<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 17, 1998
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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COSTILLA ENERGY, INC.
(Exact name of Registrant as specified in its charter)
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<TABLE>
<S> <C> <C>
DELAWARE 1311 75-2658940
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>
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<TABLE>
<S> <C>
BOBBY W. PAGE, SENIOR VICE PRESIDENT
COSTILLA ENERGY, INC.
400 WEST ILLINOIS, SUITE 1000 400 WEST ILLINOIS, SUITE 1000
MIDLAND, TEXAS 79701 MIDLAND, TEXAS 79701
(915) 683-3092 (915) 683-3092
(Address, including zip code, and telephone (Name, address, including zip code, and
number, including area code, of telephone number, including area
Registrant's principal executive offices) code, of agent for service)
</TABLE>
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Copies to:
RICHARD T. MCMILLAN
COTTON, BLEDSOE, TIGHE & DAWSON,
A PROFESSIONAL CORPORATION
500 WEST ILLINOIS, SUITE 300
MIDLAND, TEXAS 79701
(915) 684-5782
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
======================================================================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE AGGREGATE OFFERING PRICE AMOUNT OF
SECURITIES TO BE REGISTERED(1) REGISTERED OFFERING PRICE(1) PER UNIT(1) REGISTRATION FEE
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
10 1/4% Senior Notes Due 2006....... $80,000,000 100% $80,000,000 $23,600
======================================================================================================================
</TABLE>
(1) Estimated pursuant to Rule 457 solely for the purpose of calculating the
amount of the registration fee.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON
SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY
DETERMINE.
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<PAGE> 2
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED APRIL 17, 1998
PROSPECTUS
COSTILLA ENERGY, INC.
OFFER TO EXCHANGE
10 1/4% SENIOR NOTES DUE 2006
FOR $80,000,000 PRINCIPAL AMOUNT OF ITS OUTSTANDING
10 1/4% SENIOR NOTES DUE 2006
---------------------
The Exchange Offer will expire at 5:00 p.m., New York City time, on
, 1998, unless extended.
Costilla Energy, Inc., a Delaware corporation (the "Company"), hereby
offers (the "Exchange Offer"), upon the terms and subject to the conditions set
forth in this Prospectus and the accompanying Letter of Transmittal (the "Letter
of Transmittal"), to exchange up to an aggregate principal amount of $80,000,000
of its outstanding 10 1/4% Senior Notes due 2006 (the "Private Notes") for an
equal principal amount of its 10 1/4% Senior Notes due 2006 (the "Exchange
Notes") in integral multiples of $1,000. The Private Notes were issued on
January 16, 1998 (the "Issue Date"). The Company also has outstanding
$100,000,000 aggregate principal amount of 10 1/4% Senior Notes due 2006 (the
"Existing Notes") which were issued pursuant to an Indenture dated as of October
1, 1996, with State Street Bank and Trust Company, as Trustee (the "Trustee"),
which Indenture was modified by a Supplemental Indenture dated as of January 16,
1998 (as modified, the "Indenture") to permit the issuance of the Private Notes
under the Indenture. The Exchange Notes will also be issued under the Indenture.
The Exchange Notes will be general unsecured obligations of the Company and are
substantially identical (including principal amount, interest rate, maturity and
redemption rights) to the Private Notes for which they may be exchanged pursuant
to this Exchange Offer, except for certain transfer restrictions and
registration rights relating to the Private Notes. See "Description of Exchange
Notes." There will be no proceeds to the Company from the Exchange Offer;
however, pursuant to that certain Registration Rights Agreement dated as of
January 16, 1998 (the "Registration Rights Agreement") among the Company and the
Initial Purchasers (as defined herein) of the Private Notes, the Company will
bear certain offering expenses. References throughout this Prospectus to "Notes"
shall refer to the Existing Notes and the Exchange Notes collectively.
(Cover text continued on next page)
---------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 13 FOR A DISCUSSION OF CERTAIN RISKS
TO BE CONSIDERED IN CONNECTION WITH THE EXCHANGE OFFER AND IN EVALUATING AN
INVESTMENT IN THE EXCHANGE 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 THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
---------------------
THE DATE OF THIS PROSPECTUS IS , 1998
<PAGE> 3
The Company will accept for exchange any and all validly tendered Private
Notes on or prior to 5:00 p.m., New York City time, on , 1998,
unless extended (the "Expiration Date"). Tenders of Private Notes may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the Expiration
Date; otherwise such tenders are irrevocable. State Street Bank and Trust
Company is acting as exchange agent (the "Exchange Agent") and D.F. King & Co.,
Inc. is acting as information agent (the "Information Agent") in connection with
the Exchange Offer. The minimum period of time that the Exchange Offer will
remain open is 30 days (or longer if required by applicable law) after the date
notice of the Exchange Offer is mailed to the holders of the Private Notes. The
Exchange Offer is not conditioned upon any minimum principal amount of Private
Notes being tendered for exchange, but is otherwise subject to certain customary
conditions.
The Exchange Notes will bear interest at a rate equal to 10 1/4% per annum
on the same terms as the Private Notes. Interest on the Exchange Notes will be
payable semi-annually in arrears on April 1 and October 1 of each year,
commencing October 1, 1998. Private Notes that are accepted for exchange will
cease to accrue interest as of the last interest payment date on which interest
was paid on the Private Notes prior to the exchange.
The Private Notes in an aggregate principal amount of $80.0 million were
sold by the Company on the Issue Date (the "Initial Offering"), to BT Alex.
Brown Incorporated and Prudential Securities Incorporated (collectively, the
"Initial Purchasers") in a transaction not registered under the Securities Act
of 1933, as amended (the "Securities Act"), in reliance upon the exemption
provided in Section 4(2) of the Securities Act. The Initial Purchasers
subsequently placed the Private Notes with qualified institutional buyers in
reliance upon Rule 144A under the Securities Act. Accordingly, the Private Notes
may not be re-offered, resold or otherwise transferred in the United States
unless registered or unless an applicable exemption from the registration
requirements of the Securities Act is available. The Exchange Notes are being
offered hereunder in order to satisfy the obligations of the Company under the
Registration Rights Agreement. See "The Exchange Offer."
Under existing interpretations of the Securities and Exchange Commission
(the "Commission") contained in several no action letters to third parties, the
Company believes that the Exchange Notes will be freely transferable by holders
thereof (other than the Initial Purchasers, persons participating in the
distribution of the Private Notes or affiliates of the Company) after the
Exchange Offer without further registration under the Securities Act; provided,
however, that each holder that wishes to exchange its Private Notes for Exchange
Notes will be required to represent (i) that any Exchange Notes to be received
by it will be acquired in the ordinary course of its business, (ii) that at the
time of the commencement of the Exchange Offer it has no arrangement or
understanding with any person to participate in the distribution (within the
meaning of Securities Act) of the Exchange Notes, (iii) that it is not an
"affiliate" (as defined in Rule 405 promulgated under the Securities Act) of the
Company, (iv) that it is not engaged in, and does not intend to engage in, any
distribution of Exchange Notes; and (v) if such holder is a broker-dealer (a
"Participating Broker-Dealer") that will receive Exchange Notes for its own
account in exchange for Private Notes that were acquired as a result of
market-making or other trading activities, that it will deliver a prospectus in
connection with any resale of such Exchange Notes. The Company has agreed to
make available, during the period required by the Registration Rights Agreement,
a prospectus meeting the requirements of the Securities Act for use by
Participating Broker-Dealers and other persons, if any, with similar prospectus
delivery requirements for use in connection with any resale of Exchange Notes.
WHILE THE INTERPRETATIONS OF THE STAFF OF THE COMMISSION CONTAINED IN THE
AFOREMENTIONED NO ACTION LETTERS GIVE AN INDICATION OF THE COMMISSION'S POSITION
ON THE ISSUES PRESENTED, SUCH NO ACTION LETTERS ARE NOT BINDING UPON THE
COMMISSION WITH RESPECT TO ANY ISSUER OR SITUATION OTHER THAN THAT SPECIFICALLY
REFERENCED IN EACH NO ACTION LETTER. THE COMPANY HAS NOT REQUESTED A NO ACTION
LETTER FROM THE COMMISSION IN CONNECTION WITH THE EXCHANGE OFFER, AND THEREFORE
THE COMMISSION HAS NOT TAKEN A POSITION SPECIFICALLY WITH RESPECT TO THE
EXCHANGE OFFER.
<PAGE> 4
The Private Notes are traded on the Private Offering, Resales and Trading
through Automated Linkages ("PORTAL") Market of the National Association of
Securities Dealers, Inc. The Company does not intend to list the Exchange Notes
on any national securities exchange or to seek the admission thereof to trading
on the National Association of Securities Dealers automatic quotation system
("NASDAQ"). The Initial Purchasers have advised the Company that they intend to
make a market in the Exchange Notes; however, they are not obligated to do so
and any market-making may be discontinued at any time without notice.
Accordingly, no assurance can be given that an active public or other market
will develop for the Exchange Notes or as to the liquidity of or the trading
market for the Exchange Notes.
Any Private Notes not tendered and accepted in the Exchange Offer will
remain outstanding. To the extent that any Private Notes of other holders are
tendered and accepted in the Exchange Offer, a holder's ability to sell
untendered Private Notes could be adversely affected. Following consummation of
the Exchange Offer, the holders of untendered Private Notes will continue to be
subject to the existing restrictions upon transfer thereof, and will not be
entitled to exercise any of the registration rights contained in the
Registration Rights Agreement (except for certain holders who are not entitled
to participate in the Exchange Offer or who participate in the Exchange Offer,
but not do receive unrestricted Exchange Notes).
The Company expects that the Exchange Notes issued pursuant to this
Exchange Offer will be issued in the form of a Global Exchange Note (as defined
herein), which will be deposited with, or on behalf of, The Depository Trust
Company ("DTC") and registered in the name of a nominee of DTC. Beneficial
interests in the Global Exchange Note representing the Exchange Notes will be
shown on, and transfers thereof to qualified institutional buyers will be
effected through, records maintained by DTC and its participants. After the
initial issuance of the Global Exchange Note, Exchange Notes in certificated
form will be issued in exchange for the Global Exchange Note in accordance with
the normal procedures of DTC and the terms and procedures set forth in the
Indenture. See "Book-Entry; Delivery and Form."
---------------------
No dealer, salesperson or other person has been authorized to give
information or to make any representations not contained in this Prospectus,
and, if given or made, such information or representations must not be relied
upon as having been authorized by the Company. This Prospectus does not
constitute an offer to sell or the solicitation of an offer to buy any security
other than the Exchange Notes offered hereby, nor does it constitute an offer to
sell or the solicitation of any offer to buy any of the Exchange Notes to any
person in any jurisdiction in which it is unlawful to make such an offer or
solicitation to such person. Neither the delivery of this Prospectus nor any
sale made hereunder shall under any circumstances create any implication that
the information contained herein is correct as of any date subsequent to the
date hereof.
THE INFORMATION CONTAINED IN THIS PROSPECTUS WAS OBTAINED FROM THE COMPANY
AND OTHER SOURCES, BUT NO ASSURANCE CAN BE GIVEN AS TO THE ACCURACY OR
COMPLETENESS OF SUCH INFORMATION. IN MAKING AN INVESTMENT DECISION, INVESTORS
MUST RELY ON THEIR OWN EXAMINATION OF THE COMPANY AND THE TERMS OF THE OFFERING,
INCLUDING THE MERITS AND RISKS INVOLVED. THE CONTENTS OF THIS PROSPECTUS ARE NOT
TO BE CONSTRUED TO BE LEGAL, BUSINESS OR TAX ADVICE. EACH PROSPECTIVE INVESTOR
SHOULD CONSULT ITS OWN ATTORNEY, BUSINESS ADVISOR AND TAX ADVISOR AS TO LEGAL,
BUSINESS OR TAX ADVICE.
<PAGE> 5
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-4 (which term shall encompass any amendment thereto) under the Securities Act,
for the registration of the Exchange 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 the financial statement schedules and exhibits to the
Registration Statement as permitted by the rules and regulations of the
Commission. For further information, reference is made to the Registration
Statement, including the financial statement schedules and exhibits filed as a
part thereof. 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 shall be deemed qualified in its
entirety by such reference. The Registration Statement and the exhibits thereto
filed by the Company with the Commission may be inspected and copied at the
public reference facilities maintained by the Commission at Judiciary Plaza, 450
Fifth Street, N.W., Washington, DC 20549, and at the following regional offices
of the Commission: Seven World Trade Center, Suite 1300, New York, New York
10048 and Citicorp Center, 400 West Madison Street, Suite 1400, Chicago,
Illinois 606601-2511. Copies of such materials can be obtained by mail from the
Public Reference Section of the Commission at Judiciary Plaza, 450 Fifth Street,
N.W., Washington DC 20549, at prescribed rates. In addition, the Commission
maintains a site on the World Wide Web that contains reports, proxy and
information statements and other information filed electronically by the Company
with the Commission which can be accessed over the Internet at
http://www.sec.gov.
The Company is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). As long as the Company is subject to such periodic reporting and
informational requirements, it will furnish all reports and other information
required thereby to the Commission and pursuant to the Indenture will furnish
copies of such reports and other information to the Trustee.
The Company will deliver to the Trustee within 15 days after the filing of
the same with the Commission, copies of the quarterly and annual reports and of
the information, documents and other reports, if any, which the Company is
required to file with the Commission pursuant to Section 13 or 15(d) of the
Exchange Act. In the event the Company is not subject to the reporting
requirements of Section 13 or 15(d) of the Exchange Act, the Company will file
with the Commission, to the extent permitted, and provide (without exhibits) the
Trustee and holders with such annual reports and such information, documents and
other reports specified in Sections 13 and 15(d) of the Exchange Act. The
Company will also comply with the other provisions of Section 314(a) of the
Trust Indenture Act of 1939.
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS
PROSPECTUS AND THE ACCOMPANYING LETTER OF TRANSMITTAL AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY THE COMPANY OR THE EXCHANGE AGENT. NEITHER THE DELIVERY OF THIS
PROSPECTUS OR THE ACCOMPANYING LETTER OF TRANSMITTAL, OR BOTH TOGETHER, NOR ANY
SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE AN IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
NEITHER THIS PROSPECTUS NOR THE ACCOMPANYING LETTER OF TRANSMITTAL, OR BOTH
TOGETHER, CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY
OF THE SECURITIES OFFERED HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER
OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
<PAGE> 6
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 a material acquisition and
the Initial Offering. See "Recent Developments" and "Use of Proceeds." As used
herein, references to the "Company" or to "Costilla" are to Costilla Energy,
Inc. and its subsidiaries and predecessors. Certain oil and gas terms used in
this Prospectus are defined in the "Glossary" included herein. "Adjusted
EBITDA," as used herein, means net income (loss), plus interest, income taxes,
depreciation, depletion and amortization, exploration, impairment of oil and gas
properties, exploration and abandonment costs and extraordinary loss resulting
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 South/East Texas region, the Rocky Mountain region and
Permian Basin area of Texas and New Mexico. The Company's strategy focuses on
utilizing current and developing technological advancements to increase reserves
through a targeted exploration program, strategic property acquisitions and
development of existing properties. In addition, the Company owns 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 began operating in 1988 and conducted an initial public
offering (the "IPO") in October 1996. As of January 1, 1998, the Company had
total estimated net proved reserves of 15.0 Mmbbls of oil and 148.6 Bcf of gas,
aggregating 39.7 MMBOE, with a PV-10 Value of approximately $196.7 million. The
Company also has a substantial acreage position consisting of 953,268 gross
(713,107 net) acres at December 31, 1997, 665,734 gross (607,703 net) of which
are undeveloped. The Company has identified in excess of 600 drilling locations,
of which 147 are included in its proved reserves at January 1, 1998.
The Company began active efforts to acquire and develop oil and gas
properties in 1993 and, from January 1, 1993 to December 31, 1997, closed eight
acquisitions for an aggregate purchase price of approximately $138 million. The
Company has not participated in the auction process, but rather has made
acquisitions through negotiated transactions. The three most significant
acquisitions have been:
- The acquisition of 6.0 MMBOE (as of July 1, 1997) of proved reserves,
extensive undeveloped acreage and seismic data (the "Ballard
Acquisition") from Ballard Petroleum LLC ("Ballard") in August 1997 for
approximately $41.2 million, strengthening the Company's position in the
Rocky Mountain region.
- The acquisition of 10.6 MMBOE of proved reserves and undeveloped acreage
located in the Permian Basin and the South/East Texas region (the "1996
Acquisition") in June 1996 for approximately $38.7 million.
- The acquisition of 14.4 MMBOE of proved reserves and undeveloped acreage
in the Permian Basin, South/East Texas and Rocky Mountain regions (the
"1995 Acquisition") in June 1995 for approximately $46.6 million.
Costilla has in-house exploration expertise which uses 3-D seismic
technology as a primary tool to identify drilling opportunities. Since the IPO,
the Company has made 13 new exploratory discoveries utilizing 3-D technology,
which have added proved reserves of 7.4 MMBOE at January 1, 1998. The Company
experienced an approximately 60% success rate in its 1997 exploratory drilling
activities, and an overall success rate of approximately 83% in its 1997
drilling activities.
Through its acquisition, development and exploration activities, the
Company has grown substantially over the last four years, as measured by
reserves, production and cash flow.
- Estimated proved reserves have increased from 6.0 MMBOE at January 1,
1994 to 39.7 MMBOE at January 1, 1998, representing a compound annual
growth rate of 60%.
1
<PAGE> 7
- PV-10 Values have increased from $26.4 million at January 1, 1994 to
$196.7 million at January 1, 1998 representing a compound annual growth
rate of 65%.
- The Company has increased its average net daily production from 827 BOE
for the year ended December 31, 1993 to 12,671 BOE for the year ended
December 31, 1997, representing a compound annual growth rate of 98%.
- Adjusted EBITDA has increased from $1.8 million for the year ended
December 31, 1993 to approximately $40.0 million for the year ended
December 31, 1997 (pro forma for the Ballard Acquisition) representing a
compound annual growth rate of 117%.
- The Company's reserve growth has been achieved at an average all-in
finding cost of $4.32 per BOE for the period from January 1, 1993 to
December 31, 1997.
COMPANY STRENGTHS
The Company believes that its recent growth is primarily attributable to
the following factors:
- Successful Drilling Program. Employing its strategy of growth through the
drillbit, the Company has substantially increased its reserves and
production since 1993. From January 1, 1993 through January 1, 1998, the
Company replaced approximately 189% of its total production through
extensions and discoveries alone. By focusing drilling efforts on
reservoirs that have responded favorably to the application of advanced
drilling and completion techniques, management believes that the Company
can continue to increase its reserves and production by integrating the
Company's technical expertise with its large inventory of undeveloped
leasehold acreage.
- Significant Leasehold Positions. Through aggressive acreage acquisition
in its existing and new project areas, the Company seeks to establish a
significant leasehold position in each of its project areas. As a result,
the Company had approximately one million gross acres under lease at
December 31, 1997, which included in excess of 600 drilling locations at
January 1, 1998.
- Technological Leadership. The Company has developed significant expertise
in the application of 3-D seismic evaluation. The Company believes that
its expertise in employing this technology is an important factor in
supporting its recent growth and drilling success rate.
- Diversified Property Base. The Company holds a portfolio of oil and gas
properties located in the South/East Texas region, the Rocky Mountain
region and the Permian Basin. The Company believes that by conducting its
activities in distinct geographic regions it is able to reduce commodity
price and other operational risks. The Company's Moldovan interest
represents 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.
- Significant Operating Control. At January 1, 1998, the Company operated
approximately 76% of its properties as measured by PV-10 Value. This
level of operating control benefits the Company in numerous ways by
enabling the Company to (i) control the timing and nature of capital
expenditures, (ii) identify and implement cost control programs and (iii)
respond quickly to operational problems.
BUSINESS STRATEGY
The Company's strategy is to increase its oil and gas reserves, production
and cash flow from operations by utilizing a three-pronged approach which
combines an active exploration program using 3-D seismic and other technological
advances with strategic property acquisitions and focused development drilling.
The Company's management and technical staff have significant oil and natural
gas experience in the areas of drilling and completions, production operations,
acquisitions and divestitures and reservoir engineering. Most members of the
Company's technical staff, having spent substantial portions of their careers
specializing in the Company's core operating regions, have in-depth knowledge of
these regions. The Company seeks to reduce its operating and commodity risks by
holding a geographically diverse portfolio of properties, the reserves
2
<PAGE> 8
attributable to which were approximately 62% natural gas and 38% oil at January
1, 1998. The elements of the Company's strategy may be further described as
follows:
- Exploration Efforts. The Company has a staff of experienced geophysicists
and geologists who perform extensive analysis of the Company's
exploration prospects to carefully focus its 3-D seismic surveys and
identify potential drilling locations. This focus allows the Company to
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, where it can utilize the technical expertise and
experience of its staff to identify exploration prospects which may have
been previously overlooked.
- Strategic Property Acquisitions. The Company seeks to acquire producing
properties where it has identified opportunities to increase production
and reserves through both development and exploration activities. The
Company has increased the value of the properties it has acquired by
using its expertise and experience with current and advancing seismic,
drilling and production technology to aggressively manage its operations
of existing proved properties and successfully identify and develop
previously unproved reserves on acquired acreage. The Company seeks to
acquire reserves which 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.
- Development of Existing Properties. The Company is actively pursuing
development of its existing properties.
- Control of Operations. The Company prefers to operate and own the
majority working interest in its properties. This gives the Company
greater control over future development, drilling, completion and lifting
costs and the marketing of production. At January 1, 1998, the Company
operated wells constituting approximately 76% of its total PV-10 Value.
RECENT DEVELOPMENTS
The Company has had a number of recent significant developments with
respect to acquisitions, exploration successes and cost reduction efforts
through asset sales.
ACQUISITIONS
In keeping with its strategy to acquire properties with substantial
exploration potential, the Company consummated one significant acquisition in
1997 and an additional acquisition in January 1998. While both transactions have
proved reserves and current production, there are also significant acreage
positions and exploration prospects included in each acquisition.
Ballard Acquisition. In August 1997, the Company closed the Ballard
Acquisition for approximately $41.2 million. The oil and gas properties acquired
are located primarily in the Rocky Mountain region and had, as of July 1, 1997,
approximately 6.0 MMBOE of proved reserves and 212,085 net undeveloped acres.
The Company also acquired the rights to 150 square miles of 3-D seismic data and
42,000 miles of 2-D seismic data. The Company and Ballard have entered into an
Acquisition and Exploration Agreement that establishes an area of mutual
interest in the Rocky Mountain region in which the parties will jointly own,
acquire, explore and develop properties.
Manti Acquisition. In January 1998, the Company closed a transaction with
Manti Resources, Inc. and acquired producing properties and associated acreage
in South Texas (the "Manti Acquisition") in close proximity to an exploration
area the Company has been developing. The Manti Acquisition included
approximately 1.3 MMBOE of proved reserves at January 1, 1998, approximately 30
square miles of 3-D seismic data, and 16,202 gross and net undeveloped acres.
The purchase price was $10.5 million.
3
<PAGE> 9
EXPLORATION
S.W. Speaks Field, Lavaca County, Texas. The Company has drilled and
completed its initial exploratory well, the Migl-Mitchel #1 to a total depth of
14,950 feet. This well is located within the Company's 46 square mile 3-D
seismic survey and encountered two sand zones which totaled 190 feet of
productive expanded Wilcox sandstone. The well was completed from the lower of
the two sands in December 1997. Testing of the well indicated an open flow
potential of 116 Mmcf of gas per day. Gas sales commenced on January 20, 1998
and through March 24, 1998 this well has produced a total of 360 Mmcf of gas. As
of March 15, 1998, completion operations are underway on the second well, which
was drilled to a total depth of 15,847 feet. This second well penetrated three
productive Wilcox sand zones totaling 274 feet. The Company has a 100% working
interest in both wells, and owns 11,131 gross acres in this field with a 57.7%
average working interest. The Company is planning to drill four additional wells
in this field during 1998.
Hopewell Project, Harrison and Panola Counties, Texas. The Company has
acquired 6,060 gross acres in a contiguous block on this project with a 100%
working interest. The project straddles two major producing structures in the
state line area of Texas and Louisiana. The Company's acreage position has
existing production from various formations and is undeveloped in comparison to
offsetting leases. The Company has identified 100 drilling locations of which 25
have been classified as containing proved undeveloped reserves at January 1,
1998. The Company has drilled and dually completed the initial well from the
Cotton Valley and Travis Peak sands, for combined production of approximately
3,000 Mcf of gas per day as of April 15, 1998. The Company plans to drill eight
wells on the Hopewell project during 1998.
Scott and Hopper Field, Brooks County, Texas. The Company has drilled and
completed the Scott and Hopper GU 1-5 well from the shallow Vicksburg formation
at an initial rate of approximately 2,000 Mcf of gas per day. The well is
located on the producing acreage acquired in the Manti Acquisition. The Company
owns a 3-D survey of the acreage and has identified 10 additional drilling
locations. The Company owns 15,882 gross acres in the field with a 100% working
interest. The Company has plans to drill at least five wells in the Scott and
Hopper field during 1998.
Edwards-McElroy Ranch Prospect, Ector and Crane Counties, Texas. At
December 31, 1997, the Company had successfully completed a total of 26 wells on
the 80 square miles of 3-D seismic data. These wells have resulted in five new
discoveries in four formations. The Company has identified in excess of 50
drilling locations on the 11,970 gross and net acres on this prospect. The
Company is planning to drill three wells in this project during 1998.
DIVESTITURES
The Company continuously evaluates its properties to identify opportunities
to divest properties which are marginally economic, have high per-unit costs or
have limited potential. From January 1, 1997 through December 31, 1997, the
Company sold 6.6 MMBOE of what it considered high operating cost reserves.
Concho Sale. In December 1997, the Company sold certain oil and gas
properties primarily located in the Permian Basin to Concho Resources, Inc. for
$16.2 million (the "Concho Sale"). These properties had assigned proved reserves
of 4.9 MMBOE as of December 31, 1997, consisted of approximately 1,600 gross
wells, approximately 90% of which were nonoperated, included high operating cost
properties and did not fit the Company's overall business strategy.
Gulf Production Sale. In January 1998, the Company sold its interest in
approximately 190 gross wells in Oklahoma, approximately 75% of which were
non-operated, to Gulf Partners L.L.C. and Gulf Production Corp for $2.5 million
(the "Gulf Production Sale"). The properties had assigned proved reserves of 0.7
MMBOE as of January 1, 1998 and did not fit the Company's business strategy.
4
<PAGE> 10
SUMMARY AND TERMS OF THE EXCHANGE NOTES
SECURITIES OFFERED......... $80,000,000 aggregate principal amount of 10 1/4%
Senior Notes due 2006.
ISSUER..................... Costilla Energy, Inc.
MATURITY DATE.............. October 1, 2006
INTEREST ON THE EXCHANGE
NOTES.................... The Exchange Notes will bear interest at a rate
equal to 10 1/4% per annum and will be payable
semi-annually on April 1 and October 1 of each year
commencing October 1, 1998. Interest on each
Exchange Note will accrue (A) from the later of (i)
the last interest payment date on which interest
was paid on the Private Note surrendered in
exchange therefor, or (ii) if the Private Note is
surrendered for exchange on a date in a period
which includes the record date for an interest
payment date to occur on or after the date of such
exchange and as to which interest will be paid, the
date of such interest payment date or (B) if no
interest has been paid on the Private Notes, from
the Issue Date.
RANKING.................... The Notes will be general unsecured obligations of
the Company and will rank pari passu with any
unsubordinated indebtedness of the Company. The
Notes will rank senior in right of payment to all
subordinated obligations of the Company. The Notes
will be effectively subordinated to all secured
indebtedness of the Company to the extent of the
value of the assets securing such indebtedness. As
of December 31, 1997, on a pro forma basis after
giving effect to the Initial Offering, the Company
would have had approximately $0.7 million of
secured indebtedness.
OPTIONAL REDEMPTION........ The Notes will be redeemable, in whole or in part,
at the option of the Company on or after October 1,
2001, at the redemption prices set forth herein,
plus accrued interest to the date of redemption. In
addition, at any time on or prior to October 1,
1999, the Company may, at its option, redeem up to
$30.0 million in aggregate principal amount of the
Notes with the net cash proceeds of an Equity
Offering, at a redemption price equal to 110.25% of
the aggregate principal amount of the Notes to be
redeemed, plus accrued interest, if any, to the
date of redemption, provided, however, that after
giving effect to any such redemption, at least
$150.0 million in aggregate principal amount of the
Notes remains outstanding.
CHANGE OF CONTROL.......... Upon a Change of Control, each holder of the Notes
will have the right to require the Company to
repurchase such holder's Notes at a price equal to
101% of the principal amount thereof plus accrued
interest, if any, to the date of repurchase.
CERTAIN COVENANTS.......... The Indenture contains certain covenants that limit
the ability of the Company and its subsidiaries to,
among other things, incur additional indebtedness,
pay dividends or make certain other restricted
payments, consummate certain asset sales, enter
into certain transactions with affiliates, incur
liens, impose restrictions on the ability of a
subsidiary to pay dividends or make certain
payments to the Company and its subsidiaries, merge
or consolidate with any other person or sell,
assign, transfer, lease, convey or otherwise
dispose of all or substantially all of the assets
of the Company. In addition, under certain
circumstances, the
5
<PAGE> 11
Company will be required to offer to purchase the
Notes, in whole or in part, at a purchase price
equal to 100% of the principal amount thereof plus
accrued interest to the date of repurchase, with
the proceeds of certain Asset Sales. These
restrictions and qualifications are subject to a
number of important qualifications and exceptions.
See "Description of Exchange Notes -- Certain
Covenants."
For additional information regarding the Exchange Notes, see "Description
of Exchange Notes."
6
<PAGE> 12
THE EXCHANGE OFFER
THE PRIVATE NOTES.......... The Private Notes were sold by the Company on
January 16, 1998, in the Initial Offering, to the
Initial Purchasers pursuant to the Purchase
Agreement (as defined below). The Initial
Purchasers subsequently resold the Private Notes to
qualified institutional buyers pursuant to Rule
144A under the Securities Act.
REGISTRATION
REQUIREMENTS............... Pursuant to the Purchase Agreement dated January
13, 1998, by and among the Company, BT Alex. Brown
Incorporated and Prudential Securities Incorporated
(the "Purchase Agreement"), the Company and the
Initial Purchasers entered into the Registration
Rights Agreement, which grants the holders of the
Private Notes certain exchange and registration
rights. The Exchange Offer is intended to satisfy
such exchange and registration rights, which
terminate upon the consummation of the Exchange
Offer; provided, however, that if applicable law or
applicable interpretations of the staff of the
Commission do not permit the Company to effect the
Exchange Offer, or in the event certain holders are
not entitled to participate in the Exchange Offer
or do not receive unrestricted securities in the
Exchange Offer, the Company has agreed to file a
shelf registration (the "Shelf Registration
Statement") covering resales of the Private Notes.
See "The Exchange Offer -- Resale of Exchange
Notes" and "The Exchange Offer -- Shelf
Registration Statement."
THE EXCHANGE OFFER......... The Company is offering to exchange $1,000
principal amount of the Exchange Notes for each
$1,000 principal amount of Private Notes. As of the
date hereof, $80.0 million aggregate principal
amount of Private Notes are outstanding. The
Company will issue the Exchange Notes on or about
, 1998 (the "Exchange Date").
Any holder who tenders in the Exchange Offer with
the intention to participate, or for the purpose of
participating, in a distribution or secondary
resale of the Exchange Notes cannot rely on the
position of the staff of the Commission enunciated
in Exxon Capital Holdings Corporation (publicly
available May 13, 1989) or similar no action
letters and, in the absence of an exemption
therefrom, must comply with the registration and
prospectus delivery requirements of the Securities
Act in connection with the resale transaction
(which prospectus must include the selling security
holders' information required by Item 507 of
Regulation S-K under the Securities Act). Failure
to comply with such requirements in such instance
may result in such holder incurring liability under
the Securities Act for which the holder is not
indemnified by the Company.
Under existing interpretations of the Commission
contained in several no action letters to third
parties, the Company believes that the Exchange
Notes will be freely transferable by holders
thereof (other than the Initial Purchasers, persons
participating in the distribution of the Private
Notes or affiliates of the Company) after the
Exchange Offer without further registration under
the Securities Act; provided, however, that each
holder that wishes to exchange its Private Notes
for Exchange Notes will be required to represent
(i) that any Exchange Notes to be received by it
will be acquired in the ordinary course of its
business, (ii) that at the time of the commencement
of the Exchange Offer it has
7
<PAGE> 13
no arrangement or understanding with any person to
participate in the distribution (within the meaning
of Securities Act) of the Exchange Notes, (iii)
that it is not an "affiliate" (as defined in rule
405 promulgated under the Securities Act) of the
Company, (iv) that it is not engaged in, and does
not intend to engage in, the distribution of
Exchange Notes, and (v) if such holder is a
Participating Broker-Dealer that will receive
Exchange Notes for its own account in exchange for
Private Notes that were acquired as a result of
market-making or other trading activities, that it
will deliver a prospectus in connection with any
resale of such Exchange Notes. The Company will
agree to make available, during the period required
by the Registration Rights Agreement, a prospectus
meeting the requirements of the Securities Act for
use by Participating Broker-Dealers and other
persons, if any, with similar prospectus delivery
requirements for use in connection with any resale
of Exchange Notes.
EXPIRATION DATE............ 5:00 p.m., New York City time on ,
1998.
PROCEDURES FOR TENDERING
PRIVATE NOTES............ Each holder of Private Notes wishing to accept the
Exchange Offer must complete, sign and date the
accompanying Letter of Transmittal, or a facsimile
thereof, in accordance with the instructions
contained herein and therein, and mail or otherwise
deliver such Letter of Transmittal, or such
facsimile, together with the Private Notes and any
other required documentation to the Exchange Agent
at the address set forth herein. By executing the
Letter of Transmittal, each holder will represent
to the Company that, among other things, the holder
or person receiving such Exchange Notes, whether or
not such person is the holder, is acquiring the
Exchange Notes in the ordinary course of business
and that neither the holder nor any such other
person has any arrangement or understanding with
any person to participate in the distribution of
such Exchange Notes. In lieu of physical delivery
of the certificates representing Private Notes,
tendering holders may transfer Private Notes
pursuant to the procedure for book-entry transfer
as set forth under "The Exchange
Offer -- Procedures for Tendering."
SPECIAL PROCEDURES FOR
BENEFICIAL OWNERS........ Any beneficial owner whose Private Notes are
registered in the name of a broker-dealer,
commercial bank, trust company or other nominee and
who wishes to tender should contact such registered
holder promptly and instruct such registered holder
to tender on such beneficial owner's behalf. If
such beneficial owner wishes to tender on such
owner's own behalf, such owner must, prior to
completing and executing the Letter of Transmittal
and delivering its Private Notes, either make
appropriate arrangements to register ownership of
Private Notes in such owner's name or obtain a
properly completed bond power from the registered
holder. The transfer of record ownership may take
considerable time.
GUARANTEED DELIVERY
PROCEDURES............... Holders of Private Notes who wish to tender their
Private Notes and whose Private Notes are not
immediately available or who cannot deliver their
Private Notes, the Letter of Transmittal or any
other documents required by the Letter of
Transmittal to the Exchange Agent (or comply with
the procedures for book-entry transfer) prior to
the Expiration Date must tender their Private Notes
according to the guaranteed delivery
8
<PAGE> 14
procedures set forth in "The Exchange
Offer -- Guaranteed Delivery Procedures."
WITHDRAWAL RIGHTS.......... Tenders may be withdrawn at any time prior to 5:00
p.m., New York City time, on the Expiration Date
pursuant to the procedures described under "The
Exchange Offer -- Withdrawal of Tenders."
ACCEPTANCE OF PRIVATE
NOTES AND DELIVERY OF
EXCHANGE NOTES........... Subject to certain conditions, the Company will
accept for exchange any and all Private Notes that
are properly tendered in the Exchange Offer prior
to 5:00 p.m., New York City time, on the Expiration
Date. The Exchange Notes issued pursuant to the
Exchange Offer will be delivered on the Exchange
Date. See "The Exchange Offer -- Terms of the
Exchange Offer."
FEDERAL INCOME TAX
CONSEQUENCES............. The exchange pursuant to the Exchange Offer should
not be a taxable event for federal income tax
purposes. See "Certain Federal Income Tax
Consequences."
EFFECT ON HOLDERS OF
PRIVATE NOTES............ As a result of the making of this Exchange Offer,
the Company will have fulfilled one of its
obligations under the Registration Rights
Agreement, and holders of Private Notes who do not
tender their Private Notes will not have any
further registration rights under the Registration
Rights Agreement or otherwise, subject to certain
limited exceptions. Such holders will continue to
hold the untendered Private Notes and will be
entitled to all the rights and subject to all the
limitations applicable thereto under the Indenture,
except to the extent such rights or limitations, by
their terms, terminate or cease to have further
effectiveness as a result of the Exchange Offer.
All untendered Private Notes will continue to be
subject to certain restrictions on transfer.
Accordingly, if any Private Notes are tendered and
accepted in the Exchange Offer, the trading market
of the untendered Private Notes could be adversely
affected. See "The Exchange Offer" and "Risk
Factors -- Absence of Public Market."
EXCHANGE AGENT............. State Street Bank and Trust Company
INFORMATION AGENT.......... D.F. King & Co., Inc.
USE OF PROCEEDS............ There will be no cash proceeds payable to the
Company from the issuance of the Exchange Notes
pursuant to the Exchange Offer. See "Use of
Proceeds."
RISK FACTORS
See "Risk Factors" for a discussion of certain factors that should be
considered in evaluating an investment in the Notes.
9
<PAGE> 15
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 Statement of Operations 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,
-----------------------------------------
HISTORICAL
----------------------------- PRO FORMA
1997 1996 1995 1997(1)
-------- -------- ------- ---------
(IN THOUSANDS, EXCEPT RATIOS)
<S> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................................... $ 76,501 $ 55,026 $21,816 $ 82,189
Expenses:
Oil and Gas Production......................... 30,029 21,774 10,355 32,632
General and administrative..................... 8,407 5,238 3,571 9,527
Compensation related to option settlement...... -- -- 656 --
Exploration and abandonment.................... 6,588 2,550 1,652 6,788
Depreciation, depletion and amortization....... 26,409 12,430 5,958 28,439
Impairment of oil and gas properties........... 28,189 -- -- 28,189
-------- -------- ------- --------
Total Operating Expenses.................. 99,622 41,992 22,192 105,575
-------- -------- ------- --------
Operating income.................................... (23,121) 13,034 (376) (23,386)
Interest............................................ 12,979 11,281 4,591 19,053
Income (loss) from continuing operations............ (36,252) 535 (4,970) (42,591)
Net income (loss)................................... $(36,471) $ (4,440) $(4,970) $(42,810)
OTHER FINANCIAL DATA:
Capital Expenditures.............................. $113,924 $ 70,017 $62,220
Adjusted EBITDA(2)................................ 38,065 27,108 7,234 $ 40,030
Interest Expenses -- net of deferred charges
amortization................................... 12,461 10,253 4,591 18,221
Adjusted EBITDA/interest expenses(2).............. 3.1x 2.6x 1.6x 2.2x
Ratio of earnings to fixed charges(3)............. -- 1.2 -- --
BALANCE SHEET DATA (AS OF PERIOD END):
Working capital (deficit)......................... $(11,511) $ 10,320 $ 2,654
Total assets...................................... 194,088 162,790 87,367
Total debt, less current maturities............... 163,087 100,262 71,494
Redeemable predecessor capital.................... -- -- 11,576
Predecessor capital............................... -- -- (7,445)
Stockholders' equity.............................. 410 40,569 --
</TABLE>
- ---------------
(1) Assumes that the Ballard Acquisition and the Initial Offering and the
application of proceeds therefrom had taken place as of January 1, 1997 for
purposes of Statement of Operations Data and Other Financial Data.
(2) Adjusted EBITDA is presented because of its wide acceptance as a financial
indicator 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, impairment of oil and gas
properties, exploration and abandonment costs and extraordinary loss
resulting from extinguishment of debt to net income (loss). Adjusted EBITDA
should not be considered as an alternative to earnings (loss), or operating
earnings (loss), as defined by generally accepted accounting principles, as
an indicator 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 $36,100,000 and $4,967,000 for the historical periods
ended December 31, 1997, and December 31, 1995, respectively, and
$42,439,000 for the pro forma period ended December 31, 1997.
10
<PAGE> 16
SUMMARY RESERVE DATA
<TABLE>
<CAPTION>
AS OF JANUARY 1, AS
------------------------------ ADJUSTED
1998(2) 1997(2) 1996 1998(3)
-------- -------- -------- --------
<S> <C> <C> <C> <C>
ESTIMATED PROVED RESERVES(1):
Oil (Mbbls)...................................... 14,952 17,000 10,788 14,964
Gas (Mmcf)....................................... 148,637 120,272 78,152 151,987
MBOE (6 Mcf/Bbl)................................. 39,725 37,045 23,813 40,295
Percent of proved developed reserves............. 62.4% 78.3% 76.1% 62.0%
Present value of estimated future net cash flow,
before income taxes, discounted at 10% (in
thousands).................................... $196,678 $311,803 $113,296 $202,452
Reserve life index (in years)(4)................. 8.6 11.4 13.6
RESERVE REPLACEMENT DATA:
Production replacement ratio(5).................. 303% 512% 969%
</TABLE>
- ---------------
(1) Estimates of net proved oil and gas reserves at January 1, 1997, are based
on reports prepared by Williamson Petroleum Consultants, Inc.
("Williamson"), independent petroleum engineers. The reserve estimates at
January 1, 1996, were prepared by the Company. The United States reserve
estimates at January 1, 1998 were prepared by the Company, of which
approximately 72% were reviewed by Williamson. Reserve estimates
attributable to Moldova at January 1, 1998 (no Moldovan reserve estimates
were included at prior dates) were prepared by W. Scott Epley, P.E. See
"Risk Factors -- Uncertainty of Estimates of Proved Reserves and Future Net
Revenues" and "Business and Properties -- Oil and Gas Reserves."
(2) Oil and gas prices used to determine proved United States reserves and the
present value of estimated future net cash flow were $24.17 and $3.96,
respectively, at January 1, 1997, and $15.29 and $2.20, respectively, at
January 1, 1998.
(3) Gives effect to the Manti Acquisition and the Gulf Production Sale as if
both transactions had occurred as of January 1, 1998.
(4) Calculated by dividing year-end proved reserves by annual production for the
most recent year.
(5) Calculated by dividing reserve additions through acquisitions of reserves,
extensions and discoveries and revisions during the year by production for
such year.
11
<PAGE> 17
SUMMARY OPERATING DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
PRO FORMA(1)
1997 1996 1995 1997
------ ------ ------ ------------
<S> <C> <C> <C> <C>
PRODUCTION DATA:
Oil (Mbls)....................................... 2,175 1,726 950 2,491
Gas (Mmcf)....................................... 14,698 9,205 4,806 15,636
MBOE (6 Mcf/Bbl)................................. 4,625 3,260 1,751 5,097
AVERAGE SALES PRICE PER UNIT(2):
Oil (per Bbl).................................... $17.77 $19.87 $15.53 $17.80
Gas (per Mcf).................................... 2.29 2.13 1.45 2.28
COSTS PER BOE:
Production costs, including severance taxes...... $ 6.49 $ 6.68 $ 5.91 $ 6.40
Depreciation, depletion and amortization......... 5.71 3.81 3.40 5.58
</TABLE>
- ---------------
(1) Gives effect to the Ballard Acquisition as if such acquisition had occurred
as of January 1, 1997.
(2) Before deduction of production taxes and net of any hedging results.
12
<PAGE> 18
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Prospectus includes certain statements that may be deemed to be
"forward-looking statements" within the meaning of Section 27A of the Securities
Act, and Section 21E of the Exchange Act. All statements, other than statements
of historical facts, included in this Prospectus that address activities, events
or developments that the Company expects, projects, believes or anticipates will
or may occur in the future, including such matters as oil and gas reserves,
future drilling and operations, future production of oil and gas, future net
cash flows, future capital expenditures and other such matters, are
forward-looking statements. These statements are based on certain assumptions
and analysis made by management of the Company in light of its experience and
its perception of historical trends, current conditions, expected future
developments and other factors it believes are appropriate in the circumstances.
Such statements are subject to a number of assumptions, risks and uncertainties,
including the risk factors discussed herein, general economic and business
conditions, prices of oil and gas, the business opportunities (or lack thereof)
that may be presented to and pursued by the Company, changes in laws or
regulations and other factors, many of which are beyond the control of the
Company. Prospective investors are cautioned that any such statements are not
guarantees of future performance and that actual results or developments may
differ materially from those projected in the forward-looking statements.
RISK FACTORS
In evaluating an investment in the Exchange Notes being offered hereby,
prospective investors should consider carefully, among other things, the
following risk factors:
RESERVE REPLACEMENT RISK
In general, the volume of production from oil and gas properties declines
as reserves are depleted, with the rate of decline depending on reservoir
characteristics. Except to the extent the Company conducts successful
exploration and development activities or acquires properties containing proved
reserves, or both, the proved reserves of the Company will decline as reserves
are produced. The Company's future oil and gas production is, therefore, highly
dependent upon its level of success in finding or acquiring additional reserves.
The business of exploring for, developing or acquiring reserves is capital
intensive. To the extent cash flow from operations is reduced and external
sources of capital become limited or unavailable, the Company's ability to make
the necessary capital investment to maintain or expand its asset base of oil and
gas reserves would be impaired. In addition, there can be no assurance that the
Company's future exploration, development and acquisition activities will result
in additional proved reserves or that the Company will be able to drill
productive wells at acceptable costs.
SIGNIFICANT LEVERAGE AND DEBT SERVICE
As of December 31, 1997, as adjusted for the Initial Offering and the
application of the net proceeds therefrom, the Company's total long-term debt
and stockholders' equity would have been approximately $183.0 million and $0.1
million, respectively. See "Capitalization." In addition, after application of
the net proceeds of the Initial Offering, the Revolving Credit Facility (as
defined under "Description of Revolving Credit Facility") afforded the Company
$50.0 million of available borrowing capacity at January 16, 1998. 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 Revolving Credit Facility and the Indenture 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
13
<PAGE> 19
"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. 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 Revolving 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. In addition, the
Company's indebtedness under its Revolving Credit Facility is secured by
substantially all of the assets of the Company. See "Description of Revolving
Credit Facility." The pledge of such collateral to existing lenders could impair
the Company's ability to obtain financing. The inability to obtain additional
financing could have a material adverse effect on the Company.
EFFECTIVE SUBORDINATION OF NOTES
The obligations of the Company under the Revolving Credit Facility are
secured by substantially all of the assets of the Company. Holders of secured
indebtedness of the Company, including the lenders under the Revolving 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, such assets will be available to satisfy
obligations with respect to the 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 to the extent of such
pledged collateral. After giving pro forma effect to the Initial Offering and
the application of the net proceeds therefrom, the Company, at December 31,
1997, had $0.7 million of secured senior indebtedness outstanding. See
"Description of Exchange 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 December 31, 1997, the Company's only Subsidiary had
$0.2 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. There are currently no Subsidiary Guarantees. See "Description of
Exchange 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 Exchange Date 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
14
<PAGE> 20
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 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 Exchange
Notes -- Repurchase at the Option of Holders."
The Revolving 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 Revolving 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 Revolving 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 Revolving
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
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<PAGE> 21
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
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.
CONCENTRATION OF RESERVE ESTIMATES
While the Company's oil and gas reserves are attributable to in excess of
2,000 proved and proved undeveloped wells and locations, 15% of the Company's
total proved reserves at January 1, 1998 were attributable to two wells in the
Southwest Speaks Field in Lavaca County, Texas. Both wells were completed in the
first quarter of 1998. Estimates of proved undeveloped reserves, as well as
estimates made early in the productive life of wells, may be less reliable than
reserve estimates attributable to wells which have a longer production history.
Any downward revision of the reserve estimates attributable to the Southwest
Speaks Field, or any interference in production from such Field, could have a
material adverse affect on the Company's future cash flows and financial
results.
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 to fully 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
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<PAGE> 22
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 the Revolving
Credit Facility, the Private Notes and the Notes could be materially adversely
affected. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
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, 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
Messrs. Liedtke, Grella and Musselman own directly and indirectly, in the
aggregate, approximately 46% of the Company's outstanding Common Stock, $.10 par
value (the "Common Stock"). 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 "Principal Stockholders."
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.
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<PAGE> 23
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 canceled 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.
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. 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."
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<PAGE> 24
ABSENCE OF PUBLIC MARKET
The Company does not intend to apply for listing of the Exchange Notes
offered hereby on any national securities exchange or to seek approval for
quotation on NASDAQ. There can be no assurance as to the liquidity of any
markets that may develop for the Exchange Notes, the ability of holders of the
Exchange Notes to sell their Exchange Notes or the price at which holders would
be able to sell their Exchange Notes. Future trading prices of the Exchange
Notes will depend on many factors, including, among other things, prevailing
interest rates, the Company's operating results and the market for similar
securities. The Initial Purchasers have advised the Company that they currently
intend to make a market in the Exchange Notes offered hereby. However, the
Initial Purchasers are not obligated to do so and any market making may be
discontinued at any time without notice.
RELIANCE ON THIRD PARTY NO ACTION LETTERS
Statements made herein concerning the transferability of the Exchange Notes
are based upon statements made by the staff of the Commission set forth in no
action letters to third parties. While interpretations of the staff of the
Commission contained in such no action letters give an indication of the
Commission's position on the issues presented, such no action letters are not
binding upon the Commission with respect to any issuer or situation other than
that specifically referenced in the applicable no action letter. The Company has
not requested a no action letter from the Commission in connection with the
Exchange Offer, and therefore the Commission has not taken a position
specifically with respect to the Exchange Offer.
USE OF PROCEEDS
This Exchange Offer is intended to satisfy certain of the Company's
obligations under the Purchase Agreement and the Registration Rights Agreement
with respect to the Private Notes. The Company will not receive any cash
proceeds from the issuance of the Exchange Notes offered hereby. In
consideration for issuing the Exchange Notes contemplated in this Prospectus,
the Company will receive Private Notes in like principal amount, the form and
terms of which are substantially similar to the form and terms of the Exchange
Notes except as otherwise described herein. The Private Notes surrendered in
exchange for Exchange Notes will be returned to the Company and canceled and
cannot be reissued. Accordingly, the issuance of the Exchange Notes will not
result in any increase or decrease in the indebtedness of the Company.
THE EXCHANGE OFFER
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
The Private Notes were sold by the Company on January 16, 1998 to the
Initial Purchasers pursuant to the Purchase Agreement. The Initial Purchasers
subsequently placed the Private Notes with qualified institutional buyers in
reliance on Rule 144A under the Securities Act. As a condition of the purchase
of the Private Notes by the Initial Purchasers, the Company entered into the
Registration Rights Agreement with the Initial Purchasers, which requires, among
other things, that the Company file with the Commission a registration statement
under the Securities Act with respect to an offer by the Company to the holders
of the Private Notes to issue and deliver to such holders, in exchange for
Private Notes, a like principal amount of Exchange Notes. The Company is
required to use its best efforts to cause the Registration Statement relating to
the Exchange Offer to be declared effective by the Commission under the
Securities Act and commence the Exchange Offer. The Exchange Notes are to be
issued without a restrictive legend and may be reoffered and resold by the
holder without restrictions or limitations under the Securities Act (other than
the Initial Purchasers, persons participating in the distribution of the Private
Notes or any such holder that is an "affiliate" of the Company within the
meaning of Rule 405 under the Securities Act), subject to certain
representations by and conditions upon each such holder. See "-- Resale of
Exchange Notes." A copy of the Registration Rights Agreement has been filed with
the Commission.
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<PAGE> 25
The term "Holder" with respect to the Exchange Offer means any person in
whose name the Private Notes are registered on the books of the Company or any
other person who has obtained a properly completed bond power from the
registered holder.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Private
Notes validly tendered and not withdrawn prior to 5:00 p.m., New York City time,
on the Expiration Date. On the Exchange Date, the Company will issue $1,000
principal amount of Exchange Notes in exchange for $1,000 principal amount of
Private Notes accepted in the Exchange Offer. Holders may tender some or all of
their Private Notes pursuant to the Exchange Offer. However, Private Notes may
be tendered only in integral multiples of $1,000.
The form and terms of the Exchange Notes are the same as the form and terms
of the Private Notes except that (i) the Exchange Notes have been registered
under the Securities Act and hence will not bear legends restricting the
transfer thereof and (ii) the holders of the Exchange Notes will not be entitled
to certain rights under the Registration Rights Agreement. The Exchange Notes
will evidence the same debt as the Private Notes and will be entitled to the
benefits of the Indenture.
As of the date of this Prospectus, $80,000,000 aggregate principal amount
of the Private Notes was outstanding and registered in the name of Cede & Co.,
as nominee for the Depository Trust Company. The Company has fixed the close of
business of , 1998, as the record date for the Exchange Offer for
purposes of determining the persons to whom this Prospectus and the Letter of
Transmittal will be mailed initially.
The Company intends to conduct the Exchange Offer in accordance with the
applicable requirements of the Exchange Act and the rules and regulations of the
Commission thereunder, including Rule 14e-1 thereunder.
The Company shall be deemed to have accepted validly tendered Private Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering Holders
for the purposes of receiving the Exchange Notes from the Company.
If any tendered Private Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, the certificates for any such unaccepted Private Notes will be
returned, without expense, to the tendering Holder thereof as promptly as
practicable after the Expiration Date.
Holders who tender Private Notes in the Exchange Offer will not be required
to pay brokerage commissions or fees or, subject to the instructions in the
Letter of Transmittal, transfer taxes with respect to the exchange of Private
Notes pursuant to the Exchange Offer. The Company will pay all charges and
expenses, other than transfer taxes in certain circumstances, in connection with
the Exchange Offer. See "-- Fees and Expenses."
INTEREST ON THE EXCHANGE NOTES
The Exchange Notes will bear interest at a rate equal to 10 1/4 per annum
and will be payable semi-annually on April 1 and October 1 of each year
commencing October 1, 1998. Interest on each Exchange Note will accrue (A) from
the later of (i) the last interest payment date on which interest was paid on
the Private Note surrendered in exchange therefor, or (ii) if the Private Note
is surrendered for exchange on a date in a period which includes the record date
for an interest payment date to occur on or after the date of such exchange and
as to which interest will be paid, the date of such interest payment date or (B)
if no interest has been paid on the Private Notes, from the Issue Date.
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<PAGE> 26
PROCEDURES FOR TENDERING
Only a Holder of Private Notes may tender such Private Notes in the
Exchange Offer. To tender in the Exchange Offer, a Holder must complete, sign
and date the Letter of Transmittal, or a facsimile thereof, have the signatures
thereon guaranteed if required by the Letter of Transmittal and mail or
otherwise deliver such Letter of Transmittal or such facsimile, together with
the Private Notes and any other required documents, to the Exchange Agent prior
to 5:00 p.m., New York City time, on the Expiration Date. To be tendered
effectively, the Private Notes, Letter of Transmittal and other required
documents must be received by the Exchange Agent at the address set forth under
"-- Exchange Agent and Information Agent" prior to 5:00 p.m., New York City
time, on the Expiration Date. Delivery of the Private Notes may be made by book-
entry transfer in accordance with the procedures described below. Confirmation
of such book-entry transfer must be received by the Exchange Agent prior to the
Expiration Date.
By executing the Letter of Transmittal, each Holder will make to the
Company the representations set forth below in the second paragraph under
"-- Resale of Exchange Notes."
The tender by a Holder and the acceptance thereof by the Company will
constitute agreement between such holder and the Company in accordance with the
terms and subject to the conditions set forth herein and in the Letter of
Transmittal.
THE METHOD OF DELIVERY OF PRIVATE NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE. NO
LETTER OF TRANSMITTAL OR PRIVATE NOTES SHOULD BE SENT TO THE COMPANY. HOLDERS
MAY REQUEST THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES
OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR SUCH HOLDERS.
Any beneficial owner whose Private Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact the registered Holder promptly and instruct such
registered Holder to tender on such beneficial owner's behalf.
Signatures on the Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed by an Eligible Institution (as defined below)
unless the Private Notes, tendered pursuant thereto are tendered (i) by a
registered Holder who has not completed the box entitled "Special Delivery
Instructions" on the Letter of Transmittal or (ii) for the account of an
Eligible Institution. In the event that signatures on a Letter of Transmittal or
a notice of withdrawal, as the case may be, are required to be guaranteed, such
guarantee must be by an eligible guarantor institution that is a member of or
participant in the Securities Transfer Agents Medallion Program, the New York
Stock Exchange Medallion Signature Program, the Stock Exchange Medallion
Program, or an "eligible guarantor institution" within the meaning of Rule
17Ad-15 under the Exchange Act (an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the
registered Holder of any Private Notes listed therein, such Private Notes must
be endorsed or accompanied by a properly completed bond power, signed by such
registered Holder as such registered Holder's name appears on such Private Notes
with the signature thereon guaranteed by an Eligible Institution.
If the Letter of Transmittal or any Private Note or bond powers are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
The Company understands that the Exchange Agent will make a request
promptly after the date of this Prospectus to establish accounts with respect to
the Exchange Notes at DTC (the "Book-Entry Transfer
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<PAGE> 27
Facility") for the purpose of facilitating the Exchange Offer, and subject to
the establishment thereof, any financial institution that is a participant in
the Book-Entry Transfer Facility's system may make book-entry delivery of the
Private Notes by causing such Book-Entry Transfer Facility to transfer such
Private Notes into the Exchange Agent's account with respect to the Private
Notes in accordance with the Book-Entry Transfer Facility's procedures for such
transfer. Although delivery of the Private Notes may by effected through book-
entry transfer into the Exchange Agent's account at the Book-Entry Transfer
Facility, an appropriate Letter of Transmittal properly completed and duly
executed with any required signature guarantee and all other required documents
must in each case be transmitted to and received or confirmed by the Exchange
Agent at its address set forth below on or prior to the Expiration Date, or, if
the guaranteed delivery procedures described below are complied with, within the
time period provided under such procedures; provided, however, that a
participant in DTC's book-entry system may, in accordance with DTC's Automated
Tender Offer Program procedures and in lieu of physical delivery to the Exchange
Agent of a Letter of Transmittal, electronically acknowledge its receipt of, and
agreement to be bound by, the terms of the Letter of Transmittal. Delivery of
documents to the Book-Entry Transfer Facility does not constitute delivery to
the Exchange Agent.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of tendered Private Notes will be determined
by the Company in its sole discretion, which determination will be final and
binding. The Company reserves the absolute right to reject any and all Private
Notes not properly tendered or any Private Notes the Company's acceptance of
which would, in the opinion of counsel for the Company, be unlawful. The Company
also reserves the right to waive any defects, irregularities or conditions of
tender as to particular Private Notes. The Company's interpretation of the terms
and conditions of the Exchange Offer (including the instructions in the Letter
of Transmittal) will be final and binding on all parties. Unless waived, any
defects or irregularities in connection with tender of Private Notes must be
cured within such time as the Company shall determine. Although the Company
intends to notify Holders of defects or irregularities with respect to tenders
of Private Notes, neither the Company, the Exchange Agent nor any other person
shall incur any liability for failure to give such notification. Tenders of
Private Notes will not be deemed to have been made until such defects or
irregularities have been cured or waived. Any Private Notes received by the
Exchange Agent that are not properly tendered and as to which the defects or
irregularities have not been cured or waived will be returned by the Exchange
Agent to the tendering Holders, unless otherwise provided in the Letter of
Transmittal, as soon as practicable following the Expiration Date.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Private Notes and (i) whose Private Notes
are not immediately available, (ii) who cannot deliver their Private Notes, the
Letter of Transmittal or any other required documents to the Exchange Agent or
(iii) who cannot complete the procedures for book-entry transfer, prior to the
Expiration Date, may effect a tender if:
(a) the tender is made through an Eligible Institution;
(b) prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery (by facsimile transmission, mail or hand delivery)
setting forth the name and address of the Holder, the certificate number(s)
of such Private Notes and the principal amount of Private Notes tendered,
stating that the tender is being made thereby and guaranteeing that, within
five Nasdaq Stock Market trading days after the Expiration Date, the Letter
of Transmittal (or facsimile thereof), together with the certificate(s)
representing the Private Notes (or a confirmation of book-entry transfer of
Private Notes into the Exchange Agent's account at the Book-Entry Transfer
Facility) and any other documents required by the Letter of Transmittal,
will be deposited by the Eligible Institution with the Exchange Agent; and
(c) such properly completed and executed Letter of Transmittal (or
facsimile thereof), as well as the certificate(s) representing all tendered
Private Notes in proper form for transfer (or a confirmation of book-entry
transfer of such Private Notes into the Exchange Agent's account at the
Book-Entry Transfer
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<PAGE> 28
Facility) and all other documents required by the Letter of Transmittal,
are received by the Exchange Agent within five Nasdaq Stock Market trading
days after the Expiration Date.
Upon request to the Information Agent, a Notice of Guaranteed Delivery will
be sent to Holders who wish to tender their Private Notes according to the
guaranteed delivery procedures as set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Private Notes may be
withdrawn at any time prior to 5:00 p.m., New York City time, on the Expiration
Date.
To withdraw a tender of Private Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to 5:00 p.m., New York City time, on
the Expiration Date. Any such notice of withdrawal must (i) specify the name of
the person having deposited the Private Notes to be withdrawn (the "Depositor"),
(ii) identify the Private Notes to be withdrawn (including the certificate
number(s) and principal amount of such Private Notes, or, in the case of Private
Notes transferred by book-entry transfer, the name and number of the account at
the Book-Entry Transfer Facility to be credited), (iii) be signed by the Holder
in the same manner as the original signature on the Letter of Transmittal by
which such Private Notes were tendered (including any required signature
guarantees) or be accompanied by documents of transfer sufficient to have the
Trustee with respect to the Private Notes register the transfer of such Private
Notes into the name of the person withdrawing the tender, (iv) specify the name
in which any such Private Notes are to be registered, if different from that of
the Depositor and (v) if applicable because the Private Notes have been tendered
pursuant to book-entry procedures, specify the name and number of the
participant's account at DTC to be credited, if different from that of the
Depositor. All questions as to the validity, form and eligibility (including
time of receipt) of such notices will be determined by the Company, whose
determination shall be final and binding on all parties. Any Private Notes so
withdrawn will be deemed not to have been validly tendered for purposes of the
Exchange Offer and no Exchange Notes will be issued with respect thereto unless
the Private Notes so withdrawn are validly retendered. Any Private Notes which
have been tendered but which are not accepted for exchange, will be returned to
the Holder thereof without cost to such Holder as soon as practicable after
withdrawal, rejection of tender or termination of the Exchange Offer. Properly
withdrawn Private Notes may be retendered by following one of the procedures
described under "-- Procedures for Tendering" at any time prior to the
Expiration Date.
EXCHANGE AGENT AND INFORMATION AGENT
State Street Bank and Trust Company has been appointed as Exchange Agent
for the Exchange Offer. Items to be delivered to the Exchange Agent should be
addressed as follows:
<TABLE>
<S> <C>
By Registered or Certified Mail,
Overnight Mail or Hand Delivery: By Facsimile:
State Street Bank and Trust Company State Street Bank and Trust Company
Corporate Trust Department Attention: Corporate Trust Department
Two International Place (617) 664-5371
Boston, Massachusetts 02110
</TABLE>
D.F. King & Co., Inc. will serve as Information Agent for the Exchange
Offer. Questions and requests for assistance, requests for additional copies of
this Prospectus or of the Letter of Transmittal and requests for Notice of
Guaranteed Delivery forms should be directed to the Information Agent as
follows:
<TABLE>
<S> <C>
By Registered or Certified Mail,
Overnight Mail or Hand Delivery: By Telephone:
D.F. King & Co., Inc. D.F. King & Co., Inc.
77 Water Street (800)207-2872
New York, New York 10005
</TABLE>
23
<PAGE> 29
FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will be
borne by the Company. The principal solicitation is being made by mail; however,
additional solicitation may be made by telegraph, telephone, facsimile or in
person by officers and regular employees of the Company and its affiliates.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers or others soliciting
acceptances of the Exchange Offer. The Company, however, will pay the Exchange
Agent and the Information Agent reasonable and customary fees for its services
and registration expenses, including fees and expenses of the Trustee, filing
fees, blue sky fees and printing and distribution expenses.
The Company will pay all transfer taxes, if any, applicable to the exchange
of the Private Notes pursuant to the Exchange Offer. If, however, certificates
representing the Exchange Notes or the Private Notes for the principal amounts
not tendered or accepted for exchange are to be delivered to, or are to be
issued in the name of, any person other than the person signing the Letter of
Transmittal, or if a transfer tax is imposed for any reason other than the
exchange of the Private Notes pursuant to the Exchange Offer, then the amount of
any such transfer tax (whether imposed on the registered Holder or any other
person) will be payable by the tendering Holder.
ACCOUNTING TREATMENT
The Exchange Notes will be recorded at the same carrying value as the
Private Notes, as reflected in the Company's accounting records on the date of
exchange. Accordingly, no gain or loss for accounting purposes will be
recognized. The expenses of the Exchange Offer will be amortized over the term
of the Exchange Notes.
RESALE OF EXCHANGE NOTES
Based on an interpretation by the staff of the Commission set forth in
no-action letters issued to third parties, the Company believes that Exchange
Notes issued pursuant to the Exchange Offer in exchange for Private Notes may be
offered for resale, resold and otherwise transferred by any holder of such
Exchange Notes (other than the Initial Purchasers, persons participating in the
distribution of the Private Notes or any such holder which is an "affiliate" of
the Company within the meaning of Rule 405 under the Securities Act) without
compliance with the registration and prospectus delivery provisions of the
Securities Act, provided that such Exchange Notes are acquired in the ordinary
course of such holder's business and such holder does not intend to participate
and has no arrangement or understanding with any person to participate in the
distribution of such Exchange Notes. Any holder who tenders in the Exchange
Offer with the intention to participate, or for the purpose of participating, in
a distribution or secondary resale of the Exchange Notes may not rely on the
position of the staff of the Commission enunciated in Exxon Capital Holdings
Corporation (publicly available May 13, 1989) or similar no-action letters, but
rather must comply with the registration and prospectus delivery requirements of
the Securities Act in connection with any resale transaction. In addition, any
such resale transaction should be covered by an effective registration statement
containing the selling security holders' information required by Item 507 of the
Regulation S-K of the Securities Act. Each Participating Broker-Dealer that
receives Exchange Notes for its own account in exchange for Private Notes, where
such Private Notes were acquired by such Participating Broker-Dealer as a result
of market-making activities or other trading activities, must acknowledge that
it will deliver a prospectus in connection with any resale of such Exchange
Notes. See "Plan of Distribution."
By tendering in the Exchange Offer, each Holder will represent to the
Company that, among other things, (i) any Exchange Notes to be received by it
will be acquired in the ordinary course of its business, (ii) at the time of the
commencement of the Exchange Offer it has no arrangement or understanding with
any person to participate in the distribution (within the meaning of Securities
Act) of the Exchange Notes, (iii) it is not an "affiliate" (as defined in Rule
405 promulgated under the Securities Act) of the Company, (iv) it is not engaged
in, and does not intend to engage in, the distribution of Exchange Notes, and
(v) if such Holder is a Participating Broker-Dealer that will receive Exchange
Notes for its own account in exchange for Private
24
<PAGE> 30
Notes that were acquired as a result of market-making or other trading
activities, it will deliver a prospectus in connection with any resale of such
Exchange Notes. Further, by tendering in the Exchange Offer, such Holder that
was an Initial Purchaser, a person participating in the distribution of the
Private Notes or that may be deemed an "affiliate" (as defined under Rule 405 of
the Securities Act) of the Company will represent to the Company that such
Holder understands and acknowledges that the Exchange Notes may not be offered
for resale, resold or otherwise transferred by that Holder without registration
under the Securities Act or an exemption therefrom. The Company will agree to
make available, during the period required by the Registration Rights Agreement,
a prospectus meeting the requirements of the Securities Act for use by
Participating Broker-Dealers and other persons, if any, with similar prospectus
delivery requirements for use in connection with any resale of Exchange Notes.
As set forth above, the Initial Purchasers, persons participating in the
distribution of the Private Notes and affiliates of the Company are not entitled
to rely on the foregoing interpretations of the staff of the Commission with
respect to resales of the Exchange Notes without compliance with the
registration and prospectus delivery requirements of the Securities Act.
SHELF REGISTRATION STATEMENT
If the Company is not permitted to consummate the Exchange Offer because
the Exchange Offer is not permitted by any applicable law or applicable
interpretation of the Commission or the staff of the Commission or in the event
certain Holders are not entitled to participate in the Exchange Offer or do not
receive unrestricted securities in the Exchange Offer, the Company has agreed to
file with the Commission and use its best efforts to have declared effective and
keep continuously effective for up to two years a registration statement that
would allow resales of Private Notes owned by such Holders.
OTHER
Participation in the Exchange Offer is voluntary and Holders should
carefully consider whether to accept. Holders of the Private Notes are urged to
consult their financial and tax advisors in making their own decision on what
action to take.
The Company may in the future seek to acquire untendered Private Notes in
open market or privately negotiated transactions, through subsequent exchange
offers or otherwise. The Company, however, has no present plans to acquire any
Private Notes that are not tendered in the Exchange Offer or to file a
registration statement to permit resales of any untendered Private Notes unless
required under the Registration Rights Agreement.
25
<PAGE> 31
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1997, on a historical basis and as adjusted to give effect to the
Initial Offering. The following table should be read in conjunction with the
Consolidated Financial Statements, the unaudited Pro Forma Condensed Statement
of Operations, 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 Revolving Credit Facility" and note 7 of
the notes to Consolidated Financial Statements as of December 31, 1997.
<TABLE>
<CAPTION>
DECEMBER 31, 1997
---------------------------
HISTORICAL AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt, including current maturities:
Revolving Credit Facility................................. $ 33,000 $ 500
Acquisition Credit Facility............................... 30,000 --
10 1/4% Senior Notes due 2006............................ 100,000 182,000
Other..................................................... 185 185
-------- --------
Total long-term debt, including current
maturities...................................... 163,185 182,685
-------- --------
Stockholders' equity:
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; 10,150,500 shares outstanding)(1).......... 1,015 1,015
Paid-in-capital........................................... 37,425 37,425
Retained deficit.......................................... (38,030) (38,328)
-------- --------
Total stockholders' equity........................ 410 112
-------- --------
Total capitalization.............................. $163,595 $182,797
======== ========
</TABLE>
- ---------------
(1) Excludes, as of December 31, 1997, 778,250 shares of Common Stock reserved
for issuance upon exercise of outstanding stock options granted to employees
and non-employee directors.
26
<PAGE> 32
SELECTED FINANCIAL INFORMATION
The following table sets forth selected financial data of the Company. 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. 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 information. The historical results are
not necessarily indicative of the Company's future operations or financial
results.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- -------
(IN THOUSANDS, EXCEPT RATIOS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues..................... $ 72,300 $ 53,919 $ 21,693 $ 7,637 $ 4,231
Total revenues......................... 76,501 55,026 21,816 7,836 4,397
Expenses:
Oil and gas production.............. 30,029 21,774 10,355 2,351 1,688
General and administrative.......... 8,407 5,238 3,571 1,184 952
Compensation related to option
settlement........................ -- -- 656 -- --
Exploration and abandonments........ 6,588 2,550 1,652 793 218
Depreciation, depletion and
amortization...................... 26,409 12,430 5,958 1,847 884
Impairment of oil and gas
properties........................ 28,189 -- -- -- --
Interest............................ 12,979 11,281 4,591 1,458 605
Income (loss) from continuing
operations........................ (36,252) 535 (4,970) 163 73
Net income (loss)................... (36,471) (4,440) (4,970) 163 73
STATEMENT OF CASH FLOWS DATA:
Net cash provided by (used in):
Operating activities................ $ 25,032 $ 12,350 $ 6,366 $ 1,527 $ 322
Investing activities................ (92,597) (64,129) (62,467) (12,146) (6,731)
Financing activities................ 58,562 61,531 58,830 10,618 6,315
OTHER FINANCIAL DATA:
Capital expenditures................... $113,924 $ 70,017 $ 62,220 $ 11,868 $ 6,862
Dividends and distributions to
members(2).......................... -- 4,218 55 961 456
Adjusted EBITDA(1)..................... 38,065 27,108 7,234 4,301 1,757
Interest Expense -- net of deferred
charges amortization................ 12,461 10,253 4,591 1,458 605
Adjusted EBITDA/interest expense(1).... 3.1x 2.6x 1.6x 2.9x 2.9x
Ratio of earnings to fixed
charges(3).......................... -- 1.2 -- 1.1 1.0
BALANCE SHEET DATA (AS OF PERIOD END):
Working capital........................ $(11,511) $ 10,320 $ 2,654 $ 1,081 $ 1,612
Total assets........................... 194,088 162,790 87,367 24,904 13,290
Total debt, less current maturities.... 163,087 100,262 71,494 23,613 12,034
Redeemable predecessor capital......... -- -- 11,576 -- --
Predecessor capital.................... -- -- (7,445) (747) 51
Stockholders' equity................... 410 40,569 -- -- --
</TABLE>
- ---------------
(1) Adjusted EBITDA is presented because of its wide acceptance as a financial
indicator 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, impairment of oil and gas
properties, exploration and abandonment costs and extraordinary loss
resulting from extinguishment of debt to net income loss). Adjusted EBITDA
should not be considered as an alternative 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) The Company has not paid any dividends since the IPO.
(3) For purposes of calculating the ratio of earnings to fixed changes,
"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 $36,100,000 and $4,967,000 for the historical periods
ended December 31, 1997 and December 31, 1995, respectively.
27
<PAGE> 33
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. In June 1995, Costilla
consummated the 1995 Acquisition for a purchase price of approximately $46.6
million, in June 1996, Costilla consummated the 1996 Acquisition for a purchase
price of approximately $38.7 million and in August 1997, Costilla consummated
the Ballard Acquisition for a purchase price of approximately $41.2 million.
The Company's strategy is to utilize its technical staff and technological
advances to increase its oil and gas reserves, production and cash flow from
operations through an active exploration program and the acquisition and
development 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 development of acquired properties.
The Company has grown primarily through acquisitions which 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 development activities to
complement its acquisition efforts.
The Company has shown a significant increase in its oil and gas reserves
and production, especially due to its acquisitions from 1995 through 1997. The
following table sets forth certain operating data of Costilla for the periods
presented:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
OIL AND GAS PRODUCTION
Oil (Mbbls)............................................ 2,175 1,726 950
Gas (Mmcf)............................................. 14,698 9,205 4,806
MBOE................................................... 4,625 3,260 1,751
AVERAGE SALES PRICES(1):
Oil (per Bbl).......................................... $17.77 $19.87 $15.53
Gas (per Mcf).......................................... 2.29 2.13 1.45
PRODUCTION COST(2):
Per BOE................................................ $ 6.49 $ 6.68 $ 5.91
Per dollar of sales.................................... 0.42 0.40 0.48
DEPRECIATION, DEPLETION AND AMORTIZATION:
Per BOE................................................ $ 5.71 $ 3.81 $ 3.40
Per dollar of sales.................................... 0.36 0.23 0.27
</TABLE>
- ---------------
(1) Before deduction of production taxes and net of any hedging results.
(2) Production cost includes lease operating expenses and production and ad
valorem taxes, if applicable, and excludes depreciation, depletion and
amortization.
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
28
<PAGE> 34
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 sales by the proceeds received from the
related option. If market prices of oil and gas exceed the strike price of call
options, the Company is obligated to pay the contracting counterparty an amount
equal to the contracted volumes times the difference between the market price
and the strike price, therefore, reducing the effective price received for oil
and gas sales by the amount paid to the counterparty. The net effect of the
Company's commodity hedging activities reduced oil and gas revenues by
$1,226,000, $1,705,000, and $80,000 for the years ended December 31, 1997, 1996
and 1995, respectively. The Company has purchased put options on 6,500 Bbls of
oil per day which establish a floor price of $18.50 per Bbl and sold call
options on 6,500 Bbls of oil per day at $22.55 per Bbl. These oil option
contracts continue through August 1998. The referenced oil prices are based upon
the price at which West Texas Intermediate crude oil ("WTI") trades on the New
York Mercantile Exchange ("NYMEX"). The Company has historically received a
gross wellhead sales price for oil of approximately 82 - 90% of the NYMEX price.
The Company has also purchased put options on 5,000 Mmbtu of gas per day which
provide for a floor of $2.00 per Mmbtu through October 1998. Additionally, the
Company has purchased put options on 40,000 Mmbtu of gas per day which establish
a floor price of $2.15 per Mmbtu and sold call options on 40,000 Mmbtu of gas
per day at $2.55 per Mmbtu. These gas option contracts are for the period April
1998 through October 1998. The referenced gas prices are based upon the index
price for Houston Ship Channel gas sales, which is approximately 97% of NYMEX.
The Company has historically received a gross wellhead sales price for gas of
approximately 87 - 90% of NYMEX.
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 its then outstanding floating-rate indebtedness. The net
effect of the Company's interest rate hedging activities decreased interest
expense by approximately $25,000 for the year ended December 31, 1997. The net
effect of the Company's interest rate hedging activities increased interest
expense by approximately $442,000 for the year ended December 31, 1996.
Concurrent with the payment of all of the Company's floating rate debt from
proceeds of the initial public offering and the notes offering consummated in
the fourth quarter of 1996, the interest rate swap agreements ceased to qualify
as hedges. These interest rate swap agreements were marked-to-market and the
related liability of $1,712,000 was recorded. A $60 million interest rate swap
expired in May 1997. As a result of the Company's borrowings against its line of
credit, which bears interest on a floating rate basis, the remaining $24 million
interest rate swap agreement again qualified as a hedge beginning in August
1997. At each borrowing date from October 1996 to August 1997, a portion of the
interest rate swap agreement was marked-to-market with the resulting gains or
losses recorded as investment income or loss while the hedge portion is being
amortized over the remaining life of the agreement. As a result of expiration
and marking the agreements to market, the Company recorded a net investment gain
of approximately $510,000 during the year ended December 31, 1997. Concurrent
with the payment of all of the Company's floating rate debt from proceeds of the
Initial Offering in January 1998, the interest rate swap agreement ceased to
qualify as a hedge. As a result of marking-to-market the interest rate swap
agreement in January 1998, the Company recorded an additional liability of
approximately $23,000.
29
<PAGE> 35
The Company's predecessor was classified as a partnership for federal
income tax purposes. Therefore, no income taxes were paid or provided by the
Company prior to the Company's IPO and the offering of the Existing Notes.
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
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
The Company's total oil and gas revenues for the year ended December 31,
1997 were $72,300,000, representing an increase of $18,381,000 (34%) over
revenues of $53,919,000 in 1996. This increase was primarily due to successful
drilling activities and the 1996 Acquisition, which accounted for approximately
$11,099,000 and $9,214,000 of increased revenue, respectively. The Ballard
Acquisition accounted for approximately $3,372,000 of the increase. Gas
imbalances accounted for approximately $2,340,000 of the increase, with an
average price of $1.56 per Mcf. Approximately 50% of the gas imbalance relates
to production in prior periods against which a valuation allowance had been
recorded due to uncertainty of ultimate collection. During the year ended
December 31, 1997, uncertainties related to these imbalances were substantially
reduced and the related valuation allowance reversed. Management does not expect
similar effects from gas imbalances in future periods. These increases were
partially offset by the $2,152,000 net effect of lower commodity prices. The
average oil price per barrel received in 1997 was $17.77 compared to $19.87 in
1996, an 11% decrease, and the average gas price received in 1997 was $2.29
compared to $2.13 in 1996, a 7% increase. The sale of certain properties in
April 1997 and December 1996 also partially offset the increased revenues in the
amount of $3,607,000.
Oil and gas production was 4,625 MBOE in 1997 compared to 3,260 MBOE in
1996, a 42% increase. Of the 1,365 MBOE increase, approximately 657 MBOE was due
to successful drilling activities and 539 MBOE was due to the properties
acquired in the 1996 Acquisition. Gas imbalances accounted for approximately 249
MBOE of the increase. The Ballard Acquisition properties accounted for
approximately 219 MBOE of the increase. The sale of certain properties in April
1997 and December 1996 partially offset the increased production volumes.
Interest and other revenues were $940,000 for the year ended December 31,
1997 compared to $40,000 in 1996, representing an increase of $900,000. Of this
increase, $223,000 was related to increased interest income due to increased
funds earning interest. Gains on investment transactions of $510,000 were
recorded for the year ended December 31, 1997 related to an interest rate swap
contract which was marked-to-market. In the year ended December 31, 1996 losses
of $195,000 were recognized on certain investment transactions. During 1997,
losses of $146,000 related to an oil collar which was marked-to-market. No
comparable transactions existed in 1996.
Other income was $3,261,000 for the year ended December 31, 1997 compared
to $1,067,000 for 1996, representing an increase of $2,194,000 (206%). Gains
from the sale of certain oil and gas properties increased by approximately
$2,118,000. The remainder of the increase was due primarily to a gain of
approximately $70,000 recognized on the sale of the Company's interest in a
partnership which owned the Independence Plaza Building in Midland, Texas.
Oil and gas production costs for the year ended December 31, 1997 were
$30,029,000 ($6.49 per BOE), compared to $21,774,000 in 1996 ($6.68 per BOE),
representing an increase of $8,255,000 (38%), with approximately $4,026,000 of
the increase relating to the 1996 Acquisition and $1,583,000 to successful
drilling activities. The remainder of the increase was due primarily to
increased treating and transportation costs due to increased gas production and,
to a lesser extent, the Ballard Acquisition, offset in part by the sale of
certain high operating cost properties in April 1997. On a per BOE basis,
production costs decreased $0.19 (3%) due to a combination of the sale of
certain high operating cost properties in April 1997, the gas imbalance volumes
and lower production costs on newly completed wells.
General and administrative expenses for the year ended December 31, 1997
were $8,407,000, representing an increase of $3,169,000 (66%) from $5,238,000 in
1996. The increase is primarily due to additional
30
<PAGE> 36
personnel and related costs necessary to accommodate the acceleration of the
Company's oil and gas activities, the Ballard Acquisition, increased insurance
costs and other costs for a full twelve month period related to becoming a
public company in October 1996.
Exploration and abandonment expense increased to $6,588,000 for the year
ended December 31, 1997 compared to $2,550,000 in 1996. The Company incurred
$2,117,000 of seismic costs for the year ended December 31, 1997, compared to
$913,000 in 1996. Dry hole and abandonment costs increased to $3,584,000 in 1997
from $1,524,000 in 1996. The Company incurred $887,000 of other geological and
geophysical costs during the year ended December 31, 1997, compared to $113,000
in 1996. The increase in exploration and abandonments expense was primarily
related to the Company's increased drilling activities in 1997 compared to a
very low level of activity in 1996.
Depreciation, depletion and amortization expense for the year ended
December 31, 1997 was $26,409,000 compared to $12,430,000 for 1996, representing
an increase of $13,979,000 (112%). During the 1997 period, depreciation,
depletion and amortization on oil and gas production was provided at an average
rate of $5.71 per BOE compared to $3.81 per BOE for 1996. Approximately
$3,751,000 of this increase was due to successful drilling activities,
$3,078,000 related to the 1996 Acquisition and an additional $1,018,000 of the
increase was due to the recording of gas imbalances. The remainder of the
increase was due primarily to the effect of lower oil and gas prices at December
31, 1997 than those experienced at December 31, 1996.
Impairment of oil and gas properties for the year ended December 31, 1997
was $28,189,000. No comparable expense was recorded in 1996. This impairment
expense was determined under the guidelines of FAS 121 (Impairment of Long-Lived
Assets) using estimates of net undiscounted cash flow and estimated present
values for the Company's oil and gas reserves based upon the non-escalated
prices used in the Company's January 1, 1998 reserve report.
Interest expense was $12,979,000 for the year ended December 31, 1997,
compared to $11,281,000 for the comparable period in 1996. The $1,698,000 (15%)
increase was attributable primarily to increased levels of debt offset in part
by a decrease in the effective interest rate. The average amounts of applicable
interest-bearing debt in 1997 and 1996 were $128,207,000 and $95,671,000,
respectively. The effective annualized interest rate in 1997 was 10.1%, as
compared to 11.8% in 1996.
Results of operations for the year ended December 31, 1997 include an
extraordinary charge of $219,000 compared to $4,975,000 for the comparable
period in 1996. These extraordinary charges related to the early extinguishment
of the Company's prior bank credit facilities and consisted of the unamortized
balance of previously capitalized debt issuance costs.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
The Company's total oil and gas revenues for the year ended December 31,
1996 were $53,919,000, representing an increase of $32,226,000 (149%) over
revenues of $21,693,000 in 1995. This increase was primarily due to the 1996
Acquisition and 1995 Acquisition, which accounted for approximately $12,754,000
and $14,059,000 of the revenue increase, respectively. The remainder of the
increase was due to a combination of increased product prices, successful
drilling activities and the enhancement of existing production. The average oil
price per barrel received in 1996 was $19.87 compared to $15.53 in 1995, a 28%
increase, and the average gas price per Mcf received in 1996 was $2.13 compared
to $1.45 in 1995, a 47% increase.
Oil and gas production was 3,260 MBOE in 1996 compared to 1,751 MBOE in
1995, an increase of 86%. Of the 1,509 MBOE increase, approximately 723 MBOE was
due to the properties acquired in the 1996 Acquisition and 562 MBOE was due to
the properties acquired in the 1995 Acquisition, in each case including
enhancements of production after such 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 year ended December 31,
1996 compared to $123,000 in 1995, representing a decrease of $83,000, which was
primarily comprised of $195,000 in losses on investments held for trading
purposes and an increase in interest income of $67,000 in 1996 due to increased
funds earning
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<PAGE> 37
interest. Also in 1996, the Company realized gains of $1,067,000 on various
transactions for which no comparable sales were recorded in 1995.
Oil and gas production costs in 1996 were $21,774,000 ($6.68 per BOE),
compared to $10,355,000 in 1995 ($5.91 per BOE), representing an increase of
$11,419,000 (110%), due principally to the 1996 Acquisition and to a lesser
extent the 1995 Acquisition. On a per BOE basis, production costs increased
$0.77 due primarily to higher production costs per BOE for the properties
acquired in the 1996 Acquisition.
General and administrative expenses for the year ended December 31, 1996
were $5,238,000, representing an increase of $1,667,000 (47%) from 1995 of
$3,571,000. 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 and 1996 Acquisitions. However, as noted above, production
volumes increased 86% and, therefore, general and administrative expenses per
BOE decreased to $1.61 per BOE for the year ended December 31, 1996 from the
$2.04 per BOE in 1995.
Results of operations for the year ended December 31, 1995 include non-cash
compensation expense of $656,000 deemed to have been received by a minority
interest owner of the Company who was deemed to have benefitted from the
cancellation of an option to purchase an additional interest held by the other
minority interest owner.
Exploration and abandonment expense increased to $2,550,000 in 1996
compared to $1,650,000 in 1995. The Company incurred $913,000 of seismic costs
for the year ended December 31, 1996, compared to $790,000 which were incurred
in 1995. Dry hole and abandonment costs increased to $1,524,000 in 1996 from
$860,000 in 1995.
Depreciation, depletion and amortization expense for 1996 was $12,430,000
compared to $5,958,000 for 1995, representing an increase of $6,472,000 (109%).
During 1996, depreciation, depletion and amortization on oil and gas production
was provided at an average rate of $3.81 per BOE compared to $3.40 per BOE for
1995. The increases were due primarily to the 1996 and 1995 Acquisitions.
Interest expense was $11,281,000 in 1996, compared to $4,591,000 in 1995.
The $6,690,000 (146%) increase was attributable primarily to increased levels of
debt which the Company used to finance the 1996 Acquisition and amortization of
financing costs. The average amounts of applicable interest-bearing debt in 1996
and 1995 were $95,671,000 and $49,972,000, respectively. The effective
annualized interest rate in 1996 was 11.8%, as compared to 9.2% in 1995.
Results of operations for the year ended December 31, 1996 include an
extraordinary charge of $4,975,000, net of the related deferred tax benefit of
$1,042,000, related to the early extinguishment of the Company's prior bank
credit facilities (the "1995 Credit Facility" and the "Bridge Facility"). The
1995 Credit Facility was replaced by the Bridge Facility in June 1996 and the
Bridge Facility was paid off with proceeds from the IPO and the sale of the
Existing Notes in October 1996.
LIQUIDITY AND CAPITAL RESOURCES
Net Cash Used in Operating Activities
For the year ended December 31, 1997, net cash provided by operating
activities increased to $25.0 million from $12.4 million for the corresponding
period in 1996. Cash provided by operations, before changes in operating assets
and liabilities, increased to $16.6 million from $14.7 million for the
comparable period in 1996 due primarily to the Ballard Acquisition, the 1996
Acquisition and the increase in results of operations therefrom.
Net Cash Used in Investing Activities
Net cash used in investing activities for the year ended December 31, 1997
was $92.6 million. Approximately $41.2 million was used for the Ballard
Acquisition, $70.4 million was used for other oil and gas expenditures and $2.3
million was used for other property and equipment. During the year ended
December 31, 1997, approximately $21.3 million net cash was provided by sales of
oil and gas properties. For the year
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<PAGE> 38
ended December 31, 1996, net cash used in investing activities was $64.1
million. Approximately $38.7 million was used for the 1996 Acquisition, $28.3
million for additional acquisition of producing oil and gas properties and
exploration and development activities and $3.0 million primarily for other
property and equipment. During that period, approximately $6.3 million net cash
was provided by sales of oil and gas properties.
Financing Activities
For the year ended December 31, 1997, the Company incurred $87.3 million of
debt, of which approximately $33.5 million was used to repay certain prior bank
debt, $41.2 million was used for the Ballard Acquisition and the remainder was
used in connection with its exploration and development activities. In addition,
the Company used approximately $3.8 million for the purchase of 330,500 shares
of its common stock. The Company entered into a $125.0 million senior credit
agreement in June 1996, which was fully funded prior to the Company's IPO in
October 1996. Approximately $74.5 million was used for the extension and
refinancing of prior debt, $38.7 million was used for the 1996 Acquisition and
approximately $11.8 million was used for general corporate purposes. In October
1996, this senior credit facility was paid with the proceeds from the IPO and
the offering of the Existing Notes, and the Company entered into a new $50.0
million credit agreement. Approximately $19.9 million was outstanding under this
senior credit facility prior to its refinancing in August 1997.
The Company replaced the above described senior credit facility with the
Revolving Credit Facility in August 1997. Approximately $19.9 million was used
for the extension and refinancing of the prior senior credit facility and $11.2
million was used as a portion of the purchase price in the Ballard Acquisition.
The Revolving Credit Facility provides for a maximum availability of $75.0
million, with an initial borrowing base of $50.0 million. Borrowings under the
Revolving Credit Facility bear interest, at the Company's option, at a floating
rate which is at or above the lender's prime rate or above the applicable
Eurodollar rate, depending on the percentage of committed funds which have been
borrowed. Interest is payable quarterly as to base rate loans, and at the end of
the applicable interest period as to Eurodollar rate loans. The borrowing base
of the Revolving Credit Facility is automatically reduced by 5% each quarter
beginning in August 1999, and payments of principal are required in each such
quarter in which the outstanding principal balance is greater than the reduced
borrowing base. The remaining balance is payable on August 31, 2002, the
maturity date of the Revolving Credit Facility. In connection with the sale of
certain oil and gas properties on December 31, 1997 for proceeds of $16.2
million, the borrowing base was reduced to $36.5 million, $33.0 of which was
borrowed at December 31, 1997.
Contemporaneous with entering into the Revolving Credit Facility, the
Company also entered into a credit facility (the "Acquisition Credit Facility")
to provide the remaining financing for the Ballard Acquisition. The Acquisition
Credit Facility was a term loan in the amount of $30.0 million which was repaid
in full with certain of the proceeds from the sale of the Private Notes in the
Initial Offering. The net proceeds of the Initial Offering were approximately
$78.8 million. The Company used $30.0 million to repay the Acquisition Credit
Facility and $32.5 million to repay all but $0.5 million of the Revolving Credit
Facility. In mid-January 1998, approximately $10.0 million of the remaining
proceeds were used to fund the Manti Acquisition.
Capital Resources
Funding for the Company's business activities has historically been
provided by bank financings, cash flow from operations, equity sales, property
divestitures and joint ventures with industry participants. The 1995
Acquisition, 1996 Acquisition and Ballard Acquisition were substantially funded
by bank financings. The Company plans to execute its business strategy with cash
flow from operations, net proceeds from the Initial Offering and borrowings
available under the Revolving 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 various mineral interests in its normal course of business. Any
future
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<PAGE> 39
acquisition may require additional financing and will be dependent upon
financing arrangements available at the time.
The Company believes that the increased availability under the Revolving
Credit Facility resulting from the application of net proceeds of the Initial
Offering, the remaining net proceeds from the Initial Offering and cash flow
from operations will be sufficient for its budgeted 1998 capital expenditures.
However, because the Company's ultimate 1998 capital expenditures, future cash
flows and the availability of financing are subject to a number of variables,
there can be no assurance that the Company's capital resources will be
sufficient to maintain its capital expenditures. In addition, 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 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.
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.
Since December 31, 1997 oil and gas prices have continued to deteriorate.
The Company estimates that its cash flow would be reduced by $1.9 million and
$2.1 million for each $1 per barrel reduction in the price of oil and for each
$0.10 per Mcf reduction in the price of gas, respectively.
Capital Expenditures
The Company originally announced a 1998 capital budget of approximately
$70.0 million of which approximately $22.0 million was budgeted for the
acquisition of undeveloped acreage, seismic and exploitation activities. Given
the current low level of oil prices and its extensive undeveloped acreage and
seismic inventory, the Company has elected to temporarily defer non-drilling
activities pending an improvement in oil prices. In addition, the Company
intends to concentrate its drilling activities on gas prospects. Since a
significant portion of the Company's 1998 capital budget is discretionary, the
Company is able to increase or decrease its level of activity as product prices
warrant.
Recent Accounting Pronouncements
Information Systems for the Year 2000 -- The Company will be required to
modify its information systems in order to accurately process data referencing
the year 2000. Because of the importance of occurrence dates in the oil and gas
industry, the consequences of not pursuing these modifications could be very
significant to the Company's ability to manage and report operating activities.
The Company's third-party software vendor for its integrated oil and gas
information system is currently modifying the system to accurately handle the
Year 2000 issue. All necessary programming modifications are scheduled to be
completed by December 31, 1998. From a cost viewpoint, these modifications will
be part of the routine updates the Company receives from its third-party
software vendor as part of its systems support contract already in place. Thus,
the Company believes it will not incur any marginal costs with respect to the
Year 2000 issue.
Reporting Comprehensive Income -- In June 1997, the FASB issued Statement
of Accounting Standards No. 130 "Reporting Comprehensive Income" ("FAS 130")
which establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements.
Specifically, FAS 130 requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and (ii) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of a statement of
financial position. This statement is effective for fiscal years beginning after
December 15, 1997. The Company anticipates that it will adopt the provisions of
FAS 130 in its year ended December 31, 1998 consolidated financial statements.
Comprehensive income consists of the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from nonowner sources. Specifically, this includes net income and other
comprehensive income, which is made up of certain changes in assets and
liabilities that are not
34
<PAGE> 40
reported in a statement of operations but are included in the balances within a
separate document of equity in a statement of financial position. Such changes
include, but are not limited to, unrealized gains for marketable securities and
future contracts, foreign translation adjustments and minimum pension liability
adjustments.
Segment Reporting -- In June 1997, the FASB issued Statement of Accounting
Standards No. 131 "Disclosures about Segments of an Enterprise and Related
Information" ("FAS 131") which establishes standards for public business
enterprises for reporting information about operating segments in annual
financial statements and requires that such enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. This statement also establishes standards for related disclosures
about products and services, geographic areas, and major customers. FAS 131 is
effective for financial statements for periods beginning after December 15,
1997.
The Company operates in the on product line of oil and gas production in
limited geographic areas. This information and information about major customers
historically has been disclosed in the Company's annual financial statements.
The Company plans to implement FAS 131 in its year ended December 31, 1998
financial statements.
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<PAGE> 41
BUSINESS AND PROPERTIES
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 South/East Texas region, the Rocky Mountain region and the
Permian Basin area of Texas and New Mexico. The Company's strategy focuses on
utilizing current and developing technological advancements to increase reserves
through a targeted exploration program, strategic property acquisitions and
development of existing properties. In addition, the Company owns 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 began operating in 1988 and conducted the IPO in October 1996.
As of January 1, 1998, the Company had total estimated net proved reserves of
15.0 Mmbbls of oil and 148.6 Bcf of gas, aggregating 39.7 MMBOE, with a PV-10
Value of approximately $196.7 million. The Company also has a substantial
acreage position consisting of 953,268 gross (713,107 net) acres at December 31,
1997, 665,734 gross (607,703 net) of which are undeveloped. The Company has
identified in excess of 600 drilling locations, of which 147 are included in its
proved reserves at January 1, 1998.
The Company began active efforts to acquire and develop oil and gas
properties in 1993 and, from January 1, 1993 to December 31, 1997, closed eight
acquisitions for an aggregate purchase price of approximately $138 million. The
Company has not participated in the auction process, but rather has made
acquisitions through negotiated transactions. The three most significant
acquisitions have been:
- The Ballard Acquisition of 6.0 MMBOE of proved reserves (at July 1,
1997), extensive undeveloped acreage and seismic data from Ballard in
August 1997 for approximately $41.2 million, strengthening the Company's
position in the Rocky Mountain region.
- The 1996 Acquisition of 10.6 MMBOE of proved reserves and undeveloped
acreage located in the Permian Basin and the South/East Texas region in
June 1996 for approximately $38.7 million.
- The 1995 Acquisition of 14.4 MMBOE of proved reserves and undeveloped
acreage in the Permian Basin, South/East Texas and Rocky Mountain regions
in June 1995 for approximately $46.6 million.
Costilla has in-house exploration expertise which uses 3-D seismic
technology as a primary tool to identify drilling opportunities. Since the IPO,
the Company has made 13 new exploratory discoveries utilizing 3-D technology,
which have added proved reserves of 7.4 MMBOE at January 1, 1998. The Company
experienced an approximately 60% success rate in its 1997 exploratory drilling
activities, and an overall success rate of approximately 83% in its 1997
drilling activities.
Through its acquisition, development and exploration activities, the
Company has grown substantially over the last four years, as measured by
reserves, production and cash flow.
- Estimated proved reserves have increased from 6.0 MMBOE at January 1,
1994 to 39.7 MMBOE at January 1, 1998, representing a compound annual
growth rate of 60%.
- PV-10 Values have increased from $26.4 million at January 1, 1994 to
$196.7 million at January 1, 1998, representing a compound annual growth
rate of 65%.
- The Company has increased its average net daily production from 827 BOE
for the year ended December 31, 1993 to 12,671 BOE for the year ended
December 31, 1997, representing a compound annual growth rate of 98%.
- Adjusted EBITDA has increased from $1.8 million for the year ended
December 31, 1993 to approximately $40.0 million for the year ended
December 31, 1997 (pro forma for the Ballard Acquisition), which
represents a compound annual growth rate of 117%.
- The Company's reserve growth has been achieved at an average all-in
finding cost of $4.32 per BOE for the period from January 1, 1993 to
January 1, 1998.
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<PAGE> 42
COMPANY STRENGTHS
The Company believes that its recent growth is primarily attributable to
the following factors:
- Successful Drilling Program. Employing its strategy of growth through the
drillbit, the Company has substantially increased its reserves and
production since 1993. From December 31, 1992 through December 31, 1997,
the Company replaced approximately 189% of its total production through
extensions and discoveries alone. By focusing drilling efforts on
reservoirs that have responded favorably to the application of advanced
drilling and completion techniques, management believes that the Company
can continue to increase its reserves and production by integrating the
Company's technical expertise with its large inventory of undeveloped
leasehold acreage.
- Significant Leasehold Positions. Through aggressive acreage acquisition
in its existing and new project areas, the Company seeks to establish a
significant leasehold position in each of its project areas. As a result,
the Company had approximately one million gross acres under lease at
December 31, 1997, which included in excess of 600 drilling locations at
December 31, 1997.
- Technological Leadership. The Company has developed significant expertise
in the application of 3-D seismic evaluation. The Company believes that
its expertise in employing this technology is an important factor in
supporting its recent growth and drilling success rate.
- Diversified Property Base. The Company holds a portfolio of oil and gas
properties located in the South/East Texas region, the Rocky Mountain
region and the Permian Basin. The Company believes that by conducting its
activities in distinct geographic regions it is able to reduce commodity
price and other operational risks. The Company's Moldovan interest
represents 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.
- Significant Operating Control. At January 1, 1998, the Company operated
approximately 76% of its properties as measured by PV-10 Value. This
level of operating control benefits the Company in numerous ways by
enabling the Company to (i) control the timing and nature of capital
expenditures, (ii) identify and implement cost control programs and (iii)
respond quickly to operational problems.
BUSINESS STRATEGY
The Company's strategy is to increase its oil and gas reserves, production
and cash flow from operations by utilizing a three-pronged approach which
combines an active exploration program using 3-D seismic and other technological
advances with strategic property acquisitions and focused development drilling.
The Company's management and technical staff have significant oil and natural
gas experience in the areas of drilling and completions, production operations,
acquisitions and divestitures and reservoir engineering. Most members of the
Company's technical staff, having spent substantial portions of their careers
specializing in the Company's core operating regions, have in-depth knowledge of
these regions. 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 62% natural gas and 38% oil at January
1, 1998. The elements of the Company's strategy may be further described as
follows:
- Exploration Efforts. The Company has a staff of experienced geophysicists
and geologists who perform extensive analysis of the Company's
exploration prospects to carefully focus its 3-D seismic surveys and
identify potential drilling locations. This focus allows the Company to
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, where it can utilize the technical expertise and
experience of its staff to identify exploration prospects which may have
been previously overlooked.
- Strategic Property Acquisitions. The Company seeks to acquire producing
properties where it has identified opportunities to increase production
and reserves through both development and exploration activities. The
Company has increased the value of the properties it has acquired by
using its expertise
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<PAGE> 43
and experience with current and advancing seismic, drilling and
production technology to aggressively manage its operations of existing
proved properties and successfully identify and develop previously
unproved reserves on acquired acreage. The Company seeks to acquire
reserves which 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.
- Development of Existing Properties. The Company is actively pursuing
development of its existing properties.
- Control of Operations. The Company prefers to operate and own the
majority working interest in its properties. This gives the Company
greater control over future development, drilling, completion and lifting
costs and the marketing of production. At January 1, 1998, the Company
operated wells constituting approximately 76% of its total PV-10 Value.
RECENT DEVELOPMENTS
The Company has had a number of recent significant developments with
respect to acquisitions, exploration successes and cost reduction efforts
through asset sales.
Acquisitions
In keeping with its strategy to acquire properties with substantial
exploration potential, the Company consummated one significant acquisition in
1997 and an additional acquisition in January 1998. While both transactions have
proved reserves and current production, there are also significant acreage
positions and exploration prospects included in each acquisition.
Ballard Acquisition. In August 1997, the Company closed the Ballard
Acquisition for approximately $41.2 million. The oil and gas properties acquired
are located primarily in the Rocky Mountain region and had, as of July 1, 1997,
approximately 6.0 MMBOE of proved reserves and 212,085 net undeveloped acres.
The Company also acquired the rights to 150 square miles of 3-D seismic data and
42,000 miles of 2-D seismic data. The Company and Ballard have entered into an
Acquisition and Exploration Agreement that establishes an area of mutual
interest in the Rocky Mountain region in which the parties will jointly own,
acquire, explore and develop properties.
Manti Acquisition. The Manti Acquisition was closed in January 1998 and the
Company acquired producing properties and associated acreage located in South
Texas in close proximity to an exploration area the Company has been developing.
The Manti Acquisition included approximately 1.3 MMBOE of proved reserves as of
January 1, 1998, approximately 30 square miles of 3-D seismic data, and 16,202
gross and net undeveloped acres. The purchase price was $10.5 million.
Exploration
S.W. Speaks Field, Lavaca County, Texas. The Company has drilled and
completed its initial exploratory well, the Migl-Mitchel #1 to a total depth of
14,950 feet. This well is located within the Company's 46 square mile 3-D
seismic survey and encountered two sand zones which totaled 190 feet of
productive expanded Wilcox sandstone. The well was completed from the lower of
the two sands in December 1997. Testing of the well indicated an open flow
potential of 116 Mmcf of gas per day. Gas sales commenced on January 20, 1998
and through March 24, 1998 this well has produced a total of 360 Mmcf of gas. As
of March 15, 1998, completion operations are underway on the second well, which
was drilled to a total depth of 15,847 feet. This second well has penetrated
three productive Wilcox sand zones totaling 274 feet. The Company has a 100%
working interest in both wells, and owns 11,131 gross acres in this field with a
57.7% average working interest. The Company is planning to drill four additional
wells in this field during 1998.
Hopewell Project, Harrison and Panola Counties, Texas. The Company has
acquired 6,060 gross acres in a contiguous block on this project with a 100%
working interest. The project straddles two major producing structures in the
state line area of Texas and Louisiana. The Company's acreage position has
existing production from various formations and is undeveloped in comparison to
offsetting leases. The Company has
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<PAGE> 44
identified 100 drilling locations of which 25 have been classified as containing
proved undeveloped reserves at January 1, 1998. The Company has drilled and
dually completed the initial well from the Cotton Valley and Travis Peak sands,
for combined production of approximately 3,000 Mcf of gas per day as of April
15, 1998. The Company plans to drill eight wells on the Hopewell project during
1998.
Scott and Hopper Field, Brooks County, Texas. The Company has drilled and
completed the Scott and Hopper GU 1-5 well from the shallow Vicksburg formation
at an initial rate of approximately 2,000 Mcf of gas per day. The well is
located on the producing acreage acquired in the Manti Acquisition. The Company
owns a 3-D survey of the acreage and has identified 10 additional drilling
locations. The Company owns 15,882 gross acres in the field with a 100% working
interest. The Company has plans to drill at least five wells in the Scott and
Hopper field during 1998.
Edwards-McElroy Ranch Prospect, Ector and Crane Counties, Texas. At
December 31, 1997, the Company had successfully completed a total of 26 wells on
the 80 square miles of 3-D seismic data. These wells have resulted in five new
discoveries in four formations. The Company has identified in excess of 50
drilling locations on the 11,970 gross and net acres on this prospect. The
Company is planning to drill three wells in this project during 1998.
Divestitures
The Company continuously evaluates its properties to identify opportunities
to divest properties which are marginally economic, have high per-unit costs or
have limited potential. From January 1, 1997 through December 31, 1997, the
Company sold 6.6 MMBOE of what it considered high operating cost reserves.
Concho Sale. The Concho Sale was consummated in December 1997 for a total
consideration of $16.2 million. The properties included in the sale had assigned
proved reserves of 4.9 MMBOE as of December 31, 1997, consisted of approximately
1,600 gross wells, approximately 90% of which were non-operated, included high
operating cost properties and did not fit the Company's overall business
strategy.
Gulf Production Sale. The Gulf Production Sale was consummated in January
1998 for a total consideration of $2.5 million. The Company sold its interest in
approximately 190 gross wells in Oklahoma which did not fit its business
strategy. The properties had assigned proved reserves at January 1, 1998 of 0.7
MMBOE, and approximately 75% of the wells were non-operated.
PRINCIPAL PROPERTIES
The following table sets forth certain information as of January 1, 1998
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
WELLS (Mbbls) (Mmcf) (MBOE) EQUIVALENT
----- ------- ------- ---------- ----------
<S> <C> <C> <C> <C> <C>
REGION
South/East Texas............... 559 2,034 87,699 16,651 41.9%
Rocky Mountain................. 625 6,390 26,975 10,886 27.4
Permian Basin.................. 608 5,818 28,387 10,549 26.6
Other -- Domestic.............. 247 315 4,258 1,024 2.6
Foreign -- Moldova............. 26 395 1,318 615 1.5
----- ------ ------- ------ ------
Total.................. 2,065 14,952 148,637 39,725 100.00%
===== ====== ======= ====== ======
</TABLE>
SOUTH/EAST TEXAS. At January 1, 1998, 41.9% of the Company's proved
reserves were concentrated in the South/East Texas region, on shore.
S.W. Speaks Field, Lavaca County, Texas. The Company has drilled and
completed its initial exploratory well, the Migl-Mitchel #1 to a total depth of
14,950 feet. This well is located within the Company's 46 square mile 3-D
seismic survey and encountered two sand zones which totaled 190 feet of
productive
39
<PAGE> 45
expanded Wilcox sandstone. The well was completed from the lower of the two
sands in December 1997. Testing of the well indicated an open flow potential of
116 Mmcf of gas per day. Gas sales commenced on January 20, 1998 and through
March 24, 1998 this well has produced a total of 360 Mmcf of gas. As of March
15, 1998, completion operations are underway on the second well, which was
drilled to a total depth of 15,847 feet. This second well has penetrated three
productive Wilcox sand zones totaling 274 feet. The Company has a 100% working
interest in both wells, and owns 11,131 gross acres in this field with a 57.7%
average working interest. The Company is planning to drill four additional wells
in this field during 1998.
Scott and Hopper Field, Brooks County, Texas. The Company has drilled and
completed the Scott and Hopper GU 1-5 well from the shallow Vicksburg formation
at an initial rate of approximately 2,000 Mcf of gas per day. The well is
located on the producing acreage acquired in the Manti Acquisition. The Company
owns a 3-D survey of the acreage and has identified 10 additional drilling
locations. The Company owns 15,882 gross acres in the field with a 100% working
interest. The Company has plans to drill at least five wells in the Scott and
Hopper field during 1998.
Hopewell Project, Harrison and Panola Counties, Texas. The Company has
acquired 6,060 gross acres in a contiguous block on this project with a 100%
working interest. The project straddles two major producing structures in the
state line area of Texas and Louisiana. The Company's acreage position has
existing production from various formations and is undeveloped in comparison to
offsetting leases. The Company has identified 100 drilling locations of which 25
have been classified as containing proved undeveloped reserves at January 1,
1998. The Company has drilled and dually completed the initial well from the
Cotton Valley and Travis Peak sands, for combined production of approximately
3,000 Mcf of gas per day as of April 15, 1998. The Company plans to drill eight
wells on the Hopewell project during 1998.
Sealy Field, Austin County, Texas. The Sealy Field is a highly faulted area
which is further complicated by salt domes and is ideally suited to 3-D seismic
exploration. The Company has completed the acquisition and processing of a 50
square mile 3-D survey and is currently engaged in interpretation of the
resulting data. The Company owns 19,048 gross acres in the Sealy Field with 100%
working interest. The Company expects to start drilling operations by the fourth
quarter of 1998.
Cotton Valley, Limestone and Freestone Counties, Texas. The Company owns a
non-operated interest in the previously announced McMahon #4 well, a Cotton
Valley reef discovery which has been completed. Gas sales commenced on March 6,
1998, and through April 14, 1998, the well had produced approximately 304 Mmcf
of gas. The Cotton Valley sandstone is encountered above the Cotton Valley reef.
The Company has gained significant experience in utilizing new hydraulic
factoring techniques resulting in the completion of wells in the Cotton Valley
sandstone that might otherwise be considered non-commercial. The Company owns
2,984 gross acres in this area. The Company plans to drill two Cotton Valley
sandstone wells in 1998.
ROCKY MOUNTAINS. At January 1, 1998, 27.4% of the Company's proved reserves
were concentrated in the Rocky Mountain region, which includes Montana, North
Dakota, Wyoming, Colorado and Utah. The Company significantly increased both its
reserves and undeveloped acres in the Rocky Mountains as a result of the Ballard
Acquisition.
O'Brien Springs Anticline Prospect, Carbon County, Wyoming. The Company has
acquired a 35 square mile 3-D seismic survey over the O'Brien Springs Anticline.
This 12 mile long structurally complex trend is expected to yield several
undrilled closures. The Company is encouraged by preliminary interpretation of
the data. Prospective horizons include the Tensleep, Nugget, Dakota and Frontier
sands at depths of up to 7,000 feet. The Company has 19,181 gross acres on this
prospect and an approximate 30% average working interest. The Company plans to
drill an initial test during 1998.
Island Butte Field, Montezuma County, Colorado. The Company owns 7,044
gross (4,050 net) acres in this field with a 57.5% average working interest. The
Company plans to drill two horizontal wells and two exploratory wells in the
field during 1998.
PERMIAN BASIN. At January 1, 1998, 26.6% of the Company's proved reserves
were concentrated in the Permian Basin, an approximately 70-county region in
West Texas and Southeast New Mexico.
40
<PAGE> 46
Edwards-McElroy Ranch, Ector and Crane Counties, Texas. At December 31,
1997, the Company had successfully completed a total of 26 wells on the 80
square miles of 3-D seismic data. These wells have resulted in five new
discoveries in four formations. Costilla Energy has identified in excess of 50
drilling locations on the Company's 11,970 gross and net acres on this prospect.
The Company is planning to drill three wells in this project during 1998.
MARKETING ARRANGEMENTS
The Company sells the majority of its crude oil production based on the
posted price, plus market averages, in each area in which its crude oil is
produced. The majority of the Company's gas production is sold at spot market
prices. The term "spot market" is used herein to refer to contracts with terms
of six months or less or contracts which call for a redetermination of sales
prices every six months or earlier. The Company does not believe that the loss
of any of its principal oil or gas purchasers would have a material adverse
effect on it.
OIL AND GAS RESERVES
The Company's estimated total proved reserves of oil and gas as of January
1, 1998, 1997 and 1996 were as follows:
<TABLE>
<CAPTION>
AS OF JANUARY 1,
-------------------------------------------------------------
1998 1997 1996
------------------ ------------------ -----------------
OIL GAS OIL GAS OIL GAS
(Mbbls) (Mmcf) (Mbbls) (Mmcf) (Mbbls) (Mmcf)
------- ------- ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Proved developed
producing............. 10,366 63,170 13,894 82,861 8,338 50,542
Proved developed
non-producing......... 280 21,747 124 7,162 228 6,851
Proved undeveloped...... 4,306 63,720 2,982 30,249 2,222 20,759
------ ------- ------ ------- ------ ------
Total
proved...... 14,952 148,637 17,000 120,272 10,788 78,152
====== ======= ====== ======= ====== ======
</TABLE>
If the Manti Acquisition and the Gulf Production Sale (both of which were
consummated in January 1998) were included the January 1, 1998 estimates, the
total proved reserves would have been:
<TABLE>
<CAPTION>
AS ADJUSTED
AS OF JANUARY 1, 1998
----------------------------
OIL GAS
(Mbbls) (Mmcf) MBOE
------- ------- ------
<S> <C> <C> <C>
Proved developed producing............................. 10,300 62,216 20,669
Proved developed non-producing......................... 312 24,018 4,315
Proved undeveloped..................................... 4,352 65,753 15,311
------ ------- ------
Total proved................................. 14,964 151,987 40,295
====== ======= ======
</TABLE>
The following table sets forth the future net cash flows from the Company's
estimated proved reserves:
<TABLE>
<CAPTION>
AS OF JANUARY 1,
--------------------------------------------
AS ADJUSTED
1998 1997 1996 1998(1)
-------- -------- -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Future net cash flows before income
taxes................................... $305,387 $538,343 $188,337 $313,145
Future net cash flows before income taxes,
discounted at 10%....................... $196,678 $311,803 $113,296 $202,452
</TABLE>
- ---------------
(1) Gives effect to the Manti Acquisition and the Gulf Production Sale as if
both transactions had occurred on January 1, 1998.
41
<PAGE> 47
The reserve estimates reflected above for January 1, 1996 were prepared by
the Company. The estimates for January 1, 1997, were prepared by Williamson. The
United States estimates for January 1, 1998 were prepared by the Company of
which approximately 72% of which were reviewed by Williamson. Oil and gas prices
used to determine proved reserves and the present value of estimated future net
cash flow for domestic properties were $24.17 and $3.96, respectively, at
January 1, 1997, and $15.29 and $2.20, respectively, at January 1, 1998. Reserve
estimates attributable to Moldova were prepared by W. Scott Epley, P.E.
The reserves data set forth herein present estimates only. Estimates of
economically recoverable oil and gas reserves and of future net cash flows
necessarily depend upon a number of variable factors and assumptions, such as
historical production from the area compared with production from other
producing areas, the assumed effects of regulations by governmental agencies and
assumptions concerning future oil and gas prices, future operation costs,
severance and excise taxes, development costs and workover and remedial costs,
all of which may in fact vary considerably from actual results. For these
reasons, 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 but
at different times may vary substantially and such reserve estimates may be
subject to downward or upward adjustment based upon such factors. 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.
In accordance with applicable requirements of the 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.
While the Company's oil and gas reserves are attributable to in excess of
2,000 proved and proved undeveloped wells and locations, 15% of the Company's
total proved reserves at January 1, 1998 were attributable to two wells in the
Southwest Speaks Field in Lavaca County, Texas. Both wells were completed in the
first quarter of 1998. Estimates of proved undeveloped reserves, as well as
estimates made early in the productive life of wells, may be less reliable than
reserve estimates attributable to wells which have a longer production history.
Any downward revision of the reserve estimates attributable to the Southwest
Speaks Field, or any interference in production from such Field, could have a
material adverse affect on the Company's future cash flows and financial
results.
EXPLORATION AND DEVELOPMENT ACTIVITIES
The Company drilled, or participated in the drilling of, the following
number of wells during the periods indicated. At December 31, 1997, the Company
was in the process of drilling 7 gross (2.64 net) wells and was in the process
of completing 1 gross (1 net) well as a producer which are not reflected in the
following table.
42
<PAGE> 48
The Company also drilled, or participated in the drilling of, 11 gross (3.89
net) service wells utilized as salt water disposal or water injection wells
which are not reflected in the following table.
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- ------------
GROSS NET GROSS NET GROSS NET
----- ----- ----- ----- ----- ----
<S> <C> <C> <C> <C> <C> <C>
Exploratory:
Productive............................ 15 8.38 13 8.88 10 4.58
Dry................................... 10 5.81 2 2.00 6 2.57
--- ----- -- ----- -- ----
Total......................... 25 14.19 15 10.88 16 7.15
=== ===== == ===== == ====
Development:
Productive............................ 86 58.72 16 9.93 1 0.44
Dry................................... 11 8.54 5 3.20 -- --
--- ----- -- ----- -- ----
Total......................... 97 67.26 21 13.13 1 0.44
=== ===== == ===== == ====
Total:
Productive............................ 101 67.11 29 18.81 11 5.02
Dry................................... 21 14.35 7 5.20 6 2.57
--- ----- -- ----- -- ----
Total......................... 122 81.46 36 24.01 17 7.59
=== ===== == ===== == ====
</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 interest in
productive oil and gas wells as of December 31, 1997. Productive wells are
producing wells and wells capable of production.
<TABLE>
<CAPTION>
GROSS NET
----- ---
<S> <C> <C>
Oil wells................................................... 1,348 677
Gas wells................................................... 623 205
----- ---
Total............................................. 1,971 882
===== ===
</TABLE>
ACREAGE
The following table sets forth certain information regarding the Company's
developed and undeveloped leasehold acreage as of December 31, 1997, and does
not include adjustments for the Manti Acquisition. Acreage in which the
Company's interest is limited to royalty, overriding royalty, mineral and
similar interests is excluded.
<TABLE>
<CAPTION>
DEVELOPED UNDEVELOPED TOTAL
----------------- ----------------- -----------------
REGION GROSS NET GROSS NET GROSS NET
- ------ ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Permian Basin............ 74,012 35,626 80,535 62,377 154,547 98,003
South/East............... 140,935 46,700 77,412 63,388 218,347 110,088
Rocky Mountain........... 56,491 20,503 484,373 458,629 540,864 479,132
Other.................... 16,096 2,575 23,414 23,309 39,510 25,884
------- ------- ------- ------- ------- -------
Total.......... 287,534 105,404 665,734 607,703 953,268 713,107
======= ======= ======= ======= ======= =======
</TABLE>
OTHER ACTIVITIES
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 then affiliated with the
Company. The Company paid Redeco $90,000 and bore the first $2.0 million of
concession expenses in return for a 50.0% interest in Redeco. The Company and
the other member of Redeco
43
<PAGE> 49
are each responsible for bearing 50.0% of future expenses. The Concession
Agreement covers the entire country (representing approximately 8.0 million
acres) with respect to oil and gas and other minerals, and continues for various
time periods depending on the nature of the activity conducted. During 1997,
Redeco drilled four successful gas wells in southern Moldova which led to the
first sales of Moldovan-produced natural gas. Assuming satisfactory third party
financing is arranged, thirty-five additional wells are planned for 1998
following completion of a 15 mile pipeline constructed by Redeco which will
allow sales of produced gas into the Moldovan gas distribution system. Redeco
has also completed a 25 mile 2-D seismic survey.
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.
The Federal Energy Regulatory Commission ("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 services, 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
44
<PAGE> 50
the gas industry. Order 636 and subsequent FERC orders on rehearing have been
appealed and are pending judicial review. It is difficult to predict the
ultimate impact of the orders on the Company and its gas marketing efforts.
Generally, 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 liquids by pipeline, although the most recent adjustment generally
decreased rates. 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 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 it acts as operator.
Notwithstanding the Company's lack of control over wells operated by others, the
failure of the operator to comply with applicable environmental regulations may,
in
45
<PAGE> 51
certain circumstances, be attributed to the Company. The Company has no material
commitments for capital expenditures to comply with existing environmental
requirements.
EMPLOYEES
At December 31, 1997, the Company had 138 full-time employees, the majority
of whom hold options under the Company's stock option plan. None of the
Company's employees is subject to a collective bargaining agreement. The Company
considers its relations with its employees to be good. In addition to its
employees, Costilla utilizes 10 consultants, and through its arrangements with
Ballard, has access to the approximately 30 employees of Ballard for oil and gas
activities within the Rocky Mountain region area of mutual interest.
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 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 Revolving Credit
Facility. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources," and "Description of
Revolving Credit Facility."
OPERATIONAL HAZARDS AND INSURANCE
The Company's operations are subject to the hazards and risks inherent in
drilling, 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 $21.0 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.
46
<PAGE> 52
MANAGEMENT
The executive officers and directors of the Company are listed below,
together with a description of their experience and certain other information
(ages provided are as of December 31, 1997). Executive officers are appointed by
the Board of Directors.
<TABLE>
<CAPTION>
EMPLOYED
AGE SINCE POSITION WITH COMPANY
--- -------- ---------------------
<S> <C> <C> <C>
Cadell S. Liedtke................... 42 1988 Chairman of the Board and Director
Michael J. Grella................... 49 1988 President, Chief Executive Officer
and Director
Henry G. Musselman.................. 44 1992 Executive Vice President, Chief
Operating Officer and Director
W.D. Kennedy........................ 77 N/A Director
Jerry J. Langdon.................... 44 N/A Director
Samuel J. Atkins, III............... 52 N/A Director
Bobby W. Page....................... 55 1996 Senior Vice President, Treasurer,
Chief Financial Officer and
Secretary
Clifford N. Hair, Jr................ 49 1992 Senior Vice President -- Land
Roger A. Freidline.................. 47 1993 Senior Vice President -- Exploration
(Geophysics)
Sal J. Pagano....................... 46 1995 Senior Vice President -- Engineering
and Operations
Keith Atwood........................ 43 1992 Senior Vice President -- Field
Operations
Celia A. Zinn....................... 49 1996 Controller
Roger J. Wetz....................... 48 1992 Vice President -- Exploration
(Geology)
Brian K. Miller..................... 38 1992 Vice President -- Reservoir
Engineering
</TABLE>
CADELL S. LIEDTKE 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
served as Managing Partner and/or Chief Executive Officer until April 1997. Mr.
Liedtke serves on the Liberal Arts Committee at the University of Texas at
Austin, the Board of Directors of Texas Commerce Bank-Permian Basin and the
Board of Directors of the Permian Basin Petroleum Association, 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, the Permian
Basin Landman's Association and the Independent Producer's Association of
America.
MICHAEL J. GRELLA 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 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
47
<PAGE> 53
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.
W.D. KENNEDY 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, 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 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 FERC from 1988 to June 1993. After leaving the FERC, Mr. Langdon
formed Republic Gas Partners, L.L.C., which was merged with Midcoast Energy
Resources, Inc. in October 1997. Mr. Langdon is currently a private investor and
consultant.
SAMUEL J. ATKINS, III is a Director of the Company and a member of the
Compensation and Audit Committees of the Board of Directors. 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.
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.
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 and a member of the American Association
of Petroleum Landmen and the Petroleum Basin Landman's Association.
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.
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,
48
<PAGE> 54
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.
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.
CELIA A. ZINN joined the Company in 1996. From 1992 to 1996, she practiced
public accounting in Midland. Ms. Zinn has 19 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.
ROGER J. WETZ began his oil and gas career with IMCO Services, a division
of Haliburton, 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.
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.
49
<PAGE> 55
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of Common Stock as of March 31, 1998 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, (iii) each executive officer whose annual compensation
exceeds $100,000 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.
<TABLE>
<CAPTION>
NUMBER PERCENT
NAME AND ADDRESS OF SHARES OF CLASS
- ---------------- --------- --------
<S> <C> <C>
Cadell S. Liedtke........................................... 2,302,560(1) 23.1%
400 W. Illinois
Midland, Texas 79701
Michael J. Grella........................................... 1,674,310(2) 16.8%
400 W. Illinois
Midland, Texas 79701
NationsBanc Capital Corp.................................... 936,000 9.4%
100 North Tryon Street
Charlotte, North Carolina 28255
The Equitable Companies Incorporated(3)..................... 899,800 9.0%
787 Seventh Avenue
New York, New York 10019
Cumberland Associates....................................... 732,500 7.3%
1114 Avenue of the Americas
New York, New York 10036
Henry G. Musselman.......................................... 622,000(4) 6.2%
400 W. Illinois
Midland, Texas 79701
W.D. Kennedy................................................ 7,500(5) *(6)
Jerry J. Langdon............................................ 5,000(5) *(6)
Samuel J. Atkins, III....................................... 5,000(5) *(6)
Bobby W. Page............................................... 76,000(7) *(6)
Roger A. Freidline.......................................... 88,300(8) *(6)
All Officers and Directors as a group (13 persons).......... 5,175,670(9) 49.1%(6)
</TABLE>
- ---------------
* Less than 1%.
(1) Includes (a) 2,242,560 shares owned directly by Mr. Liedtke and (b) 60,000
shares owned by the Marion and Cadell S. Liedtke Family Charitable
Foundation over which Mr. Liedtke holds voting and dispositive power.
(2) Includes (a) 1,624,310 shares owned directly by Mr. Grella and (b) 50,000
shares owned by the Grella Family Charitable Foundation over which Mr.
Grella holds voting and dispositive power.
(3) Represents shares owned by Alliance Capital Management L.P., a subsidiary of
the Equitable Companies Incorporated, held behalf of clients, as reported in
the Schedule 13G filed by the Equitable Companies Incorporated, as amended
through December 31, 1997.
(4) Includes (a) 599,500 shares owned directly by Mr. Musselman, (b) 1,500
shares owned by Mr. Musselman's spouse as custodian for their children under
the Texas Uniform Transfers to Minors Act and (c) 21,000 shares owned by the
Musselman Family Charitable Foundation over which Mr. Musselman holds voting
and dispositive power.
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<PAGE> 56
(5) Includes the right to acquire beneficial ownership of 5,000 shares of Common
Stock through presently exercisable options granted under the Company's
Outside Directors Stock Option Plan.
(6) 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.
(7) Includes the right to acquire beneficial ownership of 75,000 shares of
Common Stock through a presently exercisable option granted under the
Company's 1996 Stock Option Plan.
(8) Includes the right to acquire beneficial ownership of 85,000 shares of
Common Stock through a presently exercisable option granted under the
Company's 1996 Stock Option Plan.
(9) Includes all rights of executive officers and directors to acquire
beneficial ownership of 565,000 shares of Common Stock through presently
exercisable options granted under the Company's 1996 Stock Option Plan and
Outside Directors Stock Option Plan.
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<PAGE> 57
EXECUTIVE COMPENSATION AND OTHER INFORMATION
The following table sets forth information regarding the total compensation
for 1995, 1996 and 1997 received by the Company's Chief Executive Officer and
the other executive officers of the Company whose annual compensation exceeded
$100,000 in 1997. Information for 1996 is on an annualized basis based upon
amounts paid to the named individuals after the Corporate Reorganization (as
hereinafter defined).
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
---------------------------------------- UNDERLYING
OTHER ANNUAL OPTIONS/ ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION SARS(1) COMPENSATION(2)
- --------------------------- ---- -------- ------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
Cadell S. Liedtke(3) 1997 $300,000 $50,000 -- -- $ 9,417
Chairman of the Board 1996 300,000 -- -- -- 6,738
1995 185,700 -- -- -- --
Michael J. Grella(4) 1997 $300,000 $50,000 -- -- $ 9,417
President and Chief 1996 300,000 -- -- -- 6,352
Executive Officer 1995 261,750 -- -- -- 656,000
Henry G. Musselman(5) 1997 $239,792 $36,000 -- -- $ 3,750
Executive Vice President 1996 215,000 10,000 -- -- 3,295
and Chief Operating
Officer 1995 139,800 -- -- -- --
Bobby W. Page(6) 1997 $175,000 $14,583 $18,583(7) -- $ 2,625
Senior Vice President, 1996 150,000 5,208 -- 75,000 --
Treasurer, Secretary and 1995 -- -- -- -- --
Chief Financial Officer
Roger A. Freidline 1997 $ 93,430 $ 7,786 $ 9,292(7) -- $ 78,938
Senior Vice President, 1996 88,981 7,415 -- 85,000 17,785
Exploration 1995 83,160 5,000 -- -- 7,190
</TABLE>
- ---------------
(1) The amount shown represents the number of shares subject to non-qualifying
stock options granted pursuant to the 1996 Stock Option Plan (the "Option
Plan") as described under "-- Benefit Plans."
(2) The amounts shown include contributions made by the Company pursuant to the
Company's 401(k) plan for the benefit of the named individuals. The amount
shown for Mr. Grella for 1995 represents non-cash compensation deemed to
have been accrued to him in connection with the cancellation of an option
held by a minority interest owner to purchase an additional interest in the
Company. The amounts shown for Mr. Freidline include payments made to him of
$5,111, $15,115 and $76,252 in 1995, 1996, and 1997, respectively, pursuant
to an overriding royalty interest compensation program entered into between
the Company's predecessors and Mr. Freidline. Such compensation arrangements
were discontinued prior to the IPO.
(3) Mr. Liedtke beneficially owns 2,302,560 shares of restricted Common Stock
issued to him in connection with the consolidation of the Company's
predecessors in October 1996 (the "Corporate Reorganization"), with a value
at December 31, 1997 of $25,040,340.
(4) 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, 1997 of $14,686,035.
(5) 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, 1997 of $6,644,625.
(6) Mr. Page joined the Company in June 1996.
(7) Represents the dollar value of an award of shares of Common Stock and the
amount of a cash award equal to the income tax liability for the stock
award, all granted to the named officer under the Company's Bonus Incentive
Plan (the "Bonus Plan").
52
<PAGE> 58
DIRECTOR'S COMPENSATION
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 Stock Option Plan (the "Outside Directors Plan").
The Outside Directors Plan provides for the issuance of stock options to
the outside directors of the Company. A total of 100,000 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 5,000 shares of
Common Stock will be granted each year on the date immediately following the
Company's annual meeting to each person who qualifies as an outside director.
The exercise price of each option granted under the plan will be the fair market
value (as reported on the Nasdaq Stock Market's 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. Pursuant to the terms of the plan, an
option for 5,000 shares was granted to each of the Company's three outside
directors on June 17, 1997.
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 of the
Board of Directors.
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
53
<PAGE> 59
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, 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
provided 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 an option 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.
BENEFIT PLANS
The 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
1,250,000 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.
The plan is administered by the Compensation Committee of the Board of
Directors, which 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 Compensation Committee, (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. 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
54
<PAGE> 60
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 135 persons who
are eligible to participate under the plan. No options were granted under the
Option Plan in 1997.
The following table provides information, with respect to the named
executive officers, regarding the exercise of options during fiscal year 1997
and the value of unexercised options held as of the end of fiscal year 1997:
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
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 N/A
Roger A. Freidline.......... 0 0 85,000/0 N/A
</TABLE>
- ---------------
(1) The option price of the options set forth above is $12.50 per share. The
closing sales price of the Company's Common Stock on the Nasdaq National
Market on December 31, 1997 was $10.88 per share. Therefore, the options
were not in-the-money at fiscal year end 1997.
The Bonus Plan was adopted 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 based upon an
assessment and recommendations from the Committee with respect to the following
performance factors for the year under consideration: (i) increases the net
value of the Company's assets, (ii) increases in the market value of the
Company's Common Stock as compared to the Company's peer group, (iii) increases
in the Company's oil and gas reserves; (iv) increases in the Company's oil and
gas production; (v) increases in earnings and cash flow (assuming constant
product prices); (vi) the performance of the individual in connection with the
Company's success in the foregoing areas; and (vii) 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.
55
<PAGE> 61
CERTAIN TRANSACTIONS AND RELATIONSHIPS
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. 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, 1997, A&P
received $550,000 from the Company for goods and services provided, which
accounted for approximately 94% 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, or paid to, unaffiliated third parties.
The Company was indebted to NationsBank of Texas, N.A. and/or its
affiliates during 1997 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 an executive vice president of NationsBank Corporation during a
portion of 1997. 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.
DESCRIPTION OF REVOLVING CREDIT FACILITY
In August 1997, the Company entered into a credit agreement (the "Revolving
Credit Facility") with Bankers Trust Company, as agent, to refinance its
existing bank indebtedness and to finance a portion of the Ballard Acquisition
purchase price. The Revolving Credit Facility provides for a maximum
availability of $75.0 million, with a borrowing base at January 16, 1998 of
$50.0 million, $0.5 million of which was borrowed at that date. Borrowings under
the Revolving Credit Facility bear interest, at the Company's option, at a
floating rate which is at or above the lender's prime rate or above the
applicable Eurodollar rate, depending on the percentage of committed funds which
have been borrowed. Interest is payable quarterly as to base rate loans, and at
the end of the applicable interest period as to Eurodollar rate loans. The
borrowing base of the Revolving Credit Facility is automatically reduced by 5%
each quarter beginning in August 1999, unless extended, and payments or
principal are required in each such quarter in which the outstanding principal
balance is greater than the reduced borrowing base. The remaining balance is
payable on August 28, 2002, the maturity date of the Revolving Credit Facility.
Under the Revolving Credit Facility, the Company is obligated to pay certain
fees to the lender, including a commitment fee based on the unused portion of
the commitment. The Revolving Credit Facility contains customary restrictive
covenants (including restrictions on the payment of dividends and the incurrence
of additional indebtedness) and requires the Company to maintain (i) a current
ratio of not less than 1.0 to 1.0, including amounts available under the
Revolving Credit Facility and excluding current maturities under the Revolving
Credit Facility, (ii) a ratio of EBITDA to interest expense of not less than 2.5
to 1, and (iii) a minimum tangible net worth. Borrowings under the Revolving
Credit Facility are secured by substantially all of the assets of the Company.
56
<PAGE> 62
DESCRIPTION OF EXCHANGE NOTES
GENERAL
The Private Notes were, and the Exchange Notes will be, issued under the
Indenture. The Existing Notes are also issued under the Indenture. The terms of
the Exchange Notes are identical in all material respects to the Private Notes,
except that the Exchange Notes have been registered under the Securities Act,
and therefore, will not bear legends restricting their transfer. The terms of
the Exchange 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 "-- Certain Definitions." As used in the following
summary, the term "Notes" shall include the Exchange Notes and the Existing
Notes, unless the context shall otherwise require, and the terms "Holder" and
"Holders" shall include holders of both the Exchange Notes and the Existing
Notes, as appropriate.
As of the date of this Prospectus, Costilla Redeco Energy, L.L.C., through
which the Company conducts its Moldovan operations, and Costilla Energy Pipeline
Corporation are 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 $180.0 million and will mature on
October 1, 2006. Interest on the Notes will accrue at the rate of 10 1/4% per
annum and will be payable semiannually in arrears on April 1 and October 1
commencing on October 1, 1998, to Holders of record on the immediately preceding
March 15 and September 15. Interest on the Exchange Notes will accrue (A) from
the later of (i) the last interest payment date on which interest was paid on
the Private Note surrendered in exchange therefor, or (ii) if the Private Note
is surrendered for exchange on a date in a period which includes the record date
for an interest payment date to occur on or after the date of such exchange and
as to which interest will be paid, the date of such interest payment date or (B)
if no interest has been paid on the Private Notes, from the Issue Date. 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 Revolving Credit Facility, which are secured by liens on
substantially all of the assets of the Company. See "Description of Revolving
Credit Facility." On a
57
<PAGE> 63
pro forma basis, after giving effect to the Initial Offering and the application
of proceeds therefrom, the Company would have had no senior unsecured
indebtedness, other than the Notes and trade payables, and $0.7 million of
secured Senior Indebtedness at December 31, 1997. 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 are not
Subsidiary Guarantors. The Indenture limits, 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 also limits 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." There are currently 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 provides 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 provides 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 $30.0
million in 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 $150.0 million in aggregate principal
amount of the Notes remains 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
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thereof so tendered and (3) deliver or cause to be delivered to the Trustee the
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 Revolving 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 the 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 Revolving Credit Facility. Even if such
consents to an offer to purchase were obtained or the lenders did not declare a
default under the Revolving Credit Facility, 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 provides 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
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
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<PAGE> 66
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 Revolving 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 provides 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 "-- 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 "-- 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 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
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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 "-- 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 this Prospectus, Costilla Redeco Energy, L.L.C., through
which the Company conducts its Moldovan operations, and Costilla Energy Pipeline
Corporation are Unrestricted Subsidiaries.
Restricted Payments
The Indenture provides 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 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 "-- 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
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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 IPO.
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 basis upon which the calculations
required by the covenant described under "-- 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 provides 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 2.5 to 1 determined on a
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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 "-- 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 (a) 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 (b) 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 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 provides 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;
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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 provides 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 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 provides 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 provides 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
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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
"-- Incurrence of Indebtedness and Issuance of Preferred Stock."
Transactions with Affiliates
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, 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 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 provides 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 provides 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
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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 Subsidiaries 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 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.
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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.
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
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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).
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 is 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.
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GOVERNING LAW
The Indenture, the Notes and the Subsidiary Guarantees are and/or 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 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 under payments of the Company
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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.
"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
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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 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
Stockholders"), 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),
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and excluding (viii) the impact of 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.
"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
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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 lender parties thereto (which includes, as of the date of
this Prospectus, the Revolving Credit Facility), including any increases in the
amount thereof, together with any related notes, guarantees, collateral
documents, instruments and agreements executed in connection therewith, and in
each case as such agreements may be amended (including any amendment and
restatement thereof), supplemented or otherwise modified from time to time,
including any agreements extending the maturity of, renewing, replacing,
refinancing, increasing or otherwise restructuring all or any portion of the
Indebtedness under such agreements.
"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.
"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 the Company.
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"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 Indebtedness of A&P Meter
Service and Supply, Inc. outstanding on the date of the Indenture and
performance of and payment for services provided by A&P Meter Service and
Supply, Inc. to the Company and its subsidiaries in the ordinary course of
business consistent with past practices.
"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 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
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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 repurchased, 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 "-- 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)
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,
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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 "-- 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.
"Permitted Liens" means (a) Liens existing on the date of the Indenture;
(b) Liens securing Indebtedness under the Credit Facility; (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
"-- 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
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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 setoff, 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 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, deceased 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, deceased 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.
78
<PAGE> 84
"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 percent 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
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
79
<PAGE> 85
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.
BOOK-ENTRY; DELIVERY AND FORM
Except as described in the next paragraph, the Exchange Notes initially
will be represented by one or more permanent global exchange notes
(collectively, the "Global Exchange Note"). The Global Exchange Note will be
deposited on the Exchange Date with, or on behalf of, DTC and registered in the
name of a nominee of DTC.
Exchange Notes (i) originally purchased by or transferred to "foreign
purchasers" or (ii) held by qualified institutional buyers who elect to take
physical delivery of their certificates instead of holding their interests
through the Global Exchange Note (and which are thus ineligible to trade through
DTC) (collectively referred to herein as the "Non-Global Purchasers") will be
issued in registered form (the "Certificated Security"). Upon the transfer of
any Certificated Security initially issued to a Non-Global Purchaser, such
Certificated Security will, unless the transferee requests otherwise or the
Global Exchange Note has previously been exchanged in whole for Certificated
Securities, be exchanged for an interest in the Global Exchange Note.
The Global Exchange Note. The Company expects that pursuant to procedures
established by DTC (i) upon the issuance of the Global Exchange Note, DTC or its
custodian will credit, on its internal system, the principal amount of Notes of
the individual beneficial interests represented by such Global Exchange Note to
the respective accounts of persons who have accounts with such depositary and
(ii) ownership of beneficial interests in the Global Exchange Note will be shown
on, and the transfer of such ownership will be effected only through, records
maintained by DTC or its nominee (with respect to interests of participants) and
the records of participants (with respect to interests of persons other than
participants). Ownership of beneficial interests in the Global Exchange Note
will be limited to persons who have accounts with DTC ("participants") or
persons who hold interests through participants. Holders may hold their
interests in the Global Exchange Note directly through DTC if they are
participants in such system, or indirectly through organizations which are
participants in such system.
So long as DTC, or its nominee, is the registered owner or holder of the
Exchange Notes, DTC or such nominee, as the case may be, will be considered the
sole owner or holder of the Exchange Notes represented by such Global Exchange
Note for all purposes under the Indenture. No beneficial owner of an interest in
the Global Exchange Note will be able to transfer that interest except in
accordance with DTC's procedures, in addition to those provided for under the
Indenture with respect to the Exchange Notes.
Payments of the principal, premium (if any) or interest on the Global
Exchange Note will be made to DTC or its nominee, as the case may be, as the
registered owner thereof. None of the Company, the Trustee or any Paying Agent
will have any responsibility or liability for any aspect of the records relating
to or payments made on account of beneficial ownership interests in the Global
Exchange Note or for maintaining, supervising or reviewing any records relating
to such beneficial ownership interest.
The Company expects that DTC or its nominee, upon receipt of any payment of
principal, premium (if any), and interest on the Global Exchange Note, will
credit participants' accounts with payments in amounts proportionate to their
respective beneficial interests in the principal amount of the Global Exchange
Note as shown on the records of DTC or its nominee. The Company also expects
that payments by participants to owners of beneficial interests in the Global
Exchange Note held through such participants will be governed by standing
instructions and customary practice, as is now the case with securities held for
the accounts of
80
<PAGE> 86
customers registered in the names of nominees for such customers. Such payments
will be the responsibility of such participants.
Transfers between participants in DTC will be effected in the ordinary way
through DTC's same-day funds system in accordance with DTC rules and will be
settled in same day funds. If a holder requires physical delivery of a
Certificated Security for any reason, including to sell Exchange Notes to
persons in states which require physical delivery of the Exchange Notes, or to
pledge such securities, such holder must transfer its interest in a Global
Exchange Note, in accordance with the normal procedures of DTC and with the
procedures set forth in the Indenture.
DTC has advised the Company that it will take any action permitted to be
taken by a holder of Exchange Notes (including the presentation of Exchange
Notes for exchange as described below) only at the direction of one or more
participants to whose account the DTC interests in the Global Exchange Note are
credited and only in respect of such portion of the aggregate principal amount
of Exchange Notes as to which such participant or participants has or have given
such direction. However, if there is an Event of Default under the Indenture,
DTC will exchange the Global Exchange Note for Certificated Securities, which it
will distribute to its participants.
DTC has advised the Company as follows: DTC is a limited purpose trust
company organized under the laws of the State of New York, a member of the
Federal Reserve System, a "clearing corporation" within the meaning of the
Uniform Commercial Code and a "Clearing Agency" registered pursuant to the
provisions of Section 17A of the Exchange Act. DTC was created to hold
securities for its participants and facilitate the clearance and settlement of
securities transactions between participants through electronic book-entry
changes in accounts of its participants, thereby eliminating the need for
physical movement of certificates. Participants include securities brokers and
dealers, banks, trust companies and clearing corporations and certain other
organizations. Indirect access to the DTC system is available to others such as
banks, brokers, dealers and trust companies that clear through or maintain a
custodial relationship with a participant, either directly or indirectly
("indirect participants").
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of interests in the Global Exchange Note among participants of DTC, it
is under no obligation to perform such procedures, and such procedures may be
discontinued at any time. Neither the Company nor the Trustee will have any
responsibility for the performance by DTC or its participants or indirect
participants of their respective obligations under the rules and procedures
governing their operations.
Certificated Securities. If DTC is at any time unwilling or unable to
continue as a depositary for the Global Exchange Note and a successor depositary
is not appointed by the Company within 90 days, Certificated Securities will be
issued in exchange for the Global Exchange Note.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
GENERAL
The following discussion is a summary of certain federal income tax
considerations relevant to the exchange of Private Notes for Exchange Notes, but
does not purport to be a complete analysis of all potential tax effects. The
discussion is based upon the Internal Revenue Code of 1986, as amended, Treasury
Regulations, Internal Revenue Service rulings and pronouncements, and judicial
decisions now in effect, all of which are subject to change at any time by
legislative, judicial or administrative action. Any such changes may be applied
retroactively in a manner that could adversely affect a holder of the Exchange
Notes. The description does not consider the effect of any applicable foreign,
state, local or other tax laws or estate or gift tax considerations.
EACH HOLDER SHOULD CONSULT HIS OWN TAX ADVISOR AS TO THE PARTICULAR TAX
CONSEQUENCES TO IT OF EXCHANGING PRIVATE NOTES FOR EXCHANGE NOTES, INCLUDING THE
APPLICABILITY AND EFFECT OF ANY STATE, LOCAL OR FOREIGN TAX LAWS.
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<PAGE> 87
EXCHANGE OF PRIVATE NOTES FOR EXCHANGE NOTES
The exchange of Private Notes for Exchange Notes pursuant to the Exchange
Offer should not constitute a significant modification of the terms of the
Private Notes and, therefore such exchange should not constitute an exchange for
federal income tax purposes. Accordingly, such exchange should have no federal
income tax consequences to holders of Private Notes.
PLAN OF DISTRIBUTION
Each broker-dealer that receives Exchange Notes for its own account
pursuant to the Exchange Offer must acknowledge that it will deliver a
Prospectus in connection with any resale of such Exchange Notes. The Prospectus,
as it may be amended or supplemented from time to time, may be used by a
broker-dealer in connection with resales of Exchange Notes received in exchange
for Private Notes where such Private Notes were acquired as a result of
market-making activities or other trading activities. The Company has agreed
that, during the period required by the Registration Rights Agreement, it will
make this Prospectus, as amended or supplemented, available to any broker-dealer
for use in connection with such resale.
The Company will not receive any proceeds from any sale of Exchange Notes
by broker-dealers. Exchange Notes received by broker-dealers for their own
account pursuant to the Exchange Offer may be sold from time to time in one or
more transactions in the over-the-counter market, in negotiated transactions,
through the writing of options on the Exchange Notes or a combination of such
methods of resale, at market prices prevailing at the time of resale, at prices
related to such prevailing market prices or negotiated prices. Any such resale
may be made directly to purchasers or to or through brokers or dealers who may
receive compensation in the form of commission or concessions from any such
broker-dealer or the purchasers of any such Exchange Notes. Any broker-dealer
that resells Exchange Notes that were received by it for its own account
pursuant to the Exchange Offer and any broker or dealer that participates in a
distribution of such Exchange Notes may be deemed to be an "underwriter" within
the meaning of the Securities Act and any profit on any such resale of Exchange
Notes and any commission or concessions received by any such person may be
deemed to be underwriting compensation under the Securities Act. The Letter of
Transmittal states that, by acknowledging that it will deliver and by delivering
a Prospectus, a broker-dealer will not be deemed to admit that it is an
"underwriter" within the meaning of the Securities Act.
The Company has agreed to pay all expenses incident to the Exchange Offer
(including expenses of one counsel for the Holders of the Private Notes) other
than commissions or concessions of any brokers or dealers. Any Private Notes not
exchanged in the Exchange Offer for Exchange Notes will remain subject to
certain transfer restrictions.
LEGAL MATTERS
Certain legal matters related to the Exchange Notes offered hereby will be
passed upon for the Company by Cotton, Bledsoe, Tighe and Dawson, a Professional
Corporation, Midland, Texas.
EXPERTS
The consolidated financial statements of the Company as of December 31,
1997 and 1996 and for each of the years in the three-year period ended December
31, 1997 have been included herein in reliance upon the report of KPMG Peat
Marwick LLP, independent certified public accountants, whose report appears
elsewhere herein, and upon the authority of said firm as experts in accounting
and auditing.
The statement of revenues and direct operating expenses of the Ballard
Acquisition for the year ended December 31, 1996 and the statement of revenues
and direct operating expenses of the 1995 Acquisition for the period ended June
12, 1995, have been included herein in reliance upon the reports of KPMG Peat
Marwick LLP, independent certified public accountants, whose reports appear
elsewhere herein, and upon the authority of said firm as experts in accounting
and auditing.
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 certain of the Company's properties
at January 1, 1997 and January 1, 1998 are based on reports prepared or reviewed
by Williamson Petroleum Consultants, Inc. and W. Scott Epley, P.E.
82
<PAGE> 88
GLOSSARY
The terms defined in this section are used throughout this Offering
Memorandum.
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. Barrels of oil equivalent. Determined using the ratio of six Mcf of
gas to one Bbl of crude oil, condensate or 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 quantities 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.
PV-10 Value or Present Value of Estimated Future Net Revenues. 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 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 or that is capable of
production.
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<PAGE> 89
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.
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<PAGE> 90
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Pro Forma Condensed Financial Statement of Costilla Energy,
Inc. (Unaudited):
Pro Forma Condensed Statement of Operations for the year
ended December 31, 1997................................ F-3
Notes to Unaudited Pro Forma Condensed Statement of
Operations............................................. F-4
Consolidated Financial Statements of Costilla Energy, Inc.:
Independent Auditors' Report.............................. F-7
Consolidated Balance Sheets as of December 31, 1997 and
1996................................................... F-8
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995....................... F-9
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997, 1996 and 1995........... F-10
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995....................... F-11
Notes to Consolidated Financial Statements................ F-12
Financial Statements of the Ballard Acquisition:
Independent Auditors' Report.............................. F-32
Statements of Revenues and Direct Operating Expenses for
the year ended December 31, 1996 and the Six Months
ended June 30, 1997 and 1996 (Unaudited)............... F-33
Notes to the Statements of Revenues and Direct Operating
Expenses............................................... F-34
Financial Statements of the 1995 Acquisition:
Independent Auditors' Report.............................. F-37
Statement of Revenues and Direct Operating Expenses for
the period ended June 12, 1995......................... F-38
Notes to the Statement of Revenues and Direct Operating
Expenses............................................... F-39
</TABLE>
F-1
<PAGE> 91
PRO FORMA CONDENSED STATEMENT OF OPERATIONS
The unaudited Pro Forma Condensed Statement of Operations of the Company
has been prepared to give effect to the Ballard Acquisition and the sale of the
Private Notes as if such transactions had taken place on January 1, 1997. The
Pro Forma Condensed Statement of Operations of the Company is not necessarily
indicative of the results for the period presented had the Ballard Acquisition
and the sale of the Private Notes taken place on January 1, 1997. In addition,
future results may vary significantly from the results reflected in the
accompanying Pro Forma Condensed Statement of Operations 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, Inc. and the Statements of Revenues and Direct Operating
Expenses with respect to the properties acquired in the Ballard Acquisition.
F-2
<PAGE> 92
COSTILLA ENERGY, INC.
PRO FORMA CONDENSED STATEMENT OF OPERATIONS -- UNAUDITED
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
PRE OFFERING PRO FORMA PRO FORMA
COSTILLA BALLARD PRO FORMA COSTILLA OFFERING COSTILLA
ENERGY, INC. ACQUISITION ADJUSTMENTS ENERGY, INC. ADJUSTMENTS ENERGY, INC.
------------ ----------- ----------- ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Revenues................. $ 76,501 $5,688 $ 82,189 $ 82,189
Expenses:
Oil and gas
production.......... 30,029 2,603 32,632 32,632
General and
administrative...... 8,407 1,120(1) 9,527 9,527
Exploration and
abandonments........ 6,588 200(2) 6,788 6,788
Depreciation, depletion
and amortization.... 26,409 2,030(3) 28,439 28,439
Impairment of oil and
gas properties...... 28,189 28,189 28,189
Interest............... 12,979 2,010(4) 14,989 (14,989)(5) 19,053
19,053(5)
-------- ------ -------- --------
112,601 2,603 120,564 124,628
-------- ------ -------- --------
Income (loss) before
federal income taxes
and extraordinary
item................... (36,100) 3,085 (38,375) (42,439)
Provision for federal
income taxes
Current................ 62 62 62
Deferred............... 90 90 90
-------- ------ -------- --------
Income (loss) before
extraordinary item..... $(36,252) $3,085 $(38,527) $(42,591)
======== ====== ======== ========
Income (loss) per share
before extraordinary
item................... $ -- $ (3.71) $ (4.10)
======== ======== ========
Weighted average shares
outstanding............ 10,383 10,383 10,383
======== ======== ========
</TABLE>
See accompanying notes to unaudited pro forma condensed statement of operations.
F-3
<PAGE> 93
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA CONDENSED STATEMENT OF OPERATIONS
(1) BASIS OF PRESENTATION
The Pro Forma Condensed Statement of Operations of the Company have been
prepared to give effect to the Ballard Acquisition and the sale of the Private
Notes as if such transactions had taken place on January 1, 1997. The Ballard
Acquisition is accounted for by the purchase method.
Costilla Energy, Inc. -- Represents the historical consolidated
statement of operations for the year ended December 31, 1997.
Ballard Acquisition -- Represents the revenues and direct operating
expenses of the properties acquired in the Ballard Acquisition for the
period from January 1, 1997 to August 28, 1997 (date of the Ballard
Acquisition).
(2) PRO FORMA ENTRIES
(1) To record the incremental general and administrative expenses incurred
at a contractual rate of approximately $140,000 per month as a result of the
Ballard Acquisition.
(2) To record the incremental geological and geophysical expenses incurred
at a contractual rate of approximately $25,000 per month as a result of the
Ballard Acquisition.
(3) To record estimated incremental depletion expense for the properties
acquired in the Ballard Acquisition from January 1, 1997 through August 28, 1997
(date of the Ballard Acquisition).
(4) To adjust interest expense to reflect additional borrowings for the
properties acquired in the Ballard Acquisition from January 1, 1997 to August
28, 1997 (date of the Ballard Acquisition). Also included is the amortization of
loan fees of $478,000 over a five-year period.
Incremental interest expense includes the following components:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997
------------
<S> <C>
Additional interest on borrowings associated with the
Ballard Acquisition....................................... 1,946
Amortization of loan fees................................... 64
------
$2,010
======
</TABLE>
(5) To reverse interest on existing debt and to adjust interest expense to
reflect issuance of the Private Notes at 10.25% plus the amortization of
estimated debt issuance costs over the remaining life of the Notes which mature
on October 1, 2006 ($832,000 annually). Completion of the Exchange Offer and
issuance of the Exchange Notes will have an insignificant effect on interest
expense.
F-4
<PAGE> 94
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA STATEMENT OF OPERATIONS -- (CONTINUED)
(3) SUPPLEMENTAL PRO FORMA OIL AND GAS RESERVE INFORMATION
Estimated Quantities of Proved Oil and Gas Reserves
The estimates of proved oil and gas reserves, which are located in the
United States, were prepared by the Company as of January 1, 1997 and December
31, 1997. 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 $15.29 per Bbl and a gas price of $2.20 per Mcf as of December 31, 1997. The
pro forma information assumes that the Ballard Acquisition took place on January
1, 1997.
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>
UNITED STATES MOLDOVA TOTAL
-------------------- -------------------- --------------------
OIL AND NATURAL OIL AND NATURAL OIL AND NATURAL
CONDENSATE GAS CONDENSATE GAS CONDENSATE GAS
(MBbls) (MMcf) (MBbls) (MMcf) (MBbls) (MMcf)
---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Total Proved Reserves:
Balance, January 1, 1997......... 21,254 132,607 -- -- 21,254 132,607
Revisions of previous
estimates................... (4,412) (1,084) -- -- (4,412) (1,084)
Extensions and discoveries..... 2,465 58,888 395 1,318 2,860 60,206
Production..................... (2,685) (15,349) -- -- (2,685) (15,349)
Sales of minerals-in-place..... (2,065) (27,743) -- -- (2,065) (27,743)
------ ------- --- ----- ------ -------
Balance, December 31, 1997....... 14,557 147,319 395 1,318 14,952 148,637
====== ======= === ===== ====== =======
Proved Developed Reserves:
January 1, 1997................ 18,156 99,901 -- -- 18,156 99,901
December 31, 1997.............. 10,646 84,558 -- 359 10,646 84,917
</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 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 probable reserves, anticipated
future oil and gas prices, interest rates, changes in development and production
costs and risks
F-5
<PAGE> 95
COSTILLA ENERGY, INC.
NOTES TO UNAUDITED PRO FORMA STATEMENT OF OPERATIONS -- (CONTINUED)
associated with future production. Because of these and other considerations,
estimates of fair value are necessarily subjective and imprecise.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
---------------------------------------
UNITED STATES MOLDOVA TOTALS
------------- ----------- ---------
(THOUSANDS)
<S> <C> <C> <C>
Future cash flows.......................................... $ 547,584 $ 9,063 $ 556,647
Future costs:
Production............................................... (205,454) (1,943) (207,397)
Development.............................................. (41,291) (2,572) (43,863)
--------- ------- ---------
Future net cash flows before income taxes.................. 300,839 4,548 305,387
Future income taxes........................................ 31,249 951 32,200
--------- ------- ---------
Future net cash flows...................................... 269,590 3,597 273,187
10% annual discount for estimated timing of cash flows..... (95,704) (1,560) (97,264)
--------- ------- ---------
Standardized measure of discounted net cash flows.......... $ 173,886 $ 2,037 $ 175,923
========= ======= =========
</TABLE>
- ---------------
Changes in Standardized Measure of Discounted Future Net Cash Flows From
Proved Reserves
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
---------------------------------------
UNITED STATES MOLDOVA TOTALS
------------- ----------- ---------
(THOUSANDS)
<S> <C> <C> <C>
Increase (decrease):
Extensions and discoveries and improved recovery, net of
future production and development costs............... $ 69,140 $2,576 $ 71,716
Accretion of discount.................................... 37,312 -- 37,312
Net change in sales prices net of production cost........ (170,943) -- (170,943)
Changes in estimated future development costs............ 2,272 -- 2,272
Revisions of quantity estimates.......................... (17,890) -- (17,890)
Net change in income taxes............................... 47,574 (539) 47,035
Sales, net of production costs........................... (49,557) -- (49,557)
Sales of minerals in place............................... (29,975) -- (29,975)
Changes of production rates (timing) and other........... 17,790 -- 17,790
--------- ------ ---------
Net increase (decrease)............................... (94,277) 2,037 (92,240)
Standardized measure of discounted future net cash flows:
Beginning of period................................... 268,163 -- 268,163
--------- ------ ---------
End of period......................................... $ 173,886 $2,037 $ 175,923
========= ====== =========
</TABLE>
F-6
<PAGE> 96
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Costilla Energy, Inc.:
We have audited the consolidated financial statements of Costilla Energy,
Inc. and subsidiaries as listed in the accompanying index. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated 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 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 audits provide 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, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
Midland, Texas
March 6, 1998
F-7
<PAGE> 97
COSTILLA ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 3,615 $ 12,618
Accounts receivable:
Trade, net............................................. 5,241 6,675
Affiliates............................................. -- 332
Oil and gas sales...................................... 9,312 9,031
Prepaid and other current assets.......................... 912 1,753
-------- --------
Total current assets.............................. 19,080 30,409
-------- --------
Property, plant and equipment, at cost:
Oil and gas properties, using the successful efforts
method of accounting:
Proved properties...................................... 199,355 140,477
Unproved properties.................................... 35,971 4,482
Accumulated depletion, depreciation and amortization...... (71,152) (20,435)
-------- --------
164,174 124,524
Other property and equipment, net......................... 3,766 2,420
-------- --------
Total property, plant and equipment............... 167,940 126,944
-------- --------
Other assets:
Deferred charges.......................................... 4,212 4,503
Note receivable -- other.................................. -- 250
Other..................................................... 2,856 684
-------- --------
Total other assets................................ 7,068 5,437
-------- --------
$194,088 $162,790
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt...................... $ 98 $ 98
Trade accounts payable.................................... 22,490 12,718
Undistributed revenue..................................... 4,566 3,517
Other current liabilities................................. 3,437 3,756
-------- --------
Total current liabilities......................... 30,591 20,089
-------- --------
Long-term debt, less current maturities..................... 163,087 100,262
-------- --------
Other noncurrent liabilities................................ -- 1,870
-------- --------
Stockholders' equity:
Preferred stock, $.10 par value (3,000,000 shares
authorized; no shares outstanding)..................... -- --
Common stock, $.10 par value (20,000,000 shares
authorized; 10,150,500 shares outstanding at December
31, 1997 and 10,475,000 shares outstanding at December
31, 1996).............................................. 1,015 1,047
Additional paid-in capital................................ 37,425 41,081
Retained deficit.......................................... (38,030) (1,559)
-------- --------
Total stockholders' equity........................ 410 40,569
-------- --------
Commitments and contingencies............................... -- --
-------- --------
$194,088 $162,790
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-8
<PAGE> 98
COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
Revenues:
Oil and gas sales......................................... $ 72,300 $53,919 $21,693
Interest and other........................................ 940 40 123
Gain on sale of assets.................................... 3,261 1,067 --
-------- ------- -------
76,501 55,026 21,816
-------- ------- -------
Expenses:
Oil and gas production.................................... 30,029 21,325 10,024
Oil and gas production -- affiliates...................... -- 449 331
General and administrative................................ 8,407 4,682 2,910
General and administrative -- affiliates.................. -- 556 661
Compensation related to option settlement................. -- -- 656
Exploration and abandonments.............................. 6,588 2,550 1,652
Depreciation, depletion and amortization.................. 26,409 12,430 5,958
Impairment of oil and gas properties...................... 28,189 -- --
Interest.................................................. 12,979 11,281 4,591
-------- ------- -------
112,601 53,273 26,783
-------- ------- -------
Income (loss) before federal income taxes and
extraordinary item................................... (36,100) 1,753 (4,967)
Provision for federal income taxes
Current................................................... 62 176 3
Deferred.................................................. 90 1,042 --
-------- ------- -------
Income (loss) before extraordinary item................ (36,252) 535 (4,970)
Extraordinary loss resulting from early extinguishment
of debt, net of deferred tax benefit of $129 and
$1,042............................................... (219) (4,975) --
-------- ------- -------
Net loss.......................................... $(36,471) $(4,440) $(4,970)
======== ======= =======
Preferred return and accretion of redeemable members'
capital................................................... $ -- $(3,930) $(2,842)
======== ======= =======
Loss before extraordinary item applicable to common
equity.................................................... $(36,252) $(3,395) $(7,812)
======== ======= =======
Net loss applicable to common equity........................ $(36,471) $(8,370) $(7,812)
======== ======= =======
Loss per share:
Loss before extraordinary item............................ $ (3.49) $ (0.52) $ (1.50)
Extraordinary loss resulting from early extinguishment of
debt, net of deferred tax benefit...................... (0.02) (0.77) --
-------- ------- -------
Net loss.......................................... $ (3.51) $ (1.29) $ (1.50)
======== ======= =======
Weighted average shares outstanding......................... 10,383 6,473 5,200
======== ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE> 99
COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
TOTAL
STOCKHOLDERS'
ADDITIONAL RETAINED EQUITY AND
PREDECESSOR COMMON PAID-IN EARNINGS PREDECESSOR
CAPITAL STOCK CAPITAL (DEFICIT) CAPITAL
----------- ------ ---------- --------- -------------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1994
(Predecessor)........................ $ (747) $ -- $ -- $ -- $ (747)
Issuance of predecessor interest..... 1,266 -- -- -- 1,266
Issuance costs....................... (753) -- -- -- (753)
Net loss............................. (4,970) -- -- -- (4,970)
Withdrawals.......................... (55) -- -- -- (55)
Imputed capital contribution on
settlement of option.............. 656 -- -- -- 656
Preferred return and accretion of
redeemable predecessor capital.... (2,842) -- -- -- (2,842)
------- ------ -------- -------- --------
Balance at December 31, 1995
(Predecessor)........................ (7,445) -- -- -- (7,445)
Net loss............................. (2,881) -- -- (1,559) (4,440)
Preferred return and accretion of
redeemable predecessor capital.... (2,456) -- -- -- (2,456)
Common stock issued, net............. -- 527 60,052 -- 60,579
Distributions to members............. (4,218) -- 4,218 -- --
Transfer of predecessor capital and
issuance of common stock pursuant
to the Offerings.................. 17,000 520 (23,189) -- (5,669)
------- ------ -------- -------- --------
Balance at December 31, 1996........... -- 1,047 41,081 (1,559) 40,569
Net loss............................. -- -- -- (36,471) (36,471)
Common stock issued, net............. -- 1 74 -- 75
Common stock repurchased and
retired........................... -- (33) (3,730) -- (3,763)
------- ------ -------- -------- --------
Balance at December 31, 1997........... $ -- $1,015 $ 37,425 $(38,030) $ 410
======= ====== ======== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-10
<PAGE> 100
COSTILLA ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
--------- --------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss......................................... $ (36,471) $ (4,440) $ (4,970)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation, depletion and amortization...... 26,409 12,430 5,958
Impairment of oil and gas properties.......... 28,189 -- --
Exploration and abandonments.................. 1,517 491 --
Amortization of deferred charges.............. 262 1,131 137
Deferred income tax expense................... (39) -- --
Allowance for doubtful accounts............... 208 -- --
Other noncash................................. -- 103 (75)
Compensation related to option settlement..... -- -- 656
Gain on sale of oil and gas properties........ (3,261) (1,067) --
Extraordinary loss resulting from early
extinguishment of debt...................... 348 6,017 --
Gain on investment transactions............... (534) -- --
--------- --------- --------
16,628 14,665 1,706
Changes in operating assets and liabilities:
Decrease (increase) in accounts
receivable............................... 1,485 (8,462) (4,818)
Decrease (increase) in other assets......... (3,585) (1,076) (216)
Increase (decrease) in accounts payable..... 10,822 6,067 3,745
Increase (decrease) in other liabilities.... (318) 4,475 2,655
Increase (decrease) in deferred revenue..... -- (3,319) 3,294
--------- --------- --------
Net cash provided by operating
activities............................. 25,032 12,350 6,366
--------- --------- --------
Cash flows from investing activities:
Additions to oil and gas properties.............. (111,580) (67,010) (61,500)
Proceeds from sale of oil and gas properties..... 21,327 6,388 --
Additions to other property and equipment........ (2,344) (3,007) (720)
Advances on notes receivable -- other........... -- (500) --
Advances on affiliate notes receivable........... -- -- (247)
--------- --------- --------
Net cash used in investing activities.... (92,597) (64,129) (62,467)
--------- --------- --------
Cash flows from financing activities:
Borrowings under long-term debt.................. 96,304 228,707 62,704
Payments of long-term debt....................... (33,480) (199,840) (11,232)
Proceeds from issuance of common stock, net...... 75 60,579 --
Purchase of common stock......................... (3,763) -- --
Proceeds from redeemable predecessor capital..... -- -- 10,000
Deferred loan and financing costs................ (574) (8,191) (2,587)
Redemption of member's interest.................. -- (15,506) --
Distributions to members and withdrawals......... -- (4,218) (55)
--------- --------- --------
Net cash provided by financing
activities............................. 58,562 61,531 58,830
--------- --------- --------
Net increase (decrease) in cash and cash
equivalents...................................... (9,003) 9,752 2,729
Cash and cash equivalents, beginning of period..... 12,618 2,866 137
--------- --------- --------
Cash and cash equivalents, end of period........... $ 3,615 $ 12,618 $ 2,866
========= ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-11
<PAGE> 101
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND NATURE OF OPERATIONS
Costilla Energy, Inc. ("Costilla" or the "Company") 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, and its
wholly owned subsidiaries, to acquire the assets of CSL Management Corporation
("CSL") (which owned certain office equipment used by the Company), and to
acquire the stock of Valley Gathering Company ("Valley"). Costilla was formed
for the purpose of conducting a $60 million initial public offering of common
stock and a $100 million senior notes offering (the "Offerings"), which
Offerings were completed in early October 1996.
The Company is an oil and gas exploration and production concern with
properties located principally in South and East Texas, the Rocky Mountains and
the Permian Basin regions of the United States.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
As of December 31, 1997 and 1996, 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, 1996 Costilla had three wholly owned subsidiaries: (i)
Costilla Petroleum Corporation, a Texas corporation ("CPC"), which operated
properties owned by Costilla and owned minor interests in the same properties,
(ii) Statewide Minerals, Inc., a Texas corporation ("Statewide"), which had
engaged in the purchase of small royalty and mineral interests; and (iii)
Valley, which owned several small gas gathering systems, a small gas processing
plant, certain salt water disposal systems and gas compressors. Costilla and CPC
were the sole members of two Texas limited liability companies through which the
Company's Moldovan operations are conducted.
On January 1, 1997 CPC was merged into its parent and Costilla assumed the
business, assets and liabilities of CPC. On March 1, 1997 Valley was merged into
its parent and Costilla assumed the business, assets and liabilities of Valley.
On March 5, 1997 Statewide was dissolved. This dissolution was effected for
administrative purposes subsequent to the sale on December 31, 1996 of
substantially all of the assets of Statewide for net proceeds of approximately
$3.0 million. The remaining unsold producing oil and gas properties were
transferred to Costilla on December 31, 1996.
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
F-12
<PAGE> 102
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
gas purchasers. During the year ended December 31, 1997, the Company had sales
to two customers each which exceeded 10% of total revenues, one for 14.5% and
another for 12.2%. During the year ended December 31, 1996, the Company had
sales to one customer which accounted for 11.2% of total revenues.
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 and Derivative Financial Instruments
The financial instruments that the Company accounts for as hedging
contracts must meet the following criteria: the underlying asset or liability
must expose the Company to price or interest rate risk that is not offset in
another asset or liability, the hedging contract must reduce that price or
interest rate risk, and the instrument must be designated as a hedge at the
inception of the contract and throughout the contract period. In order to
qualify as a hedge, there must be clear correlation between changes in the fair
value of the financial instrument and the fair value of the underlying asset or
liability such that changes in the market value of the financial instrument will
be offset by the effect of price or interest rate changes on the exposed items.
Premiums paid for commodity option contracts and interest rate swap
agreements which qualify as hedges 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. When these
derivative financial instruments cease to qualify as hedges, these instruments
are classified as investments held for trading purposes. Investments held for
trading purposes are marked to market at the end of each reporting period and
the net balance change is recorded as other income (loss) in the consolidated
statement of operations for the applicable period.
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 over their estimated useful lives of the assets, which range from 5
to 7 years.
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 amount received is
treated as a reduction of the cost of the interest retained.
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
F-13
<PAGE> 103
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 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, on a depletable unit
basis, is less than the carrying amount of such 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 as determined based upon
discounted future net cash flows.
Deferred Charges
The Company capitalized certain costs incurred in connection with the
issuance of $100 million of senior notes and with obtaining the Revolving Credit
Facility (see Note 7 for definitions and descriptions of each). These costs are
being amortized over the lives of the related instruments.
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. As of December 31, 1997, the Company had recorded a net gas
imbalance receivable for gas previously produced of approximately $2,341,000,
comprised of approximately 1,496,000 mcf at a net price of $1.56 per mcf.
Stock-based Compensation
The Company accounts for employee stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"). Accordingly, the Company
has only adopted the disclosure provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). See
Note 12 for the pro forma disclosures of compensation expense determined under
the fair-value provisions of SFAS 123.
Income Taxes
The Company accounts for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS 109"). Under the asset and liability method of SFAS 109, deferred
tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. Under SFAS 109, the effect on deferred tax assets and
liabilities of a change in tax rate is recognized in income in the period that
includes the enactment date.
F-14
<PAGE> 104
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Earnings Per Share
In February, 1997 the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128")
which simplifies the existing standards for computing earnings per share ("EPS")
and makes them comparable to international standards. In accordance with the
provisions of FAS 128, the Company adopted FAS 128 in its year ended December
31, 1997 financial statements, although no restatement of prior period EPS
information has been necessary. Under FAS 128, primary EPS is replaced by
"basic" EPS, which excludes dilution and is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. "Diluted" EPS, which is computed similarly to
fully-diluted EPS, reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted in the issuance of common stock that then shared
in the earnings of the entity. For the years ended December 31, 1997, 1996 and
1995, the computation of diluted net loss per share was antidilutive; therefore,
the amounts reported for basic and diluted net loss per share were the same.
Basic and diluted net income (loss) per share is reduced by the preferred
return, accretion and redemption premium on redeemable members' capital for the
years ended December 31, 1996 and 1995. For the periods prior to the Offerings,
the weighted average shares outstanding attributable to predecessor capital are
the 5,200,000 shares issued to the predecessor members upon conversion of the
LLC.
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. Such
liabilities are generally recorded at their undiscounted amounts unless the
amount and timing of payments is fixed or reliably determinable.
Reclassifications
Certain reclassifications have been made to the 1995 financial statements
to conform to the 1996 and 1997 presentation.
(3) ACQUISITION OF OIL AND GAS PROPERTIES
On August 28, 1997, the Company consummated the purchase from Ballard
Petroleum LLC ("Ballard") of certain oil and gas properties for an adjusted
purchase price of approximately $41.2 million (the "Ballard Acquisition"). The
properties are located primarily in the Rocky Mountain region of the United
States. 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 acquisition closing date, August 28, 1997. In
addition, the Company and Ballard have entered into an Acquisition and
Exploration Agreement that establishes an area of mutual interest in the Rocky
Mountain region in which the parties will jointly own, acquire, explore and
develop oil and gas properties.
On June 14, 1996, the Company consummated the purchase from Parker and
Parsley Petroleum Company of certain oil and gas properties for an adjusted
purchase price of approximately $38.7 million (the "1996 Acquisition"). 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 acquisition closing date, June 14, 1996. The Company
F-15
<PAGE> 105
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
subsequently sold for approximately $3.3 million its wholly-owned subsidiary,
Costilla Pipeline Corporation, which owned the Three Rivers Pipeline purchased
in the 1996 Acquisition. Certain other acquired properties, which were located
outside the Company's areas of strategic focus, were sold in 1996. No gain or
loss was recorded on these sales.
In June 1995 the Company acquired a group of oil and gas properties from
Parker and Parsley Petroleum Company for an adjusted purchase price of
approximately $46.6 million (the "1995 Acquisition"). The properties are located
in the Permian Basin, Gulf Coast and Rocky Mountain regions. 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 acquisition date of June 12, 1995. Certain other acquired properties,
which were located outside 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 1996 Acquisition , net of the related properties sold, and the Ballard
Acquisition had occurred on January 1, 1996. The pro forma amounts are not
necessarily indicative of the results that may be reported in the future.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-------------------
1997 1996
-------- -------
(IN THOUSANDS)
<S> <C> <C>
Revenues.................................................... $ 82,189 $75,563
Net income (loss) before extraordinary item................. (39,029) 1,007
Net income (loss) per share before extraordinary item....... (3.76) 0.10
</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, were required to adopt FAS 121 for fiscal years beginning after
December 15, 1995.
In order to determine whether an impairment had occurred at December 31,
1997, the Company estimated the expected future cash flows of its oil and gas
properties on a depletable unit basis and compared such future cash flows to the
carrying amount of the related oil and gas properties to determine if the
carrying amount was recoverable. If the costs of a depletable unit did not
appear to be recoverable, impairment on the depletable unit was recorded equal
to the difference between the estimated present value and the costs. These
estimates of net undiscounted cash flow and estimated present values for the
Company's total oil and gas reserves were based upon the non-escalated prices
used in the Company's December 31, 1997 reserve report. Based on this process, a
noncash pre-tax writedown of $28,189,000 in the carrying amount of the Company's
proved properties was recorded at December 31, 1997. No writedown in the
carrying amount of the Company's proved properties was recorded at December 31,
1996.
(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 only deals
with reputable
F-16
<PAGE> 106
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
financial institutions as counterparties and anticipates 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, the options will expire unexercised,
therefore, reducing the effective price received for oil and gas sales by the
cost of the related option. If market prices of oil and gas exceed the strike
price of call options, the Company is obligated to pay the contracting
counterparty an amount equal to the contracted volumes times the difference
between the market price and the strike price, therefore, reducing the effective
price received for oil and gas sales by the amount paid to the counterparty.
The net effect of the Company's commodity hedging activities reduced oil
and gas revenues by $1,226,000, $1,705,000, and $80,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
The following table sets forth the future volumes hedged by year and the
weighted-average strike price of the option contracts at December 31, 1997:
<TABLE>
<CAPTION>
OIL GAS
DAILY VOLUME DAILY VOLUME STRIKE PRICE
(BBLS) (MMBTU) TERM PER BBL/MMBTU
------------ ------------ ---- -------------
<S> <C> <C> <C> <C>
Oil:
1998................ 6,500 -- Jan. 98 - Aug. 98 $18.50 - $22.55(a)
Gas:
1998................ -- 5,000 Jan. 98 - Oct. 98 $2.00(b)
</TABLE>
- ---------------
(a) Represents the strike prices of a collar established with the purchase of a
put option contract and the sale of a call option contract.
(b) Represents the strike price on a purchased put option contract.
In March 1998 the Company purchased put options on 40,000 Mmbtu of gas per
day, establishing a floor price of $2.15 per Mmbtu, and sold call options on
40,000 Mmbtu of gas per day, establishing a ceiling price at $2.55 per Mmbtu,
for the period April 1998 through October 1998.
Interest Rate Swap Agreements. Prior to the Offerings, the Company utilized
two interest rate swap agreements to reduce the potential impact of increases in
interest rates on floating-rate long-term debt. Concurrent with the issuance of
the $100 million of 10.25% fixed-rate senior notes in early October 1996, the
two interest rate swap agreements ceased to be hedges. These interest rate swap
agreements were marked-to-market and the related liability recorded. The
liability for the two interest rate swap agreements was $1,712,000 at December
31, 1996. A $60 million interest rate swap agreement expired in May 1997. As a
result of the Company's borrowings against its line of credit, which bears
interest on a floating rate basis, the remaining $24 million interest rate swap
agreement again fully qualified as a hedge in August 1997. At each borrowing
date from October 1996 to August 1997, a portion of the interest rate swap
agreement was marked-to-market with the resulting gains or losses recorded as
investment income or loss while the hedge portion was being amortized over the
remaining life of the agreement. As a result of expiration and marking the
agreements to market, the Company recorded a net investment gain of
approximately $510,000 during the year ended December 31, 1997. Concurrent with
the payment of all of the Company's floating rate debt from proceeds of the 1998
Notes (as defined and discussed in Note 7), the interest rate swap agreement
ceased to qualify as a hedge. As a result of marking-to-market the interest rate
swap agreement at that time, the Company recorded an additional liability of
approximately $23,000. The interest rate swap agreement in place as of December
31, 1997 has a notional amount of $24 million with a fixed rate of 7.5% and will
expire in January, 1999.
F-17
<PAGE> 107
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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, 1997 and 1996. 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>
1997 1996
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Financial Assets:
Cash, cash equivalents and restricted
cash.................................. $ 3,615 $ 3,615 $ 12,618 $ 12,618
Receivables (trade)...................... 5,241 5,241 6,675 6,675
Receivables (oil and gas sales).......... 9,312 9,312 9,031 9,031
Commodity option contracts............... 190 1,488 592 (2,172)
Gas imbalances receivable................ 2,341 3,087 -- --
Notes receivable -- affiliate............ 476 476 684 542
Notes receivable -- other................ 250 250 500 500
Financial liabilities:
Payables (trade)......................... 22,490 22,490 12,718 12,718
Long-term debt........................... 163,087 167,587 100,262 105,512
Interest rate swap and option
agreements............................ 521 493 1,712 1,712
</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, notes receivable-other and trade payables:
The carrying amounts approximate fair value because of the short maturity
of those instruments.
Commodity option contracts: The carrying amount comprises the
unamortized premiums paid for the option contracts. The fair value is
estimated using option pricing models and essentially values the potential
for the option contracts to become in-the-money through changes in
commodity prices during the remaining terms.
Gas imbalances receivable: The carrying amount reflects the net
quantity of gas imbalances receivable based upon current prices at December
31, 1997.
Notes receivable -- affiliate: The amounts reported relate to notes
receivable from an affiliated company. The carrying amount reflects an
estimate of net present value using an assumed annual interest rate of 9%
based upon the anticipated note payment schedule.
Long-term debt: The fair value of the Company's long-term debt is
based upon the quoted market price for the senior notes at December 31,
1997 and 1996 and the carrying amounts outstanding under the two credit
facilities at December 31, 1997 (see Note 7 for a complete discussion of
long-term debt).
Interest rate swap agreements: At December 31, 1997, the Company had
an interest rate swap agreement outstanding with a notional amount of $24
million. This agreement is more fully described in Note 5. The carrying
amount is equal to the sum of the unamortized premiums paid for the
agreement and the fair value. The fair values of each of the open interest
rate swap agreements was obtained from
F-18
<PAGE> 108
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bank quotes and represent the estimated amount the Company would pay upon
termination of the agreements at December 31, 1997 and 1996, taking into
consideration interest rates at that date.
(7) LONG-TERM DEBT
Long-term debt consists of the following (thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
10.25% Senior Notes due 2006................................ $100,000 $100,000
Revolving Credit Facility................................... 33,000 100
Acquisition Credit Facility................................. 30,000 --
Other notes payable......................................... 185 260
-------- --------
163,185 100,360
Less current maturities................................... 98 98
-------- --------
$163,087 $100,262
======== ========
</TABLE>
In August 1997, the Company entered into a credit agreement (the "Revolving
Credit Facility") with Bankers Trust Company, as agent, to refinance its
existing bank indebtedness and to finance a portion of the Ballard Acquisition
purchase price. The Revolving Credit Facility provides for a maximum
availability of $75.0 million, $33.0 million of which was borrowed at December
31, 1997 against an available borrowing base of $36.5 million at such date.
Borrowings under the Revolving Credit Facility bear interest, at the Company's
option, at a floating rate which is at or above the Lender's prime rate or above
the applicable Eurodollar rate, depending on the percentage of committed funds
which have been borrowed. Interest is payable quarterly as to base rate loans,
and at the end of the applicable interest period as to Eurodollar loans. The
borrowing base of the Revolving Credit Facility is automatically reduced by 5%
each quarter beginning in August 1999, and payments of principal are required in
each quarter in which the outstanding principal balance is greater than the
reduced borrowing base. The remaining balance is payable on August 28, 2002, the
maturity date of the Revolving Credit Facility. Under the Revolving Credit
Facility, the Company is obligated to pay certain fees to the lender, including
a commitment fee based on the unused portion of the commitment. The Revolving
Credit Facility contains customary restrictive covenants (including restrictions
on the payment of dividends and the incurrence of additional indebtedness) and
requires the Company to maintain (i) a current ratio of not less than 1.0 to
1.0, including amounts available under the Revolving Credit Facility and
excluding current maturities under the Revolving Credit Facility and the
Acquisition Credit Facility, (ii) a ratio of EBITDA to interest expense of not
less than 2.50 to 1 and (iii) a minimum tangible net worth. Borrowings under the
Revolving Credit Facility are secured by substantially all of the assets of the
Company.
In August 1997, the Company also entered into a second credit agreement
(the "Acquisition Credit Facility") with Bankers Trust Company, as agent, to
provide funds for a substantial portion of the Ballard Acquisition purchase
price. The Acquisition Credit Facility is a term loan in the amount of $30.0
million and is subject to a borrowing base to be determined at least
semi-annually. Borrowings under the Acquisition Credit Facility bear interest,
at the Company's option, at a floating rate which is above the Lender's prime
rate or the applicable Eurodollar rate. Interest is payable quarterly as to base
rate loans, and at the end of the applicable interest period as to Eurodollar
loans. Principal payments commence in February 1998, and are $1.7 million
quarterly for the first year and $1.4 million each quarter thereafter for two
years, with all remaining amounts due at maturity, February 28, 2001. Borrowings
under the Acquisition Credit Facility are secured by the assets acquired in the
Ballard Acquisition.
In October 1996, the Company issued $100 million aggregate principal amount
of 10.25% Senior Notes due October 1, 2006 (the "Notes"). The Notes were sold at
par and interest is payable April 1 and October 1,
F-19
<PAGE> 109
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
commencing April 1, 1997. The Notes may not be redeemed prior to October 1,
2001, and thereafter at a premium reducing to par, plus interest, by maturity.
There is no mandatory redemption of the Notes required prior to maturity. The
Notes are general unsecured senior obligations of the Company and rank equally
in right of payment with all other senior indebtedness of the Company and senior
in right of payment of all existing future subordinated indebtedness of the
Company. The Notes are subject to an Indenture between the Company and a
trustee. The Indenture restricts, 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 assets 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. Net proceeds from the sale of the
Notes of approximately $96.1 million were used to repay existing indebtedness.
In October 1996, the Company entered into a credit agreement (the "1996
Credit Facility") with NationsBank of Texas, N.A The 1996 Credit Facility
provided 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 provided a maximum availability of $50.0
million (which amount was also the initial borrowing base), $100,000 of which
was outstanding at December 31, 1996. Availability under the borrowing base was
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 lender. Borrowings under the 1996 Credit Facility bore interest, at the
Company's option, at a floating rate which was at or above the NationsBank, N.A.
prime rate or the LIBOR rate, depending on the percentage of committed funds
which were borrowed. Interest was payable quarterly and principal was to be
amortized in twelve equal installments commencing two years from the date of the
credit agreement. Under the 1996 Credit Facility, the Company was obligated to
pay certain fees to the lender, including a commitment fee which ranged from
0.30% to 0.40% based on the unused portion of the commitment. The 1996 Credit
Facility contained customary restrictive covenants (including restrictions on
the payment of dividends and the incurrence of additional indebtedness) and
required 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. Borrowings under the 1996 Credit Facility were
secured by substantially all of the assets of the Company and any subsidiary of
the Company that guaranteed the Company's obligations under the 1996 Credit
Facility. None of the Company's subsidiaries guaranteed the Company's
obligations under the 1996 Credit Facility.
In June 1996, the Company entered into a loan agreement with NationsBridge,
L.L.C. to provide financing of up to $125 million ("Bridge Loan"). The proceeds
of this Bridge Loan were used to finance the 1996 Acquisition, to refinance the
1995 Credit Facility and for other general corporate purposes. The Company
capitalized certain costs incurred in obtaining the Bridge Loan and amortized
these costs over the estimated life of the Bridge Loan. Concurrent with the
Offerings, the $2,665,000 remaining unamortized balance of these deferred
charges were expensed as an extraordinary item.
In June 1995, the Company entered into a Credit Agreement ("1995 Credit
Facility") with a syndicate of banks to provide financing for an aggregate $185
million senior secured revolving line of credit ("Revolver Notes") and an
aggregate $15 million in senior secured term notes ("Term Notes"). In June 1996,
these notes in a total amount of $71,494,000 were paid off with a portion of the
proceeds of the Bridge Loan. The Company capitalized certain costs incurred in
obtaining the 1995 Credit Facility and amortized these costs over the lives of
the notes. Concurrent with the Bridge Loan, the $1,640,000 remaining unamortized
balance of these deferred charges were expensed as an extraordinary item.
In January 1998, the Company issued an additional $80 million aggregate
principal amount of 10.25% Senior Notes due October 1, 2006 (the "1998 Notes").
The notes were sold at a premium (102.5%) and interest is payable April 1 and
October 1, commencing April 1, 1998. The 1998 Notes may not be redeemed prior to
October 1, 2001, and thereafter at a premium reducing to par, plus interest, by
maturity. The 1998
F-20
<PAGE> 110
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Notes are subject to the same terms and conditions as the Notes. Net proceeds
from the sale of the 1998 Notes of approximately $78.8 million were used to
repay the Acquisition Credit Facility in full, all but $500,000 of the Revolving
Credit Facility and the remainder was used for general corporate working capital
needs.
In light of the issuance of the 1998 Notes and the concurrent repayment of
the Acquisition Credit Facility , there are no current maturities of long-term
debt. Therefore, all amounts owed under the Revolving Credit Facility and
Acquisition Facility as of December 31, 1997 have been classified as long-term
obligations.
The Company paid interest on long-term debt of $12,198,937, $8,838,971 and
$4,453,684 in 1997, 1996 and 1995, respectively.
(8) INCOME TAXES
Concurrent with the Offerings, the Company became a tax paying entity for
U.S. Federal income tax purposes. At that date, the tax basis of the Company's
assets and liabilities exceeded the book basis by approximately $3,500,000,
resulting in a deferred tax asset of approximately $1,200,000. A valuation
allowance was provided for 100% of this deferred tax asset.
Income tax provision (benefit) and amounts separately allocated were as
follows (thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
----------------
1997 1996
----- -------
<S> <C> <C>
Income (loss) before extraordinary item..................... $ 152 $ 1,218
Extraordinary loss resulting from early extinguishment of
debt...................................................... (129) (1,042)
----- -------
$ 23 $ 176
===== =======
</TABLE>
In 1997, the Company's effective tax rate differs from the U.S. Federal
statutory rate primarily because of a valuation allowance established for net
operating loss carryforwards, as discussed below. The Company's effective tax
rate does not differ materially from the U.S. Federal statutory rate in 1996.
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and deferred tax liabilities were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
Deferred tax assets (liabilities):
Net operating loss carryforwards.......................... $ 15,331 $ 2,805
Interest rate swap agreements............................. 116 599
Oil and gas properties, principally due to differences in
depletion, impairment and the deduction of intangible
drilling costs for tax purposes........................ 1,253 (1,692)
Other..................................................... 1,365 --
-------- -------
Net deferred tax asset...................................... 18,065 1,712
Valuation allowance of net deferred tax asset............... (18,065) (1,712)
-------- -------
Net deferred tax asset, net of valuation allowance.......... $ -- $ --
======== =======
</TABLE>
A valuation allowance is provided for when it is more likely than not that
some portion of the deferred tax assets will not be realized. Due to
uncertainties arising from a lack of earnings history and based on management's
intentions to continue an aggressive drilling program (generating intangible
drilling costs which
F-21
<PAGE> 111
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
are projected to create future losses for tax purposes), it does not appear more
likely than not that the Company will be able to utilize all the available
carryforwards prior to their ultimate expiration.
At December 31, 1997, the Company had net operating loss carryforwards of
approximately $43.8 million, which are available to offset future regular
taxable income, if any. The carryforwards expire December 31, 2011 and 2012.
(9) COMMITMENTS AND CONTINGENCIES
Leases
The Company leases equipment and office facilities under operating leases
on which rental expense for the years ended December 31, 1997, 1996 and 1995 was
$376,978, $416,442 and $311,221, respectively. Future minimum lease commitments
under noncancellable operating leases at December 31, 1997 are as follows
(thousands):
<TABLE>
<S> <C>
1998........................................................ $ 394,372
1999........................................................ 376,699
2000........................................................ 327,517
2001........................................................ 352,302
2002........................................................ 343,924
Thereafter.................................................. 1,023,048
</TABLE>
Employment Agreements
In 1996, the Company entered into employment agreements with four of its
executive officers. The employment agreements are each for three years and each
will automatically renew for successive one-year periods thereafter unless the
employee is notified to the contrary. These employment agreements provide for
base annual salary levels totaling $1,035,000 for 1998.
Each employee would receive his salary for the remaining term of the
applicable employment agreement if the Company were to terminate such person's
employment other than for cause. If such person were to voluntarily leave his
employment with the Company prior to the second anniversary of the employment
agreement no further payments would be required. With the exception of one of
the Company's executive officers, if a voluntary termination were to occur after
the second anniversary of the employee agreement, such person would be entitled
to one year's salary from the date of termination. With the exception of one of
the Company's executive officers, the employee agreements provide 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 employee agreement.
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 paid Redeco $90,000 and agreed to bear the first $2.0 million of
Concession expenses in return for a 50.0% interest in Redeco. Upon reaching the
$2.0 million in 1996, Redeco elected, according to the agreement, to pay the
Company for half of all amounts expended in excess of $750,000 plus interest.
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. The Company has no material fixed financial
commitments with respect to the Concession. As of December 31, 1997, the
Company's share of costs expended was $3,681,137.
F-22
<PAGE> 112
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Letters of Credit
As a result of certain bonding and hedging counterparty requirements, the
Company has caused irrevocable letters of credit to be issued by a bank totaling
$996,000. As of December 31, 1997, no amounts had been drawn on these letters of
credit.
(10) 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
$122,336, $58,713, and $22,531 in 1997, 1996 and 1995, respectively.
(11) REDEEMABLE PREDECESSOR CAPITAL AND PREDECESSOR 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 predecessor capital and $8,734,000 was attributed
to redeemable predecessor capital. Preferred return and accretion of predecessor
capital included in the consolidated statements of operations and the
consolidated statements of stockholders' equity includes accretion of the amount
attributable to redeemable predecessor capital to $10,000,000 over a two year
period beginning February 17, 1995. As described below, the redemption amount
was ultimately to 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.
Concurrent with the Offerings, NBCC's membership interest was redeemed for
a total of $15,506,614 and 936,000 common shares were issued to NBCC. After
accounting for the Underwriter's exercise of its over-allotment option in
November 1996, NBCC owns 8.94% of the 10,475,000 common shares outstanding at
December 31, 1996. The following table details the redemption price paid to
NBCC:
<TABLE>
<S> <C>
NBCC Preferred Capital Contribution......................... $10,000,000
Preferred Return............................................ 2,732,376
-----------
Adjusted NBCC Preferred Capital Contribution................ 12,732,376
PLUS: 10% Redemption Premium................................ 1,273,238
PLUS: Aggregate Redemption Price of NBCC's Redeemable
Unrestricted Common Units................................. 1,500,000
-----------
Total Redemption Price Paid NBCC............................ $15,505,614
===========
</TABLE>
Redeemable predecessor capital was subject to a preferential return of 15%
per annum and was 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, Inc.
(the "Regulations"). The 15% preferred return was treated as a reduction of
predecessor capital.
In addition, a portion of NBCC's interest not subject to preferential
return was classified as redeemable predecessor capital as the Company could
have been be required to repurchase such interest upon the occurrence of certain
events similar to those events requiring redemption of the redeemable
predecessor
F-23
<PAGE> 113
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
capital described above and, in any event, on or after February 17, 2000. Such
interest could have, at the Company's option, been 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 have paid in either instance would be determined by the year in
which the predecessor capital was repurchased, up to an aggregate of $5,500,000.
Prior to the Offerings in October 1996, the ultimate redemption price of
$5,500,000 was being accrued ratably over the period from February 17, 1995
through February 17, 2000 and was treated as a reduction of predecessor capital.
(12) STOCK-BASED COMPENSATION
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 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 the 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.
The plan was amended during 1997 to provide that a total of 100,000 shares
be authorized and reserved for issuance under this plan and that each person
qualifying as an outside director shall receive an option for 5,000 shares each
year that such person is elected as a director of the Company. During the year
ended December 31, 1997, options on 15,000 shares were granted under this plan,
leaving 85,000 options available for future grant under the plan as of December
31, 1997. The options granted during 1997 have a term of ten (10) years and an
exercise price of $12.50 per share, a price equal to the market price on the
date of grant. The weighted average fair value, as calculated under the
provisions of FAS 123, of the options granted in 1997 was $8.56 per share.
Bonus Incentive Plan
The Bonus Incentive 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 150,000 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 the Common Stock during
that year, are eligible to participate in the plan. Bonus awards will be
determined based upon 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.
The plan was amended during 1997 to provide that the plan be administered
by the Compensation Committee of the Board of Directors, that awards of
incentive compensation under this plan be made within 120 days after the
expiration of each fiscal year and the removal of the exclusion of ten percent
or more
F-24
<PAGE> 114
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
shareholders as eligible participants in the plan. During the year ended
December 31, 1997, 4,500 shares were issued under this plan at the current
market price of $13.38 per share.
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 adjustments 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 the 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 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 transferable
other than by will, the laws of descent and distribution or pursuant to a
qualified domestic relations order. 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 in 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. The Board
of Directors may amend without stockholder approval, in any respect other than
any amendment that requires stockholder approval by law, and may modify any
outstanding option, including the repricing of non-qualifying options, with the
consent of the option holder. There are currently approximately 135 employees
who are eligible to participate in the plan.
The plan was amended during 1997 to provide that the plan be administered
by the Compensation Committee of the Board of Directors and that a total of
1,250,000 shares be authorized and reserved for issuance under this plan.
No options were issued under this plan during 1997. During 1996, the
Company granted 711,750 stock options pursuant to the 1996 Stock Option Plan,of
which 1,500 shares were exercised in 1997. There were 547,750 options available
for future grant under the plan as of December 31, 1997. The options granted
during 1996 have a term of ten (10) years and an exercise price of $12.50 per
share, a price equal to the market price on the date of the grant. The weighted
average fair value, as calculated under the provision of SFAS 123, of the
options granted in 1996 was $6.73 per share.
The Company applies APB 25 and related Interpretations in accounting for
its stock option awards. Accordingly, no compensation expense has been
recognized for its stock option awards. If compensation expense for the stock
option awards had been determined consistent with SFAS 123, the Company's net
loss and net loss per share, for the year ended December 31, 1997 and 1996 would
have been adjusted to the following pro forma amounts:
<TABLE>
<CAPTION>
1997 1996
------------ -----------
<S> <C> <C>
Net loss................................................ $(37,740,000) $(6,285,276)
Net loss per share...................................... (3.63) (1.58)
</TABLE>
F-25
<PAGE> 115
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under SFAS 123, the fair value of each stock option grant is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions used for grants in 1997 and 1996:
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Risk-free interest rate..................................... 6.25% 6.25%
Expected life............................................... 5 years 5 years
Expected volatility......................................... 80% 54%
Expected dividend yield..................................... 0% 0%
</TABLE>
(13) RELATED PARTY TRANSACTIONS
Certain members and officers of the Company have owned interests in and
held positions with A&P Meter Service and Supply, Inc. ("A&P"), CSL, 511 Tex
L.C. ("511 Tex"), and 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. 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 amount of $294,000, including accrued interest and is dated May
22, 1996. The note is unsecured and is payable upon demand. During 1997, the
Company created an allowance of $208,000 related to these notes to reflect the
estimated present value of anticipated future payments on these notes. During
1997, 1996 and 1995, the Company paid $561,343, $520,519 and $612,139,
respectively, to A&P for goods and services provided.
During 1996 and 1995, the Company paid $517,352 and $592,920, respectively,
to CSL for management fees and lease payments on equipment.
During 1996 and 1995, the Company paid $50,742 and $67,896, respectively,
to 511 Tex for office rent.
During 1996 and 1995 the Company paid $484,000 and $440,884, respectively,
to Valley for gas compression and salt water disposal charges. During 1996 and
1995, Valley paid the Company $383,139 and $109,399, respectively, for operating
costs of its salt water disposal wells and gas compressors.
During 1996 and 1995 the LLC paid $75,000 each year to NationsBank Capital
Corp. for management fees. No management fees are due to NationsBank Capital
Corp. for any period subsequent to the Offerings.
(14) 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,
------------------------------
1997 1996 1995
-------- ------- -------
(THOUSANDS)
<S> <C> <C> <C>
Property acquisition costs:
Proved.............................................. $ 25,731 $39,505 $52,470
Unproved............................................ 32,415 721 1,742
Exploration........................................... 16,194 6,760 5,627
Development........................................... 43,942 17,723 158
-------- ------- -------
$118,282 $64,709 $59,997
======== ======= =======
</TABLE>
F-26
<PAGE> 116
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) 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, 1997 and
1995 and by Williamson Petroleum Consultants as of December 31, 1996. Williamson
Petroleum Consultants performed a review of approximately 72% of the Company's
estimated United States reserves as of December 31, 1997 (on a PV-10 basis). The
Moldova reserve estimates were prepared by W. Scott Epley, P.E. as of December
31, 1997. 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
United States reserve estimates utilizing an oil price of $15.29 per Bbl and a
gas price of $2.20 per Mcf as of December 31, 1997 and an oil price of $24.17
per Bbl and a gas price of $3.96 per Mcf as of December 31, 1996. The Company
has presented the Moldovan reserve estimates utilizing an oil price of $16.00
per Bbl and a gas price of $2.08 per Mcf as of December 31, 1997.
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.
F-27
<PAGE> 117
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
UNITED STATES MOLDOVA TOTAL
-------------------- -------------------- --------------------
OIL AND NATURAL OIL AND NATURAL OIL AND NATURAL
CONDENSATE GAS CONDENSATE GAS CONDENSATE GAS
(MBbls) (Mmcf) (MBbls) (MMcf) (MBbls) (MMcf)
---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Total Proved Reserves:
Balance, January 1, 1995........ 4,009 27,512 -- -- 4,009 27,512
Revisions of previous
estimates.................. (570) 425 -- -- (570) 425
Extensions and discoveries.... 605 8,922 -- -- 605 8,922
Production.................... (950) (4,806) -- -- (950) (4,806)
Purchases of
minerals-in-place.......... 7,694 46,099 -- -- 7,694 46,099
------ ------- ------ ------- ------ -------
Balance, December 31, 1995...... 10,788 78,152 -- -- 10,788 78,152
Revisions of previous
estimates.................. 1,782 5,440 -- -- 1,782 5,440
Extensions and discoveries.... 1,169 13,581 -- -- 1,169 13,581
Production.................... (1,726) (9,205) -- -- (1,726) (9,205)
Sales of minerals-in-place.... (119) (482) -- -- (119) (482)
Purchases of
minerals-in-place.......... 5,106 32,786 -- -- 5,106 32,786
------ ------- ------ ------- ------ -------
Balance, December 31, 1996...... 17,000 120,272 -- -- 17,000 120,272
Revisions of previous
estimates.................. (3,651) 3,064 -- -- (3,651) 3,064
Extensions and discoveries.... 2,465 58,888 395 1,318 2,860 60,206
Production.................... (2,175) (14,698) -- -- (2,175) (14,698)
Sales of minerals-in-place.... (2,065) (27,743) -- -- (2,065) (27,743)
Purchases of
minerals-in-place.......... 2,983 7,536 -- -- 2,983 7,536
------ ------- ------ ------- ------ -------
Balance, December 31, 1997...... 14,557 147,319 395 1,318 14,952 148,637
====== ======= ====== ======= ====== =======
Proved Developed Reserves:
January 1, 1995............... 2,632 16,340 -- -- 2,632 16,340
December 31, 1995............. 8,566 57,393 -- -- 8,566 57,393
December 31, 1996............. 14,018 90,023 -- -- 14,018 90,023
December 31, 1997............. 10,646 84,558 -- 359 10,646 84,917
</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 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
F-28
<PAGE> 118
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
associated with future production. Because of these and other considerations,
any estimate of fair value is necessarily subjective and imprecise.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
--------- --------- ---------
(THOUSANDS)
<S> <C> <C> <C>
UNITED STATES
Future cash flows................................. $ 547,584 $ 887,100 $ 350,653
Future costs:
Production...................................... (205,454) (323,288) (145,510)
Development..................................... (41,291) (25,469) (16,806)
--------- --------- ---------
Future net cash flows before income taxes......... 300,839 538,343 188,337
Future income taxes............................... 31,249 144,836 --
--------- --------- ---------
Future net cash flows............................. 269,590 393,507 188,337
10% annual discount for estimated timing of cash
flows........................................... (95,704) (165,273) (75,041)
--------- --------- ---------
Standardized measure of discounted net cash
flows........................................... $ 173,886 $ 228,234 $ 113,296
========= ========= =========
MOLDOVA
Future cash flows................................. $ 9,063 $ -- $ --
Future costs:
Production...................................... (1,943) -- --
Development..................................... (2,572) -- --
--------- --------- ---------
Future net cash flows before income taxes......... 4,548 -- --
Future income taxes............................... 951 -- --
--------- --------- ---------
Future net cash flows............................. 3,597 -- --
10% annual discount for estimated timing of cash
flows........................................... (1,560) -- --
--------- --------- ---------
Standardized measure of discounted net cash
flows........................................... $ 2,037 $ -- $ --
========= ========= =========
TOTALS
Future cash flows................................. $ 556,647 $ 887,100 $ 350,653
Future costs:
Production...................................... (207,397) (323,288) (145,510)
Development..................................... (43,863) (25,469) (16,806)
--------- --------- ---------
Future net cash flows before income taxes......... 305,387 538,343 188,337
Future income taxes............................... 32,200 144,836 --
--------- --------- ---------
Future net cash flows............................. 273,187 393,507 188,337
10% annual discount for estimated timing of cash
flows........................................... (97,264) (165,273) (75,041)
--------- --------- ---------
Standardized measure of discounted net cash
flows........................................... $ 175,923 $ 228,234 $ 113,296
========= ========= =========
</TABLE>
F-29
<PAGE> 119
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Changes in Standardized Measure of Discounted Future Net Cash Flows From
Proved Reserves
(In Thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- -------- --------
(THOUSANDS)
<S> <C> <C> <C>
UNITED STATES
Increase (decrease):
Purchase of minerals -- in place.................. $ 22,753 $ 49,966 $ 77,343
Extensions and discoveries and improved recovery,
net of future production and development
costs.......................................... 69,140 25,910 9,799
Accretion of discount............................. 31,180 11,330 3,678
Net change in sales prices net of production
costs.......................................... (170,943) 108,160 (3,422)
Changes in estimated future development costs..... 2,515 4,187 (2,419)
Revisions of quantity estimates................... (17,890) 29,485 (2,855)
Net change in income taxes........................ 63,408 (83,570) --
Sales, net of production costs.................... (42,271) (32,146) (11,338)
Sales of minerals in place........................ (29,975) (1,330) --
Changes of production rates (timing) and other.... 17,735 2,946 5,731
--------- -------- --------
Net increase (decrease)...................... (54,348) 114,938 76,517
Standardized measure of discounted future net cash
flows:
Beginning of period.......................... 228,234 113,296 36,779
--------- -------- --------
End of period................................ $ 173,886 $228,234 $113,296
========= ======== ========
MOLDOVA
Increase (decrease):
Purchase of minerals-in place..................... $ -- $ -- $ --
Extensions and discoveries and improved recovery,
net of future production and development
costs.......................................... 2,576 -- --
Accretion of discount............................. -- -- --
Net change in sales prices net of production
costs.......................................... -- -- --
Changes in estimated future development costs..... -- -- --
Revisions of quantity estimates................... -- -- --
Net change in income taxes........................ (539) -- --
Sales, net of production costs.................... -- -- --
Sales of minerals in place........................ -- -- --
Changes of production rates (timing) and other.... -- -- --
--------- -------- --------
Net increase (decrease)...................... 2,037 -- --
Standardized measure of discounted future net cash
flows:
Beginning of period.......................... -- -- --
--------- -------- --------
End of period................................ $ 2,037 $ -- $ --
========= ======== ========
</TABLE>
F-30
<PAGE> 120
COSTILLA ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- -------- --------
(THOUSANDS)
<S> <C> <C> <C>
TOTALS
Increase (decrease):
Purchase of minerals-in place..................... $ 22,753 $ 49,966 $ 77,343
Extensions and discoveries and improved recovery,
net of future production and development
costs.......................................... 71,716 25,910 9,799
Accretion of discount............................. 31,180 11,330 3,678
Net change in sales prices net of production
costs.......................................... (170,943) 108,160 (3,422)
Changes in estimated future development costs..... 2,515 4,187 (2,419)
Revisions of quantity estimates................... (17,890) 29,485 (2,855)
Net change in income taxes........................ 62,869 (83,570) --
Sales, net of production costs.................... (42,271) (32,146) (11,338)
Sales of minerals in place........................ (29,975) (1,330) --
Changes of production rates (timing) and other.... 17,735 2,946 5,731
--------- -------- --------
Net increase (decrease)...................... (52,311) 114,938 76,517
Standardized measure of discounted future net cash
flows:
Beginning of period.......................... 228,234 113,296 36,779
--------- -------- --------
End of period................................ $ 175,923 $228,234 $113,296
========= ======== ========
</TABLE>
The 1997 future cash flows shown above include amounts attributable to
proved undeveloped reserves requiring approximately $42.5 million of future
development costs. If these reserves are not developed, the standardized measure
of discounted future net cash flows for 1997 shown above would be reduced by
approximately $42.3 million.
F-31
<PAGE> 121
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Costilla Energy, Inc.:
We have audited the accompanying statement of revenues and direct operating
expenses of the Ballard Acquisition (see Note 1) for the year ended December 31,
1996. The statement is the responsibility of the Company's management. Our
responsibility is to express an opinion on the statement 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 statement of revenues and direct
operating expenses is 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 audit
provides a reasonable basis for our opinion.
The accompanying statement of revenues and direct operating expenses was
prepared for the purpose of complying with the rules and regulations of the
Securities and Exchange Commission (for inclusion in Form S-4 of Costilla
Energy, Inc. as described in Note 1) and is not intended to be a complete
presentation of the Ballard Acquisition interests' revenues and expenses.
In our opinion, the statement of revenues and direct operating expenses
referred to above presents fairly, in all material respects, the revenues and
direct operating expenses of the Ballard Acquisition for the year ended December
31, 1996, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas
November 7, 1997
F-32
<PAGE> 122
COSTILLA ENERGY, INC.
BALLARD ACQUISITION
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
(IN THOUSANDS)
<TABLE>
<CAPTION>
(UNAUDITED)
SIX MONTHS ENDED
YEAR ENDED JUNE 30,
DECEMBER 31, ----------------
1996 1997 1996
------------ ------ ------
<S> <C> <C> <C>
Revenues:
Oil and condensate........................................ $ 9,833 $4,553 $4,540
Natural gas............................................... 1,481 1,571 853
------- ------ ------
11,314 6,124 5,393
------- ------ ------
Direct operating expenses:
Lease operating........................................... 2,453 1,465 1,099
Workovers................................................. 417 290 406
Production taxes.......................................... 732 402 325
------- ------ ------
3,602 2,157 1,830
------- ------ ------
Revenues in excess of direct operating expenses............. $ 7,712 $3,967 $3,563
======= ====== ======
</TABLE>
See the accompanying notes to these statements.
F-33
<PAGE> 123
COSTILLA ENERGY, INC.
BALLARD ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES
(1) BASIS OF PRESENTATION
On August 28, 1997 Costilla Energy, Inc., (the "Company") acquired from
Ballard Petroleum, LLC certain oil and gas properties (the "Ballard
Acquisition") for approximately $41.2 million. The accompanying statements of
revenues and direct operating expenses for the Ballard 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 Ballard 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 Ballard Acquisition were not available and 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 Ballard 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 natural gas sold to purchasers.
Direct operating expenses are recognized on the accrual method.
Preparation of the accompanying statements of revenues and direct operating
expense requires management to make estimates and assumptions that affect the
reported amounts of revenues and direct operating expenses during the reporting
period. Actual results could differ from those estimates.
Interim Statements of Revenues and Direct Operating Expenses
The interim financial information for the periods ended June 30, 1997 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
statement of revenues and direct operating expenses for the year ended December
31, 1996.
(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 Ballard Acquisition, as of
January 1, 1996 and December 31, 1996, is based on reserve estimates prepared by
the Company's engineers, 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
F-34
<PAGE> 124
COSTILLA ENERGY, INC.
BALLARD ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES -- (CONTINUED)
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.
Below are the net estimated quantities of proved reserves and proved
developed reserves for the Ballard Acquisition.
<TABLE>
<CAPTION>
OIL GAS
(MBbls) (Mmcf)
------- ------
<S> <C> <C>
Proved reserves at January 1, 1996.......................... 4,746 10,529
Extensions and discoveries.................................. 18 2,457
Production.................................................. (510) (651)
----- ------
Proved reserves at December 31, 1996........................ 4,254 12,335
===== ======
Proved developed reserves at December 31, 1996.............. 4,138 9,878
===== ======
</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.
The following are the Company's estimated standardized measure of
discounted future net cash flows from proved reserves attributable to the
Ballard Acquisition as of December 31, 1996 (in thousands):
<TABLE>
<S> <C>
Future:
Cash inflows.............................................. $143,236
Production costs.......................................... (46,312)
Development costs......................................... (871)
--------
Net cash flows before income taxes................ 96,053
10% annual discount for estimated timing of cash flows...... (34,735)
--------
Standardized measure of discounted future net cash flows
before income taxes....................................... $ 61,318
========
</TABLE>
F-35
<PAGE> 125
COSTILLA ENERGY, INC.
BALLARD ACQUISITION
NOTES TO THE STATEMENTS OF REVENUES AND
DIRECT OPERATING EXPENSES -- (CONTINUED)
The following are the sources of changes in the standardized measure of
discounted net cash flows for the year ended December 31, 1996 (in thousands):
<TABLE>
<S> <C>
Standardized measure, January 1, 1996....................... $32,538
Extensions and discoveries, net of development costs........ 5,452
Sales, net of production costs.............................. (7,712)
Net change in prices........................................ 29,762
Accretion of discount....................................... 3,254
Other....................................................... (1,976)
-------
Standardized measure, December 31, 1996..................... $61,318
=======
</TABLE>
F-36
<PAGE> 126
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Costilla Energy, Inc.:
We have audited the accompanying statement of revenues and direct operating
expenses of the 1995 Acquisition (see Note 1) for the period ended June 12,
1995. The statement is the responsibility of the Company's management. Our
responsibility is to express an opinion on the statement 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 statement of revenues and direct
operating expenses is 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 audit
provides a reasonable basis for our opinion.
The accompanying statement of revenues and direct operating expenses was
prepared for the purpose of complying with the rules and regulations of the
Securities and Exchange Commission (for inclusion in Form S-4 of Costilla
Energy, Inc. as described in Note 1) and is not intended to be a complete
presentation of the 1995 Acquisition interests' revenues and expenses.
In our opinion, the statement of revenues and direct operating expenses
referred to above presents fairly, in all material respects, the revenues and
direct operating expenses of the 1995 Acquisition for the period ended June 12,
1995, in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas
July 4, 1996
F-37
<PAGE> 127
COSTILLA ENERGY, INC.
1995 ACQUISITION
STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
(IN THOUSANDS)
<TABLE>
<CAPTION>
PERIOD ENDED
JUNE 12,
1995
------------
<S> <C>
Revenues:
Oil and condensate........................................ $ 7,572
Natural gas............................................... 3,358
-------
10,930
-------
Direct operating expenses:
Lease operating........................................... 4,550
Workovers and dry hole costs.............................. 109
Production taxes.......................................... 923
-------
5,582
-------
Revenues in excess of direct operating expenses............. $ 5,348
=======
</TABLE>
See the accompanying notes to this statement.
F-38
<PAGE> 128
COSTILLA ENERGY, INC.
1995 ACQUISITION
NOTES TO THE STATEMENT OF REVENUES AND
DIRECT OPERATING EXPENSES
(1) BASIS OF PRESENTATION
On June 12, 1995 Costilla Energy, Inc., formerly Costilla Energy, L.L.C.
and Costilla Petroleum Company (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 statement 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 statement of revenues and direct operating expenses of the 1995
Acquisition is presented in lieu of the financial statements required under Rule
3-05 of Securities and Exchange Commission Regulation S-X.
Revenues in the accompanying statement 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 natural 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
reserve estimates prepared by the Company's engineers, using prices and costs in
effect at June 12, 1995. 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 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-39
<PAGE> 129
COSTILLA ENERGY, INC.
1995 ACQUISITION
NOTES TO THE STATEMENT OF REVENUES AND
DIRECT OPERATING EXPENSES -- (CONTINUED)
Below are the net estimated quantities of proved reserves and proved
developed reserves for the 1995 Acquisition.
<TABLE>
<CAPTION>
OIL GAS
(MBBLS) (MMCF)
------- ------
<S> <C> <C>
Proved reserves at January 1, 1995.......................... 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 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.
The following are the Company's estimated standardized measure of
discounted future net cash flows from proved reserves attributable to the 1995
Acquisition as of June 12, 1995 (in thousands):
<TABLE>
<S> <C>
Future:
Cash inflows.............................................. $191,758
Production costs.......................................... (93,268)
Development costs......................................... (4,797)
--------
Net cash flows before income taxes................ 93,693
10% annual discount for estimated timing of cash flows...... (33,074)
--------
Standardized measure of discounted future net cash flows
before income taxes....................................... $ 60,619
========
</TABLE>
The following are the sources of changes in the standardized measure of
discounted net cash flows for the period ended June 12, 1995 (in thousands):
<TABLE>
<S> <C>
Standardized measure, January 1, 1995....................... $55,670
Sales, net of production costs.............................. (5,348)
Net change in prices........................................ 8,032
Accretion of discount....................................... 2,517
Other....................................................... (252)
-------
Standardized measure, June 12, 1995......................... $60,619
=======
</TABLE>
F-40
<PAGE> 130
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THE OFFER
CONTAINED HEREIN, OTHER THAN THOSE CONTAINED IN 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 INITIAL PURCHASERS. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL, OR THE SOLICITATION OF AN OFFER TO BUY, TO ANY
PERSON IN ANY JURISDICTION WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED,
OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO
SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OF SOLICITATION.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY CIRCUMSTANCES, CREATE ANY
IMPLICATION THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE
DATE HEREOF OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
---------------------
TABLE OF CONTENTS
<TABLE>
<S> <C>
Prospectus Summary.................... 1
Cautionary Statement Regarding
Forward-Looking Statements.......... 13
Risk Factors.......................... 13
Use of Proceeds....................... 19
The Exchange Offer.................... 19
Capitalization........................ 26
Selected Financial Information........ 27
Management's Discussion and Analysis
of Financial Condition and Results
of Operations.......................
Business and Properties............... 36
Management............................ 47
Principal Stockholders................ 50
Executive Compensation and Other
Information......................... 52
Certain Transactions and
Relationships....................... 56
Description of Revolving Credit
Facility............................ 56
Description of Exchange Notes......... 57
Book-Entry; Delivery and Form......... 80
Certain Federal Income Tax
Consequences........................ 81
Plan of Distribution.................. 82
Legal Matters......................... 82
Experts............................... 82
Glossary.............................. 83
</TABLE>
======================================================
======================================================
COSTILLA ENERGY, INC.
OFFER TO EXCHANGE
$80,000,000
10 1/4% SENIOR NOTES
DUE 2006
FOR
$80,000,000
10 1/4% SENIOR NOTES
DUE 2006
---------------------
PROSPECTUS
---------------------
, 1998
======================================================
<PAGE> 131
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the General Corporation Law of the State of Delaware permits
a corporation to indemnify certain persons, including officers and directors and
former officers and directors, and to purchase insurance with respect to
liability arising out of their capacity or status as officers and directors.
Such law provides further that the indemnification permitted hereunder shall not
be deemed exclusive of any other rights to which officers and directors may be
entitled under the corporation's bylaws, any agreement or otherwise. Article IX
of the Company's Certificate of Incorporation, included in Exhibit 3.1 hereto,
and Article VI of the Company's Bylaws, included in Exhibit 3.2 hereto, provide,
in general, that the Company shall indemnify its directors and officers under
the circumstances defined in Section 145 of the General Corporation Law of the
State of Delaware and gives authority to the Company to purchase insurance with
respect to such indemnification. The Company may in the future seek to obtain
insurance providing for indemnification of officers and directors of the Company
and certain other persons against liabilities and expenses incurred by any of
them in certain stated proceedings and under certain stated conditions.
In addition, Section 102(b)(7) of the General Corporation Law of the State
of Delaware permits a corporation to limit the liability of its directors
subject to certain exceptions. In accordance with Section 102(b)(7), Article VI
of the Company's Certificate of Incorporation, included in Exhibit 3.1 hereto,
provides, in general, that no director of the Company shall be personally liable
for (i) any breach of the directors' duty of loyalty to the Company or its
stockholders, (ii) acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) unlawful payments of
dividends or unlawful stock repurchases or redemptions as provided in Section
174 of the General Corporation Law of the State of Delaware or (iv) any
transaction from which the director derived an improper personal benefit.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
*3.1 -- Certificate of Incorporation of the Company
*3.2 -- Bylaws of the Company
*4.1 -- Form of Notes or Global Certificate (included as Exhibit
A to Exhibit 4.2)
*4.2 -- Indenture dated as of October 1, 1996 by and between
State Street Bank and Trust Company, as Trustee, and the
Company, as Issuer
#4.3 -- First Supplemental Indenture dated January 16, 1998 by
and between State Street Bank and Trust Company, as
Trustee, and the Company, as Issuer (including form of
Global Certificate)
#4.4 -- Form of Note
**4.5 -- Form of Stock Certificate
##5.1 -- Opinion of Cotton, Bledsoe, Tighe & Dawson
*10.1 -- Lease Agreement dated January 12, 1996 between
Independence Plaza, Ltd. and Costilla Energy, L.L.C.
*10.2 -- Concession Agreement dated July 6, 1995 between the
Government of the Republic of Moldova and Resource
Development Company Ltd., L.L.C. (DE)
*10.3 -- Consolidation Agreement dated October 8, 1996
*10.4 -- 1996 Stock Option Plan
*10.5 -- Employment Agreement between the Company and Bobby W.
Page effective June 30, 1996
</TABLE>
II-1
<PAGE> 132
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
*10.6 -- Employment Agreement between the Company and Cadell S.
Liedtke effective October 8, 1996
*10.7 -- Employment Agreement between the Company and Michael J.
Grella effective October 8, 1996
*10.8 -- Employment Agreement between the Company and Henry G.
Musselman effective October 8, 1996
*10.9 -- Purchase and Sale Agreement dated March 8, 1996 by and
between Parker & Parsley Development L.P., Parker &
Parsley Producing L.P. and Parker & Parsley Gas
Processing Co., as Seller, and Costilla Petroleum
Corporation and Costilla Energy, L.L.C., as Purchaser
*10.10 -- Bonus Incentive Plan
+10.11 -- First and Second Amendments to 1996 Stock Option Plan of
Costilla Energy, Inc.
+10.12 -- First Amendment to Outside Directors Stock Option Plan of
Costilla Energy, Inc.
+10.13 -- First, Second and Third Amendments to Bonus Incentive
Plan of Costilla Energy, Inc.
++10.14 -- Purchase and Sale Agreement dated July 2, 1997 between
Ballard Petroleum LLC, as seller, and the Company, as
buyer
++10.15 -- Acquisition and Exploration Agreement effective as of
July 1, 1997 by and between Ballard Petroleum, LLC and
the Company
#10.16 -- Purchase Agreement dated January 13, 1998 among BT Alex.
Brown Incorporated and Prudential Securities
Incorporated, as Initial Purchasers, and the Company, as
Issuer
#10.17 -- Registration Rights Agreement dated January 16, 1998
among BT Alex. Brown Incorporated and Prudential
Securities Incorporated, as Initial Purchasers, and the
Company, as Issuer
#10.18 -- Amendment to Employment Agreement between the Company and
Cadell S. Liedtke dated April 15, 1997
#10.19 -- Amendment to Employment Agreement between the Company and
Michael J. Grella dated April 15, 1997
#10.20 -- Amendment to Employment Agreement between the Company and
Henry G. Musselman dated April 15, 1997
#10.21 -- Second Amendment to Employment Agreement between the
Company and Henry G. Musselman dated April 15, 1997
#10.22 -- Amendment to Employment Agreement between the Company and
Bobby W. Page dated April 15, 1997
#10.23 -- Amended and Restated Credit Agreement dated as of August
28, 1997 between Bankers Trust Company, as Agent and
Union Bank of California, N.A., as Co-Agent and the
Company
##12.1 -- Computation of Ratio of Adjusted EBITDA to Interest
Expense
#21.1 -- Subsidiaries of the Registrant
##23.1 -- Consent of KPMG Peat Marwick LLP
##23.2 -- Consent of Williamson Petroleum Consultants
##23.3 -- Consent of W. Scott Epley, P.E.
</TABLE>
II-2
<PAGE> 133
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
##23.4 -- Consent of Cotton, Bledsoe, Tighe & Dawson (included as
part of Exhibit 5.1)
##24.1 -- Power of Attorney
##24.2 -- Certified copy of resolution of Board of Directors of
Costilla Energy, Inc. authorizing signature by Power of
Attorney
##99.1 -- Form of Letter of Transmittal
##99.2 -- Form of Notice of Guaranteed Delivery
</TABLE>
- ---------------
* Incorporated by reference to Registration Statement on Form S-1, File No.
333-08909.
** Incorporated by reference to Registration Statement on Form S-1, File No.
333-08913.
+ Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997.
++ Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1997.
# Incorporated by reference to the Company's Annual Report on form 10-K for
the year ended December 31, 1997.
## Filed herewith.
ITEM 22. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the Company
pursuant to the foregoing provisions, or otherwise, the Company has been advised
that, in the opinion of the Securities and Exchange Commission, such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Company of expenses
incurred or paid by a directors, officer or controlling person of the company in
the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Company will, unless in the opinion of its counsel, the mater
has been settled by controlling precedent, submit to court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
The undersigned registrant hereby undertakes to respond to request for
information that is incorporated by reference into the Prospectus pursuant to
Item 4, 10(b), 11 or 13 of this form, within one business day of receipt of such
request, and to send the incorporated documents by first class mail or other
equally prompt means. This includes information contained in documents filed
subsequent to the effective date of the registration statement through the date
of responding to the request.
The undersigned registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquire involved therein, that was not the subject of and included
in the registration statement when it becomes effective.
II-3
<PAGE> 134
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant has duly
caused this registration statement to be signed on its behalf by the
undersigned, thereunder duly authorized, in the City of Midland, State of Texas
on this 17th day of April, 1998.
COSTILLA ENERGY, INC.
By: /s/ MICHAEL J. GRELLA*
----------------------------------
Michael J. Grella
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities and on the date indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ MICHAEL J. GRELLA* President, Chief Executive Officer April 17, 1998
- ----------------------------------------------------- and Director
Michael J. Grella
/s/ CADELL S. LIEDTKE* Chairman of the Board and Director April 17, 1998
- -----------------------------------------------------
Cadell S. Liedtke
/s/ HENRY G. MUSSELMAN* Executive Vice President and April 17, 1998
- ----------------------------------------------------- Director
Henry G. Musselman
/s/ JERRY J. LANGDON* Director April 17, 1998
- -----------------------------------------------------
Jerry J. Langdon
/s/ W.D. KENNEDY* Director April 17, 1998
- -----------------------------------------------------
W.D. Kennedy
/s/ SAMUEL J. ATKINS, III* Director April 17, 1998
- -----------------------------------------------------
Samuel J. Atkins, III
/s/ BOBBY W. PAGE Senior Vice President and Chief April 17, 1998
- ----------------------------------------------------- Financial Officer
Bobby W. Page
*By: /s/ BOBBY W. PAGE
------------------------------------------------
Bobby W. Page,
Attorney in Fact
</TABLE>
II-4
<PAGE> 135
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
*3.1 -- Certificate of Incorporation of the Company
*3.2 -- Bylaws of the Company
*4.1 -- Form of Notes or Global Certificate (included as Exhibit
A to Exhibit 4.2)
*4.2 -- Indenture dated as of October 1, 1996 by and between
State Street Bank and Trust Company, as Trustee, and the
Company, as Issuer
#4.3 -- First Supplemental Indenture dated January 16, 1998 by
and between State Street Bank and Trust Company, as
Trustee, and the Company, as Issuer (including form of
Global Certificate)
#4.4 -- Form of Note
**4.5 -- Form of Stock Certificate
##5.1 -- Opinion of Cotton, Bledsoe, Tighe & Dawson
*10.1 -- Lease Agreement dated January 12, 1996 between
Independence Plaza, Ltd. and Costilla Energy, L.L.C.
*10.2 -- Concession Agreement dated July 6, 1995 between the
Government of the Republic of Moldova and Resource
Development Company Ltd., L.L.C. (DE)
*10.3 -- Consolidation Agreement dated October 8, 1996
*10.4 -- 1996 Stock Option Plan
*10.5 -- Employment Agreement between the Company and Bobby W.
Page effective June 30, 1996
*10.6 -- Employment Agreement between the Company and Cadell S.
Liedtke effective October 8, 1996
*10.7 -- Employment Agreement between the Company and Michael J.
Grella effective October 8, 1996
*10.8 -- Employment Agreement between the Company and Henry G.
Musselman effective October 8, 1996
*10.9 -- Purchase and Sale Agreement dated March 8, 1996 by and
between Parker & Parsley Development L.P., Parker &
Parsley Producing L.P. and Parker & Parsley Gas
Processing Co., as Seller, and Costilla Petroleum
Corporation and Costilla Energy, L.L.C., as Purchaser
*10.10 -- Bonus Incentive Plan
+10.11 -- First and Second Amendments to 1996 Stock Option Plan of
Costilla Energy, Inc.
+10.12 -- First Amendment to Outside Directors Stock Option Plan of
Costilla Energy, Inc.
+10.13 -- First, Second and Third Amendments to Bonus Incentive
Plan of Costilla Energy, Inc.
++10.14 -- Purchase and Sale Agreement dated July 2, 1997 between
Ballard Petroleum LLC, as seller, and the Company, as
buyer
++10.15 -- Acquisition and Exploration Agreement effective as of
July 1, 1997 by and between Ballard Petroleum, LLC and
the Company
#10.16 -- Purchase Agreement dated January 13, 1998 among BT Alex.
Brown Incorporated and Prudential Securities
Incorporated, as Initial Purchasers, and the Company, as
Issuer
</TABLE>
<PAGE> 136
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
------- ----------------------
<C> <S>
#10.17 -- Registration Rights Agreement dated January 16, 1998
among BT Alex. Brown Incorporated and Prudential
Securities Incorporated, as Initial Purchasers, and the
Company, as Issuer
#10.18 -- Amendment to Employment Agreement between the Company and
Cadell S. Liedtke dated April 15, 1997
#10.19 -- Amendment to Employment Agreement between the Company and
Michael J. Grella dated April 15, 1997
#10.20 -- Amendment to Employment Agreement between the Company and
Henry G. Musselman dated April 15, 1997
#10.21 -- Second Amendment to Employment Agreement between the
Company and Henry G. Musselman dated April 15, 1997
#10.22 -- Amendment to Employment Agreement between the Company and
Bobby W. Page dated April 15, 1997
#10.23 -- Amended and Restated Credit Agreement dated as of August
28, 1997 between Bankers Trust Company, as Agent and
Union Bank of California, N.A., as Co-Agent and the
Company
##12.1 -- Computation of Ratio of Adjusted EBITDA to Interest
Expense
#21.1 -- Subsidiaries of the Registrant
##23.1 -- Consent of KPMG Peat Marwick LLP
##23.2 -- Consent of Williamson Petroleum Consultants
##23.3 -- Consent of W. Scott Epley, P.E.
##23.4 -- Consent of Cotton, Bledsoe, Tighe & Dawson (included as
part of Exhibit 5.1)
##24.1 -- Power of Attorney
##24.2 -- Certified copy of resolution of Board of Directors of
Costilla Energy, Inc. authorizing signature by Power of
Attorney
##99.1 -- Form of Letter of Transmittal
##99.2 -- Form of Notice of Guaranteed Delivery
</TABLE>
- ---------------
* Incorporated by reference to Registration Statement on Form S-1, File No.
333-08909.
** Incorporated by reference to Registration Statement on Form S-1, File No.
333-08913.
+ Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997.
++ Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1997.
# Incorporated by reference to the Company's Annual Report on form 10-K for
the year ended December 31, 1997.
## Filed herewith.
<PAGE> 1
EXHIBIT 5.1
[COTTON, BLEDSOE, TIGHE & DAWSON LETTERHEAD]
April 17, 1998
Costilla Energy, Inc.
400 West Illinois, Suite 1000
Midland, Texas 79701
Re: Registration Statement on Form S-4
Gentlemen:
We have acted as counsel for Costilla Energy, Inc., a Delaware corporation
(the "Company") in connection with the registration under the Securities Act of
1933, as amended (the "Act"), of $80,000,000 in aggregate principal amount of
the Company's 10 1/4% Senior Notes due 2006 (the "Notes"), to be exchanged for
certain outstanding 10 1/4% Senior Notes due 2006. A Registration Statement on
Form S-4 covering the issuance and sale of Notes was filed under the Act with
the Securities and Exchange Commission (the "Commission") on April 17, 1998 (the
"Registration Statement").
In reaching the conclusions expressed in this opinion, we have examined
signed copies of the Registration Statement and all exhibits thereto. We have
also examined and relied upon originals, or copies certified to our
satisfaction, of (i) the Certificate of Incorporation and Bylaws of the Company,
(ii) minutes and records of the corporate proceedings of the Company with
respect to the issuance of the Notes and related matters, and (iii) such other
agreements and instruments relating to the Company as we have deemed necessary
or appropriate for the purposes of the opinions hereinafter expressed. In
rendering such opinions, we have relied, to the extent we deemed reasonable, on
certificates and certain other information provided to us by officers of the
Company and public officials as to matters of fact of which the maker of such
certificates or the person providing such information had knowledge, without
investigation into or verification of such information. Furthermore, we have
assumed that the signatures on all documents examined by us are genuine, that
all documents and corporate record books submitted to us as originals are
authentic, accurate and complete, and that all documents submitted to use as
copies are true, correct and complete copies of the originals thereof.
Based solely upon the foregoing, subject to the assumptions, limitations
and qualifications set forth herein, and specifically limited in all respects to
the laws of the State of Texas, of the United States of America and the General
Corporation Law of the State of Delaware, we are of the opinion that the Notes
registered pursuant to the Registration Statement have been duly and validly
authorized by the Company and, when paid for, issued, exchanged or sold and
delivered in accordance with the terms of the Registration Statement, will be
binding obligations of the Company, subject to applicable bankruptcy,
insolvency, reorganization, fraudulent transfer, moratorium or similar laws
affecting creditors' rights generally and to general principles of equity and
the availability of equitable remedies. Please note in this regard that we are
not licensed to practice law in the State of Delaware, but have reviewed
Delaware law in connection with the opinions expressed herein.
We hereby consent to the use of this opinion as an exhibit to the
Registration Statement and to the reference to this Firm under the caption
"Legal Matters" in the Prospectus forming a part of the Registration Statement.
In giving this consent we do not thereby admit that we come within the category
of persons whose consent is required under the Act or the rules and regulations
of the Commission promulgated thereunder.
This opinion is rendered only to the Company and solely for the benefit of
the Company and the Commission in connection with the registration and the
issuance of the Notes pursuant to the Registration Statement. This opinion may
not be otherwise used, circulated, quoted, relied upon, or referred to by you or
<PAGE> 2
the Commission for any other purpose or by any other person, firm or corporation
for any purpose, without our prior written consent.
Yours very truly,
COTTON, BLEDSOE, TIGHE & DAWSON
By: /s/ RICHARD T. MCMILLAN
----------------------------------
Richard T. McMillan
<PAGE> 1
EXHIBIT 12.1
COSTILLA ENERGY, INC.
ADJUSTED EBITDA/INTEREST EXPENSE
(IN THOUSANDS)
<TABLE>
<CAPTION>
PRO FORMA(1)
YEARS ENDED DECEMBER 31, YEAR ENDED
-------------------------------------------------- DECEMBER 31,
1997 1996 1995 1994 1993 1997
-------- ------- ------- ------ ------ ------------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss).......... $(36,471) $(4,440) $(4,970) $ 163 $ 73 $(42,591)
Interest expense......... 12,979 11,281 4,591 1,458 605 19,053
Income taxes............. 152 1,218 3 40 (23) 152
Exploration and
abandonment........... 6,588 2,550 1,652 793 218 6,788
Depreciation, depletion
and amortization...... 26,409 12,430 5,958 1,847 884 28,439
Impairment of oil and gas
properties............ 28,189 -- -- -- -- 28,189
Gain from sale of
substantially all the
assets of wholly-owned
subsidiary............ -- (906) -- -- -- --
Extraordinary loss
resulting from early
extinguishment of
debt, net of the
related deferred tax
benefit of $129 and
$1,042................ 219 4,975 -- -- -- --
-------- ------- ------- ------ ------ --------
ADJUSTED EBITDA............ $ 38,065 $27,108 $ 7,234 $4,301 $1,757 $ 40,030
======== ======= ======= ====== ====== ========
Interest expense per
consolidated financial
statements............... $ 12,979 $11,281 $ 4,591 $1,458 $ 605 $ 19,053
Less: amortization deferred
charges.................. (518) (1,028) -- -- -- (832)
-------- ------- ------- ------ ------ --------
Interest expense -- net of
deferred charges
amortization............. $ 12,461 $10,253 $ 4,591 $1,458 $ 605 $ 18,221
======== ======= ======= ====== ====== ========
ADJUSTED EBITDA/Interest
expense -- net of
deferred charges
amortization............. 3.1x 2.6x 1.6x 2.9x 2.9x 2.2x
======== ======= ======= ====== ====== ========
</TABLE>
- ---------------
(1) Assumes that the Ballard Acquisition (closed August 28, 1997) and the
Initial Offering (closed January 16, 1998) and the application of proceeds
therefrom had taken place as of January 1, 1997.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Costilla Energy, Inc.
We consent to the use of our reports included herein and to the reference
to our firm under the heading "Experts" in the Prospectus.
KPMG PEAT MARWICK LLP
Midland, Texas
April, 17, 1998
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ENGINEERS
As independent engineering consultants, we hereby consent to the use of our
reports and data extracted therefrom (and all references to our Firm) included
in or made a part of this Registration Statement on Form S-4 relating to the
registration of 10 1/4% Notes due 2006 of Costilla Energy, Inc. to be filed with
the Securities and Exchange Commission on or about April 17, 1998.
WILLIAMSON PETROLEUM CONSULTANTS, INC.
Houston, Texas
April 17, 1998
<PAGE> 1
EXHIBIT 23.3
CONSENT OF INDEPENDENT ENGINEER
As an independent engineering consultant, I hereby consent to the use of my
reports and data extracted therefrom (and all references to me and my Firm)
included in or made a part of this Registration Statement on Form S-4 relating
to the registration of 10 1/4% Notes due 2006 of Costilla Energy, Inc. to be
filed with the Securities and Exchange Commission on or about April 17, 1998.
W. SCOTT EPLEY, P.E.
Midland, Texas
April 17, 1998
<PAGE> 1
EXHIBIT 24.1
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned, being certain of the
Officers and all of the Directors of Costilla Energy, Inc., a Delaware
Corporation, do hereby constitute and appoint Michael J. Grella and Bobby W.
Page, or either of them, with full power of substitution, our true and lawful
attorneys and agents, to do any and all acts and things in our names in the
capacities indicated which Michael J. Grella and Bobby W. Page, or either of
them, may deem necessary or advisable to enable the Company to comply with the
Securities Act of 1933, as amended, any state securities laws and any rules,
regulations and requirements of the Securities and Exchange Commission in
connection with a Registration Statement or Registration Statements on Form S-4
seeking to register 10 1/4% Notes due 2006 of Costilla Energy, Inc., to be
issued in exchange for certain outstanding 10 1/4% notes of Costilla Energy,
Inc., including specifically, but not limited to, the power and authority to
sign such Registration Statement, any and all amendments (including post-
effective amendments) to such Registration Statement and any other forms or
documents related to such Registration Statement which are required under
federal or state securities laws for us, or any of us, in our names in the
capacities indicated; and we do hereby ratify and confirm all that Michael J.
Grella and Bobby W. Page, or either of them, shall do or cause to be done by
virtue hereof. This Power of Attorney may be signed in any number of
counterparts, and each such counterpart shall be considered an original hereof.
IN WITNESS WHEREOF I have hereunto set my hand this 19th day of March,
1998.
/s/ CADELL S. LIEDTKE
------------------------------------
Cadell S. Liedtke
Chairman of the Board and Director
/s/ MICHAEL J. GRELLA
------------------------------------
Michael J. Grella
President, Chief Executive Officer
and Director
/s/ HENRY G. MUSSELMAN
------------------------------------
Henry G. Musselman
Executive Vice President, Chief
Operating Officer and Director
/s/ BOBBY PAGE
------------------------------------
Bobby W. Page
Senior Vice President, Treasurer,
Chief Financial Officer and
Secretary
/s/ JERRY LANGDON
------------------------------------
Jerry Langdon
Director
/s/ W.D. KENNEDY
------------------------------------
W.D. Kennedy
Director
/s/ SAMUEL J. ATKINS, III
------------------------------------
Samuel J. Atkins, III
Director
<PAGE> 1
EXHIBIT 24.2
CERTIFICATE OF RESOLUTION
I, Bobby W. Page, Secretary of Costilla Energy, Inc., a Delaware
Corporation, do hereby certify that the Board of Directors of Costilla Energy,
Inc., duly adopted the following resolutions as of March 19, 1998.
BE IT FURTHER RESOLVED that the directors and officers of the Company are
hereby authorized and directed to execute and deliver a Power of Attorney to
Michael J. Grella and Bobby W. Page in the following form:
"KNOW ALL MEN BY THESE PRESENTS, the undersigned, being certain of the
Officers and all of the Directors of Costilla Energy, Inc., a Delaware
Corporation, do hereby constitute and appoint Michael J. Grella and Bobby W.
Page, or either of them, with full power of substitution, our true and lawful
attorneys and agents, to do any and all acts and things in our names in the
capacities indicated which Michael J. Grella and Bobby W. Page, or either of
them, may deem necessary or advisable to enable the Company to comply with the
Securities Act of 1933, as amended, any state securities laws and any rules,
regulations and requirements of the Securities and Exchange Commission in
connection with a Registration Statement or Registration Statements on Form S-4
seeking to register 10 1/4% Notes due 2006 of Costilla Energy, Inc., to be
issued in exchange for certain outstanding 10 1/4% notes of Costilla Energy,
Inc., including specifically, but not limited to, the power and authority to
sign such Registration Statement, any and all amendments (including post-
effective amendments) to such Registration Statement and any other forms or
documents related to such Registration Statement which are required under
federal or state securities laws for us, or any of us, in our names in the
capacities indicated; and we do hereby ratify and confirm all that Michael J.
Grella and Bobby W. Page, or either of them, shall do or cause to be done by
virtue hereof. This Power of Attorney may be signed in any number of
counterparts, and each such counterpart shall be considered an original hereof."
BE IT FURTHER RESOLVED that the officers of the Company are hereby
authorized and directed to take all such further action as they may deem
advisable in order to carry out the intent and purposes of the foregoing
resolution.
IN WITNESS WHEREOF, I have hereunto set my hand on behalf of this
corporation this 10th day of April, 1998.
/s/ BOBBY W. PAGE
------------------------------------
Bobby W. Page
Secretary
<PAGE> 1
EXHIBIT 99.1
LETTER OF TRANSMITTAL
TO TENDER UNREGISTERED 10 1/4% SENIOR NOTES DUE 2006
OF
COSTILLA ENERGY, INC.
PURSUANT TO THE OFFER TO EXCHANGE AND PROSPECTUS
DATED , 1998
---------------------
THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P.M., NEW YORK CITY
TIME, ON [ ], 1998 (THE "EXPIRATION DATE"), UNLESS THE EXCHANGE OFFER
IS EXTENDED BY THE COMPANY
---------------------
PLEASE FOLLOW CAREFULLY THE ACCOMPANYING INSTRUCTIONS
EXCHANGE AGENT
Send this Letter of Transmittal and certificate(s) representing unregistered
10 1/4% Senior Notes due 2006 (the "Private Notes") of Costilla Energy, Inc. to
STATE STREET BANK AND TRUST COMPANY, the Exchange Agent for the Exchange Offer,
as follows:
<TABLE>
<S> <C>
By Registered or Certified Mail,
Overnight Mail or Hand Delivery: By Facsimile:
STATE STREET BANK AND TRUST COMPANY STATE STREET BANK AND TRUST COMPANY
CORPORATE TRUST DEPARTMENT ATTENTION: CORPORATE TRUST DEPARTMENT
TWO INTERNATIONAL PLACE (617) 664-5371
BOSTON, MASSACHUSETTS 02110
</TABLE>
Delivery of this Letter of Transmittal to an address other than as set forth
above will not constitute a valid delivery (originals of all documents sent by
facsimile should be sent promptly by registered or certified mail, overnight
mail or hand delivery).
INFORMATION AGENT
For information concerning the Exchange Offer, contact D. F. KING & CO.
INC., the Information Agent for the Exchange Offer, as follows:
<TABLE>
<S> <C>
By Registered Certified Mail,
Overnight Mail or Hand Delivery: By Telephone:
D.F. KING & CO., INC. D.F. KING & CO., INC.
77 WATER STREET (800) 207-2872
NEW YORK, NEW YORK 10005
</TABLE>
IF YOU WISH TO EXCHANGE PRIVATE NOTE(S) FOR AN EQUAL AMOUNT OF REGISTERED
10 1/4% SENIOR NOTES DUE 2006 (THE "EXCHANGE NOTES") PURSUANT TO THE EXCHANGE
OFFER, YOU MUST VALIDLY TENDER (AND NOT WITHDRAW) PRIVATE NOTES TO THE EXCHANGE
AGENT PRIOR TO THE EXPIRATION DATE.
<TABLE>
<S> <C> <C>
- ---------------------------------------------------------------------------------------------------------
DESCRIPTION OF NOTES TENDERED
- ---------------------------------------------------------------------------------------------------------
NAME(S) AND ADDRESS(ES) OF REGISTERED HOLDER(S)
(PLEASE FILL IN. IF ALREADY FILLED IN, PLEASE CORRECT ANY
ERRORS.) COSTILLA ENERGY, INC. PRIVATE NOTES TENDERED
- ---------------------------------------------------------------------------------------------------------
AGGREGATE PRINCIPAL
CERTIFICATE AMOUNT OF PRIVATE
NUMBER(S) NOTES TENDERED
------------------------------------------
------------------------------------------
------------------------------------------
------------------------------------------
Total Amount
- ---------------------------------------------------------------------------------------------------------
</TABLE>
(ATTACH A SEPARATE, SIGNED SCHEDULE IF NECESSARY)
<PAGE> 2
TERMS AND CONDITIONS
1. The undersigned hereby tenders to Costilla Energy, Inc., a Delaware
corporation (the "Company"), the Private Notes described above pursuant to the
Company's offer of $1,000 principal amount of registered Exchange Notes in
exchange for $1,000 principal amount of the Private Notes, upon the terms and
subject to the conditions contained in the Prospectus dated , 1998
(the "Prospectus"), receipt of which is hereby acknowledged, and in this Letter
of Transmittal (which together constitute the "Exchange Offer").
2. The undersigned hereby represents and warrants that it has full power
and authority to tender the Private Notes described above and that the Company
will acquire good and unencumbered title thereto, free and clear of all liens,
restrictions, charges and encumbrances and not subject to any adverse claim. The
undersigned will, upon request, execute and deliver any additional documents
deemed by the Company to be necessary or desirable to complete the tender of the
Private Notes.
3. The undersigned understands that the tender of the Private Notes
pursuant to all of the procedures set forth in the Prospectus and this Letter of
Transmittal will constitute an agreement between the undersigned and the Company
as to the terms and conditions set forth in the Prospectus and this Letter of
Transmittal.
4. The undersigned hereby represents and warrants that:
(a) the Exchange Notes acquired by it pursuant to the Exchange Offer
are being obtained in the ordinary course of business of the undersigned,
whether or not the undersigned is the holder;
(b) neither the undersigned nor any such other person is engaging in
or intends to engage in a distribution of the Exchange Notes;
(c) neither the undersigned nor any such other person has an
arrangement or understanding with any person to participate in the
distribution (within the meaning of the Securities Act of 1933, as amended
(the "Securities Act")), of such Exchange Notes; and
(d) neither the holder nor any such other person is an "affiliate," as
such term is defined under Rule 405 promulgated under the Securities Act,
of the Company.
5. If the undersigned is not a broker-dealer, the undersigned represents
that it is not engaged in, and does not intend to engage in, a distribution of
Exchange Notes. If the undersigned is a broker-dealer, the undersigned
represents that it acquired the Private Notes for its own account as a result of
market-making activities or other trading activities. If the undersigned is a
broker-dealer that will receive Exchange Notes for its own account in exchange
for Private Notes that were acquired as a result of market-making activities or
other trading activities, it acknowledges that it will deliver a prospectus in
connection with any resale of such Exchange Notes; however, by so acknowledging
and by delivering a prospectus, the undersigned will not be deemed to admit that
it is an "underwriter" within the meaning of the Securities Act. If the
undersigned is a broker-dealer and the Private Notes held for its account were
not acquired as a result of market-making or other trading activities, such
Private Notes cannot be exchanged pursuant to the Exchange Offer.
6. Any obligation of the undersigned hereunder shall be binding upon the
successors, assigns, executors, administrators, trustees in bankruptcy and legal
and personal representatives of the undersigned.
7. This tender is irrevocable, subject to withdrawal rights described in
the Prospectus.
8. Unless otherwise indicated herein under "Special Delivery Instructions,"
please issue the Exchange Notes in the name of the undersigned.
<PAGE> 3
SPECIAL DELIVERY INSTRUCTIONS
(SEE INSTRUCTION 1)
To be completed ONLY IF the Exchange Notes are to be issued or sent to
someone other than the undersigned or to the undersigned at an address other
than provided above.
Mail [ ] Issue [ ] (check appropriate boxes) Exchange Notes to:
Name:
---------------------------------
(PLEASE PRINT)
Address:
--------------------------------
--------------------------------
--------------------------------
(INCLUDING ZIP CODE)
SIGNATURE
To be completed by all exchanging noteholders. Must be signed by the
registered holder exactly as its name appears of record for the Private Notes.
If signature is by trustee, executor, administrator, guardian, attorney-in-fact,
officer of a corporation or other person acting in a fiduciary or representative
capacity, please set forth full title. See Instruction 3.
X
-----------------------------------
X
-----------------------------------
SIGNATURE(S) OF REGISTERED
HOLDER(S) OR AUTHORIZED SIGNATURE
Dated:
---------------------------------
Name(s):
-------------------------------
-------------------------------
(PLEASE TYPE OR PRINT)
Capacity:
-------------------------------
Address:
--------------------------------
--------------------------------
--------------------------------
(INCLUDING ZIP CODE)
Area Code and Telephone No.:
------------------------------------
<PAGE> 4
SIGNATURE GUARANTEE (IF REQUIRED BY INSTRUCTION 1)
Certain Signatures Must Be Guaranteed by an Eligible Institution
--------------------------------------------------------------
(NAME OF ELIGIBLE INSTITUTION GUARANTEEING SIGNATURES)
--------------------------------------------------------------
(ADDRESS (INCLUDING ZIP CODE) AND TELEPHONE NUMBER
(INCLUDING AREA CODE) OF FIRM)
--------------------------------------------------------------
(AUTHORIZED SIGNATURE)
--------------------------------------------------------------
(PRINTED NAME)
--------------------------------------------------------------
(TITLE)
Dated:
--------------------------------------------------------------
PLEASE READ THE INSTRUCTIONS ON THE FOLLOWING PAGE,
WHICH FORM A PART OF THIS LETTER OF TRANSMITTAL.
<PAGE> 5
INSTRUCTIONS TO LETTER OF TRANSMITTAL
1. GUARANTEE OF SIGNATURES. Unless the box titled "Special Delivery
Instructions" above has not been completed or the Private Notes described above
are tendered for the account of an Eligible Institution (as defined) signatures
on this Letter of Transmittal must be guaranteed by an eligible guarantor
institution that is a member of or participant in the Securities Transfer Agents
Medallion Program, the New York Stock Exchange Medallion Signature Program, the
Stock Exchange Medallion Program, or an "eligible guarantor institution" within
the meaning of Rule 17Ad-15 promulgated under the Securities Exchange Act of
1934, as amended (an "Eligible Institution").
2. DELIVERY OF LETTER OF TRANSMITTAL AND PRIVATE NOTES. Private Notes
together with a properly completed and duly executed Letter of Transmittal (or
copy thereof), should be mailed or delivered to the Exchange Agent at the
address set forth above.
THE METHOD OF DELIVERY OF PRIVATE NOTES AND THE LETTER OF TRANSMITTAL AND
ALL OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK
OF THE HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE
AN OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE. NO
LETTER OF TRANSMITTAL OR PRIVATE NOTES SHOULD BE SENT TO THE COMPANY. HOLDERS
MAY REQUEST THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST
COMPANIES, OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR SUCH HOLDERS.
3. SIGNATURE ON LETTER OF TRANSMITTAL, BOND POWERS AND ENDORSEMENTS. If
this Letter of Transmittal is signed by a person other than a registered holder
of Private Notes, such Private Notes must be accompanied by appropriate bond
powers, signed by such registered holder exactly as such registered holder's
name appears on such Private Notes.
If this Letter of Transmittal or any Private Notes or bond powers are
signed by trustees, executors, administrators, guardians, attorneys-in-fact,
officers of corporations, or others acting in a fiduciary or representative
capacity, such persons should so indicate when signing, and, unless waived by
the Company, proper evidence satisfactory to the Company of their authority to
so act must be submitted with this Letter of Transmittal.
4. TAX INFORMATION. Please complete the attached Substitute Form W-9. See
"Tax Information and Guidelines."
5. MISCELLANEOUS. All questions as to the validity, form, eligibility
(including time of receipt), acceptance, and withdrawal of tendered Private
Notes will be resolved by the Company in its sole discretion, which
determination will be final and binding. The Company reserves the absolute right
to reject any or all Private Notes not properly tendered or any Private Notes
the Company's acceptance of which would, in the opinion of counsel for the
Company, be unlawful. The Company also reserves the right to waive any defects,
irregularities, or conditions of tender as to particular Private Notes. The
Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in this Letter of Transmittal) will be final and
binding. Unless waived, any defects or irregularities in connection with tenders
of Private Notes must be cured within such time as the Company shall determine.
Neither the Company, the Exchange Agent, nor any other person shall be under any
duty to give notification of defects in such tenders nor shall any such person
incur any liability for failure to give such notification. Tenders of Private
Notes will not be deemed to have been made until such defects or irregularities
have been cured or waived. Any Private Notes received by the Exchange Agent that
are not properly tendered and as to which the defects or irregularities have not
been cured or waived will be returned by the Exchange Agent to the tendering
holder thereof as soon as practicable following the Expiration Date.
<PAGE> 6
TAX INFORMATION AND GUIDELINES
You must provide the Exchange Agent with your correct Taxpayer
Identification Number ("TIN") on the Substitute Form W-9 set forth below. If you
are an individual, your TIN is your social security number.
On the Substitute Form W-9, you must certify under penalties of perjury
that: (a) your TIN is correct, and (b) you are not subject to backup
withholding, either because the Internal Revenue Service ("IRS") has not
notified you that you are subject to backup withholding as a result of a failure
to report interest or dividends or because the IRS has notified you that you are
no longer subject to backup withholding. If the IRS has notified you that you
are subject to backup withholding because of underreporting of interest or
dividends, you must cross out item (2) in the "Certification" section of the
Substitute Form W-9. If subsequently, however, the IRS notifies you that you are
not longer subject to backup withholding, you should not cross out item (2).
Exempt persons, which include all corporations and certain foreign
individuals, are not subject to the backup withholding and reporting
requirements. An exempt person should furnish its TIN, write "Exempt" on the
face of the Substitute Form W-9, and sign and date the form. To satisfy the
Exchange Agent that a foreign person qualifies as an exempt recipient, such
person must also submit to the Exchange Agent with this Letter of Transmittal a
Form W-8, Certificate of Foreign Status, signed under penalties of perjury,
attesting to such person's foreign status.
If you are required to provide a TIN, but have not been issued a TIN and
have applied for one, or intend to apply for one in the near future, you should
write "Applied For" on the line of the Substitute Form W-9 requiring a TIN.
Generally, you will then have 60 days to get a TIN and give it to the Exchange
Agent. If the Exchange Agent does not receive your TIN within 60 days, backup
withholding, if applicable, will begin.
If you do not provide the Exchange Agent with your correct TIN, you may be
subject to a $50 penalty that the IRS imposes. Failure to comply truthfully with
the backup withholding certification requirements may also result in the
imposition of criminal and civil fines and penalties.
<PAGE> 7
<TABLE>
<S> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------------------
Name, as shown on first page hereof (if held in joint account, list first and circle the name of the person or entity whose
number you enter in Part I below.)
---------------------------------------------------------------------------------------------------------------------------------
Address (if not completed, signature in Part 1 below will constitute a certification that the address on the first page hereof is
correct.)
---------------------------------------------------------------------------------------------------------------------------------
City, State and ZIP code
---------------------------------------------------------------------------------------------------------------------------------
SUBSTITUTE PART I -- PLEASE PROVIDE YOUR TIN IN THE BOX AT RIGHT TIN -----------------------------
FORM W-9 AND CERTIFY BY SIGNING AND DATING BELOW. Social Security Number or
Employer Identification Number
----------------------------------------------------------------------------------------------
DEPARTMENT OF THE TREASURY PART II -- Awaiting TIN [ ]
INTERNAL REVENUE SERVICE For Payees exempt from backup withholding, see the enclosed Guidelines for Certification of
PAYOR'S REQUEST FOR TAXPAYER Taxpayer Number on Substitute Form W-9 and complete as instructed under "Important Tax
IDENTIFICATION NUMBER (TIN) Information" above.
</TABLE>
- --------------------------------------------------------------------------------
CERTIFICATION. Under penalties of perjury, I certify that:
(1) The number shown on this form is my correct Taxpayer Identification Number
(or I am waiting for a number to be issued to me), and
(2) I am not subject to backup withholding either because I have not been
notified by the Internal Revenue Service ("IRS") that I am subject to
backup withholding as a result of a failure to report all interest or
dividends, or the IRS has notified me that I am no longer subject to
backup withholding.
CERTIFICATION INSTRUCTIONS. You must cross out item (2) above if you have been
notified by the IRS that you are subject to backup withholding because of
under reporting interest or dividends on your tax return. However, if after
being notified by the IRS that you were subject to backup withholding you
received any other notification from the IRS that you are no longer subject to
backup withholding, do not cross out item (2). (Also see the enclosed
Guidelines for Certification of Taxpayer Identification Number on Substitute
Form W-9.)
SIGNATURE: DATE:
------------------------------- --------------------------------
<PAGE> 8
GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION
NUMBER OF SUBSTITUTE FORM W-9
GUIDELINES FOR DETERMINING THE PROPER IDENTIFICATION NUMBER TO GIVE THE
PAYER. -- Social Security numbers have nine digits separated by two hyphens:
i.e. 000-00-0000. Employer identification numbers have nine digits separated by
only one hyphen: i.e. 00-0000000. The table below will help determine the number
to give the payer.
<TABLE>
<C> <S> <C>
- ---------------------------------------------------------
FOR THIS TYPE OF ACCOUNT: GIVE THE
SOCIAL SECURITY
NUMBER OF --
- ---------------------------------------------------------
1. An individual's account The individual
2. Two or more individuals The actual owner of
(joint account) the account or, if
combined funds, any
one of the
individuals(1)
3. Husband and wife (joint The actual owner of
account) the account or, if
joint funds, either
person(1)
4. Custodian account of a minor The minor(2)
(Uniform Gift to Minors Act)
5. Adult and minor (joint The adult or, if the
account) minor is the only
contributor, the
minor(1)
6. Account in the name of The ward, minor, or
guardian or committee for a incompetent person(3)
designated ward, minor, or
incompetent person
7. a. The usual revocable The grantor-
savings trust account trustee(1)
(grantor is also trustee)
b. So-called trust account The actual owner(1)
that is not a legal or
valid trust under State
law.
=========================================================
FOR THIS TYPE OF ACCOUNT: GIVE THE
EMPLOYER
IDENTIFICATION
NUMBER OF --
- ---------------------------------------------------------
8. Sole proprietorship account. The owner
9. A valid trust, estate, or The legal entity (do
pension trust. not furnish the
identifying number of
the personal
representative or
trustee unless the
legal entity itself is
not designated in the
account title.)(5)
10. Corporate account The corporation
11. Religious, charitable, or The organization
educational organization
account.
12. Partnership account held in The partnership
the name of the business.
13. Association, club, or other The organization
tax-exempt organization.
14. A broker or registered The broker or nominee
nominee
15. Account with the Department The public entity
of Agriculture in the name
of a public entity (such as
a State or local government,
school district, or prison)
that receives agricultural
program payments
- ---------------------------------------------------------
</TABLE>
(1) List first and circle the name of the person whose number you furnish.
(2) Circle the minor's name and furnish the minor's social security number.
(3) Circle the ward's, minor's or incompetent person's name and furnish such
person's social security number.
(4) Show the name of the owner.
(5) List first and circle the name of the legal trust, estate, or pension trust.
NOTE:If no name is circled when there is more than one name, the number will be
considered to be that of the first name listed.
<PAGE> 1
EXHIBIT 99.2
NOTICE OF GUARANTEED DELIVERY TO TENDER
UNREGISTERED 10 1/4% SENIOR NOTES DUE 2006
(INCLUDING THOSE IN BOOK-ENTRY FORM)
OF
COSTILLA ENERGY, INC.
PURSUANT TO THE OFFER TO EXCHANGE AND
PROSPECTUS DATED , 1998
As set forth in the Exchange Offer (as defined in the Prospectus (as
hereinafter defined)), this form or one substantially equivalent hereto must be
used to accept the Exchange Offer if certificates for unregistered 10 1/4%
Senior Notes Due 2006 (the "Private Notes") of Costilla Energy, Inc. are not
immediately available or time will not permit a holder's Private Notes or other
required documents to reach the Exchange Agent on or prior to the Expiration
Date (as defined), or the procedure for book-entry transfer cannot be completed
on a timely basis. This form may be delivered by facsimile transmission, by
registered or certified mail, by hand delivery, or by overnight mail to the
Exchange Agent. See "The Exchange Offer -- Procedures for Tendering" in the
Prospectus.
---------------------
THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 5:00 P.M., NEW YORK CITY
TIME, ON , 1998 (THE "EXPIRATION DATE"), UNLESS THE EXCHANGE OFFER IS
EXTENDED BY THE COMPANY.
---------------------
THE EXCHANGE AGENT FOR THE EXCHANGE OFFER IS:
STATE STREET BANK AND TRUST COMPANY
<TABLE>
<S> <C>
By Registered or Certified Mail, By Facsimile:
Overnight Mail or Hand Delivery:
State Street Bank and Trust Company State Street Bank and Trust Company
Corporate Trust Department Attention: Corporate Trust Department
Two International Place (617) 664-5371
Boston, Massachusetts 02110
</TABLE>
(Originals of all documents sent by facsimile should be sent promptly by
registered or certified mail, by hand, or by overnight delivery service.)
DELIVERY OF THIS NOTICE TO AN ADDRESS OR TRANSMISSION OF INSTRUCTIONS VIA
FACSIMILE OTHER THAN AS SET FORTH ABOVE WILL NOT CONSTITUTE A VALID DELIVERY.
<PAGE> 2
Ladies and Gentlemen:
The undersigned hereby tenders to Costilla Energy, Inc., a Delaware
corporation (the "Company"), in accordance with the Company's offer, upon the
terms and subject to the conditions set forth in the Prospectus dated
, 1998 (the "Prospectus"), and in the accompanying Letter of Transmittal,
receipt of which is hereby acknowledged, $ in aggregate principal
amount of Private Notes pursuant to the guaranteed delivery procedures described
in the Prospectus.
Name(s) of Registered Holder(s):
------------------------------------
(Please Type or Print)
Address:
------------------------------------
------------------------------------
Area Code & Telephone No.:
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Certificate Number(s) for
Private Notes (if available):
------------------------------------
Total Principal Amount
of Private Notes Tendered:
------------------------------------
Signature of Registered Holder(s):
------------------------------------
Dated:
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[ ] The Depository Trust Company
(Check if shares of Private
Notes will be tendered by
book-entry transfer)
Account Number:
------------------------------------
THE GUARANTEE ON THE FOLLOWING PAGE MUST BE COMPLETED
<PAGE> 3
GUARANTEE
(NOT TO BE USED FOR SIGNATURE GUARANTEE)
The undersigned, being an eligible guarantor institution that is a member
of or participant in the Securities Transfer Agents Medallion Program, the New
York Stock Exchange Medallion Signature Program, the Stock Exchange Medallion
Program, or an "eligible guarantor institution" within the meaning of Rule
17Ad-15 under the Securities Exchange Act of 1934, as amended (the "Exchange
Act") hereby guarantees (a) that the above named person(s) "own(s)" the Private
Notes tendered hereby within the meaning of Rule 14e-4 ("Rule 14e-4") under the
Exchange Act, (b) that such tender of such Private Notes complies with Rule
14e-4, and (c) to deliver to the Exchange Agent the certificates representing
the Private Notes tendered hereby or confirmation of book-entry transfer of such
Private Notes into the Exchange Agent's account at The Depository Trust Company,
in proper form for transfer, together with the Letter of Transmittal (or
facsimile thereof), properly completed and duly executed, with any required
signature guarantees and any other required documents, within five Nasdaq Stock
Market trading days after the Expiration Date.
Name of Firm:
------------------------------------
Address:
------------------------------------
------------------------------------
Area Code and Telephone No.:
------------------------------------
Authorized Signature:
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Name:
------------------------------------
Title:
------------------------------------
Dated:
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NOTE: DO NOT SEND PRIVATE NOTES WITH THIS FORM.
PRIVATE NOTES SHOULD BE SENT ONLY WITH A LETTER OF TRANSMITTAL.
