the Company immediately preceding the
transactions; and (B) at the time of such transaction and after giving effect
thereto, be permitted to incur at least $1.00 of additional Indebtedness
pursuant to the Consolidated Interest Coverage Ratio and the Adjusted
Consolidated Net Tangible Assets to Consolidated Indebtedness Ratio tests set
forth in the first paragraph of the covenant described below under the caption
"Certain Covenants -- Incurrence of Indebtedness and Issuance of Preferred
Stock."
The Indenture will provide that (i) in the event of a sale or other
disposition of all of the assets of any Subsidiary Guarantor, by way of merger,
consolidation or otherwise, or a sale or other disposition of all of the capital
stock of any Subsidiary Guarantor or (ii) in the event that a Subsidiary
Guarantor is properly designated as an Unrestricted Subsidiary, in each case, in
accordance with the provisions of the Indenture, then such Subsidiary Guarantor
(in the event of a sale or other disposition, by way of such a merger,
consolidation or otherwise, of all of the capital stock of such Subsidiary
Guarantor or the proper designation of such Subsidiary Guarantor as an
Unrestricted Subsidiary in accordance with the provisions of the Indenture) or
the corporation acquiring the property (in the event of a sale or other
disposition of all or substantially all of the assets of such Subsidiary
Guarantor), will be released and relieved of any obligations under its
Subsidiary Guarantee; provided that the Net Proceeds of such sale or other
disposition are applied in accordance with the applicable provisions of the
Indenture. See "Certain Covenants -- Merger, Consolidation or Sale of Assets."
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OPTIONAL REDEMPTION
The Notes will not be redeemable at the Company's option prior to October 1,
2001. Thereafter, the Notes will be subject to redemption at the option of the
Company, in whole or in part, upon not less than 30 nor more than 60 days'
notice, at the redemption prices (expressed as percentages of principal amount)
set forth below plus accrued and unpaid interest to the applicable redemption
date, if redeemed during the twelve-month period beginning on October 1 of the
years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
- --------------------------------------------------------------------------------- -----------
<S> <C>
2001............................................................................. 105.125%
2002............................................................................. 103.417%
2003............................................................................. 101.708%
2004 and thereafter.............................................................. 100.000%
</TABLE>
Notwithstanding the foregoing, at any time on or before October 1, 1999, the
Company may (but shall not have the obligation to) redeem up to 30% of the
original aggregate principal amount of the Notes at a redemption price of
110.25% of the principal amount thereof, plus accrued and unpaid interest
thereon to the redemption date, with the net proceeds of an Equity Offering made
by the Company; PROVIDED that at least 70% of the aggregate principal amount of
Notes originally issued remain outstanding immediately after the occurrence of
such redemption; and PROVIDED, FURTHER, that such redemption shall occur within
75 days of the date of the closing of such Equity Offering.
If less than all of the Notes are to be redeemed at any time, selection of
Notes for redemption will be made by the Trustee on a pro rata basis; PROVIDED
that no Notes of $1,000 or less shall be redeemed in part. Notices of redemption
shall be mailed by first class mail at least 30 but not more than 60 days before
the redemption date to each Holder of Notes to be redeemed at its registered
address. If any Note is to be redeemed in part only, the notice of redemption
that relates to such Note shall state the portion of the principal amount
thereof to be redeemed. A new Note in principal amount equal to the unredeemed
portion thereof will be issued in the name of the Holder thereof upon
cancellation of the original Note. On and after the redemption date, interest
ceases to accrue on Notes or portions thereof called for redemption.
MANDATORY REDEMPTION
The Company is not required to make mandatory redemption or sinking fund
payments with respect to the Notes.
REPURCHASE AT THE OPTION OF HOLDERS
CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each Holder of Notes will have
the right to require the Company to repurchase all or any part (equal to $1,000
or an integral multiple thereof) of such Holder's Notes pursuant to the offer
described below (the "Change of Control Offer") at an offer price in cash equal
to 101% of the aggregate principal amount thereof plus accrued and unpaid
interest thereon (the "Change of Control Purchase Price") to the date of
purchase (the "Change of Control Payment Date"). Within 30 days following any
Change of Control, the Company will mail a notice to each Holder describing the
transaction or transactions that constitute the Change of Control and offering
to repurchase Notes pursuant to the procedures required by the Indenture and
described in such notice. The Change of Control Payment Date shall be a business
day not less than 30 days nor more than 60 days after such notice is mailed. The
Company will comply with the requirements of Rule 14e-1 under the Exchange Act
and any other securities laws and regulations thereunder to the extent such laws
and regulations are applicable in connection with the repurchase of the Notes as
a result of a Change of Control.
On the Change of Control Payment Date, the Company will, to the extent
lawful, (1) accept for payment all Notes or portions thereof properly tendered
pursuant to the Change of Control Offer, (2) deposit with the Paying Agent an
amount equal to the Change of Control Purchase Price in respect of all Notes or
portions thereof so tendered and (3) deliver or cause to be delivered to the
Trustee the
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Notes so accepted together with an Officers' Certificate stating the aggregate
principal amount of Notes or portions thereof being purchased by the Company.
The Paying Agent will promptly mail to each Holder of Notes so tendered the
Change of Control Payment for such Notes, and the Trustee will promptly
authenticate and mail (or cause to be transferred by book entry) to each Holder
a new Note equal in principal amount to any unpurchased portion of the Notes
surrendered, if any; PROVIDED that each such new Note will be in a principal
amount of $1,000 or an integral multiple thereof.
Except as described above with respect to a Change of Control, the Indenture
does not contain provisions that permit the Holders of the Notes to require that
the Company repurchase or redeem the Notes in the event of a takeover by any
persons other than the Approved Shareholders, or a recapitalization or similar
restructuring.
If a Change of Control Offer is made, there can be no assurance that the
Company will have available funds sufficient to pay the Change of Control
Purchase Price for all of the Notes that might be delivered by Holders seeking
to accept the Change of Control Offer. If on a Change of Control Purchase Date
the Company does not have available funds sufficient to pay the Change of
Control Purchase Price or is prohibited from purchasing the Notes, an Event of
Default would occur under the Indenture. The definition of Change of Control
includes an event by which the Company sells, conveys, transfers or leases all
or substantially all of its properties to any Person. The phrase "all or
substantially all" is subject to applicable legal precedent and as a result in
the future there may be uncertainty as to whether a Change of Control has
occurred. The existence of a Holder's right to require, subject to certain
conditions, the Company to repurchase the Notes upon a Change of Control may
deter a third party from acquiring the Company in a transaction that
constitutes, or results in, a Change of Control.
The Credit Facility provides that certain change of control events with
respect to the Company would constitute a default thereunder and prohibits the
Company from making a Change of Control Offer or Asset Sale Offer. Any future
credit agreements or other agreements relating to Senior Indebtedness to which
the Company becomes a party may contain similar restrictions and provisions. In
the event a Change of Control occurs at a time when the Company is prohibited
from purchasing Notes, the Company could seek the consent of its lenders to the
purchase of Notes or could attempt to repay or refinance the borrowings that
contain such prohibition. If the Company does not obtain such a consent or repay
such borrowings, the Company will remain prohibited from purchasing Notes. In
such case, the Company's failure to purchase tendered Notes would constitute an
Event of Default under the Indenture which would, in turn, constitute a default
under the Credit Facility. Even if such consents to an offer to purchase were
obtained or the lenders did not declare a default under the Credit Facility and
other credit facilities, the Company's ability to pay cash to the holders of the
Notes upon a repurchase may be limited by the Company's then existing financial
resources.
ASSET SALES
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, engage in an Asset Sale unless (i) the Company (or
such Subsidiary) receives consideration at the time of such Asset Sale at least
equal to the fair market value, and in the case of a lease of assets under which
the Company or any of its Subsidiaries is the lessor, a lease providing for rent
and other conditions which are no less favorable to the Company (or such
Subsidiary) in any material respect than the then prevailing market conditions
(evidenced in each case by a resolution of the Board of Directors of such entity
set forth in an Officers' Certificate delivered to the Trustee) of the assets
sold or otherwise disposed of, and (ii) at least 85% (100% in the case of such
lease payments) of the consideration therefor received by the Company or such
Subsidiary is in the form of cash or Cash Equivalents or properties used in the
Oil and Gas Business of the Company and its Subsidiaries.
The Company may apply Net Proceeds of an Asset Sale, at its option, (a) to
permanently reduce Senior Indebtedness other than Senior Revolving Indebtedness,
(b) to permanently reduce Senior Revolving Indebtedness (and to correspondingly
reduce commitments with respect thereto), or (c) to invest in properties and
assets that will be used in the Oil and Gas Business of the Company and its
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Subsidiaries. Pending the final application of any such Net Proceeds, the
Company may temporarily reduce Senior Revolving Indebtedness or otherwise invest
such Net Proceeds in any manner that is not prohibited by the Indenture. Any Net
Proceeds from Asset Sales that are not applied within 270 days after the
consummation of an Asset Sale as provided in the first sentence of this
paragraph will be deemed to constitute "Excess Proceeds." When the aggregate
amount of Excess Proceeds exceeds $5.0 million, the Company will be required to
make an offer to all Holders of Notes (an "Asset Sale Offer") to purchase the
maximum principal amount of Notes that may be purchased out of the Excess
Proceeds, at a purchase price in cash in an amount equal to 100% of the
principal amount thereof plus accrued and unpaid interest thereon to the date of
purchase, in accordance with the procedures set forth in the Indenture. To the
extent that the aggregate unpaid amount of Notes tendered pursuant to an Asset
Sale Offer is less than the Excess Proceeds, the Company may use such surplus
Excess Proceeds for general corporate purposes. If the aggregate unpaid amount
of Notes surrendered by Holders thereof exceeds the amount of Excess Proceeds,
the Trustee shall select the Notes to be purchased on a pro rata basis. Upon
completion of such offer to purchase, the amount of Excess Proceeds shall be
reset at zero.
The Credit Facility prohibits the Company from making an Asset Sale Offer.
The Indenture prohibits the Company from directly or indirectly engaging in an
Asset Sale of any Principal Properties to any Subsidiary other than a Subsidiary
Guarantor.
CERTAIN COVENANTS
OWNERSHIP OF CAPITAL STOCK
The Indenture will provide that the Company will not permit any Person
(other than the Company or any Wholly Owned Subsidiary of the Company) to own
any Capital Stock of any Subsidiary of the Company, and will not permit any
Subsidiary of the Company to issue Capital Stock (except to the Company or to a
Wholly Owned Subsidiary) in each case except (a) directors' qualifying shares,
(b) Capital Stock issued prior to the time such Person becomes a Subsidiary of
the Company, (c) if such Subsidiary merges with and into another Subsidiary, (d)
if another Subsidiary merges with and into such Subsidiary, (e) if such
Subsidiary ceases to be a Subsidiary (as a result of the sale of 100% of the
shares of such Subsidiary, the Net Proceeds from which are applied in accordance
with "Repurchase at the Option of Holders -- Asset Sales") or (f) Capital Stock
of a Subsidiary organized in a foreign jurisdiction required to be issued to, or
owned by, the government of such foreign jurisdiction or individual or corporate
citizens of such foreign jurisdiction in order for such Subsidiary to transact
business in such foreign jurisdiction.
UNRESTRICTED SUBSIDIARIES
The Board of Directors of the Company may designate any of its Subsidiaries
as an Unrestricted Subsidiary. A Subsidiary may only be so designated if (i)
immediately after giving effect to such designation no Default or Event of
Default exists, (ii) the Company would, at the time of such designation and
after giving pro forma effect thereto as if such designation had occurred at the
beginning of the applicable four-quarter period, have been permitted to incur at
least $1.00 of additional Indebtedness pursuant to the Consolidated Interest
Coverage Ratio and the Adjusted Consolidated Tangible Net Assets to Consolidated
Indebtedness Ratio tests set forth in the first paragraph of the covenant
described under the caption "-- Incurrence of Indebtedness and Issuance of
Preferred Stock," and (iii) after the date of the Indenture and prior to such
designation, no assets of the Company or of any Subsidiary of the Company
(including, without limitation, Capital Stock of any such Subsidiary) shall have
been transferred, directly or indirectly, to any Unrestricted Subsidiary or any
of its Subsidiaries, other than assets transferred in the ordinary course of
business and on terms that are no less favorable to the Company or the relevant
Subsidiary than those that would have been obtained in a comparable transaction
by the Company or such Subsidiary with an unrelated Person and except to the
extent permitted under the caption "-- Restricted Payments." Any such
designation by the Board of Directors of the Company shall be evidenced to the
Trustee by filing with the Trustee a
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<PAGE>
certified copy of the Board Resolution of the Company giving effect to such
designation and an Officers' Certificate of the Company certifying that such
designation complied with the foregoing conditions.
Any Subsidiary of the Company shall continue to be an Unrestricted
Subsidiary only if it (a) has no Indebtedness other than Non-Recourse
Indebtedness; (b) is a Person with respect to which neither the Company nor any
of its Subsidiaries has any direct or indirect obligation (x) to subscribe for
additional Equity Interests or (y) to maintain or preserve such Person's
financial condition or to cause such Person to achieve any specified levels of
operating results; and (c) has not guaranteed or otherwise directly or
indirectly provided credit support for any Indebtedness of the Company or any of
its Subsidiaries. If, at any time, any Unrestricted Subsidiary fails to meet the
foregoing requirements, such Unrestricted Subsidiary shall thereafter cease to
be an Unrestricted Subsidiary for purposes of the Indenture, such Unrestricted
Subsidiary shall execute and deliver a Subsidiary Guarantee, supplemental
indenture or other agreement pursuant to which such Person guarantees the
payment of the Notes on the same terms and conditions as the Subsidiary
Guarantees and any Indebtedness of such Unrestricted Subsidiary shall be deemed
to be incurred by a Subsidiary of the Company as of such date (and, if such
Indebtedness is not permitted to be incurred as of such date under the covenant
described under the caption "-- Incurrence of Indebtedness and Issuance of
Preferred Stock," the Company shall be in default of such covenant).
The Board of Directors of the Company may at any time designate any
Subsidiary, if previously designated as an Unrestricted Subsidiary, to be a
Subsidiary; PROVIDED that such designation shall be deemed to be an incurrence
of Indebtedness by a Subsidiary of the Company of any outstanding Indebtedness
of such Subsidiary and such designation shall only be permitted if (i) such
Indebtedness is permitted under the covenant described under the caption "--
Incurrence of Indebtedness and Issuance of Preferred Stock," (ii) no Default or
Event of Default would be in existence following such designation and (iii) such
Subsidiary shall execute and deliver a supplemental indenture pursuant to which
such Person guarantees the payment of the Notes on the same terms and conditions
as the Subsidiary Guarantees.
As of the date of the Indenture, Costilla Redeco Exploration, L.L.C. and
Costilla Redeco Operating, L.L.C., through which the Company conducts its
Moldovan operations will be Unrestricted Subsidiaries.
RESTRICTED PAYMENTS
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, directly or indirectly: (i) declare or pay any
dividend or make any distribution on account of the Company's or any of its
Subsidiaries' Equity Interests, other than dividends or distributions payable in
Equity Interests (other than Disqualified Stock) of the Company or dividends or
distributions payable to the Company or any Wholly Owned Subsidiary of the
Company; (ii) purchase, redeem or otherwise acquire or retire for value any
Equity Interests of the Company or any Subsidiary or Unrestricted Subsidiary or
other Affiliate of the Company (other than Equity Interests of the Company, any
Subsidiary or Unrestricted Subsidiary owned by the Company or any Wholly Owned
Subsidiary of the Company); (iii) make any principal payment on, or purchase,
redeem, defease or otherwise acquire or retire for value any Subordinated
Indebtedness of the Company or any Subsidiary of the Company, in each case,
prior to a scheduled mandatory sinking fund payment date or maturity date or
(iv) make any Restricted Investment (all such payments and other actions set
forth in clauses (i) through (iv) above being collectively referred to as
"Restricted Payments"), unless, at the time of and after giving effect to such
Restricted Payment:
(a) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof;
(b) the Company would, at the time of such Restricted Payment and after
giving pro forma effect thereto as if such Restricted Payment had been made
at the beginning of the applicable four-quarter period, have been permitted
to incur at least $1.00 of additional Indebtedness
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pursuant to the Consolidated Interest Coverage Ratio and the Adjusted
Consolidated Net Tangible Assets to Consolidated Indebtedness Ratio tests
set forth in the first paragraph of the covenant described below under the
caption "-- Incurrence of Indebtedness and Issuance of Preferred Stock"; and
(c) such Restricted Payment, together with the aggregate of all other
Restricted Payments made by the Company and its Subsidiaries on or after the
date of the Indenture (excluding Restricted Payments permitted by clauses
(ii), (iii), (iv) and (v) of the next succeeding paragraph), is less than
the sum of (i) 50% of the Consolidated Net Income of the Company and its
Subsidiaries for the period (taken as one accounting period) from the
beginning of the first day of the fiscal month during which the Indenture
was executed and delivered to the end of the Company's most recently ended
fiscal quarter for which internal financial statements are available at the
time of such Restricted Payment (or, if such Consolidated Net Income for
such period is a deficit, less 100% of such deficit), plus (ii) 100% of the
aggregate net cash proceeds received by the Company as capital contributions
to the Company or from the issue or sale after the date of the Indenture of
Equity Interests of the Company or of debt securities of the Company that
have been converted into such Equity Interests (other than Equity Interests
(or convertible debt securities) sold to a Subsidiary or an Unrestricted
Subsidiary of the Company and other than Disqualified Stock or debt
securities that have been converted into Disqualified Stock) other than the
Common Stock sold in the Common Stock Offering.
The foregoing clauses (b) and (c), however, will not prohibit (i) the
payment of any dividend within 60 days after the date of declaration thereof, if
at said date of declaration such payment would have complied with the provisions
of the Indenture; (ii) the payment of any dividend on Equity Interests of the
Company (other than Disqualified Stock) payable solely in shares of Equity
Interests of the Company (other than Disqualified Stock); (iii) any dividend or
other distribution payable from a Subsidiary of the Company to the Company or
any Wholly Owned Subsidiary; (iv) the making of any Restricted Investment in
exchange for, or out of the proceeds of, the substantially concurrent sale,
issuance or exchange (other than to a Subsidiary or any Unrestricted Subsidiary
of the Company) of Equity Interests of the Company (other than Disqualified
Stock); PROVIDED, that any net cash proceeds that are utilized for any such
Restricted Investment shall be excluded from clause (c) of the preceding
paragraph; (v) the redemption, repurchase, retirement or other acquisition of
any Equity Interests of the Company in exchange for, or out of the proceeds of,
the substantially concurrent sale, issuance or exchange (other than to a
Subsidiary or any Unrestricted Subsidiary of the Company) of other Equity
Interests of the Company (other than any Disqualified Stock); PROVIDED that any
net cash proceeds that are utilized for any such redemption, repurchase,
retirement or other acquisition shall be excluded from clause (c) of the
preceding paragraph; and (vi) the defeasance, redemption or repurchase of
Subordinated Indebtedness prior to a scheduled mandatory sinking fund payment
date or maturity date thereof with the net cash proceeds from an incurrence of
Permitted Refinancing Indebtedness or the substantially concurrent sale,
issuance or exchange (other than to a Subsidiary or any Unrestricted Subsidiary
of the Company) of Equity Interests of the Company (other than Disqualified
Stock) or the purchase, redemption or acquisition of Subordinated Indebtedness
prior to a scheduled mandatory sinking fund payment date or maturity date
thereof through the issuance in exchange thereof of Equity Interests of the
Company (other than Disqualified Stock); PROVIDED, that any net cash proceeds
that are utilized for any such defeasance, redemption, repurchase, purchase or
acquisition shall be excluded from clause (c) of the preceding paragraph.
The amount of all Restricted Payments (other than cash) shall be the fair
market value (evidenced by a resolution of the Board of Directors set forth in
an Officers' Certificate delivered to the Trustee) on the date of the Restricted
Payment of the asset(s) proposed to be transferred by the Company or such
Subsidiary, as the case may be, pursuant to the Restricted Payment. Not later
than the date of making any Restricted Payment, the Company shall deliver to the
Trustee an Officers' Certificate of the Company stating that such Restricted
Payment is permitted and setting forth the
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basis upon which the calculations required by the covenant described under the
caption "-- Restricted Payments" were computed, which calculations may be based
upon the Company's latest available financial statements.
INCURRENCE OF INDEBTEDNESS AND ISSUANCE OF PREFERRED STOCK
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, directly or indirectly, create, incur, issue,
assume, guarantee or otherwise become directly or indirectly liable,
contingently or otherwise, with respect to (collectively, "incur") any
Indebtedness (including Acquired Indebtedness) and that the Company will not
issue any Disqualified Stock and will not permit any of its Subsidiaries to
issue any shares of preferred stock; PROVIDED, HOWEVER, that the Company may
incur Indebtedness (including Acquired Indebtedness) and the Company may issue
shares of Disqualified Stock if: (i) the Consolidated Interest Coverage Ratio
for the Company's most recently ended four full fiscal quarters for which
internal financial statements are available immediately preceding the date on
which such additional Indebtedness is incurred or such Disqualified Stock is
issued would have been at least, during the period until the first anniversary
of the date of the Indenture, 2.25 to 1, and, thereafter, 2.5 to 1, in each
case, determined on a pro forma basis (including a pro forma application of the
net proceeds therefrom), as if the additional Indebtedness had been incurred, or
the Disqualified Stock had been issued, as the case may be, at the beginning of
such four-quarter period; (ii) the Adjusted Consolidated Net Tangible Assets
would have been at least 150% of Consolidated Indebtedness, determined on a pro
forma basis (including a pro forma application of the net proceeds therefrom)
and (iii) no Default or Event of Default shall have occurred and be continuing
or would occur as a consequence thereof; PROVIDED, that no Guarantee may be
incurred pursuant to this paragraph, unless the guaranteed Indebtedness is
incurred by the Company pursuant to this paragraph.
The foregoing provisions will not apply to:
(i) the incurrence by the Company of Indebtedness under the Credit
Facility (and the incurrence by Subsidiaries of Guarantees thereof) in an
aggregate principal amount at any time outstanding (with letters of credit
being deemed to have a principal amount equal to the maximum potential
liability of the Company and its Subsidiaries thereunder) not to exceed the
greater of (a) $50 million and (b) 15% of Adjusted Consolidated Net Tangible
Assets, in each case, less the aggregate amount of all Net Proceeds of Asset
Sales applied to permanently reduce the outstanding amount or the
commitments with respect to such Indebtedness pursuant to the covenant
described above under the caption "-- Asset Sales";
(ii) the incurrence by the Company of Indebtedness represented by the
Notes and of its Subsidiaries of Indebtedness represented by the Subsidiary
Guarantees;
(iii) the incurrence by the Company or any of its Subsidiaries of
Permitted Refinancing Indebtedness in exchange for, or the net proceeds of
which are used to extend, refinance, renew, replace, defease or refund, any
Indebtedness described in the foregoing clause (ii);
(iv) the incurrence by the Company or any of its Subsidiaries of
intercompany Indebtedness between or among the Company and any of its Wholly
Owned Subsidiaries or between or among any Wholly Owned Subsidiaries;
PROVIDED that, in the case of Indebtedness of the Company, such obligations
shall be unsecured and subordinated in case of an event of default in all
respects to the Company's obligations pursuant to the Notes; and PROVIDED,
however, that (i) any subsequent issuance or transfer of Equity Interests
that results in any such Indebtedness being held by a Person other than a
Wholly Owned Subsidiary and (ii) any sale or other transfer of any such
Indebtedness to a Person that is not either the Company or a Wholly Owned
Subsidiary shall be deemed, in each case, to constitute an incurrence of
such Indebtedness by the Company or such Subsidiary, as the case may be;
(v) the incurrence by the Company of Hedging Obligations that are
incurred for the purpose of fixing or hedging interest rate risk with
respect to any floating rate Indebtedness that is
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permitted by the Indenture to be incurred; PROVIDED that, the notional
amount of such Hedging Obligations does not exceed the principal amount of
the Indebtedness to which such Hedging Obligations relate;
(vi) the incurrence by the Company of Hedging Obligations under commodity
hedging and currency exchange agreements; PROVIDED that, such agreements
were entered into in the ordinary course of business for the purpose of
limiting risks that arise in the ordinary course of business;
(vii) The incurrence by the Subsidiaries of Indebtedness in existence on
the date of the Indenture; and
(viii) the incurrence by the Company and its Subsidiaries of Indebtedness
(in addition to Indebtedness permitted by any other clause of this
paragraph) in an aggregate principal amount at any time outstanding not to
exceed $10.0 million:
provided that no Subsidiary may incur any Indebtedness other than Indebtedness
described in the foregoing clauses (iv) or (vii) unless such Subsidiary shall
have executed and delivered a Subsidiary Guarantee and such Subsidiary Guarantee
remains in full force and effect (unless terminated in accordance with the
provisions of the Indenture).
Further, the Company will not, directly or indirectly, in any event incur
any Indebtedness which by its terms (or by the terms of any agreement governing
such Indebtedness) is subordinated to any other Indebtedness of the Company
unless such Indebtedness is also by its terms (or by the terms of any agreement
governing such Indebtedness) expressly subordinated to the Notes to the same
extent and in the same manner as such Indebtedness is subordinated pursuant to
subordination provisions that are most favorable to the holders of any other
Indebtedness of the Company.
LIENS
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, directly or indirectly, create, incur, assume or
suffer to exist any Lien (other than Permitted Liens) on any of their respective
assets, now owned or hereafter acquired, securing any Indebtedness unless the
Notes, in the case of such Indebtedness of the Company, and the Subsidiary
Guarantee of such Subsidiary Guarantor, in the case of such Indebtedness of a
Subsidiary Guarantor, are secured equally and ratably with such other
Indebtedness; PROVIDED that, if such Indebtedness is by its terms expressly
subordinate to the Notes or the Subsidiary Guarantees, the Lien securing such
subordinate or junior Indebtedness shall be subordinate and junior to the Lien
securing the Notes or the Subsidiary Guarantees with the same relative priority
as such subordinated or junior Indebtedness shall have with respect to the Notes
or the Subsidiary Guarantees, as the case may be.
DIVIDEND AND OTHER PAYMENT RESTRICTIONS AFFECTING SUBSIDIARIES
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, directly or indirectly, create or otherwise cause or
suffer to exist or become effective any encumbrance or restriction on the
ability of any Subsidiary to (i)(a) pay dividends or make any other
distributions to the Company or any of its Subsidiaries on its Capital Stock or
with respect to any other interest or participation in, or measured by, its
profits, or (b) pay any indebtedness owed to the Company or any of its
Subsidiaries, (ii) make loans or advances to the Company or any of its
Subsidiaries or (iii) transfer any of its properties or assets to the Company or
any of its Subsidiaries, (iv) transfer any of its property or assets to the
Company or any of its Subsidiaries, (v) grant liens or security interests on the
assets in favor of the Holders of Notes, or (vi) guarantee the Notes or any
renewals or refinancings thereof, except for such encumbrances or restrictions
existing under or by reason of (A) the Credit Facility, the Indenture, the Notes
or any other agreement in existence on the date of the Indenture, (B) applicable
law, (C) any instrument governing Acquired Indebtedness of Capital Stock of a
Person acquired by the Company or any of its Subsidiaries as in effect at the
time of such acquisition (except to the extent such Acquired Indebtedness was
incurred in connection with or in contemplation of such acquisition), which
encumbrance or restriction is not applicable to any Person, or the properties or
assets of any Person, other than the Person, or the property or assets of
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the Person, so acquired, PROVIDED that the Consolidated EBITDA of such Person is
not taken into account in determining whether such acquisition was permitted by
the terms of the Indenture, or (D) Permitted Refinancing Indebtedness, PROVIDED
that the restrictions contained in the agreements governing such Permitted
Refinancing Indebtedness are no more restrictive than those contained in the
agreements governing the Indebtedness being refinanced.
LIMITATION ON LAYERING INDEBTEDNESS
The Indenture will provide that the Company will not incur, create, issue,
assume, guarantee or otherwise become liable for any Indebtedness that is
subordinate or junior in right of payment to any Senior Indebtedness and senior
in any respect in right of payment to the Notes.
MERGER, CONSOLIDATION OR SALE OF ASSETS
The Indenture will provide that the Company will not, and will not permit
any Subsidiary to, in a single transaction or series of related transactions
consolidate or merge with or into (other than the consolidation or merger of a
Wholly Owned Subsidiary of the Company with another Wholly Owned Subsidiary of
the Company or into the Company) (whether or not the Company or such Subsidiary
is the surviving corporation), or directly and/or indirectly through its
Subsidiaries sell, assign, transfer, lease, convey or otherwise dispose of all
or substantially all of its properties or assets (determined on a consolidated
basis for the Company and its Subsidiaries taken as a whole) in one or more
related transactions to, another corporation, Person or entity unless (i) either
(a) the Company, in the case of a transaction involving the Company, or such
Subsidiary, in the case of a transaction involving a Subsidiary, is the
surviving corporation or (b) in the case of a transaction involving the Company,
the entity or the Person formed by or surviving any such consolidation or merger
(if other than the Company) or to which such sale, assignment, transfer, lease,
conveyance or other disposition shall have been made is a corporation organized
or existing under the laws of the United States, any state thereof or the
District of Columbia and assumes all the obligations of the Company under the
Notes and the Indenture pursuant to a supplemental indenture in a form
reasonably satisfactory to the Trustee; (ii) immediately after such transaction
no Default or Event of Default exists; and (iii) the Company or, if other than
the Company, the entity or Person formed by or surviving any such consolidation
or merger, or to which such sale, assignment, transfer, lease, conveyance or
other disposition shall have been made (A) will have Consolidated Net Worth
immediately after the transaction equal to or greater than the Consolidated Net
Worth of the Company immediately preceding the transaction and (B) will, at the
time of such transaction and after giving pro forma effect thereto as if such
transaction had occurred at the beginning of the applicable four-quarter period,
be permitted to incur at least $1.00 of additional Indebtedness pursuant to the
Consolidated Interest Coverage Ratio and the Adjusted Consolidated Net Tangible
Assets to Consolidated Indebtedness Ratio tests set forth in the first paragraph
of the covenant described above under the caption "-- Incurrence of Indebtedness
and Issuance of Preferred Stock."
TRANSACTIONS WITH AFFILIATES
The Indenture will provide that the Company will not, and will not permit
any of its Subsidiaries to, after the date of the Indenture, sell, lease,
transfer or otherwise dispose of any of its properties or assets to, or make any
payment to, or purchase any property or assets from, or enter into or suffer to
exist any transaction or series of transactions, or make any agreement, loan,
advance or guarantee with, or for the benefit of, any Affiliate (each of the
foregoing, an "Affiliate Transaction"), other than Exempt Affiliate
Transactions, unless (i) such Affiliate Transaction is on terms that are no less
favorable to the Company or the relevant Subsidiary (as reasonably determined by
the Company) than those that would have been obtained in a comparable
transaction by the Company or such Subsidiary with an unrelated Person and (ii)
the Company delivers to the Trustee (a) with respect to any Affiliate
Transaction entered into after the date of the Indenture involving aggregate
consideration in excess of $1.0 million, a resolution of the Board of Directors
set forth in an Officers' Certificate certifying that such Affiliate Transaction
complies with clause (i) above and that such Affiliate Transaction has been
approved by a majority of the disinterested members of the Board of Directors
and (b) with respect to
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any Affiliate Transaction involving aggregate consideration in excess of $5.0
million, an opinion as to the fairness to the Company or such Subsidiary of such
Affiliate Transaction from a financial point of view issued by an investment
banking firm of national standing.
SALE AND LEASEBACK
The Company will not, and will not permit any of its Subsidiaries to, enter
into any Sale and Leaseback Transaction unless (a) the Company or its
Subsidiaries entering into such Sale and Leaseback Transaction could have
incurred the Indebtedness relating to such Sale and Leaseback Transaction
pursuant to the "-- Incurrence of Indebtedness and Issuance of Preferred Stock"
and "-- Liens" covenants, (b) the Net Proceeds of such Sale and Leaseback
Transaction are at least equal to the fair market value of such property as
determined by the Board of Directors of the Company and (c) such Net Proceeds
are applied in the same manner and to the same extent as Net Proceeds from an
Asset Sale pursuant to the "-- Asset Sales" covenant.
REPORTS
The Indenture will provide that, whether or not required by the rules and
regulations of the Commission, so long as any Notes are outstanding, the Company
will furnish to the Holders of Notes, and file with the Trustee, within 15 days
after it is, or would have been, required to file such with the Commission (i)
all quarterly and annual financial information that is or would be required to
be contained in a filing with the Commission on Forms 10-Q and 10-K if the
Company is or were required to file such Forms, including a "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and,
with respect to the annual information only, a report thereon by the Company's
certified independent accountants and (ii) all current reports that are or would
be required to be filed with the Commission on Form 8-K if the Company is or
were required to file such reports. In addition, whether or not required by the
rules and regulations of the Commission, the Company will file a copy of all
such information and reports with the Commission for public availability (unless
the Commission will not accept such a filing) and make such information
available to securities analysts and prospective investors upon written request.
EVENTS OF DEFAULT AND REMEDIES
The Indenture will provide that each of the following constitutes an Event
of Default: (i) default for 30 days in the payment when due of interest on the
Notes (whether or not prohibited by the subordination provisions of the
Indenture); (ii) default in payment when due (upon redemption or otherwise) of
the principal of or premium, if any, on the Notes (whether or not prohibited by
the subordination provisions of the Indenture); (iii) failure by the Company to
comply with the provisions described under the captions "Repurchase at Option of
Holders -- Change of Control," "Repurchase at Option of Holders -- Asset Sales,"
"-- Ownership of Capital Stock," "-- Restricted Payments," "-- Incurrence of
Indebtedness and Issuance of Preferred Stock" or "-- Merger, Consolidation or
Sale of Assets"; (iv) failure by the Company or any of its Subsidiary for 60
days after notice by the Trustee or Holders of at least 25% of the aggregate
principal amount of the Notes outstanding to comply with any of its other
agreements in the Indenture or the Notes; (v) default under any mortgage,
indenture or instrument under which there may be issued or by which there may be
secured or evidenced any Indebtedness for money borrowed by the Company or any
of its Subsidiaries (or the payment of which is guaranteed by the Company or any
of its Subsidiaries) whether such Indebtedness or Guarantee now exists, or is
created after the date of the Indenture, which default (a) is caused by a
failure to pay principal of such Indebtedness at final maturity thereof (a
"Payment Default") or (b) results in the acceleration of such Indebtedness prior
to its express maturity and, in each case, the principal amount of any such
Indebtedness, together with the principal amount of any other such Indebtedness
under which there has been a Payment Default or the maturity of which has been
so accelerated, aggregates $10 million or more; (vi) failure by the Company or
any of its Subsidiaries to pay final judgments (not fully covered by insurance)
aggregating in excess of $1 million, which judgments are not paid, discharged or
stayed for a period of 60 days; (vii) certain events of bankruptcy or insolvency
with respect to the Company or any of its Subsidiaries or any Unrestricted
Subsidiary; and (viii) any
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Subsidiary Guarantor attempts to revoke its Subsidiary Guarantee or contest its
validity or any Subsidiary Guarantee shall not be in full force and effect
(other than in accordance with the terms of the Indenture).
If any Event of Default occurs and is continuing, the Trustee or the Holders
of at least 25% in principal amount of the then outstanding Notes may declare
all the Notes to be due and payable immediately. Notwithstanding the foregoing,
in the case of an Event of Default arising from certain events of bankruptcy or
insolvency with respect to the Company or any Subsidiary or any Unrestricted
Subsidiary, all outstanding Notes will become due and payable without further
action or notice. Holders of the Notes may not enforce the Indenture or the
Notes except as provided in the Indenture. Subject to certain limitations,
Holders of a majority in principal amount of the then outstanding Notes may
direct the Trustee in its exercise of any trust or power. The Indenture provides
that if a Default occurs and is continuing, generally the Trustee must, within
90 days after the occurrence of such default, give to the Holders notice of such
Default. The Trustee may withhold from Holders of the Notes notice of any
continuing Default or Event of Default (except a Default or Event of Default
relating to the payment of principal or premium, if any, or interest) if it
determines that withholding notice is in their interest.
The Holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee may on behalf of the Holders of all of the
Notes waive any existing Default or Event of Default and its consequences under
the Indenture except a continuing Default or Event of Default in the payment of
interest or premium on, or the principal of, the Notes or in respect of a
provision that cannot be amended or waived without the consent of the Holder
affected. See "Amendment, Supplement and Waiver."
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company
or any Subsidiary, as such, shall have any liability for any obligations of the
Company under the Notes or the Indenture or the Subsidiary Guarantors under
their Subsidiary Guarantees or for any claim based on, in respect of, or by
reason of, such obligations or their creation. Each Holder of Notes by accepting
a Note waives and releases all such liability. The waiver and release are part
of the consideration for issuance of the Notes. Such waiver may not be effective
to waive liabilities under the federal securities laws and it is the view of the
Commission that such waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding Notes ("Legal
Defeasance") except for (i) the rights of Holders of outstanding Notes to
receive payments in respect of the principal of, premium, if any, and interest
on such Notes when such payments are due from the trust referred to below, (ii)
the Company's obligations with respect to the Notes concerning issuing temporary
Notes, registration of Notes, mutilated, destroyed, lost or stolen Notes and the
maintenance of an office or agency for payment and money for security payments
held in trust, (iii) the rights, powers, trusts, duties and immunities of the
Trustee, and the Company's obligations in connection therewith and (iv) the
Legal Defeasance provisions of the Indenture. In addition, the Company may, at
its option and at any time, elect to have the obligations of the Company
released with respect to certain covenants that are described in the Indenture
("Covenant Defeasance") and thereafter any omission to comply with such
obligations shall not constitute a Default or Event of Default with respect to
the Notes. In the event Covenant Defeasance occurs, certain events (not
including nonpayment, bankruptcy, receivership, rehabilitation and insolvency
events) described under "Events of Default" will no longer constitute an Event
of Default with respect to the Notes.
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In order to exercise either Legal Defeasance or Covenant Defeasance, (i) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit of
the Holders of Notes, cash in U.S. dollars, noncallable Government Securities,
or a combination thereof, in such amounts as will be sufficient, in the opinion
of a nationally recognized firm of independent public accountants, to pay the
principal of, premium, if any, and interest on the outstanding Notes on the
stated maturity or on the applicable redemption date, as the case may be, and
the Company must specify whether the Notes are being defeased to maturity or to
a particular redemption date; (ii) in the case of Legal Defeasance, the Company
shall have delivered to the Trustee an opinion of counsel in the United States
reasonably acceptable to the Trustee confirming that (A) the Company has
received from, or there has been published by, the Internal Revenue Service a
ruling or (B) since the date of the Indenture, there has been a change in the
applicable federal income tax law, in either case to the effect that, and based
thereon such opinion of counsel shall confirm that, the Holders of the
outstanding Notes will not recognize income, gain or loss for federal income tax
purposes as a result of such Legal Defeasance and will be subject to federal
income tax on the same amounts, in the same manner and at the same times as
would have been the case if such Legal Defeasance had not occurred; (iii) in the
case of Covenant Defeasance, the Company shall have delivered to the Trustee an
opinion of counsel in the United States reasonably acceptable to the Trustee
confirming that the Holders of the outstanding Notes will not recognize income,
gain or loss for federal income tax purposes as a result of such Covenant
Defeasance and will be subject to federal income tax on the same amounts, in the
same manner and at the same times as would have been the case if such Covenant
Defeasance had not occurred; (iv) no Default or Event of Default shall have
occurred and be continuing on the date of such deposit (other than a Default or
Event of Default resulting from the borrowing of funds to be applied to such
deposit) or insofar as Events of Default from bankruptcy or insolvency events
are concerned, at any time in the period ending on the 123rd day after the date
of deposit; (v) such Legal Defeasance or Covenant Defeasance will not result in
a breach or violation of, or constitute a default under any material agreement
or instrument (other than the Indenture) to which the Company or any of its
Subsidiaries is a party or by which the Company or any of its Subsidiaries is
bound; (vi) the Company must deliver to the Trustee an Officers' Certificate
stating that the deposit was not made by the Company with the intent of
preferring the Holders of Notes over other creditors of the Company with the
intent of defeating, hindering, delaying or defrauding creditors of the Company
or others; and (vii) the Company must deliver to the Trustee an Officers'
Certificate and an opinion of counsel, each stating that all conditions
precedent relating to the Legal Defeasance or the Covenant Defeasance have been
complied with.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange Notes in accordance with the Indenture.
The Company, the Registrar and the Trustee may require a Holder, among other
things, to furnish appropriate endorsements and transfer documents as well as
certifications, legal opinions and other information and the Company may require
a Holder to pay any taxes and fees required by law or permitted by the
Indenture. The Company is not required to transfer or exchange any Note selected
for redemption. Also, the Company is not required to transfer or exchange any
Note for a period of 15 days before a selection of Notes to be redeemed.
The registered Holder of a Note will be treated as the owner of it for all
purposes.
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the Indenture, the
Subsidiary Guarantees or the Notes may be amended or supplemented with the
consent of the Holders of at least a majority in principal amount of the Notes
then outstanding (including consents obtained in connection with a tender offer
or exchange offer for Notes), and any existing default or compliance with any
provision of the Indenture, the Subsidiary Guarantees or the Notes may be waived
with the consent of the Holders of a majority in principal amount of the then
outstanding Notes (including consents obtained in connection with a tender offer
or exchange offer for Notes).
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Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any Notes held by a nonconsenting Holder): (i) reduce the
principal amount of Notes whose Holders must consent to an amendment, supplement
or waiver, (ii) reduce the principal of or change the fixed maturity of any Note
or alter the provisions with respect to the redemption of the Notes (other than
provisions relating to the covenants described above under the caption
"Repurchase at the Option of Holders"), (iii) reduce the rate of or change the
time for payment of interest on any Note, (iv) waive a Default or Event of
Default in the payment of principal of or premium, if any, or interest on the
Notes (except a rescission of acceleration of the Notes by the Holders of at
least a majority in aggregate principal amount of the Notes and a waiver of the
payment default that resulted from such acceleration), (v) make any Note payable
in money other than that stated in the Notes, (vi) make any change in the
provisions of the Indenture, or the Subsidiary Guarantees relating to waivers of
past Defaults or the rights of Holders of Notes to receive payments of principal
of or premium, if any, or interest on the Notes, (vii) waive a redemption
payment with respect to any Note (other than a payment required by one of the
covenants described above under the caption "Repurchase at the Option of
Holders") or (viii) make any change in the foregoing amendment and waiver
provisions.
Notwithstanding the foregoing, without the consent of any Holder of Notes,
the Company and the Trustee may amend or supplement the Indenture, the
Subsidiary Guarantees or the Notes to cure any ambiguity, defect or
inconsistency, to provide for uncertificated Notes in addition to or in place of
certificated Notes, to provide for the assumption of the Company's obligations
to Holders of Notes in the case of a merger or consolidation, to make any change
that would provide any additional rights or benefits to the Holders of Notes or
that does not adversely affect the legal rights under the Indenture of any such
Holder, or to comply with requirements of the Commission in order to effect or
maintain the qualification of the Indenture under the Trust Indenture Act.
CONCERNING THE TRUSTEE
The State Street Bank and Trust Company will be the Trustee under the
Indenture. The Trustee's current address is Corporate Trust Department, Two
International Place, 4th Floor, Boston, Massachusetts 02110.
The Holders of a majority in principal amount of the then outstanding Notes
will have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the conduct
of his own affairs. Subject to such provisions, the Trustee will be under no
obligation to exercise any of its rights or powers under the Indenture at the
request of any Holder of Notes, unless such Holder shall have offered to the
Trustee security and indemnity satisfactory to it against any loss, liability or
expense.
ADDITIONAL INFORMATION
Anyone who receives this Prospectus may obtain a copy of the Indenture
without charge by writing to Costilla Energy, Inc., 400 West Illinois, 10th
Floor, Midland, Texas 79701, Attention: Chief Financial Officer.
BOOK-ENTRY, DELIVERY AND FORM
The Notes to be sold as set forth herein will initially be issued in the
form of one Global Note (the "Global Note"). The Global Note will be deposited
on the date of the closing of the sale of the Notes offered hereby (the "Closing
Date") with the Trustee as custodian for The Depository Trust Company (the
"Depositary") and registered in the name of Cede & Co., as nominee of the
Depositary (such nominee being referred to herein as the "Global Note Holder").
The Depositary is a limited-purpose trust company that was created to hold
securities for its participating organizations (collectively, the "Participants"
or the "Depositary's Participants") and to facilitate the clearance and
settlement of transactions in such securities between Participants through
electronic book-entry changes in accounts of its Participants. The Depositary's
Participants
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include securities brokers and dealers (including the Underwriters), banks and
trust companies, clearing corporations and certain other organizations. Access
to the Depositary's system is also available to other entities such as banks,
brokers, dealers and trust companies (collectively, the "Indirect Participants"
or the "Depositary's Indirect Participants") that clear through or maintain a
custodial relationship with a Participant, either directly or indirectly.
Persons who are not Participants may beneficially own securities held by or on
behalf of the Depositary only through the Depositary's Participants or the
Depositary's Indirect Participants.
The Company expects that pursuant to procedures established by the
Depositary (i) upon deposit of the Global Note, the Depositary will credit the
accounts of Participants designated by the Underwriters with portions of the
principal amount of the Global Note and (ii) beneficial ownership of the Notes
evidenced by the Global Note will be shown on, and the transfer of such
ownership will be effected only through, records maintained by the Depositary
(with respect to the interests of the Depositary's Participants), the
Depositary's Participants and the Depositary's Indirect Participants.
Prospective purchasers are advised that the laws of some states require that
certain persons take physical delivery in definitive form of securities that
they own. Consequently, the ability to transfer Notes evidenced by the Global
Note will be limited to such extent.
So long as the Global Note Holder is the registered owner of the Global
Note, the Global Note Holder will be considered the sole owner or Holder under
the Indenture of any Notes evidenced by the Global Note. Beneficial owners of
Notes evidenced by the Global Note will not be considered the owners or Holders
thereof under the Indenture for any purpose, including with respect to the
giving of any directions, instructions or approvals to the Trustee thereunder.
Except as provided below, owners of beneficial interests in the Global Note will
not be entitled to have Notes registered in their names and will not receive or
be entitled to receive physical delivery of Notes in definitive form. Neither
the Company nor the Trustee will have any responsibility or liability for any
aspect of the records of the Depositary or for maintaining, supervising or
reviewing any records of the Depositary relating to the Notes.
Payments in respect of the principal of, premium, if any, and interest on
any Notes registered in the name of the Global Note Holder on the applicable
record date will be payable by the Company to or at the direction of the Global
Note Holder in its capacity as the registered Holder under the Indenture. Under
the terms of the Indenture, the Company and the Trustee may treat the persons in
whose names the Notes, including the Global Note, are registered as the owners
thereof for the purpose of receiving such payments. Consequently, neither the
Company nor the Trustee has or will have any responsibility or liability for the
payment of such amounts to beneficial owners of Notes. The Company believes,
however, that it is currently the policy of the Depositary to immediately credit
the accounts of the relevant Participants with such payments, in amounts
proportionate to their respective holdings of beneficial interests in the
relevant security as shown on the records of the Depositary. Payments by the
Depositary's Participants and the Depositary's Indirect Participants to the
beneficial owners of Notes will be governed by standing instructions and
customary practice and will be the responsibility of the Depositary's
Participants or the Depositary's Indirect Participants.
As long as the Notes are represented by a Global Note, the Depositary's
nominee will be the holder of the Notes and therefore will be the only entity
that can exercise a right to repayment or repurchase of the Notes. See "--
Repurchase at the Option of Holders -- Change of Control" and
"-- Asset Sales." Notice by the Depositary's Participants or the Depositary's
Indirect Participants or by owners of beneficial interests in a Global Note held
through such Participants or Indirect Participants of the exercise of the option
to elect repayment of beneficial interests in Notes represented by a Global Note
must be transmitted to the Depositary in accordance with its procedures on a
form required by the Depositary and provided to Participants. In order to ensure
that the Depositary's nominee will timely exercise a right to repayment with
respect to a particular Note, the beneficial owner of such Note must instruct
the broker or other Participant or Indirect Participant through which it holds
an interest in such Note to notify the Depositary of its desire to exercise a
right to repayment. Different firms have cut-off times for accepting
instructions from their customers and,
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accordingly, each beneficial owner should consult the broker or other
Participant or Indirect Participant through which it holds an interest in a Note
in order to ascertain the cut-off time by which such an instruction must be
given in order for timely notice to be delivered to the Depositary. The Company
will not be liable for any delay in delivery of notices of the exercise of the
option to elect repayment.
The Company will issue Notes in definitive form in exchange for the Global
Note if, and only if, either (1) the Depositary is at any time unwilling or
unable to continue as depositary and a successor depositary is not appointed by
the Company within 90 days, or (2) an Event of Default has occurred and is
continuing and the Notes registrar has received a request from the Depositary to
issue Notes in definitive form in lieu of all or a portion of the Global Note.
In either instance, an owner of a beneficial interest in the Global Note will be
entitled to have Notes equal in principal amount to such beneficial interest
registered in its name and will be entitled to physical delivery of such Notes
in definitive form. Notes so issued in definitive form will be issued in
denominations of $1,000 and integral multiples thereof and will be issued in
registered form only, without coupons.
CERTIFICATED NOTES
If the Company notifies the Trustee in writing that the Depositary is no
longer willing or able to act as a depositary and the Company is unable to
locate a qualified successor within 90 days then, upon surrender by the Global
Note Holder of its Global Note, Notes in the form of registered definitive Notes
will be issued to each person that the Global Note Holder and the Depositary
identify as being the beneficial owner of the related Notes.
Neither the Company nor the Trustee will be liable for any delay by the
Global Note Holder or the Depositary in identifying the beneficial owners of
Notes and the Company and the Trustee may conclusively rely on, and will be
protected in relying on, instructions from the Global Note Holder or the
Depositary for all purposes.
SAME-DAY SETTLEMENT AND PAYMENT
The Indenture will require that payments in respect of the Notes represented
by the Global Note (including principal, premium, if any, interest be made by
wire transfer of immediately available funds to the accounts specified by the
Global Note Holder. With respect to Certificated Notes, the Company will make
all payments of principal, premium, if any, interest by wire transfer of
immediately available funds to the accounts specified by the Holders thereof or,
if no such account is specified, by mailing a check to each such Holder's
registered address. Secondary trading in long-term notes and debentures of
corporate issuers is generally settled in clearinghouse or next-day funds. The
Company expects that secondary trading in the Certificated Notes will also be
settled in immediately available funds.
GOVERNING LAW
The Indenture, the Notes and the Subsidiary Guarantees will be governed by,
and construed in accordance with, the laws of the State of New York.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.
"ACQUIRED INDEBTEDNESS" means with respect to any specified Person, (i) any
Indebtedness of any other Person existing at the time such other Person is
merged with or into or becomes a Subsidiary of such specified Person, including,
without limitation, Indebtedness incurred in connection with, or in
contemplation of, such other Person merging with or into or becoming a
Subsidiary of such specified Person, and (ii) Indebtedness secured by a Lien
encumbering any asset acquired by such specified Person.
"ADJUSTED CONSOLIDATED NET TANGIBLE ASSETS" means, as of the date of
determination, without duplication, (a) the sum of (i) discounted future net
revenue from proved oil and gas reserves of the Company and its Subsidiaries
calculated in accordance with Commission guidelines before any state
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or federal income taxes, as estimated in a reserve report prepared as of the end
of the Company's most recently completed fiscal year, which reserve report is
prepared or audited by independent petroleum engineers, as increased by, as of
the date of determination, the discounted future net revenue of (A) estimated
proved oil and gas reserves of the Company and its Subsidiaries attributable to
any acquisition consummated since the date of such year-end reserve report, and
(B) estimated oil and gas reserves of the Company and its Subsidiary
attributable to extensions, discoveries and other additions and upward revisions
of estimates of proved oil and gas reserves due to exploration, development,
exploitation, production or other activities conducted or otherwise occurring
since the date of such year-end reserve report which would, in the case of
determinations made pursuant to clauses (A) and (B), in accordance with standard
industry practice, result in such additions or revisions, in each case
calculated in accordance with Commission guidelines (utilizing the prices
utilized in such year-end reserve report), and decreased by, as of the date of
determination, the discounted future net revenue of (C) estimated proved oil and
gas reserves of the Company and its Subsidiaries produced or disposed of since
the date of such year-end reserve report and (D) reductions in the estimated oil
and gas reserves of the Company and its Subsidiaries since the date of such
year-end reserve report attributable to downward revisions of estimates of
proved oil and gas reserves due to exploration, development, exploitation,
production or other activities conducted or otherwise occurring since the date
of such year-end reserve report which would, in the case of determinations made
pursuant to clauses (C) and (D), in accordance with standard industry practice,
result in such revisions, in each case calculated in accordance with Commission
guidelines (utilizing the prices utilized in such year-end reserve report);
provided that, in the case of each of the determinations made pursuant to
clauses (A) through (D), such increases and decreases shall be as estimated by
the Company's engineers, except that if as a result of such acquisitions,
dispositions, discoveries, extensions or revisions, there is a Material Change
that is an increase, then such increases and decreases in the discounted future
net revenue shall be confirmed in writing by independent petroleum engineers,
(ii) the capitalized costs that are attributable to oil and gas properties of
the Company and its Subsidiaries to which no proved oil and gas reserves are
attributed, based on the Company's books and records as of a date no earlier
than the date of the Company's latest annual or quarterly financial statements,
(iii) the net working capital (which shall be calculated as all current assets
of the Company and its Subsidiaries minus all current liabilities of the Company
and its Subsidiaries, except current liabilities included in Indebtedness on a
date no earlier than the date of the Company's latest annual or quarterly
financial statements) and (iv) the greater of (I) the net book value of the
other tangible assets of the Company and its Subsidiaries on a date no earlier
than the date of the Company's latest annual or quarterly financial statements
and (II) the appraised value, as estimated by independent appraisers, of other
tangible assets of the Company and its Subsidiaries as of a date no earlier than
the date of the Company's latest audited financial statements, MINUS (b) the sum
of (i) minority interests of third parties to the extent included in the
calculation of the immediately preceding clause (a), (ii) the positive
remainder, if any, obtained by subtracting (I) gas balancing underpayments of
the Company and its Subsidiaries reflected in the Company's latest audited
financial statements and not otherwise included in the calculation of the
immediately preceding clause (a) from (II) any gas balancing liabilities of the
Company and its Subsidiaries reflected in the Company's latest audited financial
statements and not otherwise included in the calculation of the immediately
preceding clause (a), and (iii) the discounted future net revenue, calculated in
accordance with Commission guidelines (utilizing the same prices utilized in the
Company's year-end reserve report), attributable to oil and gas reserves of the
Company and its Subsidiaries subject to participation interests, overriding
royalty interests or other interests of third parties, pursuant to
participation, partnership, vendor financing or other agreements then in effect,
other than pursuant to Production Payments, or that otherwise are required to be
delivered to third parties, other than pursuant to Production Payments.
"ADJUSTED CONSOLIDATED NET TANGIBLE ASSETS TO CONSOLIDATED INDEBTEDNESS
RATIO" means, at any time, the ratio of Adjusted Consolidated Net Tangible
Assets at such time to Consolidated Indebtedness at such time.
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"AFFILIATE" of any specified Person means (i) any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person or (ii) any other Person who is a director or
executive officer of (a) such specified Person or (b) any Person described in
the preceding clause (i). For purposes of this definition, "control" (including,
with correlative meanings, the terms "controlling," "controlled by" and "under
common control with"), as used with respect to any Person, shall mean the
possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
ownership of voting securities, by agreement or otherwise; PROVIDED that
beneficial ownership of 10% or more of any class, or any series of any class, of
equity securities of a Person, whether or not voting, shall be deemed to be
control.
"ASSET SALE" means with respect to any Person, the sale, lease, conveyance
or other disposition, that does not constitute a Restricted Payment or an
Investment, by such Person of any of its assets (including, without limitation,
by way of a Sale and Leaseback and including the issuance, sale or other
transfer of any Equity Interests in any Subsidiary or the sale or other transfer
of any Equity Interests in any Unrestricted Subsidiary of such Person) other
than to the Company (including the receipt of proceeds of insurance paid on
account of the loss of or damage to any asset and awards of compensation for any
asset taken by condemnation, eminent domain or similar proceeding, and including
the receipt of proceeds of business interruption insurance), in each case, in
one or a series of related transactions; PROVIDED that, notwithstanding the
foregoing, the term "Asset Sale" shall not include: (a) the sale, lease,
conveyance, disposition or other transfer of all or substantially all of the
assets of the Company, as permitted pursuant to the covenant entitled "Merger,
Consolidation or Sale of Assets," (b) the sale or lease of hydrocarbons or other
mineral interests in the ordinary course of business and customary in the Oil
and Gas Business, (c) any Production Payment, (d) a transfer of assets by the
Company to a Wholly Owned Subsidiary of the Company (other than any Principal
Properties to any Wholly Owned Subsidiary not a Subsidiary Guarantor) or by a
Wholly Owned Subsidiary of the Company to the Company or to another Wholly Owned
Subsidiary of the Company, (e) an issuance of Equity Interests by a Wholly Owned
Subsidiary of the Company to the Company or to another Wholly Owned Subsidiary
of the Company, (e) sale or other disposition of cash or Cash Equivalents, or
(f) any lease, abandonment, disposition, relinquishment or farm out of any oil
and gas property that are customary in nature and scope in the Oil and Gas
Business and are entered into in the ordinary course of the Oil and Gas Business
of the Company and its Subsidiaries.
"BENEFICIARY", when used with respect to any individual, means the spouse,
lineal descendants, parents and siblings of any such individual, the estates and
the legal representatives of any such individual and any of the foregoing and
the trustee of any bona fide trust of which any such individual and any of the
foregoing are the sole beneficiaries or grantors.
"CAPITAL LEASE OBLIGATION" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that would
at such time be required to be capitalized on a balance sheet in accordance with
GAAP.
"CAPITAL STOCK" means (i) in the case of a corporation, capital stock, (ii)
in the case of an association or business entity, any and all shares, interests,
participations, rights or other equivalents (however designated) of capital
stock, (iii) in the case of partnership, partnership interests (whether general
or limited), (iv) in the case of a limited liability company, membership
interests, and (v) any other interest or participation that confers on a Person
the right to receive a share of the profits and losses of, or distributions of
assets of, the issuing Person.
"CASH EQUIVALENT" means (a) securities issued or directly and fully
guaranteed or insured by the United States of America or any agency or
instrumentality thereof (provided that the full faith and credit of the United
States is pledged in support thereof) having maturities not more than twelve
months from the date of acquisition, (b) U.S. dollar denominated (or foreign
currency fully hedged) time deposits, certificates of deposit, Eurodollar time
deposits or Eurodollar certificates of deposit of (i) any domestic commercial
bank of recognized standing having capital and surplus in excess of $500
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million or (ii) any bank whose short-term commercial paper rating from S&P is at
least A-1 or the equivalent thereof or from Moody's is at least P-1 or the
equivalent thereof (any such bank being an "Approved Lender"), in each case with
maturities of not more than twelve months from the date of acquisition, and (c)
commercial paper issued by any Approved Lender (or by the parent company
thereof) or any variable rate notes issued by, or guaranteed by, any domestic
corporation rated A-1 (or the equivalent thereof) or better by S&P or P-1 (or
the equivalent thereof) or better by Moody's and maturing within twelve months
of the date of acquisition.
"CHANGE OF CONTROL" means such time as any of the following events occur:
(i) any "person" or "group" (as such terms are used in Sections 13(d)
and 14(d) of the Exchange Act), other than Cadell S. Liedtke, Michael J.
Grella and Henry G. Musselman and any of their respective Beneficiaries (the
"Approved Shareholders), is or becomes the "beneficial owner" (as defined in
Rule 13d-3 under the Exchange Act), directly or indirectly, of more than 50%
of the total Voting Stock of the Company;
(ii) the Company is merged with or into or consolidated with another
Person and, immediately after giving effect to the merger or consolidation,
(A) less than 50% of the total voting power of the outstanding Voting Stock
of the surviving or resulting Person is then "beneficially owned" (within
the meaning of Rule 13d-3 under the Exchange Act) in the aggregate by the
stockholders of the Company immediately prior to such merger or
consolidation, and (B) any "person" or "group" (as defined in Section
13(d)(3) or 14(d)(2) of the Exchange Act) other than the Approved
Stockholders has become the direct or indirect "beneficial owner" (as
defined in Rule 13d-3 under the Exchange Act) of more than 50% of the total
voting power of the Voting Stock of the surviving or resulting Person;
(iii) the Company, either individually or in conjunction with one or
more Subsidiaries, sells, assigns, conveys, transfers, leases or otherwise
disposes of, or the Subsidiaries sell, assign, convey, transfer, lease or
otherwise dispose of, all or substantially all of the properties of the
Company and the Subsidiaries, taken as a whole (either in one transaction or
a series of related transactions), including Capital Stock of the
Subsidiaries, to any Person (other than the Company or a Wholly Owned
Subsidiary);
(iv) during any consecutive two-year period, individuals who at the
beginning of such period constituted the Board of Directors of the Company
(together with any new directors whose election by such Board of Directors
or whose nomination for election by the stockholders of the Company was
approved by a vote of a majority of the directors then still in office who
were either directors at the beginning of such period or whose election or
nomination for election was previously so approved) cease for any reason to
constitute a majority of the Board of Directors of the Company then in
office; or
(v) the liquidation or dissolution of the Company.
"CONSOLIDATED EBITDA" means, with respect to any Person for any period, the
sum of, without duplication, (i) the Consolidated Net Income of such Person and
its Subsidiaries for such period, plus (ii) to the extent deducted in the
computation of such Consolidated Net Income, the Consolidated Interest Expense
for such period, plus (iii) to the extent deducted in the computation of such
Consolidated Net Income, amortization or write-off of deferred financing charges
for such period, plus (iv) provision for taxes based on income or profits for
such period (to the extent such income or profits were included in computing
Consolidated Net Income for such period), plus (v) to the extent deducted in the
computation of such Consolidated Net Income, consolidated depreciation,
depletion, amortization and other noncash charges of such Person and its
Subsidiaries required to be reflected as expenses on the books and records of
such Person, plus (vi) to the extent deducted in the computation of such
Consolidated Net Income, consolidated exploration and abandonment expenses of
such Person and its Subsidiaries for such periods, minus (vii) cash payments
with respect to any nonrecurring, noncash charges previously added back pursuant
to clause (v), and excluding (viii) the impact of
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foreign currency translations. Notwithstanding the foregoing, the provision for
taxes based on the income or profits of, and the depreciation and amortization
and other noncash charges of, and the exploration and abandonment expenses of, a
Subsidiary of a Person shall be added to Consolidated Net Income to compute
Consolidated EBITDA only to the extent (and in the same proportion) that the Net
Income of such Subsidiary was included in calculating the Consolidated Net
Income of such Person and only if a corresponding amount would be permitted at
the date of determination to be dividended to such Person by such Subsidiary
without prior approval (unless such approval has been obtained), pursuant to the
terms of its charter and all agreements, instruments, judgments, decrees,
orders, statutes, rules and governmental regulations applicable to that
Subsidiary or its stockholders.
"CONSOLIDATED INDEBTEDNESS" means, with respect to any Person for any time,
the Indebtedness of such Person and its Subsidiaries at such time as determined
on a consolidated basis in accordance with GAAP.
"CONSOLIDATED INTEREST COVERAGE RATIO" means with respect to any Person for
any period, the ratio of (i) Consolidated EBITDA of such Person and its
Subsidiaries for such period to (ii) Consolidated Interest Expense of such
Person and its Subsidiaries for such period. In the event that the Company or
any of its Subsidiaries incurs, assumes, Guarantees or repays or redeems any
Indebtedness (other than revolving credit borrowings) or issues or redeems
preferred stock subsequent to the commencement of the four-quarter reference
period for which the Consolidated Interest Coverage Ratio is being calculated
but on or prior to the date on which the event for which the calculation of the
Consolidated Interest Coverage Ratio is made (the "Calculation Date"), then the
Consolidated Interest Coverage Ratio shall be calculated giving pro forma effect
to such incurrence, assumption, Guarantee, repayment or redemption of
Indebtedness, or such issuance or redemption of preferred stock, as if the same
had occurred at the beginning of the applicable four-quarter reference period.
For purposes of making the computation referred to above, (i) acquisitions that
have been made by the Company or any of its Subsidiaries, including through
mergers or consolidations and including any related financing transactions,
during the four-quarter reference period or subsequent to such reference period
and on or prior to the Calculation Date shall be deemed to have occurred on the
first day of the four-quarter reference period, and (ii) the Consolidated EBITDA
attributable to discontinued operations, as determined in accordance with GAAP,
and operations or businesses disposed of prior to the Calculation Date, shall be
excluded, and (iii) the Consolidated Interest Expense attributable to
discontinued operations, as determined in accordance with GAAP, and operations
or businesses disposed of prior to the Calculation Date, shall be excluded, but
only to the extent that the obligations giving rise to such Consolidated
Interest Expense will not be obligations of the referent Person or any of its
Subsidiaries following the Calculation Date.
"CONSOLIDATED INTEREST EXPENSE" means, with respect to any Person for any
period, the sum, without duplication, of (i) the consolidated interest expense
of such Person and its Subsidiaries for such period including, without
limitation, amortization of original issue discount, noncash interest payments,
the interest component of any deferred payment obligations, the interest
component of all payments associated with Capital Lease Obligations,
commissions, discounts and other fees and charges incurred in respect of letter
of credit or bankers' acceptance financings, and net payments (if any) pursuant
to Hedging Obligations, but excluding amortization or write-off of deferred
financing charges for such period, and (ii) the consolidated interest expense of
such Person and its Subsidiaries that was capitalized during such period, and
(iii) any interest expense on Indebtedness of another Person that is Guaranteed
by such Person or one of its Subsidiaries or secured by a Lien on assets of such
Person or one of its Subsidiaries (whether or not such Guarantee or Lien is
called upon), and (iv) the product of (a) all cash dividend payments (and
noncash dividend payments in the case of a Person that is a Subsidiary) on any
series of preferred stock of such Person payable to a party other than the
Company or a Wholly Owned Subsidiary, times (b) a fraction, the numerator of
which is one and the denominator of which is one minus the then current combined
federal, state and local statutory tax rate of such Person, expressed as a
decimal, on a consolidated basis and in accordance with GAAP.
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"CONSOLIDATED NET INCOME" means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Subsidiaries for such
period, on a consolidated basis, determined in accordance with GAAP; provided
that (i) the Net Income (but not loss) of any Person that is not a Subsidiary or
that is accounted for by the equity method of accounting shall be included only
to the extent of the amount of dividends or distributions paid in cash to the
referent Person or a Wholly Owned Subsidiary thereof, (ii) the Net Income of any
Subsidiary shall be excluded to the extent that the declaration or payment of
dividends or similar distributions by that Subsidiary of that Net Income is not
at the date of determination permitted without any prior governmental approval
(unless such approval has been obtained) or, directly or indirectly, by
operation of the terms of its charter or any agreement, instrument, judgment,
decree, order, statute, rule or governmental regulation applicable to that
Subsidiary or its stockholders, (iii) the Net Income of any Person acquired in a
pooling of interests transaction for any period prior to the date of such
acquisition shall be excluded, (iv) the cumulative effect of a change in
accounting principles shall be excluded and (v) the Net Income of, or any
dividends or other distributions from, any Unrestricted Subsidiary, to the
extent otherwise included, shall be excluded unless distributed in cash to the
Company or one of its Subsidiaries.
"CONSOLIDATED NET WORTH" means, with respect to any Person as of any date,
the consolidated stockholders' equity of such Person and its consolidated
Subsidiaries as of such date less (w) the amount of such stockholders' equity
attributable to Disqualified Stock, (x) all write-ups subsequent to the date of
the Indenture in the book value of any asset owned by such Person or a
consolidated Subsidiary of such Person (other than purchase accounting
adjustments made, in connection with any acquisition of any entity that becomes
a consolidated Subsidiary of such Person after the date of the Indenture to the
book value of the assets of such entity), (y) all investments as of such date in
unconsolidated Subsidiaries and in Persons that are not Subsidiaries (except, in
each case, Permitted Investments), and (z) all unamortized debt discount and
expense and unamortized deferred charges as of such date, all of the foregoing
determined in accordance with GAAP.
"CREDIT FACILITY" means a credit facility that may be entered into among the
Company and the lenders parties thereto (which shall initially be a credit
facility among the Company, NationsBank of Texas, N.A. or one of its affiliates,
as agent, and the other lenders parties thereto), including any related notes,
guarantees, collateral documents, instruments and agreements executed in
connection therewith, and in each case as amended, modified, renewed, extended,
refunded, replaced, restated or refinanced from time to time.
"DEFAULT" means any event that is or with the passage of time or the giving
of notice or both would be an Event of Default.
"DISQUALIFIED STOCK" means (a) with respect to any Person, Capital Stock of
such Person that, by its terms (or by the terms of any security into which it is
convertible or for which it is exchangeable), or upon the happening of any event
(unless any redemption or repurchase of such Capital Stock upon the occurrence
of such event is required by any such terms, but only to the extent that a
payment in respect thereof would be permitted under the covenant set forth under
the caption "Restricted Payments"), matures or is mandatorily redeemable,
pursuant to a sinking fund obligation or otherwise, or is redeemable at the
option of the Holder thereof, in whole or in part, on or prior to the date which
is one year after the date on which the Notes mature and (b) with respect to any
Subsidiary of such Person (including with respect to any Subsidiary of the
Company), any Capital Stock other than any common stock with no preference,
privileges, or redemption or repayment provisions.
"DOLLAR-DENOMINATED PRODUCTION PAYMENTS" mean dollar denominated payment
obligations of the Company or any of its Subsidiaries that are or, upon the
occurrence of a contingent event, would be recorded as liabilities in accordance
with GAAP, together with all undertakings and obligations of the Company or any
of its Subsidiaries in connection therewith, which obligations will be deemed to
constitute Indebtedness for borrowed money for purposes of the Indenture.
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"EQUITY INTERESTS" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock), whether outstanding prior
to, on or after the date of the Indenture.
"EQUITY OFFERING" means an offer and sale of Qualified Stock of the Company
to a Person other than an Affiliate of the Company.
"EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended.
"EXEMPT AFFILIATE TRANSACTIONS" means (a) transactions between or among the
Company and/or its Wholly Owned Subsidiaries, (b) advances not to exceed
$1,000,000 at any time outstanding to officers of the Company or any Subsidiary
of the Company in the ordinary course of business to provide for the payment of
reasonable expenses incurred by such persons in the performance of their
responsibilities to the Company or such Subsidiary or in connection with any
relocation, (c) fees and compensation paid to and indemnity provided on behalf
of directors, officers or employees of the Company or any Subsidiary of the
Company in the ordinary course of business, (d) any employment agreement that is
in effect on the date of the Indenture in the ordinary course of business and
any such agreement entered into by the Company or a Subsidiary after the date of
the Indenture in the ordinary course of business of the Company or such
Subsidiary and (e) payments and transactions under the Indebtedness of A&P Meter
Service and Supply, Inc. ("A&P") to the Company outstanding on the date of the
Indenture and the performance of and payment for services provided by A&P to the
Company and its Subsidiaries in the ordinary course of business consistent with
past practice. See "Certain Transactions."
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect on the date of the Indenture.
"GUARANTEE" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.
"HEDGING OBLIGATIONS" means, with respect to any Person, the obligations of
such Person under (i) interest rate swap agreements, interest rate cap
agreements and interest rate collar agreements and (ii) other agreements or
arrangements designed to protect such Person against fluctuations in (a)
interest rates, (b) the value of foreign currencies and (c) Oil and Gas Purchase
and Sales Contracts.
"INDEBTEDNESS" means, with respect to any Person, without duplication, (a)
all liabilities of such Person for borrowed money or for the deferred purchase
price of property or services (excluding any trade accounts payable and other
accrued current liabilities incurred in the ordinary course of business), and
all liabilities of such Person incurred in connection with any letters of
credit, bankers' acceptances or other similar credit transactions or any
agreement to purchase, redeem, exchange, convert or otherwise acquire for value
any Capital Stock of such Person, or any warrants, rights or options to acquire
such Capital Stock outstanding on the date of the Indenture or thereafter, if,
and to the extent, any of the foregoing would appear as a liability upon a
balance sheet of such Person prepared in accordance with GAAP, (b) all
obligations of such Person evidenced by bonds, notes, debentures or other
similar instruments, if, and to the extent, any of the foregoing would appear as
a liability upon a balance sheet of such Person prepared in accordance with
GAAP, (c) all Indebtedness of such Person created or arising under any
conditional sale or other title retention agreement with respect to property
acquired by such Person (even if the rights and remedies of the seller or lender
under such agreement in the event of default are limited to repossession or sale
of such property), but excluding trade accounts payable arising in the ordinary
course of business, (d) all Capitalized Lease Obligations of such Person, (e)
all Indebtedness referred to in the preceding clauses of other Persons and all
dividends of other Persons, the payment of which is secured by (or for which the
holder of such
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Indebtedness has an existing right to be secured by) any Lien upon property
(including, without limitation, accounts and contract rights) owned by such
Person, even though such Person has not assumed or become liable for the payment
of such Indebtedness (the amount of such obligation being deemed to be the
lesser of the value of such property or asset or the amount of the obligation so
secured) (f) all Production Payments of such Person, (g) all guarantees by such
Person of Indebtedness referred to in this definition, (h) all Disqualified
Stock of such Person valued at the greater of its voluntary or involuntary
maximum fixed repurchase price plus accrued dividends and (i) all obligations of
such Person under or in respect to currency exchange contracts, oil or natural
gas price hedging arrangements and Hedging Obligations. For purposes hereof, the
"maximum fixed repurchase price" of Disqualified Stock which does not have a
fixed repurchase price shall be calculated in accordance with the terms of such
Disqualified Stock as if Disqualified Stock were purchased on any date on which
Indebtedness shall be required to be determined pursuant to the Indenture, and
if such price is based upon, or measured by, the fair market value of such
Disqualified Stock, such fair market value shall be determined in good faith by
the board of directors of the issuer of such Disqualified Stock; provided,
however, that if such Disqualified Stock is not at the date of determination
permitted or required to be repurchase, the "maximum fixed repurchase price"
shall be the book value of such Disqualified Stock.
"INVESTMENTS" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the form of direct or indirect
loans (including guarantees of Indebtedness or other obligations), advances or
capital contributions (excluding advances to officers and employees of the type
specified in clause (b) of the definition of Exempt Affiliate Transactions),
purchases or other acquisitions for consideration of Indebtedness, Equity
Interests or other securities and all other items that are or would be
classified as investments on a balance sheet prepared in accordance with GAAP
and the acquisition, by purchase or otherwise, of all or substantially all of
the business or assets of any other Person.
"LIEN" means, with respect to any asset, any mortgage, lien, pledge, charge,
security interest or encumbrance of any kind in respect of such asset, whether
or not filed, recorded or otherwise perfected under applicable law (including
any conditional sale or other title retention agreement, any lease in the nature
thereof, any option or other agreement to sell or give a security interest in
and any filing of or agreement to give any financing statement under the Uniform
Commercial Code (or equivalent statutes) of any jurisdiction).
"MATERIAL CHANGE" means an increase or decrease (excluding changes that
result solely from changes in prices) of more than 10% during a fiscal quarter
in the discounted future net cash flows from proved oil and gas reserves of the
Company and its Subsidiaries calculated in accordance with clause (a)(i) of the
definition of Adjusted Consolidated Net Tangible Assets; PROVIDED, however, that
the following will be excluded from the calculation of Material Change: (i) any
acquisition during the quarter of oil and gas reserves that have been estimated
by independent petroleum engineers and on which a report or reports exists and
(ii) any disposition of properties existing at the beginning of such quarter
that have been disposed of pursuant to the provisions of the Indenture described
under the caption "Redemption of the Option of the Holders."
"NET INCOME" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP and before any reduction in
respect of preferred stock dividends, excluding, however, (i) any gain (but not
loss, except as provided in (b) below), together with any related provision for
taxes on such gain (but not loss), realized in connection with (a) any Asset
Sale (including, without limitation, dispositions pursuant to Sale and Leaseback
transactions) or (b) the disposition of any securities by such Person or any of
its Subsidiary or the extinguishment of any Indebtedness of such Person or any
of its Subsidiary, other than any loss arising out of the extinguishment of
Indebtedness refinanced with the proceeds of the Notes and other securities
issued contemporaneously with the Notes or Indebtedness that was refinanced in
June 1996 by such refinanced Indebtedness, (ii) any extraordinary or
nonrecurring gain (but not loss, except as provided in (i)
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above), together with any related provision for taxes on such extraordinary or
nonrecurring gain (but not loss), and (iii) any gain (but not loss) from
currency exchange transactions not in the ordinary course of business consistent
with past practice.
"NET PROCEEDS" means the aggregate cash proceeds received by the Company or
any of its Subsidiaries in respect of any Asset Sale (including, without
limitation, any cash received upon the sale or other disposition of any noncash
consideration received in any Asset Sale), net of the direct costs relating to
such Asset Sale (including, without limitation, legal, accounting and investment
banking fees, and sales commissions) and any relocation expenses incurred as a
result thereof, taxes paid or payable as a result thereof, and any reserve for
adjustment in respect of the sale price of such asset or assets established in
accordance with GAAP.
"NON-RECOURSE INDEBTEDNESS" means Indebtedness (i) as to which neither the
Company nor any of its Subsidiaries (a) provides credit support of any kind
(including any undertaking, agreement or instrument that would constitute
Indebtedness), (b) is directly or indirectly liable (as a guarantor or
otherwise), or (c) constitutes the lender; and (ii) no default with respect to
which (including any rights that the holders thereof may have to take
enforcement action against an Unrestricted Subsidiary) would permit (upon
notice, lapse of time or both) any holder of any other Indebtedness of the
Company or any of its Subsidiaries to declare a default on such other
Indebtedness or cause the payment thereof to be accelerated or payable prior to
its stated maturity.
"OBLIGATIONS" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"OIL AND GAS BUSINESS" means the business of the exploration for, and
development, acquisition, and production of hydrocarbons, together with
activities ancillary thereto (including with limitation, the gathering,
processing, treatment, marketing and transportation of such production) and
other related energy and natural resources businesses.
"OIL AND GAS PURCHASE AND SALE CONTRACT" means with respect to any Person,
any oil and gas agreements and other agreements or arrangements or any
combination thereof entered into by such Person in the ordinary course of
business and that is designed to provide protection against oil and natural gas
price fluctuations.
"PERMITTED INVESTMENTS" means (a) any Investments by the Subsidiaries of the
Company in the Company; (b) any Investments in Cash Equivalents; (c) Investments
made as a result of the receipt of noncash consideration from an Asset Sale that
was made pursuant to and in compliance with the covenant described above under
the caption "Repurchase at the Option of Holders -- Asset Sales"; (d)
Investments outstanding as of the date of the Indenture; (e) Investments in
Wholly Owned Subsidiaries engaged in the Oil and Gas Business and Investments in
any Person that, as a result of such Investment (or a series of substantially
contemporaneous Investments made pursuant to a single plan) (x) such other
Person becomes a Wholly Owned Subsidiary engaged in the Oil and Gas Business or
(y) such other Person that is engaged in the Oil and Gas Business is merged or
consolidated with or into, or transfers or conveys all or substantially all of
its assets to the Company or a Wholly Owned Subsidiary in a transaction
permitted under the Indenture; (f) entry into operating agreements, joint
ventures, partnership agreements, working interests, royalty interests, mineral
leases, processing agreements, farm-out agreements, contracts for the sale,
transportation or exchange of oil and natural gas, unitization agreements,
pooling arrangements, area of mutual interest agreements or other similar or
customary agreements, transactions, properties, interests or arrangements, and
Investments and expenditures in connection therewith or pursuant thereto, in
each case made or entered into in the ordinary course of the Oil and Gas
Business, excluding, however, Investments in corporations; (g) entry into any
hedging arrangements in the ordinary course of business for the purpose of
protecting the Company's or any Subsidiaries's production against fluctuations
in oil or natural gas prices; (h) shares of money mutual or similar funds having
assets in excess of $500,000,000, and (i) Investments in an aggregate amount not
to exceed $5,000,000 at any one time outstanding.
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"PERMITTED LIENS" means (a) Liens existing on the date of the Indenture; (b)
Liens under the Credit Facility securing Indebtedness permitted to be incurred
in accordance with clause (i) of the second paragraph under the caption "--
Incurrence of Indebtedness and Issuance of Preferred Stock"; (c) Liens now or
hereafter securing any Hedging Obligations so long as the related Indebtedness
is permitted under clauses (v) or (vi) of the second paragraph under the caption
"-- Incurrence of Indebtedness and Issuance of Preferred Stock"; (d) Liens
securing Permitted Refinancing Indebtedness; PROVIDED, that such Liens extend to
or cover only the property or assets currently securing the Indebtedness being
refinanced; (e) Liens for taxes, assessments and governmental charges not then
due or the validity of which is being contested in good faith by appropriate
proceedings, promptly instituted and diligently conducted, and for which
adequate reserves have been established to the extent required by GAAP; (f)
statutory landlords', carriers', mechanics', workmen's, materialman's,
operator's or similar Liens arising in the ordinary course of business for sums
not delinquent or being contested in good faith by appropriate proceedings,
promptly instituted and diligently conducted, and for which adequate reserves
have been established to the extent required by GAAP; (g) easements, rights of
way, restrictions and other similar encumbrances or minor imperfections in title
that, in the case of any of the foregoing, were not incurred or created to
secure the payment of borrowed money or the deferred purchase price of property
or services, and in the aggregate do not materially and adversely affect the
value of such properties or materially impair use for the purposes of which such
properties are held by the Company or any Subsidiaries; (h) Liens on, or related
to, properties to secure all or part of the costs (other than Indebtedness)
incurred in the ordinary course of business of exploration, drilling,
development or operation thereof; (i) judgment and attachment liens not giving
rise to an Event of Default or liens created by or existing from any litigation
or legal proceeding that are currently being contested in good faith by
appropriate proceedings, promptly instituted and diligently conducted, and for
which adequate reserves have been made to the extent required by GAAP; (j) Liens
on deposits made in the ordinary course of business; (k) Liens in favor of
collecting or payor banks having a right of set-off, revocation, refund or
chargeback with respect to money or instruments of the Company or any Subsidiary
on deposit with or in possession of such bank; (l) Liens on pipeline or pipeline
facilities which arise out of operation of law; (m) Liens on deposits to secure
public or statutory obligations or in lieu of surety or appeal bonds entered
into in the ordinary course of business; (n) liens reserved in oil and gas
leases for bonus or rental payments and for compliance with the terms of such
leases; (o) Liens arising under partnership agreements, oil and gas leases,
farmout agreements, division orders, contracts for the sale, purchase, exchange,
transportation or processing of oil, gas or other hydrocarbons, unitization and
pooling declarations and agreements, development agreements, operating
agreements, area of mutual interest agreements and other agreements that are
customary in the Oil and Gas Business and that do not secure Indebtedness; (p)
(i) Liens upon any property of any Person existing at the time of acquisition
thereof by the Company or a Subsidiary, (ii) Liens upon any property of a Person
existing at the time such Person is merged or consolidated with the Company or
any Subsidiary or existing at the time of the sale or transfer of any such
property of such Person to the Company or any Subsidiary, or (iii) Liens upon
any property of a Person existing at the time such Person becomes a Subsidiary;
PROVIDED, that in each case such Lien has not been created in contemplation of
such sale, merger, consolidation, transfer or acquisition, and PROVIDED that in
each such case no such Lien shall extend to or cover any property of the Company
or any Subsidiary other than the property being acquired and improvements
thereon; (q) purchase money Liens granted in connection with the acquisition of
assets, PROVIDED, that (i) such Liens attach only to the assets so acquired with
the purchase money indebtedness secured thereby, (ii) such Liens secure only
Indebtedness that is not in excess of 100% of the purchase price of such assets,
and (iii) such Liens attach no later than 180 days after the acquisition of such
assets; and (r) Liens securing Indebtedness incurred as a result of extensions,
renewals or replacements of Indebtedness secured by Liens permitted by clauses
(p) or (q), PROVIDED, that (i) the principal amount of the Indebtedness so
issued and secured by such Lien shall not exceed the principal amount of the
Indebtedness so extended, renewed, replaced, exchanged or refinanced and (ii)
the Indebtedness so
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issued and secured by such Lien shall not be secured by any property or assets
of the Company or any Subsidiary other than the property or assets subject to
the Liens securing such Indebtedness being exchanged or refinanced.
"PERMITTED REFINANCING INDEBTEDNESS" means any Indebtedness of the Company
or any of its Subsidiaries issued in exchange for, or the net proceeds of which
are used to extend, refinance, renew, replace, defease or refund other
Indebtedness of the Company or any of its Subsidiaries; PROVIDED that: (i) the
principal amount of such Permitted Refinancing Indebtedness does not exceed the
principal or accrued amount of the Indebtedness so extended, refinanced,
renewed, replaced, defeased or refunded; (ii) such Permitted Refinancing
Indebtedness has a Weighted Average Life to Maturity and a final maturity date
equal to or greater than the Weighted Average Life to Maturity and final
maturity date, respectively, of the Indebtedness being extended, refinanced,
renewed, replaced, defeased or refunded; (iii) if the Indebtedness being
extended, refinanced, renewed, replaced, defeased or refunded is subordinated in
right of payment to the Notes or any Subsidiary Guarantees, such Permitted
Refinancing Indebtedness has a final maturity date later than the final maturity
date of, and is subordinated in right of payment to the Notes and any Subsidiary
Guarantees on terms at least as favorable to the Holders of the Note as those
contained in the documentation governing the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded; and (iv) such Indebtedness
is incurred either by the Company or by the Subsidiary who is the obligor on the
Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded.
"PRINCIPAL PROPERTIES" means the oil and gas properties and other tangible
assets and properties owned by Company on the date of the Indenture
(collectively, the "Original Principal Properties") and assets and properties of
the Company obtained in exchange for any of the Original Principal Properties.
"PRODUCTION PAYMENTS" means, collectively, Dollar-Denominated Production
Payments and Volumetric Production Payments.
"QUALIFIED STOCK" means, for any Person, any and all Capital Stock of such
Person, other than Disqualified Stock.
"RESTRICTED INVESTMENT" means an Investment other than a Permitted
Investment.
"SALE AND LEASEBACK TRANSACTION" means, with respect to the Company or any
of its Subsidiaries, any arrangement with any Person providing for the leasing
by the Company or any of its Subsidiaries as lessee of any principal property,
acquired or placed into service more than 180 days prior to such arrangement
(except leases of two years or less), whereby such property has been or is to be
sold or transferred by the Company or any of its Subsidiaries to such Person or
its Affiliates.
"SENIOR BANK INDEBTEDNESS" means the Indebtedness outstanding under the
Credit Facility.
"SENIOR INDEBTEDNESS" means (i) the Senior Bank Indebtedness and (ii) any
other Indebtedness permitted to be incurred by the Company or any of its
Subsidiaries under the terms of the Indenture, unless the instrument under which
such Indebtedness is incurred expressly provides that it is subordinated in
right of payment to any Indebtedness for money borrowed.
"SENIOR REVOLVING INDEBTEDNESS" means revolving credit borrowings and
letters of credit under the Credit Facility and/or any successor facility or
facilities.
"SUBORDINATED INDEBTEDNESS" means any Indebtedness of the Company or any of
its Subsidiaries (whether outstanding on the date of the Indenture or thereafter
incurred) that is contractually subordinated or junior in right of payment of
principal, premium and interest to the Notes or the Subsidiary Guarantees.
"SUBSIDIARY" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a combination
thereof) and (ii) any partnership (a) the sole general partner or the managing
general partner of which is such Person or a Subsidiary of such
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Person or (b) the only general partners of which are such Person or of one or
more Subsidiaries of such Person (or any combination thereof). Notwithstanding
the foregoing, an Unrestricted Subsidiary shall not be a Subsidiary of the
Company for any purposes of the Indenture.
"UNRESTRICTED SUBSIDIARY" means any Subsidiary, if designated by the Board
of Directors of the Company as an Unrestricted Subsidiary pursuant to a Board
Resolution and permitted to be so designated pursuant to the terms of the
Indenture.
"VOLUMETRIC PRODUCTION PAYMENTS" means volumetric production payment
obligations of the Company or any of its Subsidiaries that are or, upon the
occurrence of a contingent event, would be recorded as deferred revenue in
accordance with GAAP, together with all undertakings and obligations of the
Company or any of its Subsidiaries in connection therewith, which will be deemed
to constitute debt for borrowed money for purpose of the Indenture.
"VOTING STOCK" of a corporation means all classes of Capital Stock of such
corporation then outstanding and normally entitled to vote in the election of
directors.
"WEIGHTED AVERAGE LIFE TO MATURITY" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (i) the sum of the product
obtained by multiplying (a) the amount of each then remaining installment,
sinking fund, serial maturity or other required payments of principal, including
payments at final maturity, in respect thereof, by (b) the number of years
(calculated to the nearest one-twelfth) that will elapse between such date and
the making of such payment, by (ii) the then outstanding principal amount of
such Indebtedness.
"WHOLLY OWNED SUBSIDIARY" of any Person means a Subsidiary of such Person
(i) all of the outstanding Capital Stock or other ownership interests of which
(other than directors qualifying shares) shall at the time be owned by such
Person or by one or more Wholly Owned Subsidiaries of such Person or (ii)
organized in a foreign jurisdiction and is required by the applicable laws and
regulations of such foreign jurisdiction to be partially owned by the government
of such foreign jurisdiction or individual or corporate citizens of such foreign
jurisdiction in order for such Subsidiary to transact business in such foreign
jurisdiction, provided that such Person or one or more Wholly Owned Subsidiaries
of such Person, owns the remaining Capital Stock or ownership interest in such
Subsidiary and, by contract or otherwise, controls the management and business
of such Subsidiary and derives the economic benefits of ownership of such
Subsidiary to substantially the same extent as if such Subsidiary were a wholly
owned Subsidiary. Unrestricted Subsidiaries shall not be included in the
definition of Wholly Owned Subsidiary for any purposes of the Indenture.
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DESCRIPTION OF OTHER INDEBTEDNESS
EXISTING DEBT FACILITY
In June 1996, the Company entered into a credit agreement (the "Existing
Debt Facility") provided by NationsBridge, L.L.C. and NationsBank, N.A. and
consisting of a $95.0 million revolving credit loan (the "Existing Revolver")
and a $30.0 million term loan (the "Existing Term Loan"). The Existing Debt
Facility provided funds to consummate the 1996 Acquisition and to refinance the
Company's prior senior bank facility. Prudential Securities Group Inc. ("PGI")
has purchased an interest in the Existing Debt Facility.
The Existing Revolver and the Existing Term Loan each matures June 10, 1999.
No periodic principal reductions are required with respect to the Existing Term
Loan; however, quarterly principal reductions in the amount of $3.0 million are
required with respect to the Existing Revolver, commencing January 1, 1997. In
addition, the Existing Debt Facility requires that the net proceeds from the
Notes Offering be applied to reduce the amounts outstanding under the Existing
Revolver and the Existing Term Loan, and 100% of the net proceeds from the
Common Stock Offering are required to be utilized to reduce the amounts
outstanding under the Existing Term Loan and Existing Revolver.
Interest accrues on the Existing Term Loan initially at 14.0% per annum,
increasing by 0.5% per annum at the end of each successive three month period
(commencing September 13, 1996) up to a maximum of 16.5% per annum. Interest may
be paid in cash or "in kind" by delivery of additional notes having the same
terms as the notes issued pursuant to the Existing Term Loan. Interest under the
Existing Revolver accrues, at the option of the Company, at a margin in excess
of either NationsBank, N.A. "LIBOR" rate, up to a maximum of 5.0% per annum, or
NationsBank, N.A. fluctuating "prime rate" up to a maximum of 2.75% per annum.
The Existing Debt Facility is secured by a pledge of substantially all of
the Company's assets, guaranties by the Company's subsidiaries and limited
guaranties by Messrs. Liedtke, Grella and Musselman proportionate to their
membership interests in the LLC.
CREDIT FACILITY
The Credit Facility will provide the Company with a revolving facility based
on the borrowing base of its oil and gas assets which will initially be set at
$50.0 million, none of which is expected to be outstanding at its inception. The
Credit Facility is expected to be secured by a pledge of substantially all of
the assets of the Company and any subsidiary of the Company that guarantees the
Company's obligations under the Credit Facility. Initially, none of the
Company's subsidiaries will guarantee the obligations of the Company under the
Credit Facility. See "Mangement's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources" for a further
description of the Credit Facility.
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 20,000,000 shares of
Common Stock, par value $0.10 per share ("Common Stock") and 3,000,000 shares of
preferred stock, par value $0.10 per share ("Preferred Stock"). Upon the
completion of the Offerings and the Corporate Reorganization, the issued and
outstanding capital stock of the Company will consist of 10,000,000 shares of
Common Stock (or 10,720,000 shares if the underwriters' over-allotment option is
exercised in full).
The following description of certain matters relating to the capital stock
of the Company is summary in nature and is qualified in its entirety by the
provisions of the Company's Certificate of Incorporation and Bylaws, copies of
which have been filed as exhibits to the Registration Statement of which this
Prospectus is a part.
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COMMON STOCK
The holders of Common Stock are entitled to one vote per share on all
matters submitted to a vote of stockholders of the Company. In addition, such
holders are entitled to receive ratably such dividends, if any, as may be
declared from time to time by the Board of Directors out of funds legally
available therefor, subject to the payment of preferential dividends with
respect to any Preferred Stock that from time to time may be outstanding. In the
event of the dissolution, liquidation or winding-up of the Company, the holders
of Common Stock are entitled to share ratably in all assets remaining after
payment of all liabilities of the Company and subject to the prior distribution
rights of the holders of any Preferred Stock that may be outstanding at that
time. The holders of Common Stock do not have cumulative voting rights or
preemptive rights. All shares of Common Stock outstanding and to be outstanding
after the Common Stock Offering will be fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has the authority to issue 3,000,000 shares of
Preferred Stock, in one or more series, and to fix the rights, preferences,
qualifications, privileges, limitations or restrictions of each such series
without any further vote or action by the stockholders, including the dividend
rights, dividend rate, conversion rights, voting rights, terms of redemption
(including sinking fund provisions), redemption price or prices, liquidation
preferences and the number of shares constituting any series or the designations
of such series. No shares of Preferred Stock have ever been issued, and the
Company has no present plans to issue any Preferred Stock. In certain instances
the Indenture limits the ability of the Company to issue Preferred Stock. See
"Description of Notes -- Certain Covenants -- Incurrence of Indebtedness and
Issuance of Preferred Stock."
83
<PAGE>
UNDERWRITING
Upon the terms and subject to the conditions of the Underwriting Agreement
(the "Underwriting Agreement") among the Company, NationsBanc Capital Markets,
Inc. and Prudential Securities Incorporated (the "Underwriters"), the
Underwriters severally have agreed to purchase from the Company and the Company
has agreed to sell to the Underwriters severally the principal amount of Notes
set forth opposite the names of such Underwriters below:
<TABLE>
<CAPTION>
PRINCIPAL
UNDERWRITER AMOUNT
- ------------------------------------------------------------------------------------------------ ----------------
<S> <C>
NationsBanc Capital Markets, Inc................................................................ $ 90,000,000
Prudential Securities Incorporated.............................................................. 10,000,000
----------------
Total....................................................................................... $ 100,000,000
----------------
----------------
</TABLE>
In the Underwriting Agreement, the several Underwriters have agreed, subject
to certain conditions, to purchase all of the Notes, if any are purchased. The
Underwriting Agreement provides that, in the event of a default by an
Underwriter, in certain circumstances, the purchase commitments of
non-defaulting Underwriters may be increased or the Underwriting Agreement may
be terminated.
The Company has been advised by the Underwriters that they propose to offer
the Notes to the public initially at the price set forth on the cover page of
this Prospectus, to certain securities dealers (who may include Underwriters) at
such price less a concession not in excess of 0.50% of the amount per Note and
that the Underwriters and such dealers may reallow a discount not in excess of
0.25% of the amount per Note to other dealers, including the Underwriters. After
the closing of the public offering, the public offering price, the concession
and the discount to other dealers may be changed by the Underwriters.
There is no currently existing trading market for the Notes, and although
the Underwriters have advised the Company that they currently intend to make a
market in the Notes, they are not obligated to do so and any such market making
may be discontinued at any time, without notice, in the sole discretion of the
Underwriters. Accordingly, there can be no assurance as to the development or
liquidity of any market that may develop for the Notes.
The Company has agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended
(the "Securities Act"), or to contribute to payments the Underwriters may be
required to make in respect thereof.
The Underwriters have informed the Company that they do not expect to
confirm sales of Notes offered hereby to any accounts over which they exercise
discretionary authority.
NationsBanc Capital Markets, Inc. is an affiliate of NationsBank, N.A., NBCC
and NationsBridge, L.L.C. NationsBridge, L.L.C. and NationsBank, N.A. are
lenders under the Existing Credit Facility. PGI, an affiliate of Prudential
Securities Incorporated, is also a lender under the Existing Credit Facility.
See "Description of Other Indebtedness." NationsBridge, L.L.C., NationsBank,
N.A. and PGI will receive their respective proportionate shares of the repayment
by the Company of borrowings under the Existing Debt Facility from the net
proceeds of the Offerings. Prudential Securities Incorporated is also acting as
an underwriter in the Company's concurrent Common Stock Offering for which it
will receive customary underwriting discounts and commissions. In addition, the
Underwriters and their respective affiliates provide or have provided banking,
advisory and other financial services for the Company in the ordinary course of
business for which they have received customary compensation.
NBCC is a stockholder of the Company and will receive approximately $16.3
million of the proceeds of the Offerings in redemption of a portion of the
membership interests owned by it and in a distribution to it in the Corporate
Reorganization. See "Use of Proceeds," "The Company -- Corporate Reorganization"
and "Security Ownership of Certain Beneficial Owners and Management." As a
result of such ownership, The National Association of Securities Dealers, Inc.
("NASD") may view
84
<PAGE>
this offering as a participation by NationsBanc Capital Markets, Inc. in the
distribution in a public offering of the securities of an affiliate and this
Notes Offering is being made pursuant to the provisions of Rule 2720 of the
NASD's Conduct Rules. In accordance with Rule 2720, Prudential Securities
Incorporated is acting as a qualified independent underwriter in the Notes
Offering and is assuming the responsibilities of acting as such in pricing the
Notes Offering and conducting due diligence.
LEGAL MATTERS
Certain legal matters related to the Notes offered hereby are being passed
upon for the Company by Cotton, Bledsoe, Tighe & Dawson, a Professional
Corporation, Midland, Texas. Certain matters will be passed upon for the
Underwriters by Baker & Botts, L.L.P., Houston, Texas.
EXPERTS
The consolidated financial statements of Costilla Energy, L.L.C. and
subsidiaries as of December 31, 1995 and for the year then ended, the statements
of revenues and direct operating expenses of the 1996 Acquisition for the years
ended December 31, 1993, 1994 and 1995, and the statements of revenues and
direct operating expenses of the 1995 Acquisition for the years ended December
31, 1993 and 1994, and the period ended June 12, 1995, have been included herein
and in the registration statement in reliance upon the report of KPMG Peat
Marwick LLP, independent certified public accountants, appearing elsewhere
herein, and upon the authority of said firm as experts in accounting and
auditing.
The consolidated financial statements of Costilla Energy, L.L.C. and
subsidiaries as of December 31, 1994, and for the years ended December 31, 1993
and 1994, have been included herein and in the registration statement in
reliance upon the report of Elms, Faris & Co., P.C., independent certified
public accountants, appearing elsewhere herein, and upon the authority of said
firm as experts in accounting and auditing.
In September 1995, the Company changed its principal accountants from Elms,
Faris & Co., P.C. to KPMG Peat Marwick LLP. The reports of Elms, Faris & Co.,
P.C. on the Company's financial statements for the year ended December 31, 1994
did not contain an adverse opinion or a disclaimer of opinion, nor was it
qualified or modified in any way as to uncertainty, audit scope or accounting
principles. Moreover, there were no disagreements with Elms, Faris & Co., P.C.
on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure. The members of the LLC made the
decision to change the LLC's principal accountants.
Certain information appearing in this Prospectus regarding estimated
quantities of oil and gas reserves and the discounted present value of future
pre-tax cash flows therefrom attributable to the Company's properties and to the
properties included in the 1996 Acquisition is based upon estimates of such
reserves and present values prepared by Williamson Petroleum Consultants, Inc.
All of such information has been so included herein in reliance upon the
authority of such firm as experts in such matters. Set forth as Appendix A is
Williamson's Summary Reserve Report dated July 23, 1996 with respect to the oil
and gas interests of the Company and with respect to properties acquired in the
1996 Acquisition.
AVAILABLE INFORMATION
Upon completion of the Offerings, the Company will be subject to the
informational requirements of the Securities Exchange Act of 1934, as amended
(the "Exchange Act"), and, in accordance therewith, will file reports, proxy
statements and other information with the Securities and Exchange Commission
(the "Commission"). Such reports, proxy statements and other information filed
by the Company with the Commission can be inspected at the Public Reference
Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W.,
Washington, D.C. 20549, and the Regional Offices of the Commission at Citicorp
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois
85
<PAGE>
60661-2511, and 7 World Trade Center, New York, New York 10048. Copies of such
material can also be obtained from the Public Reference Section of the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549, at prescribed rates. The Commission maintains a World Wide Web site
on the Internet at HTTP:\\WWW.SEC.GOV that contains reports, proxy and
information statements and other information regarding registrants that file
electronically with the Commission.
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the Notes offered hereby. This
Prospectus, which constitutes a part of the Registration Statement, does not
contain all of the information set forth in the Registration Statement, certain
items of which are contained in exhibits to the Registration Statement as
permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the Notes offered hereby, reference
is made to the Registration Statement, including the exhibits thereto, which may
be inspected without charge at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the Regional
Offices of the Commission, and copies of which may be obtained from the
Commission at prescribed rates. Statements made in this Prospectus concerning
the contents of any document referred to herein are not necessarily complete.
With respect to each such document filed with the Commission as an exhibit to
the Registration Statement, reference is made to the exhibit for a more complete
description of the matter involved, and each such statement made herein shall be
deemed qualified by such reference.
86
<PAGE>
GLOSSARY
The terms defined in this section are used throughout this Prospectus.
ADJUSTED EBITDA. Calculated by adding interest, income taxes, depreciation,
depletion and amortization, exploration and abandonment costs and extraordinary
loss resulting from extinguishment of debt to net income (loss).
ALL-IN FINDING COSTS. The amount of total capital expenditures, including
acquisition costs, and exploration and abandonment costs for oil and gas
activities divided by the amount of proved reserves (expressed in BOE) added
during the specified period (including the effect on proved reserves of reserve
revisions).
BBL. One stock tank barrel, or 42 U.S. gallons liquid volume, used herein
in reference to crude oil or other liquid hydrocarbons.
BCF. One billion cubic feet.
BOE. Equivalent barrels of oil. In reference to natural gas, natural gas
equivalents are determined using the ratio of six Mcf of natural gas to one Bbl
of crude oil, condensate or natural gas liquids.
BTU. One British thermal unit. The quantity of heat required to raise the
temperature of one pound of water one degree Fahrenheit.
DEVELOPED ACREAGE. The number of acres which are allocated or assignable to
producing wells or wells capable of production.
DEVELOPMENT WELL. A well drilled within the proved area of an oil or gas
reservoir to the depth of a stratigraphic horizon known to be productive.
DRY WELL. A well found to be incapable of producing either oil or gas in
sufficient quantifies to justify completion of an oil or gas well.
EXPLORATORY WELL. A well drilled to find and produce oil or gas in an
unproved area, to find a new reservoir in a field previously found to be
productive of oil or gas in another reservoir, or to extend a known reservoir.
GROSS ACRES OR GROSS WELLS. The total acres or wells, as the case may be,
in which a working interest is owned.
MBBL. One thousand barrels of crude oil or other liquid hydrocarbons.
MBOE. One thousand barrels of oil equivalent.
MMBOE. One million barrels of oil equivalent.
MMBBLS. One million barrels of crude oil or other liquid hydrocarbons.
MMBTU. One million Btu's.
MCF. One thousand cubic feet.
MMCF. One million cubic feet.
NET ACRES OR NET WELLS. The sum of the fractional working interests owned
in gross acres or gross wells.
PRESENT VALUE OF ESTIMATED FUTURE NET REVENUES OR PV-10 VALUE. The present
value of estimated future net revenues is an estimate of future net revenues
from a property at its acquisition date, at a specified date, after deducting
production and ad valorem taxes, future capital costs and operating expenses,
but before deducting federal income taxes. The future net revenues have been
discounted at an annual rate of 10% to determine their "present value." The
present value is shown to indicate the
87
<PAGE>
effect of time on the value of the revenue stream and should not construed as
being the fair market value of the properties. Estimates have been made using
constant oil and natural gas prices and operating costs at the specified date.
PRODUCTIVE WELL. A well that is producing oil or gas that is capable of
production.
PROVED DEVELOPED RESERVES. Reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods.
PROVED RESERVES. The estimated quantities of crude oil, natural gas and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions.
PROVED UNDEVELOPED RESERVES. Reserves that are expected to be recovered
from new wells on undrilled acreage, or from existing wells where a relatively
major expenditure is required for recompletion.
ROYALTY INTEREST. An interest in an oil and gas property entitling the
owner to a share of oil and gas production free of costs of production.
3-D SEISMIC. Advanced technology method of detecting accumulations of
hydrocarbons identified by the collection and measurement of the intensity and
timing of sound waves transmitted into the earth as they reflect back to the
surface.
UNDEVELOPED ACREAGE. Lease acreage on which wells have not been drilled or
completed to a point that would permit the production of commercial quantities
of oil and gas regardless of whether such acreage contains proved reserves.
WORKING INTEREST. The operating interest which gives the owner the right to
drill, produce and conduct operating activities on the property and a share of
production.
88
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Financial Statements of Costilla Energy, L.L.C.:
Independent Auditors' Reports...................................................... F-2
Consolidated Balance Sheets as of December 31, 1994 and 1995, and June 30, 1996
(unaudited)....................................................................... F-4
Consolidated Statements of Operations for the years ended December 31, 1993, 1994,
and 1995, and the six months ended June 30, 1995 and 1996 (unaudited)............. F-5
Consolidated Statements of Members' Capital for the years ended December 31, 1993,
1994, and 1995, and the six months ended June 30, 1995 (unaudited)................ F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1993, 1994,
and 1995, and the six months ended June 30, 1995 and 1996 (unaudited)............. F-7
Notes to Consolidated Financial Statements......................................... F-8
Financial Statements of the 1995 Acquisition:
Independent Auditors' Report....................................................... F-23
Statements of Revenues and Direct Operating Expenses for the years ended December
31, 1993 and 1994 and the period ended June 12, 1995.............................. F-24
Notes to the Statements of Revenues and Direct Operating Expenses.................. F-25
Financial Statements of the 1996 Acquisition:
Independent Auditors' Report....................................................... F-28
Statements of Revenues and Direct Operating Expenses for the years ended December
31, 1993, 1994 and 1995, and the periods ended June 14, 1995 and 1996
(unaudited)....................................................................... F-29
Notes to the Statements of Revenues and Direct Operating Expenses.................. F-30
</TABLE>
Note: The financial statements of Costilla Energy, Inc. (incorporated in June
1996) are not presented, as Costilla Energy, Inc. has no material assets,
liabilities or equity, and has not generated any material revenues or
incurred any material expenses.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Members
Costilla Energy, L.L.C. (a Texas limited liability company):
We have audited the accompanying consolidated balance sheet of Costilla
Energy, L.L.C. (a Texas limited liability company) and subsidiaries as of
December 31, 1995, and the related consolidated statement of operations,
members' capital, and cash flows for the year then ended. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Costilla
Energy, L.L.C. and subsidiaries as of December 31, 1995, and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas
April 16, 1996 (except with respect to matters discussed in the last paragraph
of Note 7 and Note 12, as to which the date is June 14, 1996.)
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Members
Costilla Energy, L.L.C.:
We have audited the accompanying consolidated balance sheet of Costilla
Energy, L.L.C. (a Texas limited liability company) and subsidiaries (the
combination of CSL Partners, Costilla Petroleum Corporation and Statewide
Minerals, L.C.) as of December 31, 1994, and the related consolidated statements
of operations, members' capital, and cash flows for the years ended December 31,
1993 and 1994. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Costilla Energy, L.L.C. and subsidiaries as of December 31, 1994, and the
results of their operations and their cash flows for the years ended December
31, 1993 and 1994, in conformity with generally accepted accounting principles.
ELMS, FARIS & CO., P.C.
Midland, Texas
March 31, 1995
F-3
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- JUNE 30,
1994 1995 1996
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents............................................................... $ 137 $ 2,866 $ 1,164
Accounts receivable:
Trade, net............................................................................ 1,042 3,154 2,521
Affiliates............................................................................ -- 507 927
Oil and gas sales..................................................................... 1,715 3,915 5,337
Prepaid and other current assets........................................................ 223 439 2,629
------- ------- -----------
Total current assets.............................................................. 3,117 10,881 12,578
------- ------- -----------
Property, plant and equipment, at cost:
Oil and gas properties, using the successful efforts method of accounting:
Proved properties..................................................................... 22,794 79,897 126,809
Unproved properties................................................................... 2,060 2,903 4,615
Accumulated depletion, depreciation and amortization.................................... (3,562) (9,413) (13,933)
------- ------- -----------
21,292 73,387 117,491
------- ------- -----------
Other property and equipment, net......................................................... 76 679 1,640
Deferred charges (Note 2)................................................................. 29 1,736 2,654
Note receivable -- affiliate.............................................................. 390 684 684
------- ------- -----------
$24,904 $87,367 $135,047
------- ------- -----------
------- ------- -----------
<CAPTION>
LIABILITIES, REDEEMABLE MEMBERS' CAPITAL AND MEMBERS' CAPITAL
<S> <C> <C> <C>
Current liabilities:
Current maturities of long-term debt.................................................... $ 22 $ -- $ 98
Trade accounts payable.................................................................. 1,712 5,467 4,587
Undistributed revenue................................................................... 110 1,227 1,524
Other current liabilities............................................................... 192 1,691 2,103
------- ------- -----------
Total current liabilities......................................................... 2,036 8,385 8,312
------- ------- -----------
Long-term debt, less current maturities (Note 7).......................................... 23,591 71,494 122,267
Deferred income (Note 2).................................................................. 24 3,319 2,623
Other noncurrent liabilities.............................................................. -- 38 --
------- ------- -----------
Total liabilities................................................................. 25,651 83,236 133,202
------- ------- -----------
Redeemable members' capital (Note 10)..................................................... -- 11,576 13,171
------- ------- -----------
Members' capital (Note 10)................................................................ (747) (7,445) (11,326)
Commitments and contingencies (Note 8).................................................... -- -- --
------- ------- -----------
$24,904 $87,367 $135,047
------- ------- -----------
------- ------- -----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Oil and gas sales........................................ $ 4,231 $ 7,637 $ 21,693 $ 5,568 $ 19,445
Interest and other....................................... 56 87 123 5 40
Gain on sale of assets................................... 110 112 -- -- 40
--------- --------- --------- --------- ---------
4,397 7,836 21,816 5,573 19,525
--------- --------- --------- --------- ---------
Expenses:
Oil and gas production................................... 1,688 2,349 10,024 2,268 8,093
Oil and gas production -- affiliates..................... -- 2 331 145 185
General and administrative............................... 639 634 2,910 678 2,439
General and administrative -- affiliates................. 313 550 661 330 370
Compensation related to option settlement (Note 11)...... -- -- 656 656 --
Exploration and abandonments............................. 218 793 1,650 1,007 308
Depreciation, depletion and amortization................. 884 1,847 5,958 1,367 4,620
Interest................................................. 605 1,458 4,591 1,046 4,156
Other.................................................... -- -- 2 -- --
--------- --------- --------- --------- ---------
4,347 7,633 26,783 7,497 20,171
--------- --------- --------- --------- ---------
Income (loss) before federal income taxes and
extraordinary item.................................... 50 203 (4,967) (1,924) (646)
Provision for federal income taxes
Current.................................................. (25) 8 3 -- --
Deferred................................................. 2 32 -- -- --
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item................ 73 163 (4,970) (1,924) (646)
Extraordinary loss resulting from extinguishment of
debt (Note 7)......................................... -- -- -- -- (1,640)
--------- --------- --------- --------- ---------
Net income (loss).......................................... 73 163 (4,970) (1,924) (2,286)
Preferred return and accretion of redeemable members'
capital................................................. -- -- (2,842) (975) (1,595)
--------- --------- --------- --------- ---------
Net income (loss) applicable to members' capital......... $ 73 $ 163 $ (7,812) $ (2,899) $ (3,881)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
CONSOLIDATED STATEMENTS OF MEMBERS' CAPITAL
(IN THOUSANDS)
<TABLE>
<CAPTION>
MEMBERS'
CAPITAL
----------
<S> <C>
Balance at January 1, 1993............................................................................ $ 433
Net income.......................................................................................... 73
Contributions....................................................................................... 1
Withdrawals......................................................................................... (456)
----------
Balance at December 31, 1993.......................................................................... 51
Net income.......................................................................................... 163
Withdrawals......................................................................................... (961)
----------
Balance at December 31, 1994.......................................................................... (747)
Issuance of members' interest (Note 10)............................................................. 1,266
Issuance costs (Note 10)............................................................................ (753)
Net loss............................................................................................ (4,970)
Withdrawals......................................................................................... (55)
Imputed capital contribution on settlement of option (Note 11)...................................... 656
Preferred return and accretion of redeemable members' capital....................................... (2,842)
----------
Balance at December 31, 1995.......................................................................... (7,445)
Net loss (unaudited)................................................................................ (2,286)
Preferred return and accretion of redeemable members' capital (unaudited)........................... (1,595)
----------
Balance at June 30, 1996 (unaudited).................................................................. $ (11,326)
----------
----------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
--------------------------- ------------------
1993 1994 1995 1995 1996
------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)............................................................. $ 73 $ 163 $ (4,970) $ (1,924) $ (2,286)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Depreciation, depletion and amortization.................................... 884 1,847 5,958 1,367 4,620
Amortization of deferred charges............................................ -- -- 137 -- 169
Other noncash............................................................... (21) 35 (75) (28) 79
Compensation related to option settlement................................... -- -- 656 656 --
Gain on sale of oil and gas properties...................................... (110) (112) -- -- (40)
Extraordinary loss resulting from extinguishment of debt.................... -- -- -- -- 1,640
Change in operating assets and liabilities:
Increase in accounts receivable........................................... (837) (1,535) (4,818) (3,568) (1,209)
Decrease (increase) in other assets....................................... 20 301 (216) (107) (2,190)
Increase (decrease) in accounts payable................................... 262 723 4,863 2,188 (880)
Increase (decrease) in other liabilities.................................. 59 102 1,537 (1,624) 671
Increase (decrease) in deferred income.................................... (8) 3 3,294 -- (696)
------- -------- -------- -------- --------
Total adjustments....................................................... 249 1,364 11,336 (1,116) 2,164
------- -------- -------- -------- --------
Net cash provided by (used in) operating activities..................... 322 1,527 6,366 (3,040) (122)
------- -------- -------- -------- --------
Cash flows from investing activities:
Capital expenditures for oil and gas properties............................... (6,634) (11,819) (61,500) (57,261) (47,727)
Proceeds from sale of oil and gas properties.................................. 131 112 -- -- --
Additions to other property and equipment..................................... (228) (49) (720) (512) (1,996)
Advances on affiliate notes receivable........................................ -- (390) (247) -- --
------- -------- -------- -------- --------
Net cash used in investing activities................................... (6,731) (12,146) (62,467) (57,773) (49,723)
------- -------- -------- -------- --------
Cash flows from financing activities:
Borrowings under long-term debt............................................... 6,770 11,579 62,704 62,680 125,390
Payments of long-term debt.................................................... -- -- (11,232) (7,902) (74,519)
Deferred loan and financing costs............................................. -- -- (2,587) (2,587) (2,728)
Proceeds from redeemable members' capital..................................... -- -- 10,000 10,000 --
Contributions................................................................. 1 -- -- -- --
Withdrawals................................................................... (456) (961) (55) (97) --
------- -------- -------- -------- --------
Net cash provided by financing activities............................... 6,315 10,618 58,830 62,094 48,143
------- -------- -------- -------- --------
Net increase (decrease) in cash and cash equivalents............................ (94) (1) 2,729 1,281 (1,702)
Cash and cash equivalents, beginning of period.................................. 232 138 137 137 2,866
------- -------- -------- -------- --------
Cash and cash equivalents, end of period........................................ $ 138 $ 137 $ 2,866 $ 1,418 $ 1,164
------- -------- -------- -------- --------
------- -------- -------- -------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(1) ORGANIZATION AND NATURE OF OPERATIONS
Costilla Energy, L.L.C. (the "Company"), a Texas limited liability company,
was formed on February 14, 1995, as the successor to CSL Partners, a Texas
general partnership, which was organized on January 11, 1989. The Company is an
unincorporated association of several individuals and a corporation and will
cease to exist thirty (30) years from the date of formation. Its members have
limited personal liability for the Company's obligations and debts. The Company
is classified as a partnership for federal income tax purposes.
The Company is an oil and gas exploration and production concern with
properties located principally in West Texas, South Texas, and the Rocky
Mountain regions of the United States.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
As of December 31, 1995, the consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. The Company
proportionately consolidates less-than-100%-owned oil and gas partnerships and
joint ventures in accordance with industry practice. All significant accounts
and transactions between the Company and its subsidiaries have been eliminated.
At December 31, 1993 and 1994, the financial statements of the Company and its
affiliates were combined. The combining companies were owned by three
individuals prior the formation of the Company. Such individuals owned exactly
the same proportionate interest in each of the combining companies prior to
their combination into the Company on February 14, 1995. Each individual held
exactly the same proportionate interest in the combining companies as was their
proportionate interest in the Company after its formation. Management believes,
based on the exact same proportionate interests being held in the combining
companies and the Company before and after the date of its formation, that the
combination lacks substance and is not the purchase of a minority interest.
Subsequent to the formation of the Company, NBCC acquired a 30% interest in
the Company as described in Note 10.
Significant intercompany transactions were eliminated.
USE OF ESTIMATES
Preparation of the accompanying consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, cash and cash equivalents
include cash on hand and depository accounts held by banks.
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially expose the Company to concentrations
of credit risk consist primarily of unsecured accounts receivable from
unaffiliated working interest owners and crude oil and natural gas purchasers.
During the year ended December 31, 1995, the Company had sales to one customer
which accounted for 17.7% of total revenues.
F-8
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
TRADE RECEIVABLES
Trade receivables generally consist of amounts due from outside working
interest owners for their proportionate share of drilling and operating costs
incurred by the Company, as operator of the related properties.
HEDGING
Premiums paid for commodity option contracts and interest rate swap
agreements are amortized to oil and gas sales and interest expense,
respectively, over the terms of the agreements. Unamortized premiums are
included in other assets in the consolidated balance sheet. Amounts receivable
under the commodity option contracts and interest rate swap agreements are
accrued as an increase in oil and gas sales and a reduction of interest expense,
respectively, for the applicable periods.
OIL AND GAS PROPERTIES
The Company uses the successful efforts method of accounting for oil and gas
producing activities. Costs to acquire mineral interests in oil and gas
properties, to drill and equip exploratory wells that find proved reserves, and
to drill and equip development wells are capitalized. Costs to drill exploratory
wells that do not find proved reserves, geological and geophysical costs, and
costs of carrying and retaining unproved properties are expensed.
Unproved oil and gas properties that are individually significant are
periodically assessed for impairment of value, and a loss is recognized at the
time of impairment by providing an impairment allowance. Other unproved
properties are amortized based on the Company's experience of successful
drilling and average holding period. Capitalized costs of producing oil and gas
properties, after considering estimated dismantlement and abandonment costs and
estimated salvage values, are depreciated and depleted by the unit-of-production
method. Support equipment and other property and equipment are depreciated on a
straight-line basis over the estimated useful lives of the assets, which range
from 5 to 7 years.
Prior to the adoption of FAS 121 on January 1, 1995, the Company's aggregate
oil and gas properties were carried at cost, not in excess of total estimated
undiscounted future net revenues, on a worldwide basis.
On sale or retirement of a complete unit of a proved property, the cost and
related accumulated depreciation, depletion, and amortization are eliminated
from the property accounts, and the resultant gain or loss is recognized. On
retirement or sale of a partial unit of proved property, the cost is charged to
accumulated depreciation, depletion, and amortization with a resulting gain or
loss recognized in income.
On sale of an entire interest in an unproved property for cash or cash
equivalent, gain or loss on the sale is recognized, taking into consideration
the amount of any recorded impairment if the property had been assessed
individually. If a partial interest in an unproved property is sold, the amount
received is treated as a reduction of the cost of the interest retained.
IMPAIRMENT OF LONG-LIVED ASSETS
As of January 1, 1995, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 121 -- ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF ("FAS 121").
Consequently, the Company reviews its long-lived assets to be held and used,
including oil and gas properties accounted for under the successful efforts
method of accounting,
F-9
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
whenever events or circumstances indicate that the carrying value of those
assets may not be recoverable. An impairment loss is indicated if the sum of the
expected future cash flows is less than the carrying amount of the assets. In
this circumstance, the Company recognizes an impairment loss for the amount by
which the carrying amount of the asset exceeds the fair value of the asset.
DEFERRED CHARGES
The Company capitalized certain costs incurred in connection with obtaining
the Credit Agreement and the related revolver and term notes (see Note 7 for
definitions and descriptions of each). These costs are being amortized over the
lives of the notes.
DEFERRED INCOME
In November 1995, the Company entered into gas sales agreements whereby it
committed to delivery of a total of 2,379,000 Mmbtu, from December 1, 1995
through December 1, 1996, for a total fixed price of $3,429,610. Income from the
agreements is recognized in the period of delivery.
REVENUE RECOGNITION
The Company uses the sales method of accounting for crude oil revenues.
Under this method, revenues are recognized based on actual volumes of oil sold
to purchasers.
The Company uses the entitlements method of accounting for natural gas
revenues. Under this method, revenues are recognized based on actual production
of natural gas. Natural gas revenues would not have been significantly altered
in any period had the sales method of recognizing natural gas revenues been
utilized.
ENVIRONMENTAL
The Company is subject to extensive Federal, state and local environmental
laws and regulations. These laws, which are constantly changing, regulate the
discharge of materials into the environment and may require the Company to
remove or mitigate the environmental effects of the disposal or release of
petroleum or chemical substances at various sites. Environmental expenditures
are expensed or capitalized depending on their future economic benefit.
Expenditures that relate to an existing condition caused by past operations and
that have no future economic benefits are expensed. Liabilities for expenditures
of a noncapital nature are recorded when environmental assessment and/ or
remediation is probable, and the costs can be reasonably estimated.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1993 and 1994 financial
statements to conform to the 1995 presentation.
INTERIM FINANCIAL STATEMENTS
The interim financial information as of June 30, 1996, and for the six
months ended June 30, 1995 and 1996, is unaudited. However, in the opinion of
management, these interim financial statements include all the necessary
adjustments to fairly present the results of the interim periods, and all such
adjustments are of a normal recurring nature. The interim financial statements
should be read in conjunction with the audited financial statements for the
years ended December 31, 1993, 1994 and 1995.
(3) ACQUISITION OF OIL AND GAS PROPERTIES
On June 12, 1995, the Company completed the acquisition of certain oil and
gas properties and related assets from Parker & Parsley Development L.P. and
Parker & Parsley Producing L.P. for $46,621,371. The transaction was accounted
for using the purchase method. The results of operations of the acquired
properties are included in the Consolidated Statements of Operations beginning
F-10
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(3) ACQUISITION OF OIL AND GAS PROPERTIES (CONTINUED)
June 12, 1995. The Company funded the acquisition under the Credit Agreement
described in Note 7. Certain of the acquired properties, which were located
outside of the Company's areas of strategic focus, were sold in 1995. No gain or
loss was recorded on these sales.
PRO FORMA RESULTS OF OPERATIONS (UNAUDITED)
The following table reflects the pro forma results of operations as though
the acquisition, net of the related properties sold, had occurred on January 1,
1994. The pro forma amounts are not necessarily indicative of the results that
may be reported in the future.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
1994 1995
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Revenues................................................................. 35,460 32,746
Net income (loss)........................................................ 1,563 (4,655)
</TABLE>
(4) IMPAIRMENT OF LONG-LIVED ASSETS
The Company adopted FAS 121 effective as of January 1, 1995. FAS 121
requires that long-lived assets held and used by an entity, including oil and
gas properties accounted for under the successful efforts method of accounting,
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Long-lived assets
to be disposed of are to be accounted for at the lower of carrying amount or
fair value less cost to sell when management has committed to a plan to dispose
of the assets. All companies, including successful efforts oil and gas
companies, are required to adopt FAS 121 for fiscal years beginning after
December 15, 1995.
In order to determine whether an impairment had occurred, the Company
estimated the expected future cash flows of its oil and gas properties and
compared such future cash flows to the carrying amount of the oil and gas
properties to determine if the carrying amount was recoverable. Based on this
process, no writedown in the carrying amount of the Company's proved properties
was necessary at December 31, 1995.
(5) DERIVATIVE FINANCIAL INSTRUMENTS
The Company utilizes derivative financial instruments to manage well-defined
interest rate and commodity price risks. The Company is exposed to credit losses
in the event of nonperformance by the counterparties to its interest rate swap
agreements and its commodity hedges. The Company anticipates, however, that such
counterparties will be able to fully satisfy their obligations under the
contracts. The Company does not obtain collateral or other security to support
financial instruments subject to credit risk but monitors the credit standing of
the counterparties.
COMMODITY HEDGES. The Company utilizes option contracts to hedge the effect
of price changes on future oil and gas production. If market prices of oil and
gas exceed the strike price of put options,
F-11
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(5) DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED)
the options will expire unexercised, therefore reducing the effective price
received for oil and gas sales by the cost of the related option. The following
table sets forth the future volumes hedged by year and the weighted-average
strike price of the option contracts at December 31, 1995:
<TABLE>
<CAPTION>
OIL GAS
VOLUME VOLUME STRIKE PRICE
(BBLS) (MMBTU) PER BBL/MMBTU
----------- ----------- ---------------------
<S> <C> <C> <C>
Oil:
1996............................................... 1,830,000 -- $16.00 - $20.38(a)
1997............................................... 912,500 -- $16.00 - $20.65(a)
Gas:
1996............................................... -- 1,500,000 $1.65(b)
1997............................................... -- 1,350,000 $1.65(b)
</TABLE>
- ------------------------
(a) Represents the weighted-average price of collars established with the
purchase of put option contracts and the sale of call option contracts.
(b) Represents the strike price on purchased put option contracts.
INTEREST RATE SWAP AGREEMENTS. The Company utilizes interest rate swap
agreements to reduce the potential impact of increases in interest rates on
floating-rate, long-term debt. If market rates of interest experienced during
the applicable swap term are below the rates of interest effectively fixed by
the swap agreement, the rate of interest experienced by the Company will exceed
the rate that would have been experienced under the Credit Agreement. At
December 31, 1995, the Company was a party to two interest rate swap agreements,
providing the Company with a fixed interest rate for the terms of the
agreements. The following table sets forth the terms, fixed rates, and notional
amounts of the agreements in place as of December 31, 1995:
<TABLE>
<CAPTION>
NOTIONAL
PRINCIPAL FIXED
TERM AMOUNT INTEREST RATE
- ------------------------------------ ------------- -------------------------------
<S> <C> <C>
Jan. 25, 1996 to Jan. 25, 1999 $24 million ranging from 7.5% to 8.5%
May 24, 1995 to May 27, 1997 $60 million 5.99%
</TABLE>
F-12
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(6) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values
of the Company's financial instruments at December 31, 1994 and 1995. FASB
Statement No. 107, DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS,
defines the fair value of a financial instrument as the amount at which the
instrument could be exchanged in a current transaction between willing parties.
<TABLE>
<CAPTION>
1994 1995
-------------------- --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
(IN THOUSANDS)
Financial assets:
Cash, cash equivalents and restricted cash....................... $ 137 $ 137 $ 2,866 $ 2,866
Receivables (trade).............................................. 1,042 1,042 3,154 3,154
Receivables (oil and gas sales).................................. 1,715 1,715 3,915 3,915
Commodity option contracts....................................... -- -- 165 555
Interest rate swap and option agreements......................... 203 -- 146 (2,970)
Notes receivable -- affiliate.................................... 390 390 684 684
Financial liabilities:
Payables (trade)................................................. 1,712 1,712 5,467 5,467
Deferred income.................................................. -- -- 3,319 2,950
Long-term debt................................................... 23,613 23,613 71,494 71,494
</TABLE>
The carrying amounts shown in the table are included in the statement of
financial position under the indicated captions.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments:
CASH, TRADE RECEIVABLES, AND TRADE PAYABLES: The carrying amounts
approximate fair value because of the short maturity of those instruments.
OTHER CURRENT ASSETS: The amounts reported relate to the commodity option
contracts and interest rate swap agreements described in Note 5. The carrying
amount comprises the unamortized premiums paid for the contracts. The fair value
is estimated using option pricing models and essentially values the potential
for the contracts and agreements to become in-the-money through changes in
commodity prices and interest rates during the remaining terms.
NOTES RECEIVABLE-AFFILIATE: The amounts reported relate to notes receivable
from an affiliated company. The carrying amount approximates fair value because
the rate given to the affiliate company is not materially different from the
affiliate company's bank debt.
DEFERRED INCOME: The amounts reported relate to the gas purchase agreements
described in Note 2. The carrying amount represents the payments received under
the agreements for which subsequent delivery is required. The fair value is
estimated based upon the commodity price at December 31, 1995, for a similar
agreement.
LONG-TERM DEBT: The fair value of the Company's long-term debt is estimated
by discounting expected cash flows at the rates currently offered to the Company
for debt of the same remaining maturities, as advised by the Company's bankers.
F-13
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(7) LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Revolver note.......................................................... $ -- $ 59,824
Term notes............................................................. -- 11,670
Note payable to bank................................................... 23,591 --
Note payable to member................................................. 22 --
--------- ---------
23,613 71,494
Less current maturities............................................ 22 --
--------- ---------
$ 23,591 $ 71,494
--------- ---------
--------- ---------
</TABLE>
At December 31, 1995, the Company and certain of its subsidiaries are
parties to a Credit Agreement with a syndicate of banks (the "Banks"). The
Credit Agreement provides for an aggregate $185 million senior secured revolving
line of credit ("Revolver Notes") and an aggregate of $15 million in senior
secured term notes ("Term Notes"). All notes are secured with the assets of the
Company and are guaranteed by the Company's subsidiaries and, to a limited
extent, its individual members.
The Revolver Notes and Term Notes are subject to an aggregate borrowing
base, as determined by the Banks or their agents in their sole discretion and is
redetermined at least bi-annually as of January 15 and July 15, utilizing oil
and gas reserve information as of the immediately preceding period end. As of
January 15, 1996, the borrowing base was $71,670,000.
All outstanding balances under the Credit Agreement may be designated, at
the Company's option, as either "Base Rate Portions" or "Fixed Rate Portions"
(both as defined in the Credit Agreement), provided that no more than five
Eurodollar Tranches may be outstanding at any time. The Base Rate Portions of
the Revolver Notes bear interest at the fluctuating Base Rate, plus a Revolver
Base Rate Spread ranging from 0.25% to 0.75%, depending upon the outstanding
principal balances of the Term Notes. The Base Rate Portions of the Term Notes
bear interest at the fluctuating Base Rate plus 0.75%. The Fixed Rate Portions
of the Revolver Notes bear interest at the Eurodollar Rate for a fixed period of
time elected by the Company, plus a Revolver Fixed Rate Spread ranging from
2.25% to 3.00%, depending on the outstanding principal balances of the Term
Notes. The Fixed Rate Portions of the Term Notes bear interest at the Eurodollar
Rate for a fixed period of time elected by the Company, plus a Fixed Rate Spread
of 3.00%. As of December 31, 1995, the Company had elected a fixed rate of 8.82%
for the Revolver Notes and had elected fixed rates ranging from 8.82% to 8.94%
for $14,000,000 of the outstanding Term Notes at December 31, 1995. The
remaining balances of the Term Notes bear interest at the Base Rate of
NationsBank Prime plus 1.50% at December 31, 1995.
The outstanding principal balance of the Revolver Notes is due and payable
in sixty (60) monthly installments beginning August 1, 1996, and continuing
regularly thereafter until July 1, 2001. The outstanding principal balance of
the Term Notes is due and payable in two (2) installments, each of which shall
be equal to one-half of the unpaid principal balance of each note, on July 1,
1996, and January 1, 1997.
The Credit Agreement requires the Company to hedge not less than 60% of the
Company's total sales volume, through December 31, 1997, from its proved
developed producing oil and gas reserves, with a floor price of not less than
$16 per Bbl of oil or $1.50 per Mcf of gas.
F-14
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(7) LONG-TERM DEBT (CONTINUED)
Additionally, the Credit Agreement contains various restrictive covenants
and compliance requirements, which include: (a) restrictions on dividends and
the incurrence of additional indebtedness; (b) restrictions as to merger, sale
or transfer of assets; (c) limiting total lease payments and total aggregate
executive compensation to $750,000 and $500,000, respectively, in any fiscal
year; and (d) compliance with certain financial ratios.
The Company was in violation of certain covenants and compliance
requirements as of December 31, 1995. Subsequent to December 31, 1995, such
violations were waived by the Banks.
Maturities of long-term debt at December 31, 1995, are as follows (in
thousands):
<TABLE>
<S> <C>
1996...................................................... $ 10,820
1997...................................................... 17,800
1998...................................................... 11,965
1999...................................................... 11,965
2000...................................................... 11,965
Thereafter................................................ 6,979
</TABLE>
The Company paid interest on long-term debt of $546,147, $1,356,604 and
$4,453,684 in 1993, 1994 and 1995, respectively.
As described in Note 12, on June 10, 1996, the Company demonstrated its
intent and ability to refinance the current maturities under the Credit
Agreement by entering into a new loan agreement, proceeds of which were used to
repay the existing notes. Concurrently, the deferred charges associated with the
Credit Agreement were expensed as an extraordinary loss.
(8) COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases equipment and office facilities under operating leases on
which rental expense for the years ended December 31, 1993, 1994 and 1995, was
$110,023, $197,533 and $311,221, respectively. Future minimum lease commitments
under noncancellable operating leases at December 31, 1995, are as follows (in
thousands):
<TABLE>
<S> <C>
1996....................................................... $ 257
1997....................................................... 272
1998....................................................... 268
1999....................................................... 195
2000....................................................... 188
Thereafter................................................. 1,190
</TABLE>
SEVERANCE AGREEMENTS
On February 17, 1995, the Company entered into employment agreements with
each of the officers which are effective from the above date through February
17, 2000, or until terminated by the officer or the Company. In addition to
providing a base salary and nominal yearly increases for each officer, the
employment agreements provide for severance payments upon termination of any
such officer's employment or a significant reduction in that officer's duties or
responsibilities.
In the event of such a termination, the Company is obligated to pay the
officer an amount equal to the present value (discounted at 10%) of the
officer's salary which would have been paid through February 17, 2000. The
current annual base salaries for the officers covered under such employment
agreements total approximately $500,000.
F-15
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(8) COMMITMENTS AND CONTINGENCIES (CONTINUED)
EXPLORATION AND DEVELOPMENT
In July 1995, the Republic of Moldova (located in Eastern Europe between
Romania and the Ukraine) granted a Concession Agreement to Resource Development
Company Limited, L.L.C. ("Redeco"), an entity not affiliated with the Company.
The Company has paid Redeco $90,000 and agreed to bear the first $2.0 million of
Concession expenses ($214,178 of which had been expended through December 31,
1995) in return for a 50.0% interest in Redeco. After the initial $2.0 million
expenditure, Redeco and the Company are responsible for bearing 50.0% each of
future expenses. The Concession Agreement covers the entire country with respect
to oil and gas and other minerals and continues for various time periods
depending on the nature of the activity conducted. In connection with two
previously producing but now abandoned fields, Redeco's exclusive rights
continue for 20 years. Redeco's exclusive period to explore throughout the
remainder of Moldova expires in 2005, but Redeco will maintain exclusive
development rights with respect to fields discovered for a period of 20 years
from the date of first production from such field. The Company has no material
fixed financial commitments with respect to the Concession.
LETTERS OF CREDIT
As a result of certain bonding and trade creditor requirements, the Company
has caused irrevocable letters of credit to be issued by a bank totaling
$106,000. As of December 31, 1995, no amounts had been drawn on these letters of
credit.
(9) 401(K) PLAN
The Company has established a qualified cash or deferred arrangement under
IRS code section 401(k) covering substantially all employees. Under the plan,
the employees have an option to make elective contributions of a portion of
their eligible compensation, not to exceed specified annual limitations, to the
plan and the Company has an option to match a percentage of the employee's
contribution. The Company has made matching contributions to the plan totaling
$16,950, $8,921 and $22,531 in 1993, 1994 and 1995, respectively.
(10) REDEEMABLE MEMBERS' CAPITAL AND MEMBERS' CAPITAL
During 1995, NationsBanc Capital Corporation ("NBCC") contributed $10
million in exchange for a 30% ownership interest in the Company including the
preferential return described below. Of this amount, $1,266,000 was attributed
to the non-redeemable portion of members' capital and $8,734,000 was attributed
to redeemable members' capital. Preferred return and accretion of members'
capital included in the consolidated statements of operations and the
consolidated statements of members' capital includes accretion of the amount
attributable to redeemable members' capital to $10,000,000 over a two year
period beginning February 17, 1995. As described below, the redemption amount
will ultimately be equal to $10,000,000 plus a preferred return and an
additional redemption amount related to NBCC's redeemable interest not subject
to preferential return. The Company incurred $751,737 in legal fees and broker's
commissions in connection with this transaction and recorded these costs as
direct charges to members' capital in 1995.
Redeemable members' capital is subject to a preferential return of 15% per
annum on $10,000,000 and is redeemable at any time at the Company's option,
subject to a redemption premium as described below, or at NBCC's option on
February 17, 2003 or at an earlier date upon occurrence of certain events
including a change in control, certain changes in management, a change in the
Company's status as a limited liability company for tax purposes, or violation
of any of various other restrictive provisions contained in the Regulations of
Costilla Energy, L.L.C. (the "Regulations"). The
F-16
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(10) REDEEMABLE MEMBERS' CAPITAL AND MEMBERS' CAPITAL (CONTINUED)
15% preferred return is treated as a reduction of members' capital. The
redemption price to be paid by the Company shall be equal to $10,000,000 plus a
premium, determined in the year the units are purchased, as follows:
<TABLE>
<CAPTION>
YEAR AFTER PREMIUM
FEBRUARY 17, 1995 PERCENTAGE
- ----------------------- -------------
<S> <C>
1 10%
2 10%
3 8%
4 6%
5 4%
6 2%
7 0%
8 0%
</TABLE>
In addition, a portion of NBCC's interest not subject to preferential return
is classified as redeemable members' capital as the Company may be required to
repurchase such interest upon the occurrence of certain events similar to those
events requiring redemption of the redeemable members' capital described above
and, in any event, on or after February 17, 2000. Such interest may, at the
Company's option, be repurchased to the extent the Company has exercised its
right to redeem all or a portion of the redeemable members' interest subject to
the preferential return. The redemption price the Company would pay in either
instance is determined by the year in which the members' capital is repurchased,
as follows:
<TABLE>
<CAPTION>
AGGREGATE
BEFORE FEBRUARY 17 REDEMPTION PRICE
- ------------------------------------------------------------------ ----------------
<S> <C>
1996.............................................................. $ 1
1997.............................................................. 1,500,000
1998.............................................................. 3,000,000
1999.............................................................. 4,500,000
2000.............................................................. 5,500,000
</TABLE>
The ultimate redemption price of $5,500,000 is being accrued ratably over
the period from February 17, 1995 through February 17, 2000 and is treated as a
reduction of members' capital.
NBCC would retain an 18% interest in the Company after the redemptions
described above occur. Such interest is not subject to redemption.
At December 31, 1995, the Company was in violation of various restrictive
provisions of the Regulations. Subsequent to December 31, 1995, NBCC waived such
violations.
(11) RELATED PARTY TRANSACTIONS
Certain members and officers of the Company own interests in and hold
positions with A&P Meter Service and Supply, Inc. ("A&P"), CSL Management
Corporation ("CSL"), 511 Tex L.C. ("511 Tex") and Valley Gathering Company
("Valley").
Advances from the Company to A&P have been consolidated into two promissory
notes. The first note, which was originally executed December 31, 1994, totals
$390,000, including accrued interest of $20,000 at December 31, 1995. The note
bears interest at a floating rate equal to the "prime rate" plus 1.0%. No
principal or interest payments are due until the maturity of the note at
December 31, 2004. The note is secured by a second lien on A&P's accounts
receivable, inventory and equipment. The
F-17
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(11) RELATED PARTY TRANSACTIONS (CONTINUED)
second note is in the amount of $294,000, including accrued interest of $47,000,
and is dated May 22, 1996. The note bears interest at 6.0% per annum, is
unsecured and is payable upon demand. During 1995, the Company paid $612,139 to
A&P for goods and services provided.
During 1993, 1994 and 1995, the Company paid $312,623, $549,620 and
$592,920, respectively, to CSL for management fees and lease payments on
equipment.
During 1995, the Company paid $67,896 to 511 Tex for office rent.
During 1994 and 1995, the Company paid $2,458 and $440,884, respectively, to
Valley for gas compression and salt water disposal charges. During 1995, Valley
paid the Company $109,399 for operating costs of its salt water disposal wells
and gas compressors.
In connection with this acquisition of a 5% interest in the Company in 1992,
a minority owner also acquired an option to purchase an additional 20% interest
in the Company for $750,000. In 1995, the majority owner of the Company agreed
to settle this option on behalf of the Company by transferring a portion of his
ownership directly to such minority owner. The option was cancelled. This
transaction was deemed to be compensation to the remaining minority owner in the
amount of $656,000.
(12) SUBSEQUENT EVENTS
On March 8, 1996, the Company executed a Purchase and Sale Agreement with
Parker and Parsley Petroleum Company to acquire certain oil and gas properties
for an estimated adjusted purchase price of approximately $42.5 million. The
properties are located primarily in south and west Texas. The transaction was
accounted for using the purchase method. The results of operations of the
acquired properties are included in the Consolidated Statements of Operations as
of the closing date, June 14, 1996.
PRO FORMA RESULTS OF OPERATIONS (UNAUDITED)
The following table reflects the pro forma results of operations for the
six-months ended June 30, 1995 and 1996, as though both acquisitions, which
closed on June 12, 1995 and June 14, 1996, had occurred as of January 1, 1995.
The pro forma amounts are not necessarily indicative of the results that may be
reported in the future.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Revenues............................................................... $ 25,706 $ 28,748
Net loss............................................................... (4,435) (2,081)
</TABLE>
In connection with the foregoing, the Company entered into a new loan
agreement with NationsBridge L.L.C., an affiliate of the Company's current
lender, to provide financing of up to $125 million in advances (the "Loans"),
subject to certain terms and conditions. Proceeds of the Loans were used to fund
the Acquisition, to refinance substantially all of the Company's outstanding
indebtedness, and for other general corporate purposes.
Advances under the Loans were to be made in two portions, Tranche A was up
to $95,000,000 and Tranche B was $30,000,000. Tranche A initially bears
interest, at the Company's option, at the applicable prime rate ("Prime") plus
0.75% or LIBOR plus 3.0%. Each margin above Prime and LIBOR increases by 0.50%
at the end of each successive three-month period, up to a maximum of 2.75% and
5.0% for Prime and LIBOR, respectively. Tranche B initially bears interest at
14.00% per annum, increasing 0.50% at the end of each successive three-month
period, up to a maximum of 16.5%.
F-18
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(12) SUBSEQUENT EVENTS (CONTINUED)
Tranche A loans are subject to a borrowing base determination. The initial
borrowing base is $95,000,000 which is automatically reduced by $3,000,000 per
quarter beginning January 1, 1997. The borrowing base is also subject to
periodic redetermination by NationsBridge L.L.C. based on its determination of
the collateral value of the Company's oil and gas properties. Final maturity of
loans made under Tranches A and B is June 10, 1999.
The Loans are secured by first priority liens, assignments and security
interests in all oil and gas properties, pipelines and gathering systems of the
Company and stock of the Company's subsidiaries. Additionally, the Loans are
subject to various restrictive covenants and compliance requirements, including
but not limited to (a) restrictions on dividends and the incurrence of
additional indebtedness, (b) minimum limitations on the Company's current ratio
and tangible net worth, (c) limitations on payments for leases and executive
compensation, (d) maximum limitations on general and administrative expenses,
capital expenditures and the Company's ratio of debt to adjusted cash flow, and
(e) a requirement to pay to the lender all net oil and gas revenues (as defined
and as adjusted for capital expenditures) on a quarterly basis.
The Company paid the lender's fees and expenses in connection with obtaining
the Loans. The fees were approximately $2,625,000 and will increase by an
additional $625,000 if the Tranche B Loans remain outstanding for more than 90
days. As the Company believes that it is probable that the additional $625,000
in fees will be paid, the total fees of $3,250,000 are being amortized as
additional interest expense over a period of one year from the date of the
Loans. In addition, if the Tranche B amounts are not repaid within one year, an
additional amount of $4,800,000 will accrue. If such additional fee is incurred,
it will be amortized over the remaining period that the Loans are expected to be
outstanding.
(13) OIL AND GAS EXPENDITURES
The following table reflects costs incurred in oil and gas property
acquisition, exploration and development activities:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
------------------------------- ENDED MARCH 31,
1993 1994 1995 1996
--------- --------- --------- ---------------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C>
Property acquisition costs:
Proved........................................................ $ 4,665 $ 9,649 $ 52,470 $ 2,246
Unproved...................................................... 829 1,232 1,742 677
Exploration..................................................... 2,017 2,167 5,627 1,822
Development..................................................... -- -- 158 232
--------- --------- --------- -------
$ 7,511 $ 13,048 $ 59,997 $ 4,977
--------- --------- --------- -------
--------- --------- --------- -------
</TABLE>
(14) SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED)
The estimates of proved oil and gas reserves, which are located principally
in the United States, were prepared by the Company as of December 31, 1993, 1994
and 1995, and Williamson Petroleum Consultants as of March 31, 1996. Reserves
were estimated in accordance with guidelines established by the SEC and FASB
which require that reserve estimates be prepared under existing economic and
operating conditions with no provision for price and cost escalations, except by
contractual arrangements. The Company has presented the reserve estimates
utilizing an oil price of $17.79 per Bbl and a gas price of $2.03 per Mcf as of
December 31, 1995, and an oil price of $20.71 per Bbl and a gas price of $2.00
per Mcf as of March 31, 1996.
F-19
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(14) SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) (CONTINUED)
OIL AND GAS PRODUCING ACTIVITIES
Oil and gas reserve quantity estimates are subject to numerous uncertainties
inherent in the estimation of quantities of proved reserves and in the
projection of future rates of production and the timing of development
expenditures. The accuracy of such estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Results of subsequent drilling, testing and production may cause either upward
or downward revision of previous estimates. Further, the volumes considered to
be commercially recoverable fluctuate with changes in prices and operating
costs. The Company emphasizes that reserve estimates are inherently imprecise
and that estimates of new discoveries are more imprecise than those of currently
producing oil and gas properties. Accordingly, these estimates are expected to
change as additional information becomes available in the future.
<TABLE>
<CAPTION>
OIL AND CONDENSATE GAS
(MBBLS) (MMCF)
------------------- -----------
<S> <C> <C>
Total Proved Reserves:
Balance, January 1, 1993....................................................... 1,985 16,418
Revisions of previous estimates.............................................. 57 1,160
Extensions and discoveries................................................... 380 591
Production................................................................... (158) (865)
Purchases of minerals-in-place............................................... 101 4,315
------- -----------
Balance, December 31, 1993..................................................... 2,365 21,619
Revisions of previous estimates.............................................. (460) (5,424)
Extensions and discoveries................................................... 761 1,520
Production................................................................... (330) (1,600)
Purchases of minerals-in-place............................................... 1,673 11,397
------- -----------
Balance, December 31, 1994..................................................... 4,009 27,512
Revisions of previous estimates.............................................. (570) 425
Extensions and discoveries................................................... 605 8,922
Production................................................................... (950) (4,806)
Purchases of minerals-in-place............................................... 7,694 46,099
------- -----------
Balance, December 31, 1995..................................................... 10,788 78,152
Revisions of previous estimates.............................................. 437 2,615
Extensions and discoveries................................................... 592 296
Production................................................................... (338) (1,643)
Purchases of minerals-in-place............................................... -- --
------- -----------
Balance, March 31, 1996........................................................ 11,479 79,420
------- -----------
------- -----------
Proved Developed Reserves:
January 1, 1993.............................................................. 1,488 10,055
December 31, 1993............................................................ 1,785 13,268
December 31, 1994............................................................ 2,632 16,340
December 31, 1995............................................................ 8,566 57,393
March 31, 1996............................................................... 9,037 55,408
</TABLE>
F-20
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(14) SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) (CONTINUED)
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED
OIL AND GAS RESERVES
The standardized measure of discounted future net cash flows is computed by
applying year-end prices of oil and gas (with consideration of price changes
only to the extent provided by contractual arrangements) to the estimated future
production of proved oil and gas reserves, less estimated future expenditures
(based on year-end costs) to be incurred in developing and producing the proved
reserves, less estimated future income tax expenses (based on year-end statutory
tax rates, with consideration of future tax rates already legislated) to be
incurred on pretax net cash flows, less tax basis of the properties and
available credits, and assuming continuation of existing economic conditions.
The estimated future net cash flows are then discounted using a rate of 10% per
year to reflect the estimated timing of the future cash flows.
Discounted future cash flow estimates like those shown below are not
intended to represent estimates of the fair value of oil and gas properties.
Estimates of fair value should also consider probable reserves, anticipated
future oil and gas prices, interest rates, changes in development and production
costs and risks associated with future production. Because of these and other
considerations, any estimate of fair value is necessarily subjective and
imprecise.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------------------- ---------------
1993 1994 1995 1996
---------- ----------- ------------ ---------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Future cash flows........................................ $ 83,510 $ 122,098 $ 350,653 $ 396,919
Future costs:
Production............................................. (31,811) (46,345) (145,510) (162,146)
Development............................................ (4,486) (7,157) (16,806) (17,975)
---------- ----------- ------------ ---------------
Future net cash flows.................................... 47,213 68,596 188,337 216,798
10% annual discount for estimated timing of cash flows... (20,836) (31,817) (75,041) (87,707)
---------- ----------- ------------ ---------------
Standardized measure of discounted net cash flows........ $ 26,377 $ 36,779 $ 113,296 $ 129,091
---------- ----------- ------------ ---------------
---------- ----------- ------------ ---------------
</TABLE>
F-21
<PAGE>
COSTILLA ENERGY, L.L.C.
(A TEXAS LIMITED LIABILITY COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(THE INFORMATION AND AMOUNTS FOR INTERIM PERIODS ARE UNAUDITED.)
(14) SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED) (CONTINUED)
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM
PROVED RESERVES
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
--------------------------------- ---------------
1993 1994 1995 1996
--------- --------- ----------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Increase (decrease):
Purchase of minerals-in-place............................. $ 3,732 $ 15,231 $ 77,343 $ --
Extensions and discoveries and improved recovery, net of
future production and development costs.................. 2,707 4,072 9,799 6,002
Accretion of discount..................................... 2,056 2,638 3,678 2,832
Net change in sales prices, net of production costs....... (209) 503 (3,422) 9,229
Changes in estimated future development costs............. (16) 940 (2,419) (235)
Revisions of quantity estimates........................... 1,203 (7,248) (2,855) 4,839
Sales, net of production costs............................ (2,543) (5,286) (11,338) (5,174)
Changes of production rates (timing) and other............ (1,114) (448) 5,731 (1,698)
--------- --------- ----------- ---------------
Net increase............................................ 5,816 10,402 76,517 15,795
Standardized measure of discounted future net cash flows:
Beginning of period..................................... 20,561 26,377 36,779 113,296
--------- --------- ----------- ---------------
End of period........................................... $ 26,377 $ 36,779 $ 113,296 $ 129,091
--------- --------- ----------- ---------------
--------- --------- ----------- ---------------
</TABLE>
The 1995 future cash flows shown above include amounts attributable to
proved undeveloped reserves requiring approximately $15.0 million of future
development costs. If these reserves are not developed, the standardized measure
of discounted future net cash flows for 1995 shown above would be reduced by
approximately $22.4 million.
F-22
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Members
Costilla Energy, L.L.C.:
We have audited the accompanying statements of revenues and direct operating
expenses of the 1995 Acquisition (see Note 1) for the years ended December 31,
1993 and 1994, and the period ended June 12, 1995. These statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statements of revenues and direct
operating expenses are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
The accompanying statements of revenues and direct operating expenses were
prepared for the purpose of complying with the rules and regulations of the
Securities and Exchange Commission (for inclusion in Forms S-1 of Costilla
Energy, Inc. as described in Note 1) and are not intended to be a complete
presentation of the 1995 Acquisition interests' revenue and expenses.
In our opinion, the statements of revenues and direct operating expenses
referred to above present fairly, in all material respects, the revenues and
direct operating expenses of the 1995 Acquisition for the years ended December
31, 1993 and 1994, and the period ended June 12, 1995, in conformity with
generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas
July 4, 1996
F-23
<PAGE>
COSTILLA ENERGY, L.L.C.
1995 ACQUISITION
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-------------------- PERIOD ENDED
1993 1994 JUNE 12, 1995
--------- --------- --------------
<S> <C> <C> <C>
Revenues:
Oil and condensate...................................................... $ 18,542 $ 16,217 $ 7,572
Natural gas............................................................. 13,780 11,407 3,358
--------- --------- --------------
32,322 27,624 10,930
Direct operating expenses:
Lease operating......................................................... 13,376 11,220 4,550
Workovers and dry hole costs............................................ 462 470 109
Production taxes........................................................ 2,070 2,023 923
--------- --------- --------------
15,908 13,713 5,582
--------- --------- --------------
Revenues in excess of direct operating expenses........................... $ 16,414 $ 13,911 $ 5,348
--------- --------- --------------
--------- --------- --------------
</TABLE>
See the accompanying notes to these statements.
F-24
<PAGE>
COSTILLA ENERGY, L.L.C.
1995 ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
(1) BASIS OF PRESENTATION
On June 12, 1995, Costilla Energy, L.L.C. and Costilla Petroleum Corporation
(collectively, the "Company") acquired from Parker & Parsley Development L.P.
and Parker & Parsley Producing L.P. (collectively, "Parker & Parsley") certain
oil and gas properties (the "1995 Acquisition") for $46,621,371. The
accompanying statements of revenues and direct operating expenses for the 1995
Acquisition do not include general and administrative expenses, interest income
or expense, a provision for depreciation, depletion and amortization, or any
provision for income taxes since historical expenses of this nature incurred by
Parker & Parsley are not necessarily indicative of the costs to be incurred by
the Company.
Historical financial information reflecting financial position, results of
operations, and cash flows of the 1995 Acquisition, are not presented because
the purchase price was assigned to the oil and gas property interests acquired.
Other assets acquired and liabilities assumed were not material. Accordingly,
the historical statements of revenues and direct operating expenses of the 1995
Acquisition are presented in lieu of the financial statements required under
Rule 3-05 of Securities and Exchange Commission Regulation S-X.
Revenues in the accompanying statements of revenues and direct operating
expenses are recognized on the sales method. Under this method, revenues are
recognized based on actual volumes of oil and gas sold to purchasers. Direct
operating expenses are recognized on the accrual method.
(2) SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)
ESTIMATED QUANTITIES OF PROVED OIL AND GAS RESERVES
Reserve information presented below for the 1995 Acquisition is based on
Company prepared reserve estimates, using prices and costs in effect at December
31, 1993 and 1994, and the period ended June 12, 1995. Changes in reserve
estimates were derived by adjusting the period-end quantities and values for
actual production using historical prices and costs.
Proved reserves are estimated quantities of crude oil and natural gas which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed reserves are those which are expected to
be recovered through existing wells with existing equipment and operating
methods. Oil and gas reserve quantity estimates are subject to numerous
uncertainties inherent in the estimation of quantities of proved reserves and in
the projection of future rates of production and the timing of development
expenditures. The accuracy of such estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Results of subsequent drilling, testing and production may cause either upward
or downward revision of previous estimates. Further, the volumes considered to
be commercially recoverable fluctuate with changes in prices and operating
costs. The Company emphasizes that reserve estimates are inherently imprecise
and that estimates of new discoveries are more imprecise than those of currently
producing oil and gas properties. Accordingly, these reserve estimates are
expected to change as additional information becomes available in the future.
F-25
<PAGE>
COSTILLA ENERGY, L.L.C.
1995 ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES (CONTINUED)
(2) SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)
(CONTINUED)
Below are the net estimated quantities of proved reserves and proved
developed reserves for the 1995 Acquisition.
<TABLE>
<CAPTION>
OIL (MBBLS) GAS (MMCF)
----------- -----------
<S> <C> <C>
Proved reserves at December 31, 1992............................... 9,880 60,199
Production......................................................... (1,204) (6,914)
----------- -----------
Proved reserves at December 31, 1993............................... 8,676 53,285
Production......................................................... (1,142) (6,778)
----------- -----------
Proved reserves at December 31, 1994............................... 7,534 46,507
Production......................................................... (479) (2,405)
----------- -----------
Proved reserves at June 12, 1995................................... 7,055 44,102
----------- -----------
----------- -----------
Proved developed reserves at June 12, 1995......................... 6,707 38,151
----------- -----------
----------- -----------
</TABLE>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS OF PROVED OIL AND
GAS RESERVES
The Company has estimated the standardized measure of discounted future net
cash flows and changes therein relating to proved oil and gas reserves in
accordance with the standards established by the Financial Accounting Standards
Board through its Statement No. 69. The estimates of future cash flows and
future production and development costs are based on period-end sales prices for
oil and gas, estimated future production of proved reserves, and estimated
future production and development costs of proved reserves, based on current
costs and economic conditions. The estimated future net cash flows are then
discounted at a rate of 10%.
Discounted future net cash flow estimates like those shown below are not
intended to represent estimates of the fair market value of oil and gas
properties. Estimates of fair market value should also consider probable
reserves, anticipated future oil and gas prices, interest rates, changes in
development and production costs and risks associated with future production.
Because of these and other considerations, any estimate of fair market value is
necessarily subjective and imprecise.
The following are the Company's estimated standardized measure of discounted
future net cash flows from proved reserves attributable to the 1995 Acquisition:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1993 1994 JUNE 12, 1995
----------- ----------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Future:
Cash inflows................................................. $ 222,698 $ 188,828 $ 191,758
Production costs............................................. (111,619) (97,988) (93,268)
Development costs............................................ (4,797) (4,797) (4,797)
----------- ----------- -------------
Net cash flows before income taxes......................... 106,282 86,043 93,693
10% annual discount for estimated timing of cash flows......... (37,518) (30,373) (33,074)
----------- ----------- -------------
Standardized measure of discounted future net cash flows before
income taxes.................................................. $ 68,764 $ 55,670 $ 60,619
----------- ----------- -------------
----------- ----------- -------------
</TABLE>
F-26
<PAGE>
COSTILLA ENERGY, L.L.C.
1995 ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES (CONTINUED)
(2) SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)
(CONTINUED)
The following are the sources of changes in the standardized measure of
discounted net cash flows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER
31,
---------------------- PERIOD ENDED
1993 1994 JUNE 12, 1995
---------- ---------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Standardized measure, beginning of period.................... $ 96,022 $ 68,764 $ 55,670
Sales, net of production costs............................... (16,414) (13,911) (5,348)
Net change in prices......................................... (15,892) (3,910) 8,032
Accretion of discount........................................ 9,602 6,876 2,517
Other........................................................ (4,554) (2,149) (252)
---------- ---------- -------------
Standardized measure, end of period.......................... $ 68,764 $ 55,670 $ 60,619
---------- ---------- -------------
---------- ---------- -------------
</TABLE>
F-27
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Members
Costilla Energy, L.L.C.:
We have audited the accompanying statements of revenues and direct operating
expenses of the 1996 Acquisition (see Note 1) for the years ended December 31,
1993, 1994 and 1995. These statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these statements
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the statements of revenues and direct
operating expenses are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
The accompanying statements of revenues and direct operating expenses were
prepared for the purpose of complying with the rules and regulations of the
Securities and Exchange Commission (for inclusion in Forms S-1 of Costilla
Energy, Inc. as described in Note 1) and are not intended to be a complete
presentation of the 1996 Acquisition interests' revenues and expenses.
In our opinion, the statements of revenues and direct operating expenses
referred to above present fairly, in all material respects, the revenues and
direct operating expenses of the 1996 Acquisition for the years ended December
31, 1993, 1994 and 1995, in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
Midland, Texas
July 4, 1996
F-28
<PAGE>
COSTILLA ENERGY, L.L.C.
1996 ACQUISITION
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED PERIODS
DECEMBER 31, ENDED JUNE 14,
------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
(UNAUDITED)
Revenues:
Oil and condensate...................................... $ 11,467 $ 10,170 $ 10,564 $ 5,140 $ 5,205
Natural gas............................................. 11,294 10,105 8,645 3,763 3,434
Gas plant............................................... 57 57 126 47 42
Transportation.......................................... 39 379 556 253 542
--------- --------- --------- --------- ---------
22,857 20,711 19,891 9,203 9,223
Direct operating expenses:
Lease operating......................................... 10,977 9,053 9,232 3,965 4,020
Workovers and dry hole costs............................ 675 869 1,002 256 450
Production taxes........................................ 1,166 1,089 992 458 453
Gas plant............................................... 131 350 598 393 269
Transportation.......................................... 10 394 587 268 222
--------- --------- --------- --------- ---------
12,959 11,755 12,411 5,340 5,414
--------- --------- --------- --------- ---------
Revenues in excess of direct operating expenses........... $ 9,898 $ 8,956 $ 7,480 $ 3,863 $ 3,809
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See the accompanying notes to these statements.
F-29
<PAGE>
COSTILLA ENERGY, L.L.C.
1996 ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
(1) BASIS OF PRESENTATION
On June 14, 1996, Costilla Energy, L.L.C. and Costilla Petroleum Corporation
(collectively, the "Company") acquired from Parker & Parsley Development L.P.,
Parker & Parsley Producing L.P. and Parker & Parsley Gas Processing Co.
(collectively, "Parker & Parsley") certain oil and gas properties (the "1996
Acquisition") for approximately $42.5 million. The accompanying statements of
revenues and direct operating expenses for the 1996 Acquisition do not include
general and administrative expenses, interest income or expense, a provision for
depreciation, depletion and amortization, or any provision for income taxes
since historical expenses of this nature incurred by Parker & Parsley are not
necessarily indicative of the costs to be incurred by the Company.
Historical financial information reflecting financial position, results of
operations, and cash flows of the 1996 Acquisition, are not presented because
the purchase price was assigned to the oil and gas property interests acquired.
Other assets acquired and liabilities assumed were not material. Accordingly,
the historical statements of revenues and direct operating expenses of the 1996
Acquisition are presented in lieu of the financial statements required under
Rule 3-05 of Securities and Exchange Commission Regulation S-X.
Revenues in the accompanying statements of revenues and direct operating
expenses are recognized on the sales method. Under this method, revenues are
recognized based on actual volumes of oil and gas sold to purchasers. Direct
operating expenses are recognized on the accrual method.
INTERIM STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
The interim financial information for the periods ended June 14, 1995 and
1996, is unaudited. However, in the opinion of management, the interim
statements of revenues and direct operating expenses include all the necessary
adjustments to fairly present the results of the interim periods and all such
adjustments are of a normal recurring nature. The interim statements of revenues
and direct operating expenses should be read in conjunction with the audited
statements of revenues and direct operating expenses for the years ended
December 31, 1993, 1994 and 1995.
(2) SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)
ESTIMATED QUANTITIES OF PROVED OIL AND GAS RESERVES
Reserve information presented below for the 1996 Acquisition, as of March
31, 1996, is based on reserve estimates prepared by Williamson Petroleum
Consultants, using prices and costs in effect at that date. Changes in reserve
estimates were derived by adjusting such quantities and values for actual
production using historical prices and costs.
Proved reserves are estimated quantities of crude oil and natural gas which
geological and engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating conditions. Proved developed reserves are those which are expected to
be recovered through existing wells with existing equipment and operating
methods. Oil and gas reserve quantity estimates are subject to numerous
uncertainties inherent in the estimation of quantities of proved reserves and in
the projection of future rates of production and the timing of development
expenditures. The accuracy of such estimates is a function of the quality of
available data and of engineering and geological interpretation and judgment.
Results of subsequent drilling, testing and production may cause either upward
or downward revision of previous estimates. Further, the volumes considered to
be commercially recoverable fluctuate with changes in prices and operating
costs. The Company emphasizes that reserve estimates are inherently imprecise
and that
F-30
<PAGE>
COSTILLA ENERGY, L.L.C.
1996 ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES (CONTINUED)
(2) SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED) (CONTINUED)
estimates of new discoveries are more imprecise than those of currently
producing oil and gas properties. Accordingly, these reserve estimates are
expected to change as additional information becomes available in the future.
Below are the net estimated quantities of proved reserves and proved
developed reserves for the 1996 Acquisition.
<TABLE>
<CAPTION>
OIL (MBBLS) GAS (MMCF)
----------- -----------
<S> <C> <C>
Proved reserves at December 31, 1992.................................................... 7,211 49,963
Production.............................................................................. (718) (5,481)
----- -----------
Proved reserves at December 31, 1993.................................................... 6,493 44,482
Production.............................................................................. (685) (5,217)
----- -----------
Proved reserves at December 31, 1994.................................................... 5,808 39,265
Production.............................................................................. (656) (4,773)
----- -----------
Proved reserves at December 31, 1995.................................................... 5,152 34,492
Production.............................................................................. (154) (991)
----- -----------
Proved reserves at March 31, 1996....................................................... 4,998 33,501
----- -----------
----- -----------
Proved developed reserves at March 31, 1996............................................. 4,515 28,961
----- -----------
----- -----------
</TABLE>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS OF PROVED OIL AND GAS
RESERVES
The Company has estimated the standardized measure of discounted future net
cash flows and changes therein relating to proved oil and gas reserves in
accordance with the standards established by the Financial Accounting Standards
Board through its Statement No. 69. The estimates of future cash flows and
future production and development costs are based on year-end sales prices for
oil and gas, estimated future production of proved reserves, and estimated
future production and development costs of proved reserves, based on current
costs and economic conditions. The estimated future net cash flows are then
discounted at a rate of 10%.
Discounted future net cash flow estimates like those shown below are not
intended to represent estimates of the fair market value of oil and gas
properties. Estimates of fair market value should also consider probable
reserves, anticipated future oil and gas prices, interest rates, changes in
development and production costs and risks associated with future production.
Because of these and other considerations, any estimate of fair market value is
necessarily subjective and imprecise.
F-31
<PAGE>
COSTILLA ENERGY, L.L.C.
1996 ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES (CONTINUED)
(2) SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED) (CONTINUED)
The following are the Company's estimated standardized measure of discounted
future net cash flows from proved reserves attributable to the 1996 Acquisition:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------- MARCH 31,
1993 1994 1995 1996
------------ ------------ ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Future:
Cash inflows.............................................. $ 181,010 $ 156,222 $ 165,862 $ 175,507
Production costs.......................................... (116,115) (105,104) (93,878) (91,202)
Development costs......................................... (4,101) (4,101) (4,101) (4,101)
------------ ------------ ----------- -----------
Net cash flows before income taxes...................... 60,794 47,017 67,883 80,204
10% annual discount for estimated timing of cash flows...... (22,564) (17,451) (25,195) (29,768)
------------ ------------ ----------- -----------
Standardized measure of discounted future net cash flows
before income taxes........................................ $ 38,230 $ 29,566 $ 42,688 $ 50,436
------------ ------------ ----------- -----------
------------ ------------ ----------- -----------
</TABLE>
The following are the sources of changes in the standardized measure of
discounted net cash flows:
<TABLE>
<CAPTION>
THREE MONTH
YEARS ENDED DECEMBER 31, PERIOD ENDED
------------------------------- MARCH 31,
1993 1994 1995 1996
--------- --------- --------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Standardized measure, beginning of period....................... $ 56,372 $ 38,230 $ 29,566 $ 42,688
Sales, net of production costs.................................. (9,943) (9,264) (7,983) (2,090)
Net change in prices............................................ (11,890) (2,838) 18,141 9,277
Accretion of discount........................................... 5,637 3,823 2,957 1,067
Other........................................................... (1,946) (385) 7 (506)
--------- --------- --------- ------------
Standardized measure, end of period............................. $ 38,230 $ 29,566 $ 42,688 $ 50,436
--------- --------- --------- ------------
--------- --------- --------- ------------
</TABLE>
F-32
<PAGE>
APPENDIX A
July 23, 1996
Costilla Energy, Inc.
400 West Illinois, Suite 1000
Midland, Texas 79701
Attention Mr. Michael J. Grella
Gentlemen:
Subject: Summary Letter (for Inclusion in a Prospectus Included in a
Registration Statement for Costilla Energy, Inc. on Form S-1)
Combining Specific Data from Two Williamson Petroleum
Consultants, Inc. Evaluations (1) to the Interests of Costilla
Petroleum Corporation in Various Properties and (2) to the
Interests of Parker & Parsley Petroleum USA, Inc. in Various
Properties Included in Their First Quarter 1996 Sales Package
Effective April 1, 1996
Williamson Project 6.8393
In accordance with your request, Williamson Petroleum Consultants, Inc.
(Williamson) has prepared a summary letter for inclusion in a prospectus for
Costilla Energy, Inc. (Costilla). The filing of this Prospectus gives effect to
the conversion of Costilla Energy, L.L.C. to Costilla Energy, Inc. This summary
letter includes specific data from two evaluations the subjects of which are
described in Item I. All values and discussion of proved reserves and net
revenues, data utilized, assumptions, and qualifications are taken from and
include by reference data from these two evaluations.
Interests in this summary letter represent the April 1, 1996 effective date
consolidation of the ownership interests of Costilla and the ownership interests
of Parker & Parsley in various properties included in their first quarter 1996
sales package which Costilla acquired on June 14, 1996 but which was made
effective as of January 1, 1996. The Costilla interests include all the
interests of Costilla Energy, L.L.C. and all its wholly-owned subsidiaries
including Costilla Petroleum Corporation.
I. THE TWO SUBJECT EVALUATIONS
This summary letter combines certain proved oil and gas reserves and
revenues from the following two Williamson evaluations:
(1) Evaluation of Oil and Gas Reserves to the Interests of Costilla
Petroleum Corporation in Various Properties, Effective April 1, 1996,
Utilizing Nonescalated Economics, for Disclosure to the Securities and
Exchange Commission, Williamson Project 6.8393, transmitted July 18, 1996
(the Costilla report)
(2) Evaluation of Oil and Gas Reserves to the Interests of Parker & Parsley
Petroleum USA, Inc. in Various Properties Included in Their First Quarter
1996 Sales Package, Effective April 1, 1996, Utilizing Nonescalated
Economics, for Disclosure to the Securities and Exchange Commission,
Williamson Project 6.8393, transmitted July 18, 1996 (the Acquisition
report)
II. ESTIMATED SEC RESERVES AND FUTURE NET REVENUES
Projections of the reserves that are attributable to the consolidated
interests in this summary letter were based on economic parameters and operating
conditions considered applicable as of April 1, 1996 and are pursuant to the
requirements of the Securities and Exchange Commission (SEC).
In accordance with instructions from Costilla, Williamson utilized lease
operating expenses for the Costilla-operated properties in the Costilla report
that excluded COPAS overhead and internal
A-1
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 2
indirect overhead which are billed to outside working interest owners. The
exclusion of these costs for the operated properties results in the calculation
of a lower economic limit and causes the economic lifetime to be extended.
Williamson has not quantified the incremental reserves resulting from this
procedure. COPAS overhead was excluded from the lease operating expenses for the
Parker & Parsley-operated properties in the Acquisition report.
The present values of the estimated future net revenues from proved reserves
were calculated using a discount rate of 10.00 percent per year and were
computed in accordance with the financial reporting requirements of the SEC.
Following is a summary of the results of the two evaluations effective April 1,
1996:
<TABLE>
<CAPTION>
PROVED PROVED
DEVELOPED DEVELOPED PROVED TOTAL
PRODUCING NONPRODUCING UNDEVELOPED PROVED
-------------- ----------------- ---------------- --------------
<S> <C> <C> <C> <C>
Net Reserves to the Evaluated Interests:
Oil/Condensate, BBL...................... 13,122,088 429,450 2,924,589 16,476,127
Gas, MCF................................. 76,439,217 7,929,591 28,551,497 112,920,305
Future Net Revenue, $:
Undiscounted............................. 212,071,507 18,097,949 66,832,632 297,002,088
Discounted Per Annum at 10.00 Percent.... 135,185,097 9,530,285 34,811,523 179,526,905
</TABLE>
- ------------------------
Note: The values presented in this table are taken from evaluations described in
Item I and include by reference all data, qualifications, and assumptions
from these evaluations. Realization of these values is contingent on
achieving successful results from the various schedules and assumptions in
these evaluations. The available engineering data and the completeness
and/or quality of data utilized in evaluating the properties are detailed
in the specific evaluation. Review of any additionally available data may
necessitate revision to these interpretations and assumptions and impact
these values.
III. DEFINITIONS OF SEC RESERVES (1)
The estimated reserves presented in this summary letter are net proved
reserves, including proved developed producing, proved developed nonproducing,
and proved undeveloped reserves, and were computed in accordance with the
financial reporting requirements of the SEC. In preparing these evaluations, no
attempt has been made to quantify the element of uncertainty associated with any
category. Reserves were assigned to each category as warranted. The definitions
of oil and gas reserves pursuant to the requirements of the Securities Exchange
Act are:
PROVED RESERVES (2)
Proved reserves are the estimated quantities of crude oil, natural gas, and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under the economic criteria employed and existing operating
- ------------------------
(1) For evaluations prepared for disclosure to the Securities and Exchange
Commission, see SEC ACCOUNTING RULES. Commerce Clearing House, Inc. October
1981, Paragraph 290, Regulation 210.4-10, p. 329.
(2) Any variations to these definitions will be clearly stated in the report.
A-2
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 3
conditions, i.e., prices and costs as of the date the estimate is made. Prices
and costs include consideration of changes provided only by contractual
arrangements but not on escalations based upon an estimate of future conditions.
A. Reservoirs are considered proved if economic producibility is supported by
either actual production or conclusive formation test. The area of a
reservoir considered proved includes:
1. that portion delineated by drilling and defined by gas-oil and/or
oil-water contacts, if any; and
2. the immediately adjoining portions not yet drilled, but which can be
reasonably judged as economically productive on the basis of available
geological and engineering data. In the absence of information on fluid
contacts, the lowest known structural occurrence of hydrocarbons controls
the lower proved limit of the reservoir.
B. Reserves which can be produced economically through application of improved
recovery techniques (such as fluid injection) are included in the "proved"
classification when successful testing by a pilot project, or the operation
of an installed program in the reservoir, provides support for the
engineering analysis on which the project or program was based.
C. Estimates of proved reserves do not include the following:
1. oil that may become available from known reservoirs but is classified
separately as "indicated additional reserves;"
2. crude oil, natural gas, and natural gas liquids, the recovery of which
is subject to reasonable doubt because of uncertainty as to geology,
reservoir characteristics, or economic factors;
3. crude oil, natural gas, and natural gas liquids, that may occur in
undrilled prospects; and
4. crude oil, natural gas, and natural gas liquids, that may be recovered
from oil shales, coal (3), gilsonite and other such sources.
PROVED DEVELOPED RESERVES (4)
Proved developed reserves are reserves that can be expected to be recovered
through existing wells with existing equipment and operating methods. Additional
oil and gas expected to be obtained through the application of fluid injection
or other improved recovery techniques for supplementing the natural forces and
mechanisms of primary recovery should be included as "proved developed reserves"
only after testing by a pilot project or after the operation of an installed
program has confirmed through production response that increased recovery will
be achieved.
PROVED UNDEVELOPED RESERVES
Proved undeveloped reserves are reserves that are expected to be recovered
from new wells on undrilled acreage, or from existing wells where a relatively
major expenditure is required for recompletion. Reserves on undrilled acreage
shall be limited to those drilling units offsetting productive
- ------------------------
(3) According to Staff Accounting Bulletin 85, excluding certain coalbed methane
gas.
(4) Williamson Petroleum Consultants, Inc. separates proved developed reserves
into proved developed producing and proved developed nonproducing reserves.
This is to identify proved developed producing reserves as those to be
recovered from actively producing wells; proved developed nonproducing
reserves as those to be recovered from wells or intervals within wells,
which are completed but shut in waiting on equipment or pipeline
connections, or wells where a relatively minor expenditure is required for
recompletion to another zone.
A-3
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 4
units that are reasonably certain of production when drilled. Proved reserves
for other undrilled units can be claimed only where it can be demonstrated with
certainty that there is continuity of production from the existing productive
formation. Under no circumstances should estimates for proved undeveloped
reserves be attributable to any acreage for which an application of fluid
injection or other improved recovery technique is contemplated, unless such
techniques have been proved effective by actual tests in the area and in the
same reservoir.
IV. DISCUSSION OF SEC RESERVES
A. THE COSTILLA REPORT
A total of 1,014 properties in 294 fields were evaluated in the Costilla
report. Nineteen individual properties had values greater than 1.0 percent
of the total future net revenue discounted at 10.00 percent per annum (DFNR)
and in aggregate represent 34.5 percent of the DFNR in the Costilla report.
The most valued property, the T.B. Pruett Gas Unit No. 3, Soda Lake field,
Ward County, Texas, had a value equal to 4.5 percent of the total DFNR in
the Costilla report. The top eight major-value fields are Talbot (Canyon),
Howard County, Texas; Spraberry (Trend Area), Various Counties, Texas; Soda
Lake (Fusselman), Ward County, Texas; South Buffalo Ridge, Crane County,
Texas; Wattenberg, Weld County, Colorado; East Goldsmith, Ector County,
Texas; Raymond, Sheridan County, Montana; and South West Speaks, Lavaca
County, Texas. These fields contain ten of the 19 top value properties and
represent, in aggregate, 41.0 percent of the total DFNR in the Costilla
report. The remaining 286 fields represent 59.0 percent with no field having
more than 2.9 percent of the DFNR in the Costilla report. A more detailed
property review is included in the Costilla report.
Area oil prices were provided by Costilla to be used at the effective date
with the written assurance that the use of these area prices is reasonable
on an aggregate basis and would not materially affect the income from any
major-value property. These area prices were calculated by adjusting the
West Texas Intermediate oil April 1, 1996 posted price of $20.75 per barrel.
The oil price adjustments for each area are the calculated differences
between the actual price received during 1995 and the posted price for West
Texas Intermediate oil during that same period. After the effective date,
prices were held constant for the life of the properties. No attempt has
been made to account for oil price fluctuations which have occurred in the
market subsequent to the effective date of this report.
Gas prices were provided by Costilla to be used at the effective date. These
prices were based on the April 1996 spot price of $1.75 per million British
thermal units (MMBTU) at the Waha, Texas receipt point. This price was
adjusted with an area price adjustment which was calculated as the
difference between the actual price received during 1995 and the stop price.
The resultant price was further adjusted for the BTU content of the gas for
each well. If the BTU content was unknown, it was assumed to be one MMBTU
per MCF of gas. After the effective date, prices were held constant for the
life of the properties unless Costilla indicated that changes were provided
for by contract. All gas prices were applied to projected wellhead volumes.
It should be emphasized that with the current economic uncertainties,
fluctuation in market conditions could significantly change the economics of
the properties included in this report.
Operating expenses were provided by Costilla and represented, when possible,
the latest available 12-month average of all recurring expenses excluding
COPAS and internal indirect overhead costs which are billable to the working
interest owners. These expenses included, but were not limited to, all
direct operating expenses, field overhead costs, and any ad valorem taxes
not
A-4
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 5
deducted separately. Expenses for workovers, well stimulations, and other
maintenance were not included in the operating expenses unless such work was
expected on a recurring basis. Judgments for the exclusion of the
nonrecurring expenses were made by Costilla. In accordance with instructions
from Costilla, Williamson has excluded COPAS overhead and internal indirect
overhead which are billed to the outside working interest owners from the
operating expenses for Costilla-operated properties. The exclusion of these
costs for operated properties results in the calculation of a lower economic
limit and causes the economic lifetime to be extended. Williamson has not
calculated the reserves that have been added as a result of this procedure.
For new and developing properties where data were unavailable, operating
expenses were estimated by Costilla. Operating costs were held constant for
the life of the properties.
State production taxes have been deducted at the published rates as
appropriate. For operated properties, average county ad valorem taxes
provided by Costilla were deducted for those properties located in states
for which the data were available. Any ad valorem taxes for nonoperated
properties or for properties in other states were assumed to be included in
the operating expenses.
All capital costs for drilling and completion of wells and nonrecurring
workover or operating costs have been deducted as applicable. These costs
were provided by Costilla. No adjustments were made to account for the
potential effect of inflation on these costs.
Neither salvage values nor abandonment costs were provided by Costilla to be
included in this evaluation.
B. THE ACQUISITION REPORT
A total of 1,091 properties in 135 fields were evaluated in the Acquisition
report. Eighteen individual properties had values greater than 1.0 percent
of the total DFNR and in aggregate represent 35.5 percent of the DFNR in the
Acquisition report. The most valued property, the H.W. Glasscock Unit,
Howard-Glasscock field, Glasscock County, Texas, has a projected value of
5.7 percent of the total DFNR in the Acquisition report. The top eight
major-value fields are World, Crockett County, Texas; Dimmitt, Loving
County, Texas; Panna Maria, Karnes County, Texas; Giddings, Various
Counties, Texas; Caldwell, Burleson County, Texas; Coletto Creek, Victoria
County, Texas; Sawyer, Sutton County, Texas; and Jameson, Coke County,
Texas. These fields contain 11 of the 18 top value properties and represent,
in aggregate, 51.9 percent of the total DFNR in the Acquisition report. The
remaining fields represent 48.1 percent with no field having more than 2.9
percent of the DFNR in the Acquisition report. A more detailed property
review is included in the Acquisition report.
Area oil prices were provided by Costilla and Parker & Parsley to be used at
the effective date with the written assurance that the use of these area
prices is reasonable on an aggregate basis and would not materially affect
the income from any major-value property. These area prices were calculated
by adjusting the West Texas Intermediate oil April 1, 1996 posted price of
$20.75 per barrel. The oil price adjustments as calculated by Parker &
Parsley for each area are the calculated differences between the actual
price received during 1995 and the posted price for West Texas Intermediate
oil during that same period. After the effective date, prices were held
constant for the life of the properties. No attempt has been made to account
for oil price fluctuations which have occurred in the market subsequent to
the effective date of this report.
Gas prices were provided by Costilla and Parker & Parsley to be used at the
effective date. These prices were based on the April 1996 spot price of
$1.75 per million British thermal units
A-5
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 6
(MMBTU) at the Waha, Texas receipt point. This price was adjusted with an
area price adjustment which was calculated as the difference between the
actual price received during 1995 and the stop price. The resultant price
was further adjusted for the BTU content of the gas for each well. If the
BTU content was unknown, it was assumed to be one MMBTU per MCF of gas.
After the effective date, prices were held constant for the life of the
properties unless Costilla indicated that changes were provided for by
contract. All gas prices were applied to projected wellhead volumes.
It should be emphasized that with the current economic uncertainties,
fluctuation in market conditions could significantly change the economics of
the properties included in this report.
Operating expenses were provided by Costilla and Parker & Parsley and
represented, when possible, the latest available 12-month average of all
recurring expenses excluding COPAS and internal indirect overhead costs
which are billable to the working interest owners. These expenses included,
but were not limited to, all direct operating expenses, field overhead
costs, and any ad valorem taxes not deducted separately. Expenses for
workovers, well stimulations, and other maintenance were not included in the
operating expenses unless such work was expected on a recurring basis.
Judgments for the exclusion of the nonrecurring expenses were made by
Costilla or Parker & Parsley. In accordance with instructions from Costilla,
Williamson has excluded COPAS overhead which is billed to the outside
working interest owners from the operating expenses for Parker &
Parsley-operated properties. The exclusion of these costs for operated
properties results in the calculation of a lower economic limit and causes
the economic lifetime to be extended. Williamson has not calculated the
reserves that have been added as a result of this procedure. For new and
developing properties where data were unavailable, operating expenses were
estimated by Costilla or Parker & Parsley. Operating costs were held
constant for the life of the properties.
State production taxes have been deducted at the published rates as
appropriate. For operated properties, average county ad valorem taxes
provided by Costilla were deducted for those properties located in states
for which the data were available. Any ad valorem taxes for nonoperated
properties or for properties in other states were assumed to be included in
the operating expenses.
All capital costs for drilling and completion of wells and nonrecurring
workover or operating costs have been deducted as applicable. These costs
were provided by Costilla or Parker & Parsley. No adjustments were made to
account for the potential effect of inflation on these costs.
Neither salvage values nor abandonment costs were provided by Costilla to be
included in this evaluation.
V. GENERAL EVALUATION CONSIDERATIONS PERTAINING TO THE COSTILLA AND ACQUISITION
REPORTS
The individual projections prepared to produce this summary letter include
data that describe the production forecasts and associated evaluation parameters
such as interests, taxes, product prices, operating costs, investments, salvage
values, abandonment costs, and net profit interests, as applicable.
Net income to the evaluated interests is the future net revenue payable to
others, taxes, operating expenses, investments, salvage values, abandonment
costs, and net profit interests, as applicable. The future net revenue is before
federal income tax and excludes consideration of any encumbrances against the
properties if such exist.
No opinion is expressed by Williamson as to the fair market value of the
evaluated properties.
A-6
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 7
The future net revenues presented in this summary letter were based on
projections of oil and gas production. It was assumed there would be no
significant delay between the date of oil and gas production and the receipt of
the associated revenue for this production.
This summary letter includes only those costs and revenues which are
considered by Costilla to be directly attributable to individual leases and
areas. There could exist other revenues, overhead costs, or other costs
associated with Costilla which are not included in this summary letter. Such
additional costs and revenues are outside the scope of this summary letter. This
summary letter is not a financial statement for Costilla and should not be used
as the sole basis for any transaction concerning Costilla, Parker & Parsley, or
the evaluated properties.
The reserves projections in this summary letter are based on the use of the
available data and accepted industry engineering methods. Future changes in any
operational or economic parameters or production characteristics of the
evaluated properties could increase or decrease their reserves. Unforeseen
changes in market demand or allowables set by various regulatory agencies could
also cause actual production rates to vary from those projected. The dates of
first production for nonproducing properties were based on estimates by Costilla
or Williamson and the actual dates may vary from those estimated. Williamson
reserves the right to alter any of the reserves projections and the associated
economics included in this summary letter in any future evaluation based on
additional data that may be acquired.
All data utilized in the preparation of this summary letter with respect to
interests, reversionary status, oil and gas prices, gas categories, gas contract
terms, operating expenses, investments, salvage values, abandonment costs, net
profit interests, well information and current operating conditions, as
applicable, were provided by Costilla, Parker & Parsley, and the operators. Data
obtained after the effective date of the report but prior to the completion of
the report were used only if such data were applied consistently. If such data
were used, the reserves category assignments reflect the status of the wells as
of the effective date. In the Costilla report, daily production data after April
1, 1996 were utilized for new wells in the South Buffalo Ridge, Concho Bluff
(Queen), East Goldsmith (Queen), King Mountain (Penn), and Talbot (Canyon)
fields to assist in determining initial producing and decline rates. Daily
production since the effective date was also used for the Pyote Gas Unit 5 No.
1A, Block 16 (Devonian) field, Ward County, Texas to establish the producing
rate after the well was affected by gas plant problems and for the State 16-05
well in the Raymond field, Sheridan County, Montana to establish the initial
rate of production subsequent to the installation of a downhole pump. Production
data generally through December 1995 or January 1996 provided by Costilla for
the properties in the Costilla report and through November or December 1995
provided by Parker & Parsley for the properties in the Acquisition report were
utilized. All data have been reviewed for reasonableness and, unless obvious
errors were detected, have been accepted as correct. It should be emphasized
that revisions to the projections of reserves and economics included in this
summary letter may be required if the provided data are revised for any reason.
No inspection of the properties was made as this was not considered within the
scope of these projects. No investigation was made of any environmental
liabilities that might apply to the evaluated properties, and no costs are
included for any possible related expenses.
Unless specifically identified and documented by Costilla or Parker &
Parsley as having curtailment problems, gas production trends have been assumed
to be a function of well productivity and not of market conditions. The effect
of "take or pay" clauses in gas contracts was not considered.
A-7
<PAGE>
Costilla Energy, Inc.
Mr. Michael J. Grella
July 23, 1996
Page 8
Oil reserves are expressed in United States (U.S.) barrels of 42 U.S.
gallons. Gas volumes are expressed in thousands of cubic feet (MCF) at 60
degrees Fahrenheit and at the legal pressure base that prevails in the state in
which the reserves are located. No adjustment of the individual gas volumes to a
common pressure base has been made.
Costilla represented to Williamson that it has, or can generate, the
financial and operational capabilities to accomplish those projects evaluated by
Williamson which require capital expenditures.
The estimates of reserves contained in this summary letter were determined
by accepted industry methods and in accordance with the definitions of oil and
gas reserves set forth above. Methods utilized in this summary letter include
extrapolation of historical production trends, material balance determinations,
analogy to similar properties, and volumetric calculations.
Where sufficient production history and other data were available, reserves
for producing properties were determined by extrapolation of historical
production trends or through the use of material balance determinations. Analogy
to similar properties or volumetric calculations were used for nonproducing
properties and those producing properties which lacked sufficient production
history and other data to yield a definitive estimate of reserves. Reserves
projections based on analogy are subject to change due to subsequent changes in
the analogous properties or subsequent production from the evaluated properties.
Volumetric calculations are often based upon limited log and/or core analysis
data and incomplete reservoir fluid and formation rock data. Since these limited
data must frequently be extrapolated over an assumed drainage area, subsequent
production performance trends or material balance calculations may cause the
need for significant revisions to the estimates of reserves.
It should be emphasized that with the current economic uncertainties,
fluctuation in market conditions could significantly change the economics in
this summary letter.
VII. DECLARATION OF INDEPENDENT STATUS AND CONSENT
We understand that our estimates are to be included in a Registration
Statement on Form S-1 (the Registration Statement) to be filed with the SEC and
in the Prospectus as included in such Registration Statement which will be
registered under the Securities Act of 1933, as amended.
Williamson is an independent consulting firm and does not own any interests
in the oil and gas properties covered by this summary letter. Roy C. Williamson,
Jr., Chief Executive Officer, owns a 2.5 percent working interest in six wells
in the Outlook field, Sheridan County, Montana, which have a total value of
$138,912 to the interests of Costilla. No employee, officer or director of
Williamson is an employee, officer or director of Costilla or Parker & Parsley.
Neither the employment of nor the compensation received by Williamson is
contingent upon the values assigned to the oil and gas properties covered by
this summary letter.
We consent to the inclusion of this summary letter in the Registration
Statement, the inclusion in the Registration Statement of data extracted from
this summary letter and to all references to our firm in the Prospectus,
including any references to our firm as Experts.
Yours very truly,
WILLIAMSON PETROLEUM CONSULTANTS, INC.
A-8
<PAGE>
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NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS, AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY THE
SECURITIES IN ANY JURISDICTION WHERE, OR ANY PERSON TO WHOM, IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT
THERE HAS NOT BEEN A CHANGE IN THE FACTS SET FORTH IN THIS PROSPECTUS OR IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
UNTIL OCTOBER 28, 1996, ALL DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED
TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO
DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND
WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 10
The Company.................................... 16
Common Stock Offering.......................... 16
Use of Proceeds................................ 17
Capitalization................................. 18
Pro Forma Condensed Financial Statements....... 19
Selected Financial Information................. 27
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 28
Business and Properties........................ 34
Management..................................... 46
Security Ownership of Certain Beneficial Owners
and Management................................ 49
Executive Compensation and Other Information... 50
Certain Transactions........................... 53
Description of Notes........................... 55
Description of Other Indebtedness.............. 82
Description of Capital Stock................... 82
Underwriting................................... 84
Legal Matters.................................. 85
Experts........................................ 85
Available Information.......................... 85
Glossary....................................... 87
Index to Financial Statements.................. F-1
Summary Reserve Report......................... A-1
</TABLE>
[LOGO]
COSTILLA ENERGY, INC.
$100,000,000 10 1/4% SENIOR
NOTES DUE 2006
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PROSPECTUS
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NATIONSBANC CAPITAL MARKETS, INC.
PRUDENTIAL SECURITIES INCORPORATED
OCTOBER 2, 1996
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