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SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934
(Amendment No. )
Filed by the Registrant [x]
Filed by a Party other than the Registrant[ ]
Check the appropriate box:
[ ] Preliminary Proxy Statement
[x] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section
240.14a-12
COSTILLA ENERGY, INC.
(Name of Registrant as Specified in its Charter)
COSTILLA ENERGY, INC.
(Name of Person(s) Filing Proxy Statement)
Payment of Filing Fee (Check the appropriate box):
[x] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
1) Title of each class of securities to which transaction applies.
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2) Aggregate number of securities to which transaction applies:
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3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined.):
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4) Proposed maximum aggregate value of transaction:
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5) Total fee paid:
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number, or
the Form or Schedule and the date of its filing.
1) Amount Previously Paid:
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2) Form, Schedule or Registration Statement No.:
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3) Filing Party:
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4) Date Filed:
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COSTILLA ENERGY, INC.
400 W. ILLINOIS, SUITE 1000
MIDLAND, TEXAS 79701
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
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To Our Stockholders:
The Annual Meeting of Stockholders of Costilla Energy, Inc., a Delaware
corporation (the "Company"), will be held at the Petroleum Club, 501 Wall Ave.,
Midland, Texas on Monday, June 16, 1997, at 2:00 p.m., for the following
purposes:
1. To elect two directors for a term of three years in accordance with
the Certificate of Incorporation and bylaws of the Company.
2. To ratify the appointment of KPMG Peat Marwick LLP as independent
public accountants for the Company for the fiscal year ending December
31, 1997.
3. To amend the 1996 Stock Option Plan of Costilla Energy, Inc. to
increase the number of shares of the Company's common stock reserved
and authorized for issuance under the plan and to change
administration of the plan from the Board of Directors to the
Compensation Committee.
4. To amend the Outside Directors Stock Option Plan of Costilla Energy,
Inc. to increase the number of shares of the Company's common stock
reserved and authorized for issuance under the plan and to increase
the number of shares included in each option granted under the plan.
5. To amend the Bonus Incentive Plan of Costilla Energy, Inc. to allow
broader participation under the plan and to change administration of
the plan from the Board of Directors to the Compensation Committee.
6. To transact such other business as may properly come before the
meeting.
Stockholders of record at the close of business on May 14, 1997, are entitled to
notice of and to vote at the meeting or any adjournments thereof.
Midland, Texas By Order of the Board
May 21, 1997 Bobby W. Page
Secretary
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WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE SIGN THE PROXY AND
RETURN IT PROMPTLY IN THE ENCLOSED ENVELOPE.
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COSTILLA ENERGY, INC.
400 W. Illinois, Suite 1000
Midland, Texas 79701
PROXY STATEMENT
This proxy statement and related proxy are being mailed to stockholders
of Costilla Energy, Inc. (the "Company") on or about May 21, 1997, in
connection with the solicitation by the Company of proxies to be used at the
Annual Meeting of Stockholders of the Company to be held at the Petroleum
Club, 501 Wall Ave., Midland, Texas on Monday, June 16, 1997 at 2:00 p.m.,
and at all adjournments thereof.
Any person giving a proxy has the power to revoke it at any time before it
is voted by filing with the Secretary of the Company an instrument revoking the
proxy, by delivering a properly executed proxy of a later date or by attending
the Annual Meeting and voting in person. The Company will bear the costs of
solicitation of proxies. The Company may also reimburse persons holding stock
in their names or in those of their nominees for their reasonable expenses in
sending proxy material to their principals and obtaining their proxies. The
solicitation is being made by mail and may also be made by telephone or by
telecopy by officers, directors and regular employees of the Company, who will
receive no additional compensation therefor. Total expenses of the solicitation
are expected to be nominal.
Stockholders of record at the close of business on May 14, 1997, are
entitled to notice of and to vote at the meeting. At the close of business on
such date, the Company had 10,476,500 shares of Common Stock, $.10 par value per
share (the "Common Stock"), outstanding, each share being entitled to one vote.
Properly executed proxies will be voted in accordance therewith, or if no
direction is indicated thereon, (i) in favor of the nominees for Director named
herein, (ii) in favor of ratifying the appointment of KPMG Peat Marwick LLP as
the Company's independent public accountants, (iii) in favor of the amendments
to each of the 1996 Stock Option Plan, the Outside Directors Stock Option Plan
and the Bonus Incentive Plan (collectively, the "Plans"), and (iv) in the
discretion of the persons appointed as proxies upon any other business that may
properly come before the meeting or any adjournment thereof. With respect to
the election of Directors, a stockholder may, by properly completing the
enclosed proxy, vote in favor of all nominees or withhold his or her votes as to
all nominees or as to specific nominees. Directors will be elected by the
affirmative vote of a plurality of the shares represented at the meeting in
person or by proxy and entitled to vote on the election of Directors. The
Company's Certificate of Incorporation prohibits cumulative voting in the
election of Directors. The ratification of the appointment of independent
public accountants, the amendment of each of the Plans and all other matters
properly coming before the meeting will be decided by the affirmative vote of a
majority of the shares represented at the meeting in person or by proxy and
entitled to vote on such matters, except as otherwise required by law or by the
Company's Certificate of Incorporation or bylaws.
The votes will be counted by one or more inspectors appointed by the Board
of Directors, who will determine, among other things, the number of votes
necessary for the stockholders to take action in accordance with the foregoing
requirements and the votes withheld or cast for and against each matter. All
properly executed proxies and ballots, regardless of the nature of vote or the
absence of a vote indication (but not including broker non-votes), are counted
in determining the number of shares represented at the meeting. Neither broker
non-votes nor abstentions are counted as affirmative votes, in whole or in part.
Page 2
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PROPOSAL NO. 1 ELECTION OF TWO DIRECTORS
The Board of Directors is composed of three classes of members. One class
of Directors is elected each year to hold office for a three-year term and until
successors of such class are duly elected and qualified. At the meeting the
Class I Directors will be elected, and W.D. Kennedy and Jerry J. Langdon, the
current Class I Directors, have been nominated for such positions. Except where
the authority to do so has been withheld, it is the intention of the persons
named in the proxy to vote to elect Messrs. Kennedy and Langdon as Directors for
three-year terms. Each of the nominees has consented to being named in the
proxy statement and to serve, if elected. If for any unforeseen cause, either
of the nominees should decline or be unable to serve, the proxies will be voted
to fill any vacancy so arising in accordance with the discretionary authority of
the persons named in the proxy.
Information with respect to the nominees for election and Directors
continuing in office regarding age, positions with the Company or other
principal occupations for the past five years, other directorships and the year
each was initially elected a Director of the Company is as follows (there are no
family relationships among the following named persons):
NOMINEES FOR ELECTION TO THE BOARD OF DIRECTORS
FOR THREE-YEAR TERM EXPIRING IN 2000 (CLASS I)
W. D. KENNEDY, age 76, is a Director of the Company and a member of the
Compensation and Audit Committees of the Board of Directors. Mr. Kennedy has
served as a Director since July 1996. He 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. Mr.
Kennedy remains an active investor in the oil and gas business. Mr. Kennedy is
a member of the All-American Wildcatters Association, a past president of the
Permian Basin Petroleum Association and a former director of the Texas Mid-
Continent Oil and Gas Association.
JERRY J. LANGDON, age 44, is a Director of the Company and a member of the
Compensation and Audit Committees of the Board of Directors. Mr. Langdon has
served as a Director since July 1996. He has previously held positions with HNG
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 companies, financial institutions and law firms on a
variety of technical, commercial and regulatory issues. Mr. Langdon served as a
member of the Federal Energy Regulatory Commission ("FERC") from 1988 to June
1993. Since leaving the FERC, Mr. Langdon formed Republic Gas Corp., and its
successor Republic Gas Partners, L.L.C. ("Republic"), to acquire, construct and
operate natural gas pipelines, gathering, processing, treating and marketing
facilities. Mr. Langdon is the president of Republic and its subsidiaries. The
Company owned an equity interest in Republic during the last fiscal year. See
"Certain Transactions and Relationships--Certain Business Relationships."
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR EACH OF THE ABOVE NAMED NOMINEES.
MEMBERS OF THE BOARD OF DIRECTORS CONTINUING IN OFFICE
TERM EXPIRING IN 1998 (CLASS II)
SAMUEL J. ATKINS, III, age 52, is a Director of the Company. Mr. Atkins became
a Director in April 1997. Prior to his retirement on March 1, 1997, Mr. Atkins
was executive vice president of NationsBank Corporation for in excess of the
past five years. He also served as a director of NationsBank of Texas, N.A.
from May 1995 until February 1997. Mr. Atkins is currently a private investor.
Page 3
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MEMBERS OF THE BOARD OF DIRECTORS CONTINUING IN OFFICE
TERM EXPIRING IN 1999 (CLASS III)
CADELL S. LIEDTKE, age 41, is Chairman of the Board and a Director of the
Company, having served in such capacities since the inception of the Company in
July 1996. Prior to April 15, 1997, Mr. Liedtke also served as Chief Executive
Officer of the Company. He is a member of the Audit Committee of the Board of
Directors. Mr. 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
Landman's Association and the Independent Producer's Association of America.
MICHAEL J. GRELLA, age 47, is President, Chief Executive Officer and a Director
of the Company. He has served as President and as Director since the inception
of the Company in July 1996 and as Chief Executive Officer since April 15, 1997.
Mr. Grella also served as Chief Operating Officer of the Company and its
predecessor entities from 1988 until April 15, 1997. He 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's Association.
HENRY G. MUSSELMAN, age 42, is Executive Vice President, Chief Operating Officer
and a Director of the Company, having served as Executive Vice President and a
Director since the inception of the Company in July 1996 and as Chief Operating
Officer since April 15, 1997. Mr. 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
prior to 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.
PROPOSAL NO. 2 RATIFICATION OF APPOINTMENT OF INDEPENDENT
PUBLIC ACCOUNTANTS
Upon the recommendation of the Audit Committee of the Board of Directors,
the Board has selected KPMG Peat Marwick LLP as the independent public
accountants of the Company and its subsidiaries for the fiscal year ending
December 31, 1997. KPMG Peat Marwick LLP has been the Company's independent
public accountants since inception and has an office in Midland, Texas where the
Company's principal office is located. The Company has been advised that a
representative of KPMG Peat Marwick LLP will be present at the Annual Meeting.
The representative will have an opportunity to make a statement at the Meeting
and to respond to appropriate questions raised at the Meeting.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR RATIFICATION OF THE
APPOINTMENT OF KPMG PEAT MARWICK LLP AS INDEPENDENT PUBLIC ACCOUNTANTS FOR THE
COMPANY.
Page 4
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PROPOSAL NO. 3 AMENDMENT OF 1996 STOCK OPTION PLAN
A total of 850,000 shares of Common Stock were initially authorized and
reserved for issuance under the 1996 Stock Option Plan (the "Option Plan"),
subject to certain adjustments to reflect changes in capitalization. A summary
of the Option Plan, including certain tax matters, is set forth herein under
"Executive Compensation - Option Grants In Last Fiscal Year."
In connection with the Company's initial public offering, stock options
were granted covering substantially all of the shares of Common Stock authorized
and reserved for issuance under the Option Plan. However, certain senior
executive officers did not receive stock options at that time, and therefore do
not have the long term incentives intended by the Company's adoption of the
Option Plan. Also, only a small number of shares remain available under the
Option Plan for future option grants to new or existing officers and employees.
The Board of Directors has determined that it is in the best interests of
the Company to increase the number of shares of Common Stock available under the
Option Plan so that additional options can be granted to fulfill the purpose of
attracting, retaining, rewarding and providing long term stock ownership
incentives to the officers and employees of the Company as provided in the
Option Plan. Toward this end, the Board has adopted, subject to stockholder
approval, an amendment to the Option Plan to increase the number of shares of
Common Stock authorized and reserved under the Option Plan from 850,000 to
1,250,000. The Company intends to file a Registration Statement on Form S-8
with respect to the Option Plan to register such additional shares of Common
Stock pursuant to the Securities Act of 1933 (the "Securities Act") as soon as
practicable after the amendment is approved by the Company's stockholders.
In addition, because the Option Plan is an integral part of the Company's
compensation policy, see "Executive Compensation--Compensation Committee Report
on Executive Compensation," and certain of the officers receiving benefits under
that policy are also employee directors, the Board has determined that the
Option Plan should be administered by the nonemployee directors on the
Compensation Committee. As a result, the Board has also adopted, subject to
stockholder approval, an amendment to the Option Plan changing administration of
the plan from the Board to the Compensation Committee. Pending stockholder
approval of this amendment, the Board has delegated its authority to administer
the Option Plan to the Committee.
The effect of the amendments to the Option Plan on the benefits available
to the officers and employees of the Company cannot be specifically determined
at this time. Generally, the amendments will allow additional options to be
granted to such persons under the Option Plan, but the benefits to such persons
will be unknown until such additional options are granted. Likewise, it is not
possible to determine the benefits which such persons may have received as a
result of the amendments if the amendments had been in effect in 1996 because it
is unknown whether any additional options would have been granted if more
authorized and reserved shares had been available. The benefits and amounts of
options already granted to the executive officers under the Option Plan are set
forth herein under "Executive Compensation".
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR APPROVAL OF THIS AMENDMENT OF THE
1996 STOCK OPTION PLAN.
Page 5
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PROPOSAL NO. 4 AMENDMENT OF OUTSIDE DIRECTORS STOCK OPTION PLAN
A total of 50,000 shares of Common Stock were initially authorized and
reserved for issuance under the Outside Directors Stock Option Plan (the
"Outside Directors Plan"), subject to certain adjustments to reflect changes in
capitalization. The Outside Directors Plan provides, in general, that an option
for 1,000 shares of Common Stock will be granted each year immediately following
the Company's annual meeting to each person who qualifies as an outside
director. A summary of the Outside Directors Plan, including certain tax
matters, is set forth herein under "Board of Directors and Committees."
It is important for the Company to retain its current outside directors, as
well as be able to attract and retain qualified outside directors in the future,
and for those outside directors to have their interests aligned with the
Company's stockholders. Therefore, the Board of Directors has determined that
it is in the best interests of the Company to amend the Outside Directors Plan
to increase the number of shares of Common Stock included in each annual option
grant under the Plan. To accommodate such increase and to provide availability
under the plan for option grants to additional outside directors, the Board has
also determined that it is necessary to further amend the Outside Directors Plan
to increase the number of shares available under the plan. To accomplish these
objectives, the Board has adopted, subject to stockholder approval, amendments
to the Outside Directors Plan increasing the number of shares of Common Stock
included in each option from 1,000 to 5,000 and increasing the total number of
shares of Common Stock authorized and reserved for issuance under the plan from
50,000 to 100,000. The Company intends to file a Registration Statement on Form
S-8 with respect to the Outside Directors Plan to register such additional
shares of Common Stock pursuant to the Securities Act as soon as practicable
after the amendment is approved by the Company's stockholders.
The benefits which the Company's outside directors will receive if the
amendments to the Outside Directors Plan are approved will depend upon
qualification of such persons as outside directors following annual stockholder
meetings beginning in 1997. Therefore, such benefits cannot be specifically
determined at this time. Because the Company did not have an annual meeting in
1996, no benefits would have accrued pursuant to the amendments if they had been
in effect in 1996.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR APPROVAL OF THIS AMENDMENT OF THE
OUTSIDE DIRECTORS STOCK OPTION PLAN.
PROPOSAL NO. 5 AMENDMENT OF BONUS INCENTIVE PLAN
The Bonus Incentive Plan (the "Bonus Plan") provides that the Company 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 have contributed to the success of the Company as determined by
the Compensation Committee upon authority delegated by the Board (pending an
amendment to the plan providing for administration of the plan by the
Committee). A total of 100,000 shares of Common Stock are 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. Currently, all officers, directors and advisors of the Company
or a subsidiary of the Company and all employees of the Company or a subsidiary
of the Company who have completed a minimum of 180 days of service and are
employed by the Company or such subsidiary on the last day of the plan year are
eligible to participate in the plan, other than such persons who own ten percent
or more of the outstanding shares of Common Stock during that year. Bonus
awards are 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 are awarded after review and upon approval of the
Compensation Committee, subject to the terms and conditions of the plan.
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The Compensation Committee has determined that the Bonus Plan should be an
integral part of the Company's compensation policy and structure, including the
compensation of the Chairman of the Board and the President and Chief Executive
Officer. See "Executive Compensation--Compensation Committee Report on
Executive Compensation." Since each of the Chairman of the Board and the
President and Chief Executive Officer currently owns more than 10 percent of the
outstanding shares of Common Stock, they are not currently eligible to
participate under the Bonus Plan. The Board has determined that it is in the
best interests of the Company to amend the Bonus Plan to delete the limitation
on ten percent stockholders participating under the Bonus Plan and allow such
persons to participate so long as the other participation criteria are
satisfied, and has adopted an amendment to the Bonus Plan eliminating that
limitation, subject to stockholder approval.
In addition, because the Bonus Plan is an important part of the Company's
compensation policy and certain of the officers receiving benefits under that
policy are also employee directors, the Board of Directors has determined that
the Bonus Plan should be administered by the nonemployee directors who are on
the Compensation Committee. As a result, the Board has adopted, subject to
stockholder approval, an amendment to the Bonus Plan changing administration of
the plan from the Board to the Compensation Committee. Pending stockholder
approval of this amendment, the Board has delegated its authority to administer
the Bonus Plan to the Committee.
The effect of the amendments to the Bonus Plan on the benefits available to
the officers, employees and directors of the Company cannot be specifically
determined at this time. Generally, the amendments will allow awards to be made
to such persons regardless of their stock ownership position, but the benefits
to such persons will be unknown until such awards are granted. The awards
already granted to the executive officers under the Bonus Plan and the intended
use of the plan in the Company's compensation structure are described herein
under "Executive Compensation--Compensation Committee Report on Executive
Compensation."
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR APPROVAL OF THIS AMENDMENT OF THE
BONUS INCENTIVE PLAN.
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BOARD OF DIRECTORS AND COMMITTEES
As of the date of this Proxy Statement, compensation for non-employee
directors consists 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 day of a Board meeting. In addition, the non-
employee Directors are participants in the Company's Outside Directors Plan
described below.
The Outside Directors Plan provides for the issuance of stock options to
the outside directors of the Company. Subject to the amendment of the Outside
Directors Plan described as Proposal No. 4 herein, a total of 50,000 shares of
Common Stock has been authorized and reserved for issuance under the plan, with
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 (to be increased to 5,000 pursuant to the proposed
amendment of the plan) will be granted each year on the date immediately
following the Company's annual meeting to each person who qualifies as an
outside director, beginning in 1997. 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. In the event of the death of
a participant under the plan, such participant's option(s) may be exercised by
the heirs or personal representative of the 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 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 approval by law or the rules of any
exchange on which the Common Stock is listed, and may modify an outstanding
option, including the repricing of such options, with the consent of the option
holder. The Company currently has six directors, three of whom are eligible to
participate in the plan.
The Board of Directors has two committees. The Compensation Committee is
composed of Messrs. Kennedy and Langdon, neither of whom is an employee of the
Company. The Committee has the responsibilities of establishing the Company's
executive compensation policies, reviewing the performance and setting the
salaries of the officers of the Company, awarding cash bonuses to such officers,
administering the Bonus Plan and the Option Plan, and advising and making
recommendations to the Board with respect to compensation related matters,
generally. The Company became a public company in October 1996 and the
Compensation Committee was formed by the Board in 1997; therefore, the Committee
did not meet in 1996. The Compensation Committee will make recommendations to
the Board concerning the salaries of all officers, benefit plans and other
compensation matters.
The Audit Committee is composed of Messrs. Liedtke, Kennedy and Langdon,
with Bobby W. Page, the Company's Chief Financial Officer, as an ex officio
member. The Audit Committee was formed by the Board in 1997; therefore, the
Committee did not meet in 1996. The Committee recommended to the Board of
Directors the selection of KPMG Peat Marwick LLP as the Company's independent
public accountants. The Committee will review the annual financial statements
and discuss them with the auditors and financial staff of the Company; review
the independence of the independent public accountants conducting the audit;
review the services provided by the independent public accountants; discuss with
management and the auditors the Company's accounting system and related systems
of internal control; and consult as it deems necessary with the independent
public accountants and the Company's internal financial staff.
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The Company was formed in July 1996 and completed its initial public
offering in October 1996. All Board actions taken during 1996 were taken by
written consent of the Board of Directors and no meetings of the Board or its
committees were held in 1996.
CERTAIN TRANSACTIONS AND RELATIONSHIPS
THE CORPORATE REORGANIZATION
The Company was formed to consolidate and continue certain operations
previously conducted by Costilla Energy, L.L.C. ("L.L.C."), its subsidiaries and
certain of its affiliates. Concurrent with the completion of the Company's
initial public offering in October 1996, certain of the operations of L.L.C.,
its subsidiaries and certain of its affiliates were consolidated, and the
Company succeeded to the oil and gas properties, exploration and development
operations and the natural gas gathering and marketing operations of those
entities. The foregoing transactions are referred to collectively herein as the
"Corporate Reorganization." In connection with the Corporate Reorganization,
5,200,000 shares of Common Stock were issued to the owners of L.L.C., being
Messrs. Liedtke, Grella and Musselman and NationsBanc Capital Corp. ("NBCC").
Certain of the transactions comprising the Corporate Reorganization
represented transactions between the Company, or its predecessors, and its
affiliates. Messrs. Liedtke, Grella and Musselman, the shareholders of Valley
Gathering Company ("Valley") and CSL Management Corporation ("CSL"), sold the
stock of Valley and the assets of CSL to the Company for $0.7 million. The
purchase price was 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 which were acquired. No third party conducted an
appraisal of either Valley or CSL.
Messrs. Liedtke, Grella and Musselman received an aggregate distribution
from L.L.C. of approximately $3.5 million which was estimated to be the federal
income tax liability (as well as the federal income tax liability on such
distribution) which would be owed by Messrs. Liedtke, Grella and Musselman as a
result of the Corporate Reorganization. While the amount to be distributed was
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 also received a distribution of
$0.8 million. However, NBCC has no tax or other liability with respect to such
distribution.
CERTAIN CONTRACTUAL ARRANGEMENTS
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,
supplies meter reading services which measure 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. 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, 1996, A&P received $520,519 from the
Company for goods and services provided, which accounted for approximately 34%
of A&P's gross revenues. The Company believes that the goods and services and
charges therefor are comparable to those the Company could have obtained from
unaffiliated third parties.
During 1996 the Company paid $449,000 to Valley for gas compression and
salt water disposal charges and
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<PAGE>
Valley paid the Company $383,139 for operating costs of its salt water
disposal wells and gas compressors. Also during 1996, the Company paid CSL
$517,352 for management fees and lease payments on equipment, and paid NBCC
$75,000 in management fees in connection with the operation of the L.L.C. In
the Corporate Reorganization, the L.L.C. was merged into the Company and the
Company acquired the stock of Valley and the assets of CSL. Subsequently,
Valley was also merged into the Company. As a result, no future transactions
will occur between the Company and Valley or CSL and no additional management
fees will be paid to NBCC in connection with the operation of L.L.C.
During a portion of 1996, the Company had an office lease with 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 1996 was $50,742. The Company
moved from this office space in mid-1996 and the lease was terminated in October
1996. The Company no longer has any transactions with 511 Tex. L.C.
As a private company prior to its initial public offering, the Company and
its principal owners, Messrs. Liedtke, Grella and Musselman, and their
affiliates, entered into transactions resulting in sums being paid and owed by
the Company to the principal owners and their affiliates and sums being paid and
owed by the principal owners and their affiliates to the Company. At December
31, 1996, such persons and their affiliates owed the Company $321,310. All such
amounts have subsequently been paid in full, including accrued interest, and
such transactions are being wound up and discontinued.
The Company has agreed that, upon the request of NBCC, on up to two
occasions, the Company will register under 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 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.
CERTAIN BUSINESS RELATIONSHIPS
The Company had a 40.5% interest in Republic during the last fiscal year.
Mr. Langdon, a Director of the Company, is the president and an equity interest
owner in Republic. The Company did not have any transactions with Republic
during 1996. In March 1997, the Company sold its entire interest in Republic
and no longer has any relationship or transactions with Republic.
The Company was indebted to NationsBank of Texas, N.A. and/or its
affiliates during and at the end of 1996 in varying amounts which were, at
times, material to the Company. Mr. Atkins, a Director of the Company, was a
director of NationsBank of Texas, N.A. and the executive vice president of
NationsBank Corporation during 1996. Mr. Atkins resigned from his positions
with the NationsBank entities in March 1997 and was appointed as a Director of
the Company in April 1997. Prior to April 1997, Mr. Atkins did not have any
affiliation with the Company.
Page 10
<PAGE>
INFORMATION CONCERNING SECURITY OWNERSHIP
Under regulations of the Securities and Exchange Commission, persons who
have power to vote or dispose of shares of the Company, either alone or jointly
with others, are deemed to be beneficial owners of such shares. The following
table sets forth certain information regarding the beneficial ownership of
Common Stock as of March 31,1997, by (i) each person who is the beneficial owner
of 5 percent or more of the outstanding Common Stock (based upon copies of all
Schedule 13Gs and 13Ds provided to the Company), (ii) each Director of the
Company and each nominee for Director, (iii) each executive officer named in the
Summary Compensation Table herein and (iv) all Officers and Directors of the
Company as a group. Unless otherwise noted, the persons and entities named
below have sole voting and investment power with respect to the shares listed
opposite each of their names,
AMOUNT AND NATURE OF PERCENT OF
NAME BENEFICIAL OWNERSHIP CLASS
- ---- -------------------- ----------
Cadell S. Liedtke
400 W. Illinois
Midland, Texas 79701 2,302,560 22.0%
Michael J. Grella
400 W. Illinois
Midland, Texas 79701 1,561,960 14.9%
NationsBanc Capital Corp.
100 North Tryon Street
Charlotte, North Carolina 28255 936,000 8.9%
The Equitable Companies
Incorporated (1)
787 Seventh Avenue
New York, New York 100190 1,476,200 14.1%
Henry G. Musselman
400 W. Illinois
Midland, Texas 79701 622,000(2) 5.9%
W.D. Kennedy 7,500 *
Jerry J. Langdon 0 *
Samuel J. Atkins 0 *
Bobby W. Page 75,000(3) * (4)
All Officers and Directors as
group (13 persons) 5,044,820(5) 45.8%(4)
_______________________________________________________________________________
*Less than 1%.
(1) Represents shares owned by The Equitable Life Assurance Society of
the United States and Alliance Capital Management L.P., subsidiaries
of the Equitable Companies Incorporated, held for investment and on
behalf of clients, respectively, as reported in the Schedule 13G
filed by the
Page 11
<PAGE>
Equitable Companies Incorporated, as amended through March 31, 1997.
(2) Includes (a) 620,500 shares owned directly by Mr. Musselman and (b)
1,500 shares owned by Mr. Musselman's spouse as custodian for their
children under the Texas Uniform Transfers to Minors Act.
(3) Includes the right to acquire beneficial ownership of 75,000 shares of
Common Stock through presently exercisable options granted under the
Option Plan.
(4) For purposes of calculating these percentages, the shares which the
named person or persons has or have the right to acquire within 60
days by exercise of the stock 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.
(5) Includes all rights of executive officers to acquire beneficial
ownership through presently exercisable options to purchase 550,000
shares of Common Stock granted under the Option Plan.
EXECUTIVE COMPENSATION
The following table sets forth information regarding the total compensation
for 1995 and 1996 received by the Company's Chief Executive Officer and the
other executive officers of the Company whose annual compensation exceeded
$100,000 in 1996. Information for 1994 is not comparable since the Company's
predecessor at that time was a general partnership in which the partners
received periodic partnership distributions in lieu of salary.
Information for 1996 is on an annualized basis based upon amounts paid to the
named individuals after the Corporate Reorganization.
SUMMARY COMPENSATION TABLE
<TABLE>
LONG-TERM
COMPENSATION
AWARDS
ANNUAL COMPENSATION ---------------
------------------------------------------ SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION(1) YEAR SALARY BONUS COMPENSATION OPTIONS/SARS(2) COMPENSATION(3)
- ------------------------------ ---- -------- ------- ------------ --------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Cadell S. Liedtke (4)
Chairman of the Board and
Chief Executive Officer 1996 $300,000 -- -- -- $ 6,738
1995 185,700 -- -- -- --
Michael J. Grella (5)
President and Chief
Operating Officer 1996 $300,000 -- -- -- $ 6,352
1995 261,750 -- -- -- 656,000
Henry G. Musselman (6)
Executive Vice President 1996 $215,000 $10,000 -- -- $ 3,295
1995 139,800 -- -- -- --
Bobby W. Page (7)
Senior Vice President,
Treasurer and Chief
Financial Officer 1996 $150,000 $ 5,208 -- 75,000 --
1995 -- -- -- -- --
</TABLE>
____________________________
(1) The positions with the Company shown in the Table are those held by
the named individuals in 1996. Subsequent changes in such positions
are described in these footnotes.
Page 12
<PAGE>
(2) The amount shown represents the number of shares subject to a non-
qualifying stock option granted pursuant to the Option Plan described
under "--Option Grants In Last Fiscal Year."
(3) The amounts shown represent (a) non-cash compensation deemed to have
been accrued to Mr. Grella in 1995 in connection with the cancellation
of an option held by a minority interest owner to purchase an
additional interest in the Company, and (b) contributions made by the
Company during 1996 pursuant to the Company's 401(k) plan for the
benefit of the named individuals.
(4) Mr. Liedtke served as Chief Executive Officer from July 1996 to April
1997 and is currently Chairman of the Board. Mr. Liedtke beneficially
owns 2,302,560 shares of restricted Common Stock issued to him in
connection with the Corporate Reorganization, with a value at December
31, 1996 of $31,383,893.
(5) Mr. Grella served as President and Chief Operating Officer from July
1996 to April 1997 and is currently the President and Chief Executive
Officer of the Company. Mr. Grella beneficially owns 1,350,440 shares
of restricted Common Stock issued to him in connection with the
Corporate Reorganization, with a value at December 31, 1996 of
$18,406,497.
(6) Mr. Musselman is currently Executive Vice President and Chief
Operating Officer. Mr. Musselman beneficially owns 611,000 shares of
restricted Common Stock issued to him in connection with the Corporate
Reorganization, with a value at December 31, 1996 of $8,327,930.
(7) Mr. Page joined the Company in June 1996 and currently also
serves as the Secretary of the Company.
EMPLOYMENT AGREEMENTS
Messrs. Liedtke, Grella and Musselman have entered into employment
agreements (as the same have been amended, the "Founders Employment Agreements")
with the Company which became effective upon the closing of the Company's
initial public offering in October 1996. The Founders Employment Agreements are
each for three years, commencing in October 1996 and each will automatically
renew for successive one-year periods thereafter unless the employee is notified
to the contrary. The Founders Employment Agreements provide annual base salary
levels for Messrs. Liedtke and Musselman of $300,000 and $250,000, respectively.
Pursuant to an amendment to his employment agreement approved in April 1997, Mr.
Grella's annual base salary is determined by the Compensation Committee as more
fully discussed under "--Compensation Committee Report on Executive
Compensation."
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 employment other than for cause.
However, 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 subsequent to 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, 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 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,
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<PAGE>
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 included 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 received
options to purchase 75,000 shares of Common Stock, and receives 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.
OPTION GRANTS IN LAST FISCAL YEAR
The following table provides information regarding the grant of stock
options to the executive officers named in the Summary Compensation Table in
fiscal year 1996. In addition, hypothetical gains of 5% and 10% required by
rules of the Securities and Exchange Commission (listed in the table under
"Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation
for Option Term") are shown for the stock option shown. These hypothetical
gains are based on assumed rates of annual compound stock price appreciation of
5% and 10% from the date the stock option was granted over the full option term
of ten (10) years. The actual realized value of the option may be significantly
greater or less than the amounts shown. The values shown for 5 percent and 10
percent appreciation equate to a stock price of $20.36 and $32.42, respectively,
at the October 2, 2006 expiration date of the option. The closing sales price
of the Company's Common Stock on the Nasdaq National Market on April 23, 1997
was $12.75 per share.
<TABLE>
Individual Grants Potential Realizable
- -------------------------------------------------------------------------- Value at Assumed
Number of % of Total Annual Rates of Stock
Securities Options/SARs Price Appreciation
Underlying Granted to Exercise or For Option Term
Options/SARs Employees in Price Base -----------------------
Name Granted (#)(1) Fiscal Year ($/Sh) (2) Expiration Date 5%($) 10% ($)
- ---- -------------- ------------ ----------- --------------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Bobby W. Page 75,000 10.5% $12.50 October 2, 2006 $589,500 $1,494,000
</TABLE>
____________________
(1) The stock option shown was fully vested and immediately exercisable on
the date of the grant and is a non-qualifying option under the Option
Plan.
(2) Represents the fair market value on the date of the grant.
The option shown above was granted pursuant to the Option Plan which
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. Subject to the amendment of the Option
Plan described as Proposal No. 3 herein, a total of 850,000 shares of Common
Stock has been authorized and reserved for issuance under the plan, with
adjustment to reflect changes in the Company's capitalization resulting from
stock splits, stock dividends and similar events. The plan currently provides
that it is administered by the Board of Directors, with 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
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<PAGE>
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. The Board has delegated its authority to administer the plan
to the Compensation Committee pending approval of an amendment to the Option
Plan changing such administration from the Board to the Committee. See
"Proposal No. 3 Amendment of 1996 Stock Option Plan." 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 the
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. 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 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 will be treated as compensation
by the Company for federal income tax purposes. The Board of Directors may
amend the plan, without stockholder approval, in any respect other than any
amendment that requires stockholder approval by law or the rules of an
exchange on which the Common Stock is listed, and may modify an outstanding
option, including the repricing of non-qualifying options, with the consent of
the option holder. There are currently approximately 130 persons who are
eligible to participate under the plan.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
The following table provides information, with respect to the named
executive officers, regarding the exercise of options during fiscal year 1996
and the value of unexercised options held as of the end of fiscal year 1996:
<TABLE>
Number of Securities Value of
Underlying Unexercised
Unexercised Options/ In-the-Money
SARs at Options/SARs at
FY-End (#) FY-End ($)
------------- ---------------
Shares Acquired Exercisable/ Exercisable/
Name on Exercise (#) Value Realized Unexercisable Unexercisable (1)
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bobby W. Page 0 0 75,000/0 $70,500/$0
</TABLE>
(1) The option price of the option set forth above is $12.50 per share.
The average of the Company's bid and ask price on the Nasdaq National
Market on December 31, 1996 was $13.44 per share.
Page 15
<PAGE>
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
GENERAL
The Compensation Committee of the Board of Directors is comprised of two
outside directors, W.D. Kennedy and Jerry J. Langdon. The Committee is
responsible for adopting and implementing executive compensation policies, in
general, and setting the compensation of the Company's officers and
administering the Option Plan and the Bonus Plan, in particular. The primary
objectives of the compensation plans and policies are (i) to attract and
retain highly qualified executive officers, (ii) to reward exceptional
performance by management and (iii) to provide financial incentives for
management to maximize and enhance stockholder value.
The Compensation Committee has adopted a compensation policy focused on the
Company's performance in increasing its oil and gas reserves and production,
while reflecting the importance of cash flow and earnings. The Committee
believes that such a policy reflects the Company's strategic goals of
exploration and development of its existing properties. The policy also
emphasizes achieving growth in cash flow and earnings, while recognizing the
effect volatile oil and gas prices can have on such factors notwithstanding the
Company's performance with respect to reserves and production. In addition, the
Committee reviews and considers compensation policies and activities of
companies comparable to the Company in size, industry type and business
strategy.
These general policies and objectives are used by the Committee in
establishing the main elements of the Company's executive compensation system:
base salary, short term incentives and long term incentives. The Committee
believes that the use of variable, at risk compensation in the form of short and
long term incentives provides focus on achievement of specific financial goals
and aligns the interests of the officers with those of the Company's
stockholders.
BASE SALARY
The base salaries of Messrs. Liedtke, Musselman and Page are set pursuant
to employment agreements. The annual salaries of the other officers of the
Company, including Mr. Grella, are set annually by the Compensation Committee
based upon salaries for comparable positions in the industry and upon each
officer's performance, experience and time with the Company. In addition, Mr.
Grella's annual salary is also subject to adjustment based upon the performance
of the Company as to its strategic goals and the other factors discussed under
"-Compensation of Chief Executive Officer."
The Company's initial public offering was completed in the fourth quarter
of 1996 and the Compensation Committee was not formed until 1997. As a result,
the 1996 salaries of the officers were set by the managers of Costilla Energy,
L.L.C., the predecessor to the Company. Such salaries were based upon
comparable compensation in the industry for the services provided by such
officers and the officers' performance and experience.
SHORT TERM INCENTIVES
The Company adopted the Bonus Plan as a means of awarding its officers and
employees for extraordinary individual and Company performance. Awards under
the Bonus Plan may be granted annually and may be in the form of cash or shares
of Common Stock or a combination thereof. The form and amount of an award
granted under the Bonus Plan is determined by the Compensation Committee (under
authority delegated to the Committee by the Board pending possible amendment of
the Bonus Plan, see "Proposal No. 5 Amendment of the Bonus Incentive Plan"
herein) based upon an assessment and recommendations from the Committee with
respect to the following performance factors for the year under consideration:
(i) increases in the Company's oil and gas reserves; (ii) increases in the
Company's oil and gas production; (iii) increases in earnings and cash flow
(assuming constant product prices); (iv)
Page 16
<PAGE>
the performance of the individual executive officer in connection with the
Company's success in the foregoing areas; and (v) outstanding individual
performance in contributing to the achievement of the Company's long term
strategic goals. The performance with respect to such factors is measured
against past performance and against the goals and objectives established by
the Company for the year in question. No specific weighting is applied to
the analysis of these factors. In addition to awards under the Bonus Plan,
the Compensation Committee may authorize additional cash bonuses for certain
or all executive officers in recognition of outstanding individual
performance in the advancement of the Company's long term objectives.
No awards were granted under the Bonus Plan during 1996. Cash bonuses were
paid during the fourth quarter of 1996 to the executive officers other than the
Messrs. Liedtke and Grella. The amounts of such cash bonuses were generally in
proportion to the recipient's base salary. After a review of the 1996 fiscal
year by the Compensation Committee, awards of Common Stock were granted under
the Bonus Plan in 1997 to certain employees and all officers, other than Messrs.
Liedtke, Grella and Musselman. Since Messrs. Liedtke and Grella did not receive
either the 1996 cash bonus or the Common Stock bonus, they were each paid a cash
bonus in 1997. Mr. Musselman, who did not receive a Common Stock bonus and
received a 1996 cash bonus which was proportionally smaller than the other 1996
cash bonuses, was also paid a cash bonus in 1997. Such cash bonuses to Messrs.
Liedtke, Grella and Musselman were based upon the Committee's review of the
1996 fiscal year. All such awards and bonuses were granted and paid in
recognition of the growth of the Company during 1996 and the successful
completion of the Company's initial public offering.
LONG TERM INCENTIVES
The Company adopted the Option Plan in order to attract and retain
qualified personnel and provide incentives to its officers and employees to
promote Company performance which will enhance the value of the Common Stock.
The Compensation Committee believes that the grant of stock options under the
Option Plan to officers and employees aligns the interest of such officers and
employees with the interests of the Company's stockholders. The size of an
individual option grant is based primarily upon the optionee's responsibilities
and position with the Company, and is determined by the Compensation Committee
under authority delegated by the Board (pending possible amendment of the Option
Plan, see "Proposal No. 3 Amendment of the 1996 Stock Option Plan" herein).
Other factors include the optionee's performance, potential for promotion and
impact on the Company's performance. The Company does not have a policy
concerning the timing and frequency of the grant of stock options under the
Plan.
During 1996, the Company granted stock options to all officers, other than
Messrs. Liedtke, Grella and Musselman, and to certain employees following the
Company's initial public offering. The recipients and the size of such options
were determined by the Board of Directors, and were based primarily upon the
individual's position and the years of experience with the Company.
COMPENSATION OF CHIEF EXECUTIVE OFFICER
During 1996 Mr. Liedtke served as the Chief Executive Officer of the
Company as well as his current position of Chairman of the Board. In such
capacities, Mr. Liedtke's compensation was established pursuant to his
employment agreement. Beginning in April 1997, Mr. Grella will serve as the
Chief Executive Officer, and Mr. Liedtke will continue as the Chairman of the
Board. The following is a discussion of the Compensation Committee's policy for
the future compensation of Mr. Grella as the Chief Executive Officer (the
"CEO").
The general compensation policies for all officers of the Company as
discussed above also apply to the CEO. The CEO's annual salary is subject to
adjustment based directly upon the Company's annual performance with respect to
growth in the Company's oil and gas reserves and increases in the Company's
earnings. In the event the volume of the Company's oil and gas reserves
increases during the year under consideration, the CEO's compensation will be
increased by an amount equal to $2,500 for each one percent of such increase in
reserves, up to a maximum of $250,000. If the volume of the Company's oil and
gas reserves decreases during the year under consideration, the
Page 17
<PAGE>
CEO's compensation will be decreased by an amount equal to $1,000 for each
one percent of such decrease in reserves, with a maximum decrease of
$100,000. All such determinations with respect to reserves will be based
upon reports prepared at the end of the fiscal year by the Company's
independent petroleum engineers using product prices equal to the prices used
pursuant to the rules of the Securities and Exchange Commission at the end of
the year prior to the year under consideration. The CEO's compensation will
also be increased by an amount equal to three quarters of one percent (.75%)
of any increase in the Company's income before federal income taxes and
extraordinary items from the end of the prior fiscal year to the end of the
current fiscal year, based upon financial statements which have been audited
by the Company's independent public accountants. No reduction in
compensation will automatically occur if the Company's earnings decrease.
The adjustments discussed in the preceding paragraph may be paid, at the
option of the Committee, in cash or shares of Common Stock as a bonus, as an
adjustment to the CEO's annual salary, as stock options granted to the CEO under
the Option Plan, or in such combination as the Committee may deem appropriate.
In addition, all or a portion of such amounts may be deferred. The Committee
believes that including shares of Common Stock and stock options in the CEO's
compensation package will enhance the mutuality of interest of the CEO with the
Company's stockholders. Mr. Grella does not currently hold any stock options,
and the Committee intends to grant an option to Mr. Grella to provide long term
incentive with respect to the value of the Common Stock.
The Committee intends for the CEO's compensation to be substantially linked
to the performance of the Company as it effects the value of the Common Stock
for the benefit of all its stockholders.
SECTION 162(m) OF THE INTERNAL REVENUE CODE
The Company does not have and does not propose to adopt any policy with
respect to the limits on deductibility of annual executive compensation in
excess of $1 million pursuant to Section 162(m) of the Internal Revenue Code.
The Company has not paid and does not anticipate paying compensation at such
levels in the foreseeable future.
The Compensation Committee believes that it has developed an appropriate
structure within which to reward and motivate its officers as they build value
for the Company's stockholders.
W.D. Kennedy
Jerry J. Langdon
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee, which was formed in 1997, consists of Messrs.
Kennedy and Langdon. Neither of the members of the Committee is, or has ever
been, an officer or employee of the Company.
Page 18
<PAGE>
COMPARISON OF CUMULATIVE TOTAL SHAREHOLDER RETURN
The Company's Common Stock began trading publicly on October 3, 1996. Set
forth below is a line graph comparing the percentage change in the cumulative
total shareholder return on the Company's stock against the total return of the
Nasdaq Market Index and a peer group for the period from October 3, 1996, to
December 31, 1996. The peer group index is a published index consisting of
approximately 50 oil and natural gas production companies. The chart indicates
the value, on the dates specified, of $100 invested at October 3, 1996, and
assumes reinvestment of all dividends.
COMPARISON OF CUMULATIVE TOTAL RETURN AMONG
COSTILLA ENERGY, INC., NASDAQ MARKET INDEX
AND PEER GROUP INDEX
10/03/96 10/31/96 11/29/96 12/31/96
-------- -------- -------- --------
COSTILLA ENERGY, INC. $100.00 $100.99 $ 97.03 $107.92
PEER GROUP INDEX $100.00 $108.25 $111.92 $110.50
NASDAQ MARKET INDEX $100.00 $ 98.85 $104.99 $104.75
Page 19
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SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely upon a review of Forms 3,4 and 5 and amendments thereto
furnished to the Company pursuant to the rules and regulations promulgated under
Section 16(a) of the Securities Exchange Act of 1934 during and with respect to
the Company's last fiscal year and upon certain written representations received
by the Company, the Company is not aware of any failure by a reporting person of
the Company to timely file reports required under Section 16(a) other than the
late filing of a Form 4 by Mr. Kennedy relating to one purchase transaction.
RECEIPT OF STOCKHOLDER PROPOSALS
For inclusion in the Company's 1998 proxy statement, all stockholder
proposals for consideration at the Annual Meeting of Stockholders of the Company
to be held in 1998 must be received at the Company's principal executive
offices, 400 W. Illinois, Suite 1000, Midland, Texas 79701, Attention: Bobby W.
Page, by January 21, 1998. Such proposals must also comply with all other
regulations of the Securities and Exchange Commission.
OTHER BUSINESS
The Company knows of no other business to come before the meeting. If
however, other matters properly come before the meeting, it is the intention of
the persons named in the enclosed proxy to vote the shares represented thereby
in accordance with their best judgment.
AVAILABILITY OF ANNUAL REPORT
THE ANNUAL REPORT OF THE COMPANY FOR THE FISCAL YEAR ENDED DECEMBER 31,
1996, WHICH CONTAINS THE COMPANY'S FORM 10-K INCLUDING FINANCIAL STATEMENTS, HAS
BEEN MAILED TO EACH STOCKHOLDER OF RECORD ON THE ABOVE-REFERENCED RECORD DATE.
By order of the Board of Directors,
Bobby W. Page
Secretary
Dated: May 21, 1997
Page 20
<PAGE>
PROXY
COSTILLA ENERGY, INC.
THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS AND MAY BE
REVOKED PRIOR TO ITS EXERCISE
The undersigned hereby appoints Cadell S. Liedtke, Michael J. Grella and
Henry G. Musselman and each of them with, full power of substitution, to act as
attorneys and proxies for the undersigned and to vote all shares of Common Stock
of Costilla Energy, Inc. (the "Company") which the undersigned is entitled to
vote at the Annual Meeting of Stockholders to be held on June 16, 1997 at 2:00
p.m., local time, and at any adjournments thereof, on the matters set forth in
the Notice of Annual Meeting of Stockholders and Proxy Statement dated May 21,
1997 (the "Proxy Statement"), as follows:
Proposal No. 1: Election of Directors
NOMINEES:
W.D. Kennedy and Jerry J. Langdon
FOR
all nominees listed above (except for named individual nominees for
whom authority is withheld below)
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WITHHOLD AUTHORITY
to vote for all nominees listed below
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WITHHOLD AUTHORITY
to vote for any individual nominee (see INSTRUCTION below)
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(INSTRUCTION: To withhold authority to vote for any individual
nominee, write that nominee's name on the space provided below)
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<PAGE>
Proposal No. 2: Ratification of the Appointment of KPMG Peat Marwick
LLP as independent public accountants for the Company
for the fiscal year ending December 31, 1997.
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FOR
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AGAINST
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ABSTAIN
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Proposal No. 3: Amendment of 1996 Stock Option Plan of Costilla Energy,
Inc. as described in the Proxy Statement.
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FOR
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AGAINST
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ABSTAIN
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Proposal No. 4: Amendment of Outside Directors Stock Option Plan of
Costilla Energy, Inc. as described in the Proxy
Statement.
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FOR
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AGAINST
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ABSTAIN
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<PAGE>
Proposal No. 5: Amendment of Bonus Incentive Plan of Costilla Energy,
Inc. as described in the Proxy Statement.
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FOR
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AGAINST
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ABSTAIN
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THIS PROXY WILL BE VOTED AS DIRECTED, BUT IF NO INSTRUCTIONS ARE SPECIFIED,
IT WILL BE VOTED FOR THE NOMINEES FOR DIRECTORS AND IN FAVOR OF THE PROPOSALS
SHOWN ABOVE. IF ANY OTHER BUSINESS IS PRESENTED AT SUCH MEETING, THIS PROXY WILL
BE VOTED BY THE PROXY HOLDERS IN THEIR BEST JUDGMENT. AT THE PRESENT TIME, THE
BOARD OF DIRECTORS KNOWS OF NO OTHER BUSINESS TO BE PRESENTED AT THE MEETING.
This Proxy should be dated, signed by the Stockholder exactly as his name
appears on this Proxy, and returned promptly in the enclosed envelope. PERSONS
SIGNING IN A FIDUCIARY CAPACITY SHOULD SO INDICATE, AND JOINT OWNERS SHOULD EACH
SIGN. By signing below, the undersigned acknowledges receipt from the Company of
a Notice of Annual Meeting, a Proxy Statement dated May 21, 1997 and a copy of
the Company's 1996 Annual Report.
Dated: , 1997.
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Signed:
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PROXIES MUST BE SIGNED AND DATED TO BE VALID
