-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KXQTgPId/gAEGFQ5Wd4x5Z/CSF0R2QWMJ1gkd5/lttnjcm3OOo9FMv4n9p7CwEbX UcHeEYd3N1P0fPs6c8ivzw== 0000950129-03-004273.txt : 20030814 0000950129-03-004273.hdr.sgml : 20030814 20030814162231 ACCESSION NUMBER: 0000950129-03-004273 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20030630 FILED AS OF DATE: 20030814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CARRIZO OIL & GAS INC CENTRAL INDEX KEY: 0001040593 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 760415919 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-29187-87 FILM NUMBER: 03848035 BUSINESS ADDRESS: STREET 1: 14701 ST MARYS LANE STREET 2: STE 800 CITY: HOUSTON STATE: TX ZIP: 77079 BUSINESS PHONE: 2814961352 MAIL ADDRESS: STREET 1: 14701 ST MARYS LANE STREET 2: SUITE 800 CITY: HOUSTON STATE: TX ZIP: 77079 10-Q 1 h08461e10vq.txt CARRIZO OIL & GAS, INC.- JUNE 30, 2003 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 2003 ------------- [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _________ Commission File Number 000-22915. CARRIZO OIL & GAS, INC. (Exact name of registrant as specified in its charter) TEXAS 76-0415919 ----- ---------- (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 14701 ST. MARY'S LANE, SUITE 800, HOUSTON, TX 77079 - --------------------------------------------- ----- (Address of principal executive offices) (Zip Code)
(281) 496-1352 (Registrant's telephone number) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] The number of shares outstanding of the registrant's common stock, par value $0.01 per share, as of August 1, 2003, the latest practicable date, was 14,237,217. CARRIZO OIL & GAS, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 INDEX
PART I. FINANCIAL INFORMATION PAGE Item 1. Consolidated Balance Sheets - As of December 31, 2002 and June 30, 2003 2 Consolidated Statements of Operations - For the three and six month periods ended June 30, 2003 and 2002 3 Consolidated Statements of Cash Flows - For the six month periods ended June 30, 2003 and 2002 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 3A. Quantitative and Qualitative Disclosure About Market Risk 33 Item 4. Controls and Procedures 34 PART II. OTHER INFORMATION Items 1-6. 35 SIGNATURES 37
CARRIZO OIL & GAS, INC. CONSOLIDATED BALANCE SHEETS (UNAUDITED)
DECEMBER 31, JUNE 30, 2002 2003 ------------- ------------- ASSETS (In thousands) CURRENT ASSETS: Cash and cash equivalents $ 4,743 $ 4,060 Accounts receivable, trade (net of allowance for doubtful accounts of $0.5 million at December 31, 2002 and June 30, 2003, respectively) 8,207 8,557 Advances to operators 501 686 Deposits 46 71 Other current assets 605 365 ------------- ------------- Total current assets 14,102 13,739 PROPERTY AND EQUIPMENT, net (full-cost method of accounting for oil and natural gas properties) 120,526 119,986 Investment in Pinnacle Gas Resources, Inc. (Note 3) -- 7,256 Deferred financing costs 760 679 ------------- ------------- $ 135,388 $ 141,660 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable, trade $ 9,957 $ 13,063 Accrued liabilities 1,014 1,807 Advances for joint operations 1,550 1,673 Current maturities of long-term debt 1,609 786 Current maturities of seismic obligation payable 1,414 1,809 ------------- ------------- Total current liabilities 15,544 19,138 LONG-TERM DEBT 37,886 33,925 SEISMIC OBLIGATION PAYABLE 1,103 -- ASSET RETIREMENT OBLIGATION -- 669 DEFERRED INCOME TAXES 7,666 10,112 COMMITMENTS AND CONTINGENCIES (Note 6) CONVERTIBLE PARTICIPATING PREFERRED STOCK (10,000,000 shares of preferred stock authorized, of which 150,000 are shares designated as convertible participating shares, with 65,294 and 68,559 convertible participating shares issued and outstanding at December 31, 2002 and June 30, 2003, respectively) (Note 7) 6,373 6,735 SHAREHOLDERS' EQUITY: Warrants (3,262,821 outstanding at December 31, 2002 and June 30, 2003, respectively) 780 780 Common stock, par value $.01 (40,000,000 shares authorized with 14,177,383 and 14,232,717 issued and outstanding at December 31, 2002 and June 30, 2003, respectively) 142 142 Additional paid in capital 63,224 63,338 Retained earnings 3,058 7,499 Accumulated other comprehensive loss (388) (678) ------------- ------------- 66,816 71,081 ------------- ------------- $ 135,388 $ 141,660 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. -2- CARRIZO OIL & GAS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE FOR THE SIX MONTHS ENDED MONTHS ENDED JUNE 30, JUNE 30, ------------------------ ------------------------ 2002 2003 2002 2003 ---------- ---------- ---------- ---------- (IN THOUSANDS EXCEPT PER SHARE AMOUNTS) OIL AND NATURAL GAS REVENUES $ 6,780 $ 8,828 $ 10,807 $ 19,492 COSTS AND EXPENSES: Oil and natural gas operating expenses (exclusive of depreciation shown separately below) 1,341 1,763 2,353 3,483 Depreciation, depletion and amortization 2,636 2,605 4,606 5,641 General and administrative 1,143 1,267 2,059 2,650 Accretion expense related to asset retirement obligations -- 10 -- 18 Stock option compensation (14) 33 (56) 23 ---------- ---------- ---------- ---------- Total costs and expenses 5,106 5,678 8,962 11,815 ---------- ---------- ---------- ---------- OPERATING INCOME 1,674 3,150 1,845 7,677 OTHER INCOME AND EXPENSES: Other income and expenses 33 (82) 127 18 Interest income 8 22 28 40 Interest expense (216) (118) (432) (316) Interest expense, related parties (560) (591) (1,112) (1,174) Capitalized interest 776 704 1,544 1,479 ---------- ---------- ---------- ---------- INCOME BEFORE INCOME TAXES 1,715 3,085 2,000 7,724 INCOME TAXES (Note 5) 641 1,125 782 2,794 ---------- ---------- ---------- ---------- NET INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,074 1,960 1,218 4,930 DIVIDENDS AND ACCRETION ON PREFERRED STOCK 168 181 242 362 ---------- ---------- ---------- ---------- NET INCOME AVAILABLE TO COMMON SHAREHOLDERS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 906 1,779 976 4,568 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- -- -- 128 ---------- ---------- ---------- ---------- NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 906 $ 1,779 $ 976 $ 4,440 ========== ========== ========== ========== BASIC EARNINGS PER COMMON SHARE BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ 0.06 $ 0.13 $ 0.07 $ 0.32 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE NET OF INCOME TAXES 0.00 0.00 0.00 (0.01) ---------- ---------- ---------- ---------- BASIC EARNINGS PER COMMON SHARE $ 0.06 $ 0.13 $ 0.07 $ 0.31 ========== ========== ========== ========== DILUTED EARNINGS PER COMMON SHARE BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ 0.06 $ 0.11 $ 0.07 $ 0.28 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE NET OF INCOME TAXES 0.00 0.00 0.00 (0.01) ---------- ---------- ---------- ---------- DILUTED EARNINGS PER COMMON SHARE $ 0.06 $ 0.11 $ 0.07 $ 0.27 ========== ========== ========== ========== PRO FORMA AMOUNTS ASSUMING ASSET RETIREMENTS OBLIGATION IS APPLIED RETROACTIVELY: BASIC EARNINGS PER COMMON SHARE $ 0.00 $ 0.13 $ 0.07 $ 0.32 ========== ========== ========== ========== DILUTED EARNINGS PER COMMON SHARE $ 0.00 $ 0.11 $ 0.07 $ 0.27 ========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. -3- CARRIZO OIL & GAS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 2003 ---------------------------- 2002 2003 ------------ ------------ (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income before cumulative effect of change in accounting principle $ 1,218 $ 4,930 Adjustment to reconcile net income to net cash provided by operating activities- Depreciation, depletion and amortization 4,606 5,641 Discount accretion 43 60 Ineffective derivative instruments (389) (91) Interest payable in kind 667 704 Stock option compensation (benefit) (56) 23 Deferred income taxes 700 2,704 Changes in assets and liabilities- Accounts receivable (380) (350) Other assets (261) 336 Accounts payable (2,333) 776 Other liabilities 268 324 ------------ ------------ Net cash provided by operating activities 4,083 15,057 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures (11,105) (13,984) Change in capital expenditure accrual 2,697 2,329 Advances to operators (405) (185) Advances for joint operations 3,362 123 ------------ ------------ Net cash used in investing activities (5,451) (11,717) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from the sale of common stock 11 115 Net proceeds from the sale of preferred stock 5,785 -- Net proceeds from the sale of warrants 15 -- Advances under Borrowing Base Credit Facility 6,500 -- Debt repayments (7,952) (4,138) ------------ ------------ Net cash provided by (used in) financing activities 4,359 (4,023) ------------ ------------ NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,991 (683) CASH AND CASH EQUIVALENTS, beginning of period 3,236 4,743 ------------ ------------ CASH AND CASH EQUIVALENTS, end of period $ 6,227 $ 4,060 ============ ============ SUPPLEMENTAL CASH FLOW DISCLOSURES: Cash paid for interest (net of amounts capitalized) $ -- $ -- ============ ============ Cash paid for income taxes $ -- $ -- ============ ============ Common stock issued for oil and gas property (Note 8) $ 475 $ -- ============ ============
The accompanying notes are an integral part of these consolidated financial statements. -4- CARRIZO OIL & GAS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. ACCOUNTING POLICIES The consolidated financial statements included herein have been prepared by Carrizo Oil & Gas, Inc. (the Company), and are unaudited, except for the balance sheet at December 31, 2002, which has been prepared from the audited financial statements at that date. The financial statements reflect the accounts of the Company and its subsidiary after elimination of all significant intercompany transactions and balances. The financial statements reflect necessary adjustments, all of which were of a recurring nature, and are in the opinion of management necessary for a fair presentation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The Company believes that the disclosures presented are adequate to allow the information presented not to be misleading. The financial statements included herein should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. 2. EARNINGS PER COMMON SHARE Supplemental earnings per share information is provided below:
FOR THE THREE MONTHS ENDED JUNE 30, ----------------------------------------------------------------------------- (In thousands except share and per share amounts) INCOME SHARES PER-SHARE AMOUNT ------------------------ ----------------------- ----------------------- 2002 2003 2002 2003 2002 2003 ---------- ---------- ---------- ---------- ---------- ---------- Net income $ 1,074 $ 1,960 Less: Dividends and Accretion of Discount on Preferred Shares (168) (181) ---------- ---------- Basic Earnings per Share Net income available to common shareholders 906 1,779 14,151,011 14,211,173 $ 0.06 $ 0.13 ========== ========== Dilutive effect of Stock Options, Warrants and Preferred Stock conversions -- -- 3,118,534 2,384,642 ---------- ---------- ---------- ---------- Diluted Earnings per Share Net income available to common shareholders plus assumed conversions $ 906 $ 1,779 17,269,545 16,595,815 $ 0.06 $ 0.11 ========== ========== ========== ========== ========== ==========
FOR THE SIX MONTHS ENDED JUNE 30, ----------------------------------------------------------------------------- (In thousands except share and per share amounts) INCOME SHARES PER-SHARE AMOUNT ------------------------ ----------------------- ----------------------- 2002 2003 2002 2003 2002 2003 ---------- ---------- ---------- ---------- ---------- ---------- Net income before cumulative effect of change in accounting principle $ 1,218 $ 4,930 Less: Dividends and Accretion of Discount on Preferred Shares (242) (362) ---------- ---------- Basic Earnings per Share Net income available to common shareholders 976 4,568 14,139,894 14,204,690 $ 0.07 $ 0.32 ========== ========== Dilutive effect of Stock Options, Warrants and Preferred Stock conversions -- -- 2,842,993 2,260,300 ---------- ---------- ---------- ---------- Diluted Earnings per Share Net income available to common shareholders plus assumed conversions $ 976 $ 4,568 16,982,887 16,464,990 $ 0.07 $ 0.28 ========== ========== ========== ========== ========== ==========
-5-
FOR THE SIX MONTHS ENDED JUNE 30, ---------------------------------------------------------------------------------- (In thousands except share and per share amounts) INCOME SHARES PER-SHARE AMOUNT ----------------- ----------------------------- ----------------------------- 2002 2003 2002 2003 2002 2003 ------- ------- ------------- ------------- ------------- ------------- Cumulative effect of change in accounting principle net of income taxes $ -- $ (128) Basic Earnings per Share Net loss available to common shareholders -- -- 14,139,894 14,204,690 $ 0.00 $ (0.01) ============= ============= Dilutive effect of Stock Options, Warrants and Preferred Stock conversions -- -- 2,842,993 2,260,300 ------- ------- ------------- ------------- Diluted Earnings per Share Net income available to common shareholders plus assumed conversions $ -- $ (128) 16,982,887 16,464,990 $ 0.00 $ (0.01) ======= ======= ============= ============= ============= =============
FOR THE SIX MONTHS ENDED JUNE 30, ----------------------------------------------------------------------------- (In thousands except share and per share amounts) INCOME SHARES PER-SHARE AMOUNT ------------------------ ----------------------- ----------------------- 2002 2003 2002 2003 2002 2003 ---------- ---------- ---------- ---------- ---------- ---------- Net income $ 1,218 $ 4,802 Less: Dividends and Accretion of Discount on Preferred Shares (242) (362) ---------- ---------- Basic Earnings per Share Net income available to common shareholders 976 4,440 14,139,894 14,204,690 $ 0.07 $ 0.31 ========== ========== Dilutive effect of Stock Options, Warrants and Preferred Stock conversions -- -- 2,842,993 2,260,300 ---------- ---------- ---------- ---------- Diluted Earnings per Share Net income available to common shareholders plus assumed conversions $ 976 $ 4,440 16,982,887 16,464,990 $ 0.07 $ 0.27 ========== ========== ========== ========== ========== ==========
Basic earnings per common share is based on the weighted average number of shares of common stock outstanding during the periods. Diluted earnings per common share is based on the weighted average number of common shares and all dilutive potential common shares outstanding during the periods. The Company had outstanding 189,833 and 146,500 stock options and 252,632 warrants during the three months ended June 30, 2002 and 2003, respectively, which were antidilutive and were not included in the calculation because the exercise price of these instruments exceeded the underlying market value of the options and warrants. The Company had outstanding 202,333 and 156,500 stock options and 252,632 warrants during the six months ended June 30, 2002 and 2003, respectively, which were antidilutive and were not included in the calculation because the exercise price of these instruments exceeded the underlying market value of the options and warrants. At June 30, 2002 and 2003, the Company also had zero and 1,202,791 shares, respectively, based on the assumed conversion of the Series B Convertible Participating Preferred Stock, that were antidilutive and were not included in the calculation. 3. INVESTMENT IN PINNACLE GAS RESOURCES, INC. THE PINNACLE TRANSACTION On June 23, 2003, pursuant to a Subscription and Contribution Agreement by and among the Company and its wholly-owned subsidiary, CCBM, Inc. ("CCBM"), Rocky Mountain Gas, Inc. ("RMG") and the Credit Suisse First Boston Private Equity entities, named therein (the "CSFB Parties"), CCBM and RMG contributed their respective interests, having a estimated fair value of approximately $7.5 million each, in (1) leases in the Clearmont, Kirby, Arvada and Bobcat project areas and (2) oil and gas reserves in the Bobcat project area to a newly formed entity, Pinnacle Gas Resources, Inc., a Delaware corporation ("Pinnacle"). In exchange for the contribution of these assets, CCBM and RMG each received 37.5% of the common stock of Pinnacle ("Pinnacle Common Stock") as of the closing date and options to purchase Pinnacle Common Stock ("Pinnacle Stock Options"). In connection with the oil and natural gas leases contributed to Pinnacle, CCBM no longer has a drilling obligation (see "General Overview" in the MDA for further discussion). -6- Simultaneously with the contribution of these assets, the CSFB Parties contributed approximately $17.6 million of cash to Pinnacle in return for the Redeemable Preferred Stock of Pinnacle ("Pinnacle Preferred Stock"), 25% of the Pinnacle Common Stock as of the closing date and warrants to purchase Pinnacle Common Stock ("Pinnacle Warrants"). The CSFB Parties also agreed to contribute additional cash, under certain circumstances, of up to approximately $11.8 million to Pinnacle to fund future drilling, development and acquisitions. The CSFB Parties currently have greater than 50% of the voting power of the Pinnacle capital stock through their ownership of Pinnacle Common Stock and Pinnacle Preferred Stock. Currently, on a fully diluted basis, assuming that all parties exercised their Pinnacle Warrants and Pinnacle Options, the CSFB Parties, CCBM and RMG would have ownership interests of approximately 46.2%, 26.9% and 26.9%, respectively. On a fully-diluted basis, assuming the additional $11.8 million of cash was contributed by the CSFB Parties and all Pinnacle Warrants and Pinnacle Options were exercised by all parties, the CSFB Parties would own 54.6% of Pinnacle and CCBM and RMG would each own 22.7% of Pinnacle. Immediately following the contribution and funding, Pinnacle used approximately $6.2 million of the proceeds from the funding to acquire an approximate 50% working interest in existing leases and approximately 36,529 gross acres prospective for coalbed methane development in the Powder River Basin of Wyoming from Gastar Exploration, Ltd. The leases include 95 producing coalbed methane wells currently in the early stages of dewatering. These wells are producing at a combined gross rate of approximately 2.5 MMcfd, or an estimated 1 MMcfd net to Pinnacle. Pinnacle also agreed to fund up to $14.9 million of future drilling and development costs on these properties on behalf of Gastar prior to December 31, 2005. The drilling and development work will be done under the terms of an earn-in joint venture agreement between Pinnacle and Gastar. The majority of these leases are part of, or adjacent to, the Bobcat project area. All of CCBM and RMG's interests in the Bobcat project area, the only producing coalbed methane property owned by CCBM prior to the transaction, were contributed to Pinnacle. Pinnacle currently owns interests in approximately 131,000 gross acres in the Powder River Basin. Prior to and in connection with its contribution of assets to Pinnacle, CCBM paid RMG approximately $1.8 million in cash as part of its outstanding purchase obligation on the coalbed methane property interests CCBM previously acquired from RMG. The approximate $1.2 million remaining balance of CCBM's obligation to RMG is scheduled to be paid in monthly installments of approximately $52,805 through November 2004 and a balloon payment on December 31, 2004. The RMG note is secured solely by CCBM's interests in the remaining oil and natural gas leases in Wyoming and Montana. In connection with the Company's investment in Pinnacle, the Company received a reduction in the principal amount of the RMG note of approximately $1.5 million and relinquished the right to receive certain revenues related to the properties contributed to Pinnacle. CCBM continues its coalbed methane business activities and, in addition to its interest in Pinnacle, owns direct interests in approximately 189,000 gross acres of coalbed methane properties in the Castle Rock project area in Montana and the Oyster Ridge project area in Wyoming, which were not contributed to Pinnacle. CCBM and RMG will continue to conduct exploration and development activities on these properties as well as pursue other potential acquisitions. The Bobcat property was producing approximately 400 Mcfe of coalbed methane gas net to CCBM's interest immediately prior to its contribution to Pinnacle. Other than indirectly through Pinnacle, CCBM currently has no proved reserves of, and is no longer receiving revenue from, coalbed methane gas. ACCOUNTING AND TAX TREATMENT For accounting purposes, the transaction will be treated as a reclassification of a portion of CCBM's investments in the contributed properties. The property contribution made by CCBM to Pinnacle is intended to be treated as a tax-deferred exchange as constituted by property transfers under section 351(a) of the Internal Revenue Code of 1986, as amended. The FASB issued Interpretation 46, "Consolidation of Variable Interest Entities" ("FIN 46"), in January 2003. FIN 46 requires the consolidation of certain types of entities in which a company absorbs a majority of another entity's expected losses, receives a majority of the other entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the other entity. These entities are called "variable interest entities". The provisions of FIN 46 are effective for the Company in the second quarter for new transactions or entities formed in 2003 and in the third quarter for transactions or entities formed prior to 2003. If an entity is determined to be a "variable interest entity" ("VIE"), the entity must be consolidated by the "primary beneficiary". The primary beneficiary is the holder of the variable interests that absorbs a majority of the variable interest entity's expected losses or receives a majority of the entity's residual returns in the event no holder has a majority of the expected losses. The determination of the primary beneficiary is based on projected cash flows at the inception of the variable interests. Because Steven A. Webster, Chairman of Carrizo, is also a managing director of Credit Suisse First Boston ("Related Parties in Pinnacle Transaction" below), -7- Carrizo could be defined as the primary beneficiary if the projected cash flows analysis indicated losses in excess of the equity invested. The initial determination of whether an entity is a VIE is to be reconsidered only when one or more of the following occur (1) the entity's governing documents or the contractual arrangements among the parties involved change, (2) the equity investment of some part thereof is returned to the investors, and other parties become exposed to expected losses or (3) the entity undertakes additional activities or acquires additional assets that increase the entity's expected losses. We have determined that we should not consolidate Pinnacle, under FIN 46, because our current projected cash flow analysis of Pinnacle's operations at inception does not indicate that Pinnacle is not a VIE. Accordingly, our investment in Pinnacle has been recorded using the equity method of accounting. The reclassification of investments in contributed properties resulting from the transaction with Pinnacle are reflected in accordance with the full cost method of accounting in the Company's balance sheet included in this Form 10-Q for the six months ended June 30, 2003. RELATED PARTIES IN THE PINNACLE TRANSACTION Steven A. Webster, Chairman of the Board of the Company, is also a managing director of Credit Suisse First Boston Private Equity and is therefore a related party to this transaction. TRANSITION SERVICES AGREEMENT The Company entered into a transition services agreement with Pinnacle pursuant to which the Company will provide certain accounting, treasury, tax, insurance and financial reporting functions to Pinnacle through the end of 2003 for a monthly fee equal to our actual cost to provide such services. After December 31, 2003, the agreement will automatically renew on a quarterly basis unless one of the parties gives notice of its intent to terminate the agreement. Similarly, Pinnacle has also entered into a transition services agreement with RMG to provide Pinnacle assistance in setting up operational accounting and management systems for a monthly fee equal to the actual cost to provide such services. After December 31, 2003, the agreement will automatically renew on a quarterly basis unless one of the parties gives notice of its intent to terminate the agreement. -8- 4. LONG-TERM DEBT At December 31, 2002 and June 30, 2003, long-term debt consisted of the following:
DECEMBER 31, JUNE 30, 2002 2003 ----------- ----------- Borrowing base facility $ 8,500 $ 7,000 Senior subordinated notes, related parties 25,478 26,225 Capital lease obligations 267 305 Non-recourse note payable to Rocky Mountain Gas, Inc. 5,250 1,180 ----------- ----------- 39,495 34,710 Less: current maturities (1,609) (786) ----------- ----------- $ 37,886 $ 33,924 =========== ===========
On May 24, 2002, the Company entered into a credit agreement with Hibernia National Bank (the "Hibernia Facility") which matures on January 31, 2005, and repaid its existing facility with Compass Bank (the "Compass Facility"). The Hibernia Facility provides a revolving line of credit of up to $30.0 million. It is secured by mortgaged properties; which include substantially all of the Company's producing oil and gas properties assets, and is guaranteed by the Company's subsidiary. The borrowing base will be determined by Hibernia National Bank at least semi-annually on each October 31 and April 30. The initial borrowing base was $12.0 million, and the borrowing base as of April 30, 2003 was $16.0 million. Each party to the credit agreement can request one unscheduled borrowing base determination subsequent to each scheduled determination. The borrowing base will at all times equal the borrowing base most recently determined by Hibernia National Bank, less quarterly borrowing base reductions required subsequent to such determination. Hibernia National Bank will reset the borrowing base amount at each scheduled and each unscheduled borrowing base determination date. The initial quarterly borrowing base reduction, which commenced on June 30, 2002, was $1.3 million. The quarterly borrowing base reduction effective January 31, 2003 was $1.8 million. There was an increase in the borrowing base for the quarter ended June 30, 2003 of $2.2 million. On December 12, 2002, the Company entered into an Amended and Restated Credit Agreement with Hibernia National Bank that provided additional availability under the Hibernia Facility in the amount of $2.5 million which was structured as an additional "Facility B" under the Hibernia Facility. As such, the total borrowing base under the Hibernia Facility as of December 31, 2002 and June 30, 2003 was $15.5 million and $16.0 million, respectively, of which $8.5 million and $7.0 million was outstanding on December 31, 2002 and June 30, 2003, respectively. The Facility B bore interest at LIBOR plus 3.375%, was secured by certain leases and working interests in oil and natural gas wells and matured on April 30, 2003. If the principal balance of the Hibernia Facility ever exceeds the borrowing base as reduced by the quarterly borrowing base reduction (as described above), the principal balance in excess of such reduced borrowing base will be due as of the date of such reduction. Otherwise, any unpaid principal or interest will be due at maturity. If the principal balance of the Hibernia Facility ever exceeds any re-determined borrowing base, the Company has the option within thirty days to (individually or in combination): (i) make a lump sum payment curing the deficiency; (ii) pledge additional collateral sufficient in Hibernia National Bank's opinion to increase the borrowing base and cure the deficiency; or (iii) begin making equal monthly principal payments that will cure the deficiency within the ensuing six-month period. Such payments are in addition to any payments that may come due as a result of the quarterly borrowing base reductions. For each tranche of principal borrowed under the revolving line of credit, the interest rate will be, at the Company's option: (i) the Eurodollar Rate, plus an applicable margin equal to 2.375% if the amount borrowed is greater than or equal to 90% of the borrowing base, 2.0% if the amount borrowed is less than 90%, but greater than or equal to 50% of the borrowing base, or 1.625% if the amount borrowed is less than 50% of the borrowing base; or (ii) the Base Rate, plus an applicable margin of 0.375% if the amount borrowed is greater than or equal to 90% of the borrowing base. Interest on Eurodollar Loans is payable on either the last day of each Eurodollar option period or monthly, whichever is earlier. Interest on Base Rate Loans is payable monthly. The Company is subject to certain covenants under the terms of the Hibernia Facility, including, but not limited to the maintenance of the following financial covenants: (i) a minimum current ratio of 1.0 to 1.0 (including availability under the borrowing base), (ii) a minimum quarterly debt services coverage of 1.25 times, and (iii) a minimum shareholders equity equal to $56.0 million, plus 100% of all subsequent common and preferred equity contributed by shareholders, plus 50% of all positive earning occurring subsequent to such quarter end, all ratios as more particularly discussed in the credit facility. The Hibernia Facility also places restrictions on -10- additional indebtedness, dividends to non-preferred stockholders, liens, investments, mergers, acquisitions, asset dispositions, asset pledges and mortgages, change of control, repurchase or redemption for cash of the Company's common or preferred stock, speculative commodity transactions, and other matters. At December 31, 2002 and June 30, 2003, amounts outstanding under the Hibernia Facility totaled $8.5 million and $7.0 million, respectively, with an additional $4.3 million and $9.0 million, respectively, under Facility A and $2.5 million under Facility B at December 31, 2002 available for future borrowings. No amounts under the Compass Facility were outstanding at December 31, 2002. At December 31, 2002 and June 30, 2003, one letter of credit was issued and outstanding under the Hibernia Facility in the amount of $0.2 million. On June 29, 2001, CCBM, Inc., a wholly owned subsidiary of the Company ("CCBM"), issued a non-recourse promissory note payable in the amount of $7.5 million to RMG as consideration for certain interests in oil and natural gas leases held by RMG in Wyoming and Montana. The RMG note was payable in 41-monthly principal payments of $0.1 million plus interest at 8% per annum commencing July 31, 2001 with the balance due December 31, 2004. The RMG note is secured solely by CCBM's interests in the oil and natural gas leases in Wyoming and Montana. At December 31, 2002 and June 30, 2003, the outstanding principal balance of this note was $5.3 million and $1.2 million, respectively. In connection with the Company's investment in Pinnacle (see Note 3), the Company received a reduction in the principal amount of the RMG note of approximately $1.5 million and relinquished the right to certain revenues related to the properties contributed to Pinnacle. In December 2001, the Company entered into a capital lease agreement secured by certain production equipment in the amount of $0.2 million. The lease is payable in one payment of $11,323 and 35 monthly payments of $7,549 including interest at 8.6% per annum. In October 2002, the Company entered into a capital lease agreement secured by certain production equipment in the amount of $0.1 million. The lease is payable in 36 monthly payments of $3,462 including interest at 6.4% per annum. In May 2003, the Company entered into a capital lease agreement secured by certain production equipment in the amount of $0.1 million. The lease is payable in 36 monthly payments of $3,030 including interest at 5.5% per annum. The Company has the option to acquire the equipment at the conclusion of the lease for $1 under all of these leases. DD&A on the capital leases for the three months ended June 30, 2002 and 2003 amounted to $8,000 and $20,000, respectively. DD&A on the capital leases for the six months ended June 30, 2002 and 2003 amounted to $16,000 and $38,000 respectively, and accumulated DD&A on the leased equipment at December 31, 2002 and June 30, 2003 amounted to $28,000 and $56,000, respectively. In December 1999, the Company consummated the sale of $22.0 million principal amount of 9% Senior Subordinated Notes due 2007 (the "Subordinated Notes") and $8.0 million of common stock and Warrants. The Company sold $17.6 million, $2.2 million, $0.8 million, $0.8 million and $0.8 million principal amount of Subordinated Notes; 2,909,092, 363,636, 121,212, 121,212 and 121,212 shares of the Company's common stock and 2,208,152, 276,019, 92,006, 92,006 and 92,006 Warrants to CB Capital Investors, L.P. (now known as JPMorgan Partners, LLC), Mellon Ventures, L.P., Paul B. Loyd, Jr., Steven A. Webster and Douglas A.P. Hamilton, respectively. The Subordinated Notes were sold at a discount of $0.7 million, which is being amortized over the life of the notes. Interest payments are due quarterly commencing on March 31, 2000. The Company may elect, for a period of up to five years, to increase the amount of the Subordinated Notes for 60% of the interest which would otherwise be payable in cash. As of December 31, 2002 and June 30, 2003, the outstanding balance of the Subordinated Notes had been increased by $3.9 million and $4.6 million, respectively, for such interest paid in kind. The Company is subject to certain covenants under the terms of the Subordinated Notes securities purchase agreement, including but not limited to, (a) maintenance of a specified tangible net worth, (b) maintenance of a ratio of EBITDA (earnings before interest, taxes, depreciation and amortization) to quarterly Debt Service (as defined in the agreement) of not less than 1.00 to 1.00, and (c) a limitation of its capital expenditures to an amount equal to the Company's EBITDA for the immediately prior fiscal year (unless approved by the Company's Board of Directors and a JPMorgan Partners, LLC appointed director), as well as limits on the Company's ability to (i) incur indebtedness, (ii) incur or allow liens, (iii) engage in mergers, consolidation, sales of assets and acquisitions, (iv) declare dividends and effect certain distributions (including restrictions on distributions upon the Common Stock), (v) engage in transactions with affiliates and (vi) make certain repayments and prepayments, including any prepayment of the subordinated debt, indebtedness that is guaranteed or credit-enhanced by any affiliate of the Company, and prepayments that effect certain permanent reductions in revolving credit facilities. EBITDA was part of a negotiated covenant with the purchasers and is presented here as a disclosure of the Company's covenant obligations. At December 31, 2002 and June 30, 2003, the Company believes it was in compliance with all of its debt covenants. -11- 5. INCOME TAXES The Company estimates its annual effective tax rate to be approximately 35%, which also approximates its statutory rate. The Company provided deferred tax expense of $0.6 million and $1.1 million for the three months ended June 30, 2002 and 2003, respectively, and $0.7 million and $2.7 million for the six months ended June 30, 2002 and 2003, respectively. 6. COMMITMENTS AND CONTINGENCIES From time to time, the Company is party to certain legal actions and claims arising in the ordinary course of business. While the outcome of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect on the financial position or results of operations of the Company. The operations and financial position of the Company continue to be affected from time to time in varying degrees by domestic and foreign political developments as well as legislation and regulations pertaining to restrictions on oil and natural gas production, imports and exports, natural gas regulation, tax increases, environmental regulations and cancellation of contract rights. Both the likelihood and overall effect of such occurrences on the Company vary greatly and are not predictable. During August 2001, the Company entered into an agreement whereby the lessor will provide to the Company up to $0.8 million in financing for production equipment utilizing capital leases. At December 31, 2002 and June 30, 2003, two and three leases in the amount of $0.4 million and $0.5 million, respectively, had been executed under this facility. Pursuant to agreements entered into with RMG in June 2001, CCBM has an obligation to fund $2.5 million of drilling costs on behalf of RMG. Through June 30, 2003, CCBM had satisfied $2.2 million of the drilling obligation on behalf of RMG. 7. CONVERTIBLE PARTICIPATING PREFERRED STOCK In February 2002, the Company consummated the sale of 60,000 shares of Convertible Participating Series B Preferred Stock (the "Series B Preferred Stock") and Warrants to purchase 252,632 shares of Carrizo's common stock for an aggregate purchase price of $6.0 million. The Company sold 40,000 and 20,000 shares of Series B Preferred Stock and 168,422 and 84,210 Warrants to Mellon Ventures, Inc. and Steven A. Webster, respectively. The Series B Preferred Stock is convertible into common stock by the investors at a conversion price of $5.70 per share, subject to adjustments, and is initially convertible into 1,052,632 shares of common stock. Dividends on the Series B Preferred Stock will be payable in either cash at a rate of 8% per annum or, at the Company's option, by payment in kind of additional shares of the same series of preferred stock at a rate of 10% per annum. At December 31, 2002 and June 30, 2003, the outstanding balance of the Series B Preferred Stock has been increased by $0.5 million (5,294 shares) and $0.9 million (8,559 shares), respectively, for dividends paid in kind. The Series B Preferred Stock is redeemable at varying prices in whole or in part at the holders' option after three years or at the Company's option at any time. The Series B Preferred Stock will also participate in any dividends declared on the common stock. Holders of the Series B Preferred Stock will receive a liquidation preference upon the liquidation of, or certain mergers or sales of substantially all assets involving, the Company. Such holders will also have the option of receiving a change of control repayment price upon certain deemed change of control transactions. The warrants have a five-year term and entitle the holders to purchase up to 252,632 shares of Carrizo's common stock at a price of $5.94 per share, subject to adjustments, and are exercisable at any time after issuance. The warrants may be exercised on a cashless exercise basis. Net proceeds of this financing were approximately $5.8 million and were used primarily to fund the Company's ongoing exploration and development program and general corporate purposes. 8. SHAREHOLDER'S EQUITY The Company issued 106,472 and 55,334 shares of common stock during the six months ended June 30, 2002 and June 30, 2003, respectively. The shares issued during the six months ended June 30, 2002 were partial consideration for the acquisition of an interest in certain oil and natural gas properties and the shares issued during the six months ended June 30, 2003 were the result of the exercise of options granted under the Company's Incentive Plan. In June of 1997, the Company established the Incentive Plan of Carrizo Oil & Gas, Inc. (the "Incentive Plan"). In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation", which requires the Company to record stock-based compensation at fair value. In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock Based Compensation - Transition and Disclosure". The Company has adopted the disclosure requirements of SFAS No. 148 and has elected to record employee compensation expense utilizing the intrinsic value method permitted under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees". The Company accounts for its employees' stock-based compensation plan under -12- APB Opinion No. 25 and its related interpretations. Accordingly, any deferred compensation expense would be recorded for stock options based on the excess of the market value of the common stock on the date the options were granted over the aggregate exercise price of the options. This deferred compensation would be amortized over the vesting period of each option. Had compensation cost been determined consistent with SFAS No. 123 "Accounting for Stock Based Compensation" for all options, the Company's net income (loss) and earnings per share would have been as follows:
FOR THE THREE MONTHS ENDED JUNE 30, ---------------------------------- 2002 2003 --------------- --------------- (In thousands except per share amounts) Net income available to common shareholders, as reported $ 906 $ 1,779 Less: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects (199) (132) --------------- --------------- Pro forma net income (loss) available to common shareholders $ 707 $ 1,647 =============== =============== Net income per common share, as reported: Basic $ 0.06 $ 0.13 Diluted 0.06 0.11 Pro Forma net income (loss) per common share, as if value method had been applied to all awards: Basic $ 0.05 $ 0.12 Diluted 0.04 0.10
-13-
FOR THE SIX MONTHS ENDED JUNE 30, ---------------------------------- 2002 2003 --------------- --------------- (In thousands except per share amounts) Net income available to common shareholders, as reported $ 976 $ 4,440 Less: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects (259) (264) --------------- --------------- Pro forma net income (loss) available to common shareholders $ 717 $ 4,176 =============== =============== Net income per common share, as reported: Basic $ 0.07 $ 0.32 Diluted 0.07 0.28 Pro Forma net income (loss) per common share, as if value method had been applied to all awards: Basic $ 0.05 $ 0.29 Diluted 0.04 0.25
Diluted earnings per share amounts for the three months ended June 30, 2002 and 2003 are based upon 17,269,545 and 16,595,815 shares, respectively, that include the dilutive effect of assumed stock option and warrant conversions of 3,118,534 and 2,384,642, respectively. Diluted earnings per share amounts for the six months ended June 30, 2002 and 2003 are based upon 16,982,887 and 16,464,990 shares, respectively, that include the dilutive effect of assumed stock options and warrant conversions of 2,842,993 and 2,260,300, respectively. 9. CHANGE IN ACCOUNTING PRINCIPLE In June 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations". This Statement is effective for fiscal years beginning after June 15, 2002, and the Company adopted the Statement effective January 1, 2003. During the three months ended March 31, 2003, the Company recorded a cumulative effect of change in accounting principle of $0.1 million, $0.4 million as proved properties and $0.5 million as a liability for its plugging and abandonment expenses. 10. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITY The Company's operations involve managing market risks related to changes in commodity prices. Derivative financial instruments, specifically swaps, futures, options and other contracts, are used to reduce and manage those risks. The Company addresses market risk by selecting instruments whose value fluctuations correlate strongly with the underlying commodity being hedged. The Company enters into swaps, options, collars and other derivative contracts to hedge the price risks associated with a portion of anticipated future oil and natural gas production. While the use of hedging arrangements limits the downside risk of adverse price movements, it may also limit future gains from favorable movements. Under these agreements, payments are received or made based on the differential between a fixed and a variable product price. These agreements are settled in cash at expiration or exchanged for physical delivery contracts. The Company enters into the majority of its hedging transactions with two counterparties and a netting agreement is in place with those counterparties. The Company does not obtain collateral to support the agreements but monitors the financial viability of counterparties and believes its credit risk is minimal on these transactions. In the event of nonperformance, the Company would be exposed to price risk. The Company has some risk of accounting loss since the price received for the product at the actual physical delivery point may differ from the prevailing price at the delivery point required for settlement of the hedging transaction. -14- As of December 31, 2002 and June 30, 2003, $0.4 million and $0.7 million, net of tax of $0.2 million and $0.4 million, respectively, remained in accumulated other comprehensive income related to the valuation of the Company's hedging positions. Total oil purchased and sold under swaps and collars during the three months ended June 30, 2002 and 2003 were 45,500 Bbls and 63,300 Bbls, respectively. Total natural gas purchased and sold under swaps and collars during the three months ended June 30, 2002 and 2003 were 728,000 MMBtu and 819,000 MMBtu, respectively. Total oil purchased and sold under swaps and collars during the six months ended June 30, 2002 and 2003 were 45,500 Bbls and 126,300 Bbls, respectively. Total natural gas purchased and sold under swaps and collars during the six months ended June 30, 2002 and 2003 were 1,538,000 MMBtu and 1,349,000 MMBtu, respectively. The net losses realized by the Company under such hedging arrangements were $0.4 million and $0.4 million for the three months ended June 30, 2002 and 2003, respectively, and are included in oil and natural gas revenues. The net losses realized by the Company under such hedging arrangements were $0.4 million and $1.7 million for the six months ended June 30, 2002 and 2003, respectively, and are included in oil and natural gas revenues. At December 31, 2002 and June 30, 2003 the Company had the following outstanding hedge positions:
AS OF DECEMBER 31, 2002 - ----------------------------------------------------------------------------------------------------------- CONTRACT VOLUMES ----------------------------- AVERAGE AVERAGE AVERAGE QUARTER BBls MMbtu FIXED PRICE FLOOR PRICE CEILING PRICE - ---------------------------- ------------- -------------- -------------- -------------- ----------------- First Quarter 2003 27,000 $ 24.85 First Quarter 2003 36,000 $ 23.50 $ 26.50 First Quarter 2003 540,000 3.40 5.25 Second Quarter 2003 27,300 24.85 Second Quarter 2003 36,000 23.50 26.50 Second Quarter 2003 546,000 3.40 5.25 Third Quarter 2003 552,000 3.40 5.25 Fourth Quarter 2003 552,000 3.40 5.25
AS OF JUNE 30, 2003 - ----------------------------------------------------------------------------------------------------------- CONTRACT VOLUMES ----------------------------- AVERAGE AVERAGE AVERAGE QUARTER BBls MMbtu FIXED PRICE FLOOR PRICE CEILING PRICE - ---------------------------- ------------- -------------- -------------- -------------- ----------------- Third Quarter 2003 276,000 $ 4.70 Third Quarter 2003 552,000 $ 3.40 $ 5.25 Fourth Quarter 2003 552,000 3.40 5.25 Second Quarter 2004 273,000 4.00 5.20 Third Quarter 2004 276,000 4.00 5.20 Fourth Quarter 2004 93,000 4.00 5.20
During July 2003, the Company entered into swap arrangements covering 36,800 Bbls of oil for August 2003 through October 2003 production with a fixed price of $30.00. In addition to the hedge positions above, during the second quarter of 2003, the Company acquired options to sell 6,000 MMBtu of natural gas per day for the period July 2003 through August 2003 (552,000 MMBtu) at $8.00 per MMBtu for approximately $119,000. The Company acquired these options to protect its cash position against potential margin calls on certain natural gas derivatives due to large increases in the price of natural gas. These options have been classified as derivatives. As of June 30, 2003, these options have been adjusted to their estimated fair market value of approximately $28,000 and a charge for the adjustment of $91,000 has been included in other income and expense for the three months ended June 30, 2003. 11. NEW ACCOUNTING PRONOUNCEMENTS Effective July 1, 2003, we will adopt SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". This standard will not have a material impact on our consolidated financial statements. -15- The FASB issued Interpretation 46, "Consolidation of Variable Interest Entities" ("FIN 46"), in January 2003. FIN 46 requires the consolidation of certain types of entities in which a company absorbs a majority of another entity's expected losses, receives a majority of the other entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the other entity. The Company has identified no transactions or related entities that required consolidation under this interpretation. Currently, the FASB and representatives of the SEC accounting staff are engaged in discussions on the issue of whether SFAS 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangibles", which were effective June 30, 2001, called for mineral rights held under a lease or other contractual arrangement to be classified on the balance sheet as intangible assets and accompanied by specific footnote disclosures. Historically, oil and gas companies, including the Company, have included these costs with all other oil and gas property costs in Property, Plant, and Equipment on the consolidated balance sheet. In the event this interpretation is adopted, a substantial portion of the acquisition costs of oil and gas properties would be required to be classified on the balance sheet as an intangible asset. The Company believes this interpretation would not have a material effect on our results of operations for the periods presented or in the future as these intangible assets would be depleted using the units of production method in a manner consistent with the method currently used to calculate depletion, depreciation, and amortization expense ("DD&A") on those assets. 12. SUBSEQUENT EVENTS EXCHANGE TRANSACTION ON JULY 31, 2003 Pursuant to an exchange election provided in a letter agreement, dated May 1, 2001, with certain participants in the Carrizo 2001 Seismic and Acreage Program (the "2001 Program"), the Company is issuing to such participants, who have exercised their election, approximately 168,000 shares of its common stock in exchange for the participants' entire interest in the 2001 Program, including approximately 350 square miles of 3D seismic data and working interests in certain producing properties. The exchange transaction is effective on July 31, 2003 and will be valued using the close price of the Company's stock on that date, for a total of approximately $1.2 million. AWARDED ACREAGE IN THE NORTH SEA ON JULY 31, 2003 The Company has been awarded seven acreage blocks, consisting of one "Traditional" and six "Promote" licenses, in the United Kingdom's 21st Round of Licensing. The awarded blocks, to explore for oil and natural gas totaling approximately 209,000 acres, are located within mature producing areas of the Central and Southern North Sea in water depths of 30 to 270 feet. The Company plans to promote these interests to other parties experienced in drilling and operating in this province. G&G costs will be incurred to maximize the value of our retained interest. The Company's estimated project commitments for the next two years are $0.7 million comprised of $0.3 million for seismic data, $0.1 million for leasehold costs and $0.1 million for data processing in 2003 and $0.2 million for seismic data purchases in 2004. The Promote licenses do not have drilling commitments and the Traditional license would be cancelled after two years if the Company or its assignee elects not to commit to drilling a well. -16- ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is management's discussion and analysis of certain significant factors that have affected certain aspects of the Company's financial position and results of operations during the periods included in the accompanying unaudited financial statements. This discussion should be read in conjunction with the discussion under "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the annual financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and the unaudited financial statements included elsewhere herein. Unless otherwise indicated by the context, references herein to "Carrizo" or "Company" mean Carrizo Oil & Gas, Inc., a Texas corporation that is the registrant. GENERAL OVERVIEW The Company began operations in September 1993 and initially focused on the acquisition of producing properties. As a result of the increasing availability of economic onshore 3-D seismic surveys, the Company began to obtain 3-D seismic data and options to lease substantial acreage in 1995 and began to drill its 3-D based prospects in 1996. The Company drilled 25 gross wells in 2002 and 16 gross wells through the six months ended June 30, 2003 in the Gulf Coast region. The Company has budgeted to drill up to 27 gross wells (10.7 net) in the Gulf Coast region in 2003; however, the actual number of wells drilled will vary depending upon various factors, including the availability and cost of drilling rigs, land and industry partner issues, Company cash flow, success of drilling programs, weather delays and other factors. If the Company drills the number of wells it has budgeted for 2003, depreciation, depletion and amortization, oil and gas operating expenses and production are expected to increase over levels incurred in 2002. The Company has typically retained the majority of its interests in shallow, normally pressured prospects and sold a portion of its interests in deeper, overpressured prospects. The Company has primarily grown through the internal development of properties within its exploration project areas, although the Company acquired properties with existing production in the Camp Hill Project in late 1993, the Encinitas Project in early 1995 and the La Rosa Project in 1996. The Company made these acquisitions through the use of limited partnerships with Carrizo or Carrizo Production, Inc. as the general partner. In addition, in November 1998, the Company acquired assets in Wharton County, Texas in the Jones Branch project area for approximately $3.0 million. During the second quarter of 2001, the Company formed CCBM, Inc. ("CCBM") as a wholly-owned subsidiary. CCBM was formed to acquire interests in certain oil and gas leases in Wyoming and Montana in areas prospective for coalbed methane and develop such interests. The Company also acquired a 1,940 gross acre coalbed methane property in Wyoming, the "Bobcat Project", for $0.7 million in cash and common stock in July 2002. CCBM planned to spend up to $5.0 million for drilling costs on these leases through December 2003, 50% of which would be spent pursuant to an obligation to fund $2.5 million of drilling costs on behalf of RMG, from whom the interests in the leases were acquired. Through June 30, 2003, CCBM has satisfied $2.2 million of its $2.5 million obligation on behalf of RMG. CCBM has drilled or acquired 75 gross wells (28.0 net) and incurred total drilling costs of $3.0 million through December 31, 2002 and drilled two gross wells (one net) and incurred total drilling costs of $0.4 million during the six months ended June 30, 2003. These wells typically take up to 18 months to evaluate and determine whether or not they are successful. CCBM had budgeted to drill up to 50 gross (18 net) wells in 2003 before the Pinnacle transaction discussed below. CCBM no longer has a drilling obligation in connection with the properties contributed to Pinnacle. Accordingly, CCBM has no plans to drill any coalbed methane wells in the second half of 2003. The coalbed methane wells include 17 wells acquired as a result of the Bobcat acquisition. CCBM contributed its interests in leasehold acreage and 59 gross wells (24 net) to Pinnacle in June 2003. During the second quarter of 2003, CCBM contributed its interests in (1) leases in the Clearmont, Kirby, Arvada and Bobcat project area and (2) oil and gas reserves in the Bobcat project area to a newly formed entity, Pinnacle Gas Resources, Inc. ("Pinnacle"). In exchange for the contribution of these assets, CCBM received common stock of Pinnacle as of the closing date and options to purchase Pinnacle common stock. See "The Pinnacle Transaction" later in this section for a complete description of this transaction. The Company retained its interests in approximately 189,000 gross acres in the Castle Rock project area in Montana and the Oyster Ridge project area in Wyoming. Pursuant to an exchange election provided in a letter agreement, dated May 1, 2001, with certain participants in the Carrizo 2001 Seismic and Acreage Program (the "2001 Program"), the Company is issuing to such participants, who have exercised their election, approximately 168,000 shares of its common stock in exchange for the participants' program interest in the 2001 Program, including approximately 350 square miles of 3D seismic data and working interests in certain producing properties. The exchange transaction is effective on July 31, 2003 and will be valued using the close price of the Company's stock on that date, or approximately $1.2 million. -17- The Company has been awarded seven acreage blocks, consisting of one "Traditional" and six "Promote" licenses, in the United Kingdom's 21st Round of Licensing. The awarded blocks, to explore for oil and natural gas totaling approximately 209,000 acres, are located within mature producing areas of the Central and Southern North Sea in water depths of 30 to 270 feet. The Company plans to promote these interests to other parties experienced in drilling and operating in this province. G&G costs will be incurred to maximize the value of our retained interest. The Company's estimated project committments for the next two years are $0.7 million comprised of $0.3 million for seismic data, $0.1 million for leasehold costs and $0.1 million for data processing in 2003 and $0.2 million for seismic data purchases in 2004. The Promote licenses do not have drilling commitments and the Traditional license would be cancelled after two years if the Company or its assignee elects not to commit to drilling a well. The Company's operations involve managing market risks related to changes in commodity prices. Derivative financial instruments, specifically swaps, futures, options and other contracts, are used to reduce and manage those risks. The Company addresses market risk by selecting instruments whose value fluctuations correlate strongly with the underlying commodity being hedged. The Company enters into swaps, options, collars and other derivative contracts to hedge the price risks associated with a portion of anticipated future oil and natural gas production. While the use of hedging arrangements limits the downside risk of adverse price movements, it may also limit future gains from favorable movements. Under these agreements, payments are received or made based on the differential between a fixed and a variable product price. These agreements are settled in cash at expiration or exchanged for physical delivery contracts. The Company enters into the majority of its hedging transactions with two counterparties and a netting agreement is in place with those counterparties. The Company does not obtain collateral to support the agreements but monitors the financial viability of counterparties and believes its credit risk is minimal on these transactions. In the event of nonperformance, the Company would be exposed to price risk. The Company has some risk of accounting loss since the price received for the product at the actual physical delivery point may differ from the prevailing price at the delivery point required for settlement of the hedging transaction. As of December 31, 2002 and June 30, 2003, $0.4 million and $0.7 million, net of tax of $0.2 million and $0.4 million, respectively, remained in accumulated other comprehensive income related to the valuation of the Company's hedging positions. Total oil purchased and sold under swaps and collars during the three months ended June 30, 2002 and 2003 were 45,500 Bbls and 63,300 Bbls, respectively. Total natural gas purchased and sold under swaps and collars during the three months ended June 30, 2002 and 2003 were 728,000 MMBtu and 819,000 MMBtu, respectively. Total oil purchased and sold under swaps and collars during the six months ended June 30, 2002 and 2003 were 45,500 Bbls and 126,300 Bbls, respectively. Total natural gas purchased and sold under swaps and collars during the six months ended June 30, 2002 and 2003 were 1,538,000 MMBtu and 1,349,000 MMBtu, respectively. The net losses realized by the Company under such hedging arrangements were $0.4 million and $0.4 million for the three months ended June 30, 2002 and 2003, respectively, and are included in oil and natural gas revenues. The net losses realized by the Company under such hedging arrangements were $0.4 million and $1.7 million for the six months ended June 30, 2002 and 2003, respectively, and are included in oil and natural gas revenues. -18- At December 31, 2002 and June 30, 2003 the Company had the following outstanding hedge positions:
AS OF DECEMBER 31, 2002 - ----------------------------------------------------------------------------------------------------------- CONTRACT VOLUMES ----------------------------- AVERAGE AVERAGE AVERAGE QUARTER BBls MMbtu FIXED PRICE FLOOR PRICE CEILING PRICE - ---------------------------- ------------- -------------- -------------- -------------- ----------------- First Quarter 2003 27,000 $ 24.85 First Quarter 2003 36,000 $ 23.50 $ 26.50 First Quarter 2003 540,000 3.40 5.25 Second Quarter 2003 27,300 24.85 Second Quarter 2003 36,000 23.50 26.50 Second Quarter 2003 546,000 3.40 5.25 Third Quarter 2003 552,000 3.40 5.25 Fourth Quarter 2003 552,000 3.40 5.25
AS OF JUNE 30, 2003 - ----------------------------------------------------------------------------------------------------------- CONTRACT VOLUMES ----------------------------- AVERAGE AVERAGE AVERAGE QUARTER BBls MMbtu FIXED PRICE FLOOR PRICE CEILING PRICE - ---------------------------- ------------- -------------- -------------- -------------- ----------------- Third Quarter 2003 276,000 $ 4.70 Third Quarter 2003 552,000 $ 3.40 $ 5.25 Fourth Quarter 2003 552,000 3.40 5.25 Second Quarter 2004 273,000 4.00 5.20 Third Quarter 2004 276,000 4.00 5.20 Fourth Quarter 2004 93,000 4.00 5.20
During July 2003, the Company entered into swap arrangements covering 36,800 Bbls of oil for August 2003 through October 2003 production with a fixed price of $30.00. In addition to the hedge position above, during the second quarter of 2003, the Company acquired options to sell 6,000 MMBtu of natural gas per day for the period July 2003 through August 2003 (552,000 MMBtu) at $8.00 per MMBtu for approximately $119,000. The Company acquired these options to protect its cash position against potential margin calls on certain natural gas derivatives due to large increases in the price of natural gas. These options have been classified as derivatives. As of June 30, 2003, these options have been adjusted to their estimated fair market value of approximately $28,000 and a charge for the adjustment of $91,000 has been included in other income and expense for the three months ended June 30, 2003. RESULTS OF OPERATIONS Three Months Ended June 30, 2003, Compared to the Three Months Ended June 30, 2002 Oil and natural gas revenues for the three months ended June 30, 2003 increased 30% to $8.8 million from $6.8 million for the same period in 2002. Production volumes for natural gas during the three months ended June 30, 2003 decreased 26% to 1.0 Bcf from 1.3 Bcf for the same period in 2002. Average natural gas prices increased 65% to $5.64 per Mcf in the second quarter of 2003 from $3.42 per Mcf in the same period in 2002. Production volumes for oil in the second quarter of 2003 increased 24% to 118 Bbls from 95 Bbls for the same period in 2002. Average oil prices increased 16% to $28.23 per barrel in the second quarter of 2003 from $24.35 per barrel in the same period in 2002. The increase in oil production was due primarily to the commencement of production at the Burkhart #1R, Pauline Huebner A-382 #1, Matthes Huebner #1 and Hankamer #1 wells offset by the natural decline in production from other wells. The decrease in natural gas production was primarily due to a workover at the Delta Farms #1 the natural decline in production at the Delta Farms #1, the Staubach #1, Riverdale #2 and other wells offset by the commencement of production at the Burkhart #1R, Pauline Huebner A-382 #1, Matthes Huebner #1 and Hankamer #1 wells. Oil and natural gas revenues include the impact of hedging activities as discussed above under "General Overview". -19- The following table summarizes production volumes, average sales prices and operating revenues for the Company's oil and natural gas operations for the three months ended June 30, 2002 and 2003:
2003 Period Compared to 2002 Period ---------------------------------- June 30, ---------------------------------- Increase % Increase 2002 2003 (Decrease) (Decrease) ------------------ --------------- ------------------ -------------- Production volumes - Oil and condensate (MBbls) 95 118 23 24% Natural gas (MMcf) 1,308 973 (335) (26)% Average sales prices - (1) Oil and condensate (per Bbls) $ 24.35 $ 28.23 $ 3.88 16% Natural gas (per Mcf) 3.42 5.64 2.22 65% Operating revenues (In thousands)- Oil and condensate $ 2,310 $ 3,344 $ 1,034 45% Natural gas 4,470 5,484 1,014 23% ------------------ --------------- ------------------ Total $ 6,780 $ 8,828 $ 2,048 30% ================== =============== ==================
- ---------- (1) Includes impact of hedging activities. Oil and natural gas operating expenses for the three months ended June 30, 2003 increased 32% to $1.8 million from $1.3 million for the same period in 2002 primarily due to higher severance taxes and other operating costs associated with the addition of new production. Operating expenses per equivalent unit increased 47% to $1.05 per Mcfe in the second quarter of 2003 from $0.71 per Mcfe in the same period in 2002 primarily as a result of the natural production decline of existing wells, the addition of the Delta Farms #2 (a relatively higher operating cost well) and higher severance taxes. Depreciation, depletion and amortization (DD&A) expense for the three months ended June 30, 2003 was unchanged at $2.6 million as compared to the same period in 2002. DD&A was unchanged due to decreased production offset by expenses resulting from additional seismic and drilling costs. General and administrative expense for the three months ended June 30, 2003 increased 11% to $1.3 million from $1.1 million for the same period in 2002 primarily as a result of the addition of contract staff to handle increased drilling and production activities, higher compensation costs and higher insurance. Interest income for the three months ended June 30, 2003 increased to $22,000 from $8,000 in the second quarter of 2002 primarily as a result of higher cash balances during the second quarter of 2003. Capitalized interest in the second quarter of 2003 decreased to $0.7 million from $0.8 million in the second quarter of 2002. Income taxes increased to $1.1 million for the three months ended June 30, 2003 from $0.6 million for the same period in 2002 as a result of higher taxable income based on the factors described above. Income before income taxes for the three months ended June 30, 2003 increased to $3.1 million from $1.7 million in the same period in 2002. Net income for the three months ended June 30, 2003 increased to $2.0 million from $1.1 million for the same period in 2002 primarily as a result of the factors described above. Six Months Ended June 30, 2003, Compared to the Six Months Ended June 30, 2002 Oil and natural gas revenues for the six months ended June 30, 2003 increased 80% to $19.5 million from $10.8 million for the same period in 2002. Production volumes for natural gas during the six months ended June 30, 2003 decreased 14% to 2.1 Bcf from 2.4 Bcf for the same period in 2002. Average natural gas prices increased 88% to $5.78 per Mcf in the first six months of 2003 from $3.08 per Mcf in the same period in 2002. Production volumes for oil in the first six months of 2003 increased 74% to 258 Bbls from 148 Bbls for the same period in 2002. Average oil prices increased 26% to $29.04 per barrel in the first six months of 2003 from $22.97 per barrel in the same period in 2002. The increase in oil production was due primarily to the commencement of production at the Burkhart #1R, Pauline Huebner A-382 #1, Matthes Huebner #1 and Hankamer #1 wells offset by the natural decline in production from other wells. The decrease in natural gas production was primarily due to a workover at the Delta Farms #1, the natural decline in production at the Staubach #1, Riverdale #2 and other wells offset by the commencement of production at the Burkhart #1R, Pauline Huebner A-382 #1, Matthes Huebner #1 and Hankamer #1 wells. Oil and natural gas revenues include the impact of hedging activities as discussed above under "General Overview". -20- The following table summarizes production volumes, average sales prices and operating revenues for the Company's oil and natural gas operations for the six months ended June 30, 2002 and 2003:
2003 Period Compared to 2002 Period --------------------------------- June 30, ------------------------------------ Increase % Increase 2002 2003 (Decrease) (Decrease) ------------------ ----------------- ---------------- --------------- Production volumes - Oil and condensate (MBbls) 148 258 110 74% Natural gas (MMcf) 2,406 2,077 (329) (14)% Average sales prices - (2) Oil and condensate (per Bbls) $ 22.97 $ 29.04 $ 6.07 26% Natural gas (per Mcf) 3.08 5.78 2.70 88% Operating revenues (In thousands)- Oil and condensate $ 3,401 $ 7,480 $ 4,079 120% Natural gas 7,406 12,012 4,606 62% ----------------- --------------- --------------- Total $ 10,807 $ 19,492 $ 8,685 80% ================= =============== ===============
- ---------- (2) Includes impact of hedging activities. Oil and natural gas operating expenses for the six months ended June 30, 2003 increased 48% to $3.5 million from $2.4 million for the same period in 2002 primarily due to higher severance taxes and other operating costs associated with the addition of new production. Operating expenses per equivalent unit increased 35% to $0.96 per Mcfe in the first six months of 2003 from $0.71 per Mcfe in the same period in 2002 primarily as a result of the natural decline in production on older wells and the addition of the Delta Farms #2, a relatively higher cost well. Depreciation, depletion and amortization (DD&A) expense for the six months ended June 30, 2003 increased 22% to $5.6 million from $4.6 million for the same period in 2002. This increase was due to increased production and additional seismic and drilling costs. General and administrative expense for the six months ended June 30, 2003 increased 28% to $2.7 million from $2.1 million for the same period in 2002 primarily as a result of the addition of contract staff to handle increased drilling and production activities, higher compensation costs and higher insurance. Interest income for the six months ended June 30, 2003 increased to $40,000 from $28,000 in the first six months of 2002 primarily as a result of higher cash balances during the first quarter of 2003. Capitalized interest was $1.5 million in the first six months of 2003 and 2002. Income taxes increased to $2.8 million for the six months ended June 30, 2003 from $0.8 million for the same period in 2002 as a result of higher taxable income based on the factors described above. The Company adopted Financial Accounting Standards Board's Statement of Financial Standards No. 143 "Accounting for Asset Retirement Obligations" effective January 1, 2003 and recorded a cumulative effect of change in accounting principle of $0.1 million in the six months ended June 30, 2003. Income before income taxes for the six months ended June 30, 2003 increased to $7.7 million from $2.0 million in the same period in 2002. Net income for the six months ended June 30, 2003 increased to $4.9 million from $1.2 million for the same period in 2002 primarily as a result of the factors described above. LIQUIDITY AND CAPITAL RESOURCES The Company has made and is expected to make oil and gas capital expenditures in excess of its net cash flows provided by operating activities in order to complete the exploration and development of its existing properties. The Company will require additional sources of financing to fund drilling expenditures on properties currently owned by the Company and to fund leasehold costs and geological and geophysical costs on its exploration projects. -21- While the Company believes that the current cash balances and anticipated 2003 cash provided by operating activities will provide sufficient capital to carry out the Company's 2003 exploration plans, management of the Company continues to seek financing for its capital program from a variety of sources. No assurance can be given that the Company will be able to obtain additional financing on terms that would be acceptable to the Company. The Company's inability to obtain additional financing could have a material adverse effect on the Company. Without raising additional capital, the Company anticipates that it may be required to limit or defer its planned oil and gas exploration and development program, which could adversely affect the recoverability and ultimate value of the Company's oil and gas properties. The Company's primary sources of liquidity have included proceeds from the 1997 initial public offering, from the December 1999 sale of Subordinated Notes, Common Stock and Warrants, the 2002 sale of shares of Series B Convertible Participating Preferred Stock and Warrants, the 1998 sale of shares of Series A Preferred Stock and Warrants, funds generated by operations, equity capital contributions, borrowings (primarily under revolving credit facilities) and the Palace Agreement that provided a portion of the funding for the Company's 1999, 2000, 2001 and 2002 drilling program in return for participation in certain wells. Cash flows provided by operating activities were $4.1 million and $15.1 million for the six months ended June 30, 2002 and 2003, respectively. The increase in cash flows provided by operating activities in 2003 as compared to 2002 was due primarily to additional revenue as a result of higher oil and natural gas prices and higher oil and condensate production offset by the increase of working capital during the first six months of 2003. The Company has budgeted capital expenditures for the year ended December 31, 2003 of approximately $27.2 million of which $6.9 million is expected to be used to fund 3-D seismic surveys and land acquisitions and $20.3 million of which is expected to be used for drilling activities in the Company's project areas. The Company has budgeted to drill up to approximately 27 gross wells (10.7 net) in the Gulf Coast region and no CCBM coalbed methane wells in 2003. The actual number of wells drilled and capital expended is dependent upon available financing, cash flow, availability and cost of drilling rigs, land and partner issues and other factors. The Company has continued to reinvest a substantial portion of its cash flows into increasing its 3-D supported drilling prospect portfolio, improving its 3-D seismic interpretation technology and funding its drilling program. Oil and gas capital expenditures were $14.1 million for the six months ended June 30, 2003, which included $2.2 million of capitalized interest and general and administrative costs. The Company's drilling efforts in the Gulf Coast region resulted in the successful completion of 17 gross wells (6.0 net) during the year ended December 31, 2002 and 14 gross wells (4.2 net) during the six months ended June 30, 2003. Of the 77 gross wells (29 net) drilled or acquired by CCBM through June 30, 2003, 24 gross wells (8 net) are currently producing and 53 gross wells (21 net) are awaiting evaluation before a determination can be made as to their success. THE PINNACLE TRANSACTION OVERVIEW On June 23, 2003, pursuant to a Subscription and Contribution Agreement by and among the Company and its wholly-owned subsidiary, CCBM, Inc. ("CCBM"), Rocky Mountain Gas, Inc. ("RMG") and the Credit Suisse First Boston Private Equity entities, named therein (the "CSFB Parties"), CCBM and RMG contributed their respective interests, having a estimated fair value of approximately $7.5 million each, in (1) leases in the Clearmont, Kirby, Arvada and Bobcat project areas and (2) oil and gas reserves in the Bobcat project area to a newly formed entity, Pinnacle Gas Resources, Inc., a Delaware corporation ("Pinnacle"). In exchange for the contribution of these assets, CCBM and RMG each received 37.5% of the common stock of Pinnacle ("Pinnacle Common Stock") as of the closing date and options to purchase Pinnacle Common Stock ("Pinnacle Stock Options"). In connection with the oil and natural gas leases contributed to Pinnacle, CCBM no longer has a drilling obligation (see "General Overview" in the MDA for further discussion). Simultaneously with the contribution of these assets, the CSFB Parties contributed approximately $17.6 million of cash to Pinnacle in return for the Redeemable Preferred Stock of Pinnacle ("Pinnacle Preferred Stock"), 25% of the Pinnacle Common Stock as of the closing date and warrants to purchase Pinnacle Common Stock ("Pinnacle Warrants"). The CSFB Parties also agreed to contribute additional cash, under certain circumstances, of up to approximately $11.8 million to Pinnacle to fund future drilling, development and acquisitions. The CSFB Parties currently have greater than 50% of the voting power of the Pinnacle capital stock through their ownership of Pinnacle Common Stock and Pinnacle Preferred Stock. -22- Currently, on a fully diluted basis, assuming that all parties exercised their Pinnacle Warrants and Pinnacle Options, the CSFB Parties, CCBM and RMG would have ownership interests of approximately 46.2%, 26.9% and 26.9%, respectively. On a fully-diluted basis, assuming the additional $11.8 million of cash was contributed by the CSFB Parties and all Pinnacle Warrants and Pinnacle Options were exercised by all parties, the CSFB Parties would own 54.6% of Pinnacle and CCBM and RMG would each own 22.7% of Pinnacle. Immediately following the contribution and funding, Pinnacle used approximately $6.2 million of the proceeds from the funding to acquire an approximate 50% working interest in existing leases and approximately 36,529 gross acres prospective for coalbed methane development in the Powder River Basin of Wyoming from Gastar Exploration, Ltd. The leases include 95 producing coalbed methane wells currently in the early stages of dewatering. These wells are producing at a combined gross rate of approximately 2.5 MMcfd, or an estimated 1 MMcfd net to Pinnacle. Pinnacle also agreed to fund up to $14.9 million of future drilling and development costs on these properties on behalf of Gastar prior to December 31, 2005. The drilling and development work will be done under the terms of an earn-in joint venture agreement between Pinnacle and Gastar. The majority of these leases are part of, or adjacent to, the Bobcat project area. All of CCBM and RMG's interests in the Bobcat project area, the only producing coalbed methane property owned by CCBM prior to the transaction, were contributed to Pinnacle. Pinnacle currently owns interests in approximately 131,000 gross acres in the Powder River Basin. Prior to and in connection with its contribution of assets to Pinnacle, CCBM paid RMG approximately $1.8 million in cash as part of its outstanding purchase obligation on the coalbed methane property interests CCBM previously acquired from RMG. The approximate $1.2 million remaining balance of CCBM's obligation to RMG is scheduled to be paid in monthly installments of approximately $52,805 through November 2004 and a balloon payment on December 31, 2004. The RMG note is secured solely by CCBM's interests in the remaining oil and natural gas leases in Wyoming and Montana. In connection with the Company's investment in Pinnacle, the Company received a reduction in the principal amount of the RMG note of approximately $1.5 million and relinquished the right to receive certain revenues related to the properties contributed to Pinnacle. CCBM continues its coalbed methane business activities and, in addition to its interest in Pinnacle, owns direct interests in approximately 189,000 gross acres of coalbed methane properties in the Castle Rock project area in Montana and the Oyster Ridge project area in Wyoming, which were not contributed to Pinnacle. CCBM and RMG will continue to conduct exploration and development activities on these properties as well as pursue other potential acquisitions. The Bobcat property was producing approximately 400 Mcfe of coalbed methane gas net to CCBM's interest immediately prior to its contribution to Pinnacle. Other than indirectly through Pinnacle, CCBM currently has no proved reserves of, and is no longer receiving revenue from, coalbed methane gas. Accounting and Tax Treatment For accounting purposes, the transaction will be treated as a reclassification of a portion of CCBM's investments in the contributed properties. The property contribution made by CCBM to Pinnacle is intended to be treated as a tax-deferred exchange as constituted by property transfers under section 351(a) of the Internal Revenue Code of 1986, as amended. The FASB issued Interpretation 46, "Consolidation of Variable Interest Entities" ("FIN 46"), in January 2003. FIN 46 requires the consolidation of certain types of entities in which a company absorbs a majority of another entity's expected losses, receives a majority of the other entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the other entity. These entities are called "variable interest entities". The provisions of FIN 46 are effective for the Company in the second quarter for new transactions or entities formed in 2003 and in the third quarter for transactions or entities formed prior to 2003. If an entity is determined to be a "variable interest entity" ("VIE"), the entity must be consolidated by the "primary beneficiary". The primary beneficiary is the holder of the variable interests that absorbs a majority of the variable interest entity's expected losses or receives a majority of the entity's residual returns in the event no holder has a majority of the expected losses. The determination of the primary beneficiary is based on projected cash flows at the inception of the variable interests. Because Steven A. Webster, Chairman of Carrizo, is also a managing director of Credit Suisse First Boston ("Related Parties in Pinnacle Transaction" below), Carrizo could be defined as the primary beneficiary if the projected cash flows analysis indicated losses in excess of the equity invested. The initial determination of whether an entity is a VIE is to be reconsidered only when one or more of the following occur (1) the entity's governing documents or the contractual arrangements among the parties involved change, (2) the equity investment of some part thereof is returned to the investors, and other parties become exposed to expected losses or (3) the entity undertakes additional activities or acquires additional assets that increase the entity's expected losses. -23- We have determined that we should not consolidate Pinnacle, under FIN 46, because our current projected cash flow analysis of Pinnacle's operations at inception does not indicate that the Pinnacle is not a VIE. Accordingly, our investment in Pinnacle has been recorded using the equity method of accounting. The reclassification of investments in contributed properties resulting from the transaction with Pinnacle are reflected in accordance with the full cost method of accounting in the Company's balance sheet included in this Form 10-Q for the six months ended June 30, 2003. Related Parties in the Pinnacle Transaction Steven A. Webster, Chairman of the Board of the Company, is also a managing director of Credit Suisse First Boston Private Equity and is therefore a related party to this transaction. Transition Services Agreement The Company entered into a transition services agreement with Pinnacle pursuant to which the Company will provide certain accounting, treasury, tax, insurance and financial reporting functions to Pinnacle through the end of 2003 for a monthly fee equal to our actual cost to provide such services. After December 31, 2003, the agreement will automatically renew on a quarterly basis unless one of the parties gives notice of its intent to terminate the agreement. Similarly, Pinnacle has also entered into a transition services agreement with RMG to provide Pinnacle assistance in setting up operational accounting and management systems for a monthly fee equal to the actual cost to provide such services. After December 31, 2003, the agreement will automatically renew on a quarterly basis unless one of the parties gives notice of its intent to terminate the agreement. Area of Mutual Interest Agreement The Company, CCBM, RMG, RMG's majority shareholder U.S. Energy Corp. ("U.S. Energy") and the CSFB Parties also entered into an area of mutual interest agreement covering the Powder River Basin in Wyoming and Montana (but excluding most of Powder River County, Montana) providing that Pinnacle has the right until June 23, 2008 to acquire at cost from the Company, CCBM, RMG and U.S. Energy any interest in oil and gas leases or mineral interests that such parties may have acquired in the covered area, subject to specified exceptions. Securityholders' Agreement The Company, the CSFB Parties, CCBM, RMG, U.S. Energy, Peter G. Schoonmaker and Gary W. Uhland (the "Securityholders") and Pinnacle also entered into a Securityholders' Agreement (the "Securityholders' Agreement"). The Securityholders' Agreement provides for an initial eight person board of directors, which initially would include four directors nominated by the CSFB Parties and two nominated by each of CCBM and RMG, subject to change as their respective ownership percentages change. In the Securityholders' Agreement, the Securityholders grant to each other a right of first offer and co-sale rights. If the CSFB Parties propose to sell all of their Pinnacle Shares to a third party, under certain circumstances the CSFB parties may require the other Securityholders to include all of their Pinnacle Shares in such sale. In such a sale, the Pinnacle Preferred Stock will have a preferred right to receive an amount equal to the Liquidation Value (as defined below) per share plus accrued and unpaid dividends prior to the holders of shares of Pinnacle Common Stock and common stock equivalents. -24- Under the Securityholders' Agreement, Pinnacle grants the Securityholders pre-emptive rights to purchase certain securities in order to maintain their proportionate ownership of Pinnacle. The Securityholders' Agreement also generally provides for multiple demand registration rights with respect to the Pinnacle Common Stock in favor of the CSFB Parties and piggyback certain registration rights for each of CCBM and RMG subject to the satisfaction of specified conditions. Pinnacle Stock Options The same number of Pinnacle Stock Options were issued to both CCBM and RMG in two tranches. CCBM and RMG each have a continuing option (the "Tranche A" option) to purchase up to 25,000 shares of common stock at a purchase price of $100 per share, with a price escalation of 10% per annum, compounded quarterly. In addition, CCBM and RMG, each have another continuing option (the "Tranche B" option) to purchase up to 25,000 additional shares of common stock at a purchase price of $100 per share, with a price escalation of 20% per annum, compounded quarterly. The Tranche B option cannot be exercised until all 25,000 shares are first purchased under the Tranche A option. Pinnacle Preferred Stock The Pinnacle Preferred Stock generally has the right to vote together with the Pinnacle Common Stock and has a class vote on specified matters, including certain extraordinary transactions. In the event of any dissolution, liquidation, or winding up by Pinnacle, the holder of each share of Pinnacle Preferred Stock will be entitled to be paid $100 per share out of the assets of Pinnacle available for distribution to its shareholders (the "Liquidation Value"). Dividends on the Pinnacle Preferred Stock will be payable either in cash at a rate of 10.5% per annum through June 23, 2011 and then 12.5% thereafter or, at Pinnacle's option, by payment in kind of additional shares of the Pinnacle Preferred Stock. For each additional share of Pinnacle Preferred Stock distributed to a holder as an in kind dividend, Pinnacle will also deliver to such holder one Pinnacle Warrant, which will have an exercise price equal to the exercise price of the outstanding Pinnacle Warrants on the date of such distribution. On or after July 1, 2005, Pinnacle may redeem all or any portion of the Pinnacle Preferred Stock (provided, that if any Pinnacle Warrants are still outstanding, Pinnacle may redeem all but a single share) at a premium to the Liquidation Value if redeemed on or at any time after July 1, 2009. The Pinnacle Preferred Stock is required to be redeemed by Pinnacle upon (1) specified changes of control or (2) specified events of default at a price per share, with respect to a redemption pursuant to clause (1) above, equal to 101% of the Liquidation Value and, with respect to a redemption pursuant to clause (2) above, prior to June 30, 2005, equal to 110% of the Liquidation Value and, thereafter, equal to the Applicable Optional Redemption Price. Pinnacle Warrants The Pinnacle Warrants entitle the holders to purchase up to 130,000 shares of Pinnacle Common Stock at a price of $100 per share and are exercisable at any time until June 30, 2013. The Pinnacle Warrants can be exercised in cash, by tender of the Pinnacle Preferred Stock and on a cashless net exercise basis. The Pinnacle Warrants are subject to certain adjustments, including, in certain cases, an adjustment of the exercise price to equal the lowest price at which Pinnacle Common Stock is sold if such shares are sold below the then-current exercise price. FINANCING ARRANGEMENTS On May 24, 2002, the Company entered into a credit agreement with Hibernia National Bank (the "Hibernia Facility") which matures on January 31, 2005, and repaid its existing facility with Compass Bank (the "Compass Facility"). The Hibernia Facility provides a revolving line of credit of up to $30.0 million. It is secured by the Mortgaged Properties, which include substantially all of the Company's producing oil and gas properties, and is guaranteed by the Company's subsidiary. -25- The borrowing base will be determined by Hibernia National Bank at least semi-annually on October 31 and April 30. The initial borrowing base was $12.0 million, and the borrowing base as of April 30, 2003 was $16.0 million. Each party to the credit agreement can request one unscheduled borrowing base determination subsequent to each scheduled determination. The borrowing base will at all times equal the borrowing base most recently determined by Hibernia National Bank, less quarterly borrowing base reductions required subsequent to such determination. Hibernia National Bank will reset the borrowing base amount at each scheduled and each unscheduled borrowing base determination date. The initial quarterly borrowing base reduction, which commenced on June 30, 2002, was $1.3 million. The quarterly borrowing base reduction effective January 31, 2003 was $1.8 million. There was an increase in the borrowing base for the quarter ended June 30, 2003 of $2.2 million. On December 12, 2002, the Company entered into an Amended and Restated Credit Agreement with Hibernia National Bank that provided additional availability under the Hibernia Facility in the amount of $2.5 million which was structured as an additional "Facility B" under the Hibernia Facility. As such, the total borrowing base under the Hibernia Facility as of December 31, 2002 and June 30, 2003 was $15.5 million and $16.0 million, respectively, of which $8.5 million and $7.0 million was outstanding on December 31, 2002 and June 30, 2003, respectively. The Facility B bore interest at LIBOR plus 3.375%, was secured by certain leases and working interests in oil and natural gas wells and matured on April 30, 2003. If the principal balance of the Hibernia Facility ever exceeds the borrowing base as reduced by the quarterly borrowing base reduction (as described above), the principal balance in excess of such reduced borrowing base will be due as of the date of such reduction. Otherwise, any unpaid principal or interest will be due at maturity. If the principal balance of the Hibernia Facility ever exceeds any re-determined borrowing base, the Company has the option within thirty days to (individually or in combination): (i) make a lump sum payment curing the deficiency; (ii) pledge additional collateral sufficient in Hibernia National Bank's opinion to increase the borrowing base and cure the deficiency; or (iii) begin making equal monthly principal payments that will cure the deficiency within the ensuing six-month period. Such payments are in addition to any payments that may come due as a result of the quarterly borrowing base reductions. For each tranche of principal borrowed under the revolving line of credit, the interest rate will be, at the Company's option: (i) the Eurodollar Rate, plus an applicable margin equal to 2.375% if the amount borrowed is greater than or equal to 90% of the borrowing base, 2.0% if the amount borrowed is less than 90%, but greater than or equal to 50% of the borrowing base, or 1.625% if the amount borrowed is less than 50% of the borrowing base; or (ii) the Base Rate, plus an applicable margin of 0.375% if the amount borrowed is greater than or equal to 90% of the borrowing base. Interest on Eurodollar Loans is payable on either the last day of each Eurodollar option period or monthly, whichever is earlier. Interest on Base Rate Loans is payable monthly. The Company is subject to certain covenants under the terms of the Hibernia Facility, including, but not limited to the maintenance of the following financial covenants: (i) a minimum current ratio of 1.0 to 1.0 (including availability under the borrowing base), (ii) a minimum quarterly debt services coverage of 1.25 times, and (iii) a minimum shareholders equity equal to $56.0 million, plus 100% of all subsequent common and preferred equity contributed by shareholders, plus 50% of all positive earning occurring subsequent to such quarter end, all ratios as more particularly discussed in the credit facility. The Hibernia Facility also places restrictions on additional indebtedness, dividends to non-preferred stockholders, liens, investments, mergers, acquisitions, asset dispositions, asset pledges and mortgages, change of control, repurchase or redemption for cash of the Company's common or preferred stock, speculative commodity transactions, and other matters. At December 31, 2002 and June 30, 2003, amounts outstanding under the Hibernia Facility totaled $8.5 million and $7.0 million, respectively, with an additional $4.3 million and $8.8 million, respectively, under Facility A and $2.5 million under Facility B at December 31, 2002 available for future borrowings. No amounts under the Compass Facility were outstanding at December 31, 2002. At December 31, 2002 and June 30, 2003, one letter of credit was issued and outstanding under the Hibernia Facility in the amount of $0.2 million. On June 29, 2001, CCBM, Inc., a wholly owned subsidiary of the Company ("CCBM"), issued a non-recourse promissory note payable in the amount of $7.5 million to RMG as consideration for certain interests in oil and natural gas leases held by RMG in Wyoming and Montana. The RMG note was payable in 41-monthly principal payments of $0.1 million plus interest at 8% per annum commencing July 31, 2001 with the balance due December 31, 2004. The RMG note is secured solely by CCBM's interests in the oil and natural gas leases in Wyoming and Montana. At December 31, 2002 and June 30, 2003, the outstanding principal balance of this note was $5.3 million and $1.2 million, respectively. In connection with the Company's investment in Pinnacle, the Company received a reduction in the principal amount of the RMG note of approximately $1.5 million and relinquished the right to receive certain revenues related to the properties contributed to Pinnacle. -26- In December 2001, the Company entered into a capital lease agreement secured by certain production equipment in the amount of $0.2 million. The lease is payable in one payment of $11,323 and 35 monthly payments of $7,549 including interest at 8.6% per annum. In October 2002, the Company entered a capital lease agreement secured by certain production equipment in the amount of $0.1 million. The lease is payable in 36 monthly payments of $3,462 including interest at 6.4% per annum. In May 2003, the Company entered into a capital lease agreement secured by certain production in the amount of $0.1 million. The lease is payable in 36 monthly payments of $3,030 including interest at 5.5% per annum. The Company has the option to acquire the equipment at the conclusion of the lease for $1, under all of these leases. DD&A on the capital leases for six months ended June 30, 2002 and 2003 amounted to $8,000 and $20,000, respectively, and accumulated DD&A on the leased equipment at December 31, 2002 and June 30, 2003 amounted to $28,000 and $56,000, respectively. In December 1999, the Company consummated the sale of $22.0 million principal amount of 9% Senior Subordinated Notes due 2007 (the "Subordinated Notes") and $8.0 million of common stock and Warrants. The Company sold $17.6 million, $2.2 million, $0.8 million, $0.8 million and $0.8 million principal amount of Subordinated Notes; 2,909,092, 363,636, 121,212, 121,212 and 121,212 shares of the Company's common stock and 2,208,152, 276,019, 92,006, 92,006 and 92,006 Warrants to CB Capital Investors, L.P. (now known as JPMorgan Partners, LLC), Mellon Ventures, L.P., Paul B. Loyd, Jr., Steven A. Webster and Douglas A.P. Hamilton, respectively. The Subordinated Notes were sold at a discount of $0.7 million, which is being amortized over the life of the notes. Interest payments are due quarterly commencing on March 31, 2000. The Company may elect, for a period of up to five years, to increase the amount of the Subordinated Notes for 60% of the interest which would otherwise be payable in cash. As of December 31, 2002 and June 30, 2003, the outstanding balance of the Subordinated Notes had been increased by $3.9 million and $4.6 million, respectively, for such interest paid in kind. The Company is subject to certain covenants under the terms of the Subordinated Notes securities purchase agreement, including but not limited to, (a) maintenance of a specified tangible net worth, (b) maintenance of a ratio of EBITDA (earnings before interest, taxes, depreciation and amortization) to quarterly Debt Service (as defined in the agreement) of not less than 1.00 to 1.00, and (c) a limitation of its capital expenditures to an amount equal to the Company's EBITDA for the immediately prior fiscal year (unless approved by the Company's Board of Directors and a JPMorgan Partners, LLC appointed director), as well as limits on the Company's ability to (i) incur indebtedness, (ii) incur or allow liens, (iii) engage in mergers, consolidation, sales of assets and acquisitions, (iv) declare dividends and effect certain distributions (including restrictions on distributions upon the Common Stock), (v) engage in transactions with affiliates and (vi) make certain repayments and prepayments, including any prepayment of the subordinated debt, indebtedness that is guaranteed or credit-enhanced by any affiliate of the Company, and prepayments that effect certain permanent reductions in revolving credit facilities. EBITDA was part of a negotiated covenant with the purchasers and is presented here as a disclosure of our covenant obligations. In February 2002, the Company consummated the sale of 60,000 shares of Series B Preferred Stock and 2002 Warrants to purchase 252,632 shares of Common Stock for an aggregate purchase price of $6.0 million. The Company sold $4.0 million and $2.0 million of Series B Preferred Stock and 168,422 and 84,210 Warrants to Mellon Ventures, Inc. and Steven A. Webster, respectively. The Series B Preferred Stock is convertible into Common Stock by the investors at a conversion price of $5.70 per share, subject to adjustment, and is initially convertible into 1,052,632 shares of Common Stock. The approximately $5.8 million net proceeds of this financing were used to fund the Company's ongoing exploration and development program and general corporate purposes. Dividends on the Series B Preferred Stock will be payable in either cash at a rate of 8% per annum or, at the Company's option, by payment in kind of additional shares of the Series B Preferred Stock at a rate of 10% per annum. At December 31, 2002 and June 30, 2003 the outstanding balance of the Series B Preferred Stock had been increased by $0.5 million (5,294 shares) and $0.9 million (8,559 shares), respectively, for dividends paid in kind. In addition to the foregoing, if the Company declares a cash dividend on the Common Stock of the Company, the holders of shares of Series B Preferred Stock are entitled to receive for each share of Series B Preferred Stock a cash dividend in the amount of the cash dividend that would be received by a holder of the Common Stock into which such share of Series B Preferred Stock is convertible on the record date for such cash dividend. Unless all accrued dividends on the Series B Preferred Stock shall have been paid and a sum sufficient for the payment thereof set apart, no distributions may be paid on any Junior Stock (which includes the Common Stock) (as defined in the Statement of Resolutions for the Series B Preferred Stock) and no redemption of any Junior Stock shall occur other than subject to certain exceptions. The Series B Preferred Stock is required to be redeemed by the Company at any time after the third anniversary of the initial issuance of the Series B Preferred Stock (the "Issue Date") upon request from any holder at a price per share equal to Purchase Price/Dividend Preference (as defined below). The Company may redeem the Series B Preferred Stock after the third anniversary of the Issue Date, at a price per share equal to the Purchase Price/Dividend Preference and, prior to that time, at varying preferences to the Purchase Price/Dividend Purchase. "Purchase Price/Dividend Preference" is defined to mean, generally, $100 plus all cumulative and accrued dividends on such share of Series B Preferred Stock. -27- In the event of any dissolution, liquidation or winding up or certain mergers or sales or other disposition by the Company of all or substantially all of its assets (a "Liquidation"), the holder of each share of Series B Preferred Stock then outstanding will be entitled to be paid out of the assets of the Company available for distribution to its shareholders, the greater of the following amounts per share of Series B Preferred Stock: (i) $100 in cash plus all cumulative and accrued dividends and (ii) in certain circumstances, the "as-converted" liquidation distribution, if any, payable in such Liquidation with respect to each share of Common Stock. Upon the occurrence of certain events constituting a "Change of Control" (as defined in the Statement of Resolutions), the Company is required to make an offer to each holder of Series B Preferred Stock to repurchase all of such holder's Series B Preferred Stock at an offer price per share of Series B Preferred Stock in cash equal to 105% of the Change of Control Purchase Price, which is generally defined to mean $100 plus all cumulative and accrued dividends. The 2002 Warrants have a five-year term and entitle the holders to purchase up to 252,632 shares of Carrizo's Common Stock at a price of $5.94 per share, subject to adjustment, and are exercisable at any time after issuance. For accounting purposes, the 2002 Warrants were recorded at a value of $0.06 per 2002 Warrant. EFFECTS OF INFLATION AND CHANGES IN PRICE The Company's results of operations and cash flows are affected by changing oil and gas prices. If the price of oil and gas increases (decreases), there could be a corresponding increase (decrease) in the operating cost that the Company is required to bear for operations, as well as an increase (decrease) in revenues. Inflation has had a minimal effect on the Company. CRITICAL ACCOUNTING POLICIES The following summarizes several of our critical accounting policies: Use of Estimates The preparation of 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 periods. Actual results could differ from these estimates. Oil and Natural Gas Properties Investments in oil and natural gas properties are accounted for using the full-cost method of accounting. All costs directly associated with the acquisition, exploration and development of oil and natural gas properties are capitalized. Such costs include lease acquisitions, seismic surveys, and drilling and completion equipment. The Company proportionally consolidates its interests in oil and natural gas properties. The Company capitalized compensation costs for employees working directly on exploration activities of $0.4 million and $0.7 million for the six months ended June 30, 2002 and 2003, respectively. Maintenance and repairs are expensed as incurred. Oil and natural gas properties are amortized based on the unit-of-production method using estimates of proved reserve quantities. Investments in unproved properties are not amortized until proved reserves associated with the projects can be determined or until they are impaired. Unevaluated properties are evaluated periodically for impairment on a property-by-property basis. If the results of an assessment indicate that the properties are impaired, the amount of impairment is added to the proved oil and natural gas property costs to be amortized. The amortizable base includes estimated future development costs and, where significant, dismantlement, restoration and abandonment costs, net of estimated salvage values. The depletion rate per thousand cubic feet equivalent (Mcfe) for the six months ended June 30, 2002 and 2003 was $1.39 and $1.50 respectively. Dispositions of oil and natural gas properties are accounted for as adjustments to capitalized costs with no gain or loss recognized, unless such adjustments would significantly alter the relationship between capitalized costs and proved reserves. The net capitalized costs of proved oil and natural gas properties are subject to a "ceiling test", which limits such costs to the estimated present value, discounted at a 10% interest rate, of future net revenues from proved reserves, based on current economic and operating conditions. If net capitalized costs exceed this limit, the excess is charged to operations through depreciation, depletion and amortization. No write-down of the Company's oil and natural gas assets was necessary for the six months ended June 30, 2002 or -28- 2003. Based on oil and natural gas prices in effect on December 31, 2001, the unamortized cost of oil and natural gas properties exceeded the cost center ceiling. As permitted by full cost accounting rules, improvements in pricing subsequent to December 31, 2001 removed the necessity to record a write-down. Using prices in effect on December 31, 2001 the pretax write-down would have been approximately $0.7 million. Because of the volatility of oil and natural gas prices, no assurance can be given that the Company will not experience a write-down in future periods. Depreciation of other property and equipment is provided using the straight-line method based on estimated useful lives ranging from five to 10 years. Currently, the FASB and representatives of the SEC accounting staff are engaged in discussions on the issue of whether SFAS 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangibles", which were effective June 30, 2001, called for mineral rights held under a lease or other contractual arrangement to be classified on the balance sheet as intangible assets and accompanied by specific footnote disclosures. Historically, oil and gas companies, including the Company, have included these costs with all other oil and gas property costs in Property, Plant, and Equipment on the consolidated balance sheet. In the event this interpretation is adopted, a substantial portion of the acquisition costs of oil and gas properties would be required to be classified on the balance sheet as an intangible asset. The Company believes this interpretation would not have a material effect on our results of operations for the periods presented or in the future as these intangible assets would be depleted using the units of production method in a manner consistent with the method currently used to calculate depletion, depreciation, and amortization expense ("DD&A") on those assets. Oil and Natural Gas Reserve Estimates The process of estimating quantities of proved reserves is inherently uncertain, and the reserve data included in this document are estimates prepared by the Company. Reserve engineering is a subjective process of estimating underground accumulations of hydrocarbons that cannot be measured in an exact manner. The process relies on interpretation of available geologic, geophysical, engineering and production data. The extent, quality and reliability of this data can vary. The process also requires certain economic assumptions regarding drilling and operating expense, capital expenditures, taxes and availability of funds. The SEC mandates some of these assumptions such as oil and natural gas prices and the present value discount rate. Proved reserve estimates prepared by others may be substantially higher or lower than the Company's estimates. Because these estimates depend on many assumptions, all of which may differ from actual results, reserve quantities actually recovered may be significantly different than estimated. Material revisions to reserve estimates may be made depending on the results of drilling, testing, and rates of production. It should not be assumed that the present value of future net cash flows is the current market value of the Company's estimated proved reserves. In accordance with SEC requirements, the Company based the estimated discounted future net cash flows from proved reserves on prices and costs on the date of the estimate. The Company's rate of recording depreciation, depletion and amortization expense for proved properties is dependent on the Company's estimate of proved reserves. If these reserve estimates change, the rate at which the Company records these expenses will change. Derivative Instruments and Hedging Activities In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities". This statement, as amended by SFAS No. 137 and SFAS No. 138, establishes standards of accounting for and disclosures of derivative instruments and hedging activities. This statement requires all derivative instruments to be carried on the balance sheet at fair value with changes in a derivative instrument's fair value recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133 was effective for the Company beginning January 1, 2001 and was adopted by the Company on that date. In accordance with the current transition provisions of SFAS No. 133, the Company recorded a cumulative effect transition adjustment of $2.0 million (net of related tax expense of $1.1 million) in accumulated other comprehensive income to recognize the fair value of its derivatives designated as cash flow hedging instruments at the date of adoption. Upon entering into a derivative contract, the Company designates the derivative instruments as a hedge of the variability of cash flow to be received (cash flow hedge). Changes in the fair value of a cash flow hedge are recorded in other comprehensive income to the -29- extent that the derivative is effective in offsetting changes in the fair value of the hedged item. Any ineffectiveness in the relationship between the cash flow hedge and the hedged item is recognized currently in income. Gains and losses accumulated in other comprehensive income associated with the cash flow hedge are recognized in earnings as oil and natural gas revenues when the forecasted transaction occurs. All of the Company's derivative instruments at December 31, 2002 and June 30, 2003 were designated and effective as cash flow hedges except certain options described below under "Volatility of Oil and Natural Gas Prices". When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the derivative will continue to be carried on the balance sheet at its fair value and gains and losses that were accumulated in other comprehensive income will be recognized in earnings immediately. In all other situations in which hedge accounting is discontinued, the derivative will be carried at fair value on the balance sheet with future changes in its fair value recognized in future earnings. The Company typically uses fixed rate swaps and costless collars to hedge its exposure to material changes in the price of natural gas and oil. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated cash flow hedges to forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged transactions. The Company's Board of Directors sets all of the Company's hedging policy, including volumes, types of instruments and counterparties, on a quarterly basis. These policies are implemented by management through the execution of trades by either the President or Chief Financial Officer after consultation and concurrence by the President, Chief Financial Officer and Chairman of the Board. The master contracts with the authorized counterparties identify the President and Chief Financial Officer as the only Company representatives authorized to execute trades. The Board of Directors also reviews the status and results of hedging activities quarterly. Income Taxes Under Statement of Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for Income Taxes", deferred income taxes are recognized at each year end for the future tax consequences of differences between the tax bases of assets and liabilities and their financial reporting amounts based on tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce the deferred tax asset to the amount expected to be realized. Contingencies Liabilities and other contingencies are recognized upon determination of an exposure, which when analyzed indicates that it is both probable that an asset has been impaired or that a liability has been incurred and that the amount of such loss is reasonably estimable. VOLATILITY OF OIL AND NATURAL GAS PRICES The Company's revenues, future rate of growth, results of operations, financial condition and ability to borrow funds or obtain additional capital, as well as the carrying value of its properties, are substantially dependent upon prevailing prices of oil and natural gas. Historically, the markets for oil and natural gas have been volatile, and such markets are likely to continue to be volatile in the future. Prices for oil and natural gas are subject to wide fluctuation in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty and a variety of additional factors that are beyond the control of the Company. These factors include the level of consumer product demand, weather conditions, domestic and foreign governmental regulations, the price and availability of alternative fuels, political conditions in the Middle East, the foreign supply of oil and natural gas, the price of foreign imports and overall economic conditions. It is impossible to predict future oil and natural gas price movements with certainty. Declines in oil and natural gas prices may materially adversely affect the Company's financial condition, liquidity, and ability to finance planned capital expenditures and results of operations. Lower oil and natural gas prices also may reduce the amount of oil and natural gas that the Company can produce economically. Oil and natural gas prices have declined in the recent past and there can be no assurance that prices will recover or will not decline further. The Company typically uses fixed rate swaps and costless collars to hedge its exposure to material changes in the price of natural gas and oil. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated cash flow hedges to forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an -30- ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged transactions. The Company's Board of Directors sets all of the Company's hedging policy, including volumes, types of instruments and counterparties, on a quarterly basis. These policies are implemented by management through the execution of trades by either the President or Chief Financial Officer after consultation and concurrence by the President, Chief Financial Officer and Chairman of the Board. The master contracts with the authorized counterparties identify the President and Chief Financial Officer as the only Company representatives authorized to execute trades. The Board of Directors also reviews the status and results of hedging activities quarterly. As of December 31, 2002 and June 30, 2003, $0.4 million and $0.7 million, net of tax of $0.2 million and $0.4 million, respectively, remained in accumulated other comprehensive income related to the valuation of the Company's hedging positions. Total oil purchased and sold under swaps and collars during the three months ended June 30, 2002 and 2003 were 45,500 Bbls and 63,300 Bbls, respectively. Total natural gas purchased and sold under swaps and collars during the three months ended June 30, 2002 and 2003 were 728,000 MMBtu and 819,000 MMBtu, respectively. Total oil purchased and sold under swaps and collars during the six months ended June 30, 2002 and 2003 were 45,500 Bbls and 126,300 Bbls, respectively. Total natural gas purchased and sold under swaps and collars during the six months ended June 30, 2002 and 2003 were 1,538,000 MMBtu and 1,349,000 MMBtu, respectively. The net losses realized by the Company under such hedging arrangements were $0.4 million and $0.4 million for the three months ended June 30, 2002 and 2003, respectively, and are included in oil and natural gas revenues. The net losses realized by the Company under such hedging arrangements were $0.4 million and $1.7 million for the six months ended June 30, 2002 and 2003, respectively, and are included in oil and natural gas revenues. At December 31, 2002 and June 30, 2003 the Company had the following outstanding hedge positions:
AS OF DECEMBER 31, 2002 - ----------------------------------------------------------------------------------------------------------- CONTRACT VOLUMES ----------------------------- AVERAGE AVERAGE AVERAGE QUARTER BBls MMbtu FIXED PRICE FLOOR PRICE CEILING PRICE - ---------------------------- ------------- -------------- -------------- -------------- ----------------- First Quarter 2003 27,000 $ 24.85 First Quarter 2003 36,000 $ 23.50 $ 26.50 First Quarter 2003 540,000 3.40 5.25 Second Quarter 2003 27,300 24.85 Second Quarter 2003 36,000 23.50 26.50 Second Quarter 2003 546,000 3.40 5.25 Third Quarter 2003 552,000 3.40 5.25 Fourth Quarter 2003 552,000 3.40 5.25
AS OF JUNE 30, 2003 - ----------------------------------------------------------------------------------------------------------- CONTRACT VOLUMES ----------------------------- AVERAGE AVERAGE AVERAGE QUARTER BBls MMbtu FIXED PRICE FLOOR PRICE CEILING PRICE - ---------------------------- ------------- -------------- -------------- -------------- ----------------- Third Quarter 2003 276,000 $ 4.70 Third Quarter 2003 552,000 $ 3.40 $ 5.25 Fourth Quarter 2003 552,000 3.40 5.25 Second Quarter 2004 273,000 4.00 5.20 Third Quarter 2004 276,000 4.00 5.20 Fourth Quarter 2004 93,000 4.00 5.20
During July 2003, the Company entered into swap arrangements covering 36,800 Bbls of oil for August 2003 through October 2003 production with a fixed price of $30.00. In addition to the hedge positions above, during the second quarter of 2003, the Company acquired options to sell 6,000 MMBtu of natural gas per day for the period July 2003 through August 2003 (552,000 MMBtu) at $8.00 per MMBtu for approximately $119,000. -31- The Company acquired these options to protect its cash position against potential margin calls on certain natural gas derivatives due to large increases in the price of natural gas. These options have been classified as derivatives. As of June 30, 2003, these options have been adjusted to their estimated fair market value of approximately $28,000 and a charge for the adjustment of $91,000 has been included in other income and expense for the three months ended June 30, 2003. NEW ACCOUNTING PRONOUNCEMENTS Effective July 1, 2003, we will adopt SFAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". This standard will not have a material impact on our consolidated financial statements. The FASB issued Interpretation 46, "Consolidation of Variable Interest Entities" ("FIN 46"), in January 2003. FIN 46 requires the consolidation of certain types of entities in which a company absorbs a majority of another entity's expected losses, receives a majority of the other entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the other entity. The Company has identified no transactions or related entities that required consolidation under this interpretation. Currently, the FASB and representatives of the SEC accounting staff are engaged in discussions on the issue of whether SFAS 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangibles", which were effective June 30, 2001, called for mineral rights held under a lease or other contractual arrangement to be classified on the balance sheet as intangible assets and accompanied by specific footnote disclosures. Historically, oil and gas companies, including the Company, have included these costs with all other oil and gas property costs in Property, Plant, and Equipment on the consolidated balance sheet. In the event this interpretation is adopted, a substantial portion of the acquisition costs of oil and gas properties would be required to be classified on the balance sheet as an intangible asset. The Company believes this interpretation would not have a material effect on our results of operations for the periods presented or in the future as these intangible assets would be depleted using the units of production method in a manner consistent with the method currently used to calculate depletion, depreciation, and amortization expense ("DD&A") on those assets. FORWARD LOOKING STATEMENTS The statements contained in all parts of this document, including, but not limited to, those relating to the Company's schedule, targets, estimates or results of future drilling, budgeted wells, increases in wells, budgeted and other future capital expenditures, use of offering proceeds, outcome and effects of litigation, expected production or reserves, increases in reserves, acreage working capital requirements, hedging activities, the ability of expected sources of liquidity to implement its business strategy, level of risk and capital involved in the North Sea project area, the application of FIN 46 to Pinnacle, and any other statements regarding future operations, financial results, business plans and cash needs and other statements that are not historical facts are forward looking statements. When used in this document, the words "anticipate," "estimate," "expect," "may," "project," "believe" and similar expression are intended to be among the statements that identify forward looking statements. Such statements involve risks and uncertainties, including, but not limited to, those relating to the Company's dependence on its exploratory drilling activities, the volatility of oil and natural gas prices, the need to replace reserves depleted by production, operating risks of oil and natural gas operations, the Company's dependence on its key personnel, factors that affect the Company's ability to manage its growth and achieve its business strategy, risks relating to, limited operating history, technological changes, significant capital requirements of the Company, the potential impact of government regulations in the United States and elsewhere, litigation, competition, the uncertainty of reserve information and future net revenue estimates, property acquisition risks, availability of equipment, weather and other factors detailed in the Company's Annual Report on Form 10-K for the year ended December 31, 2002 and other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. -32- ITEM 3A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding our exposure to certain market risks, see "Quantitative and Qualitative Disclosures about Market Risk" in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2002 except for the Company's hedging activity subsequent to December 31, 2002 as described above in "Volatility of Oil and Natural Gas Prices". There have been no material changes to the disclosure regarding our exposure to certain market risks made in the Annual Report. For additional information regarding our long-term debt, see Note 4 of the Notes to Unaudited Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q. -33- ITEM 4 - CONTROLS AND PROCEDURES In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2003 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. There has been no change in our internal controls over financial reporting that occurred during the three months ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. -34- PART II. OTHER INFORMATION Item 1 - Legal Proceedings From time to time, the Company is party to certain legal actions and claims arising in the ordinary course of business. While the outcome of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect on the financial position or results of operations of the Company. Item 2 - Changes in Securities and Use of Proceeds Pursuant to an exchange election provided in a letter agreement, dated May 1, 2001, with certain participants in the Carrizo 2001 Seismic and Acreage Program (the "2001 Program"), the Company is issuing to such participants, who have exercised their election, approximately 168,000 shares of its common stock in exchange for the participants' entire interest in the 2001 Program, including approximately 350 square miles of 3D seismic data and working interests in certain producing properties. The exchange transaction is effective on July 31, 2003 and will be valued using the close price of the Company's common stock on that date, for a total of approximately $1.2 million. Such transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof as a transaction not involving any public offering. Item 3 - Defaults Upon Senior Securities None. Item 4 - Submission of Matters to a Vote of Security Holders At the Annual Meeting of Carrizo Oil & Gas, Inc. held on May 23, 2003, there were represented by person or by proxy 13,879,926 shares out of 14,200,716 entitled to vote as of the record date, constituting a quorum. The matters submitted to a vote of shareholders were (1) the reelection of Steven A. Webster, Christopher C. Behrens, Bryan R. Martin, Douglas A.P. Hamilton, Paul B. Loyd, Jr., F. Gardner Parker, S.P. Johnson IV and Frank A. Wojtek as directors, (2) the approval of an amendment to the incentive plan to provide for additional stock option grants to the chairman and members of certain committee of the Board of Directors and (3) the approval of the appointment of Ernst & Young LLP as Independent Public Accountants for the fiscal year ended December 31, 2003. With respect to the election of directors, the following number of votes were cast for the nominees: 13,554,530 for Mr. Webster and 325,396 withheld; 13,554,530 for Mr. Behrens and 325,396 withheld; 13,554,330 for Mr. Martin and 325,596 withheld; 13,554,530 for Mr. Hamilton and 325,396 withheld; 7,611,358 for Mr. Loyd and 325,596 withheld; 13,553,810 for Mr. Parker and 326,116 withheld; 13,519,805 for Mr. Johnson and 360,121 withheld; and 13,554,530 for Mr. Wojtek and 325,396 withheld. There were no abstentions in the election of directors. With respect to the amendment to the incentive plan, 10,991,953 votes were cast for the amendment, 464,794 votes were against and 7,340 votes abstained. With respect to the appointment of Ernst & Young LLP as Independent Public Accountants, 13,860,068 votes were cast for the appointment, 10,882 votes were against, and 8,976 votes abstained. Item 5 - Other Information On August 14, 2003, the Company announced the appointment of Paul F. Boling as Vice President and Chief Financial Officer, Secretary and Treasurer of the Company. Frank A. Wojtek left the Company to pursue other interests. Paul F. Boling, age 49, joined Carrizo as Chief Financial Officer, Vice President, Secretary and Treasurer on August 12, 2003. From 2001 to 2003, Mr. Boling was the Global Controller for Resolution Performance Products, LLC., an international epoxy resins manufacturer. From 1990 to 2001, Mr. Boling served in a number of financial and managerial positions with Cabot Oil & Gas Corporation, serving most recently as Vice President, Finance. Mr. Boling is a CPA and holds a B.B.A. from Baylor University. Item 6 - Exhibits and Reports on Form 8-K Exhibits
Exhibit Number Description - ---------- ----------------------------------------------------------------- +2.1 -- Combination Agreement by and among the Company, Carrizo Production, Inc., Encinitas Partners Ltd., La Rosa Partners Ltd., Carrizo Partners Ltd., Paul B. Loyd, Jr., Steven A. Webster, S.P. Johnson IV, Douglas A.P.
-35- Hamilton and Frank A. Wojtek dated as of September 6, 1997 (incorporated herein by reference to Exhibit 2.1 to the Company's Registration Statement on Form S-1 (Registration No. 333-29187)). +3.1 -- Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). +3.2 -- Amended and Restated Bylaws of the Company, as amended by Amendment No. 1 (incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form 8-A (Registration No. 000-22915) Amendment No. 2 (incorporated herein by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated December 15, 1999) and Amendment No. 3 (Incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated February 20, 2002). +3.3 -- Statement of Resolution dated February 20, 2002 establishing the Series B Convertible Participating Preferred Stock providing for the designations, preferences, limitations and relative rights, voting, redemption and other rights thereof (Incorporated herein by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated February 20, 2002). 10.1 -- Contribution and Subscription Agreement dated June 23, 2003 by and among Pinnacle Gas Resources, Inc., CCBM, Inc., Rocky Mountain Gas, Inc. and the CSFB Parties listed therein. 10.2 -- Transition Services Agreement dated June 23, 2003 by and between the Company and Pinnacle Gas Resources, Inc. 31.1 -- CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 -- CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 -- CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 -- CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
+ Incorporated herein by reference as indicated. Reports on Form 8-K The Company filed a Current Report on Form 8-K on April 29, 2003 (information furnished not filed) and a Current Report on Form 8-K on May 8, 2003 (information furnished not filed). -36- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. Carrizo Oil & Gas, Inc. (Registrant) Date: August 14, 2003 By: /s/S. P. Johnson, IV -------------------------------------------- President and Chief Executive Officer (Principal Executive Officer) Date: August 14, 2003 By: /s/Paul F. Boling -------------------------------------------- Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) -37- EXHIBIT INDEX
Exhibit Number Description - ---------- ----------------------------------------------------------------- +2.1 -- Combination Agreement by and among the Company, Carrizo Production, Inc., Encinitas Partners Ltd., La Rosa Partners Ltd., Carrizo Partners Ltd., Paul B. Loyd, Jr., Steven A. Webster, S.P. Johnson IV, Douglas A.P. Hamilton and Frank A. Wojtek dated as of September 6, 1997 (incorporated herein by reference to Exhibit 2.1 to the Company's Registration Statement on Form S-1 (Registration No. 333-29187)). +3.1 -- Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). +3.2 -- Amended and Restated Bylaws of the Company, as amended by Amendment No. 1 (incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form 8-A (Registration No. 000-22915) Amendment No. 2 (incorporated herein by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated December 15, 1999) and Amendment No. 3 (Incorporated herein by reference to Exhibit 3.1 to the Company's Current Report on Form 8-K dated February 20, 2002). +3.3 -- Statement of Resolution dated February 20, 2002 establishing the Series B Convertible Participating Preferred Stock providing for the designations, preferences, limitations and relative rights, voting, redemption and other rights thereof (Incorporated herein by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated February 20, 2002). 10.1 -- Contribution and Subscription Agreement dated June 23, 2003 by and among Pinnacle Gas Resources, Inc., CCBM, Inc., Rocky Mountain Gas, Inc. and the CSFB Parties listed therein. 10.2 -- Transition Services Agreement dated June 23, 2003 by and between the Company and Pinnacle Gas Resources, Inc. 31.1 -- CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 -- CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 -- CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 -- CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
+ Incorporated herein by reference as indicated. EX-10.1 3 h08461exv10w1.txt CONTRIBUTION & SUBSCRIPTION AGREEMENT EXHIBIT 10.1 ================================================================================ PINNACLE GAS RESOURCES, INC. PREFERRED STOCK AND COMMON STOCK CONTRIBUTION AND SUBSCRIPTION AGREEMENT DATED AS OF JUNE 23, 2003 ================================================================================ TABLE OF CONTENTS ARTICLE I. DEFINITIONS ..............................................................6 Section 1.1 Definitions ......................................................6 ARTICLE II. ISSUANCE OF SECURITIES .................................................16 Section 2.1 Initial CCBM Contribution .......................................16 Section 2.2 Initial RMG Contribution ........................................16 Section 2.3 Option of the Contributing Parties to Purchase Additional Shares ...............................................17 Section 2.4 Initial CSFB Contribution .......................................18 Section 2.5 Subsequent CSFB Contribution ..........ERROR! BOOKMARK NOT DEFINED. Section 2.6 Grant of Additional Warrants ....................................20 Section 2.7 Allocation Agreement ............................................20 Section 2.8 Disclaimers .....................................................20 ARTICLE III. CLOSING ...............................................................21 ARTICLE IV. CONDITIONS TO CLOSING ..................................................21 Section 4.1 Closing Conditions of the Investors .............................21 Section 4.2 Closing Conditions of the CSFB Parties ..........................23 Section 4.3 Closing Conditions of CCBM ......................................24 Section 4.4 Closing Conditions of RMG .......................................25 Section 4.5 Closing Conditions of the Company ...............................25 ARTICLE V. CONDITIONS TO THE SUBSEQUENT CSFB CONTRIBUTION ..........................26 Section 5.1 Conditions to the Subsequent CSFB Contribution ..................26 ARTICLE VI. COVENANTS ..............................................................27 Section 6.1 Cooperation, Approvals, Further Action ..........................27 Section 6.2 Closing Conditions; Adverse Effect ..............................27 Section 6.3 Supplements to Schedules ........................................27 Section 6.4 Access ..........................................................28 Section 6.5 Confidentiality .................................................28 Section 6.6 Additional Affirmative Covenants of the Company .................28 Section 6.7 Taxes. ..........................................................29 Section 6.8 Public Disclosures ..............................................30 Section 6.9 Brokers' Fees ...................................................30 Section 6.10 Company Records .................................................30 Section 6.11 Retention of Stock Certificates; Negative Pledge ................30 ARTICLE VII. REPRESENTATIONS AND WARRANTIES OF THE COMPANY ........................ 31 Section 7.1 Organization; Qualification and Authority; Binding Obligations .............................................31 Section 7.2 Authorized Shares and Related Matters ...........................31 Section 7.3 Defaults; Indebtedness ..........................................32 Section 7.4 No Violation ....................................................32 Section 7.5 Offering of Shares ..............................................32
ARTICLE VIII. REPRESENTATIONS, AND WARRANTIES OF THE INVESTORS .....................32 Section 8.1 Investment Matters ..............................................32 Section 8.2 Authority .......................................................33 Section 8.3 No Conflicts ....................................................34 Section 8.4 Other Agreements ................................................34 ARTICLE IX. REPRESENTATIONS AND WARRANTIES OF CCBM .................................34 Section 9.1 Organization; Qualification and Authority; Binding Obligations ..34 Section 9.2 Defaults; Outstanding Debt ......................................35 Section 9.3 No Violation ....................................................35 Section 9.4 Consents ........................................................35 Section 9.5 Investment Company Status .......................................35 Section 9.6 Taxes ...........................................................35 Section 9.7 Compliance with Law .............................................36 Section 9.8 Proceedings .....................................................36 Section 9.9 Title ...........................................................36 Section 9.10 Contracts .......................................................36 Section 9.11 Permits .........................................................37 Section 9.12 Consents, Preferential Rights, etc ..............................37 Section 9.13 Marketing. ......................................................37 Section 9.14 Change in Condition. ............................................37 Section 9.15 No Other Activities .............................................38 Section 9.16 Contributed Assets ..............................................38 ARTICLE X. REPRESENTATIONS AND WARRANTIES OF RMG ...................................38 Section 10.1 Organization; Qualification and Authority; Binding Obligations ..38 Section 10.2 Defaults; Outstanding Debt ......................................38 Section 10.3 No Violation ....................................................39 Section 10.4 Consents ........................................................39 Section 10.5 Investment Company Status .......................................39 Section 10.6 Taxes ...........................................................39 Section 10.7 Compliance with Law .............................................39 Section 10.8 Proceedings .....................................................40 Section 10.9 Title ...........................................................40 Section 10.10 Contracts .......................................................40 Section 10.11 Permits .........................................................40 Section 10.12 Consents, Preferential Rights, etc ..............................41 Section 10.13 Marketing. ......................................................41 Section 10.14 Change in Condition. ............................................41 Section 10.15 No Other Activities .............................................41 Section 10.16 Contributed Assets ..............................................41 Section 10.17 Environmental Matters ...........................................41 Section 10.18 Operation of the Proven Properties. .............................42 ARTICLE XI. TRANSFER OF SECURITIES .................................................42 Section 11.1 Restriction on Transfer .........................................42 Section 11.2 Restrictive Legends .............................................42
ARTICLE XII. TERMINATION ...........................................................43 Section 12.1 Termination .....................................................43 Section 12.2 Effect of Termination ...........................................43 ARTICLE XIII. MISCELLANEOUS ........................................................44 Section 13.1 Indemnification .................................................44 Section 13.2 Indemnification Procedures ......................................46 Section 13.3 Dispute Resolution ..............................................48 Section 13.4 Consent to Amendments ...........................................49 Section 13.5 Survival of Representations and Warranties ......................49 Section 13.6 Successors and Assigns; No Third Party Benefit ..................49 Section 13.7 Notices .........................................................50 Section 13.8 Descriptive Headings ............................................51 Section 13.9 Satisfaction Requirement ........................................51 Section 13.10 Governing Law ...................................................52 Section 13.11 Entire Agreement ................................................52 Section 13.12 Severability ....................................................52
Schedule 2.1(a)-1 CCBM Contributed Assets Schedule 2.1(a)-2 Assumed CCBM Liabilities Schedule 2.2(a)-1 RMG Contributed Assets Schedule 2.2(a)-2 Assumed RMG Liabilities Schedule 9.8 CCBM Proceedings Schedule 9.10 CCBM Contracts Schedule 9.12 CCBM Required Consents Schedule 9.13 CCBM Marketing Schedule 9.16 CCBM Excluded Assets Schedule 10.8 RMG Proceedings Schedule 10.10 RMG Contracts Schedule 10.12 RMG Required Consents Schedule 10.13 RMG Marketing Schedule 10.16 RMG Excluded Assets Exhibit A Form of AMI Agreement Exhibit B Form of Assignment, Assumption and Bill of Sale Exhibit C Form of Carrizo Transition Services Agreement Exhibit D-1 Form of Schoonmaker Employment Agreement Exhibit D-2 Form of Uhland Employment Agreement
Exhibit E Form of RMG Transition Services Agreement Exhibit F Form of Securityholders Agreement Exhibit G Allocations Exhibit H Form of Certificate of Incorporation Exhibit I Form of Certificate of Designations Exhibit J Form of Bylaws Exhibit K-1 Form of Company Officer's Certificate Exhibit K-2 Form of CCBM/RMG Officer's Certificate Exhibit L Approved 2003 Capital Expenditures Budget Exhibit M Approved 2003 General and Administrative Expenses Budget Exhibit N Form of Baker Botts Legal Opinion Exhibit O Form of Davis Graham & Stubbs Legal Opinion
PINNACLE GAS RESOURCES, INC. CONTRIBUTION AND SUBSCRIPTION AGREEMENT This CONTRIBUTION AND SUBSCRIPTION AGREEMENT, dated as of June 23, 2003 (this "AGREEMENT"), is entered into by and among Pinnacle Gas Resources, Inc., a Delaware corporation (the "COMPANY"), CCBM, Inc., a Delaware corporation ("CCBM"), Rocky Mountain Gas, Inc., a Wyoming corporation ("RMG"), and each of the CSFB Parties (as defined herein, and collectively with CCBM and RMG, the "INVESTORS"). WHEREAS, subject to terms and conditions of this Agreement, CCBM has agreed to contribute certain assets to the Company in exchange for the issuance of common stock, par value $.01, of the Company ("COMMON STOCK") and an option to purchase additional newly issued shares of Common Stock; WHEREAS, subject to terms and conditions of this Agreement, RMG has agreed to contribute certain assets to the Company in exchange for the issuance of Common Stock and an option to purchase additional newly issued shares of Common Stock; WHEREAS, subject to the terms and conditions of this Agreement, the CSFB Parties (as defined below) and have agreed to contribute cash to the Company in exchange for the issuance of Common Stock, Series A Redeemable Preferred Stock, par value $.01 per share, of the Company ("PREFERRED STOCK") and warrants exercisable for the purchase of Common Stock at a price per share equal to $100.00, as the same may be adjusted as provided therein ("WARRANTS"); and WHEREAS, the parties hereto agree that the contributions by CCBM and RMG contemplated by the foregoing clauses are intended to constitute transfers described in Section 351(a) of the Internal Revenue Code of 1986, as amended; NOW, THEREFORE, in consideration of the premises, mutual covenants and agreements hereinafter contained and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I. DEFINITIONS Section 1.1 Definitions. For the purpose of this Agreement, and in addition to terms defined elsewhere in this Agreement, the following terms shall have the following meanings. In addition, all terms of an accounting character not specifically defined herein have the meanings assigned thereto by the Financial Accounting Standards Board and generally accepted accounting principles. "AAA" has the meaning set forth in Section 13.3(d). "ACQUIRED ASSETS" means the assets acquired by the Company pursuant to the First Source Agreements. 6 "ACQUISITIONS" means the acquisition of assets by the Company pursuant to the First Source Agreements. "ADDITIONAL SHARES" has the meaning set forth in Section 2.3(a). "AFFILIATE" means, with respect to any Person, any Person controlling, controlled by, or under common control with such Person. For the purposes of this definition, "control" means the possession of the power to direct or cause the direction of management and policies of such Person, whether through the direct or indirect ownership of voting securities, by contract or otherwise. "AGREEMENT" has the meaning set forth in the preamble. "AMI AGREEMENT" means the Area of Mutual Interest Agreement to be entered into among the Company and the Investors concurrently with the execution of this Agreement in the form of Exhibit A attached hereto. "APPROVALS" means any approvals, authorizations, grants of authority, consents, orders, qualifications, permits, licenses, variances, exemptions, franchises, concessions, certificates, filings or registrations or any waivers of the foregoing, or any notices, statements or other communications required to be filed with, delivered to or obtained from any Governmental Entity or any other Person. "ASSIGNMENT, ASSUMPTION AND BILL OF SALE" means those certain Assignments, Assumptions and Bills of Sale executed by each of CCBM and RMG in the form of Exhibit B attached hereto. "ASSOCIATES" of any Person, means any officer, director or employee of such Person and such officer's, director's or employee's spouse, heirs, executors, administrators, testamentary trustees, legatees or beneficiaries." "ASSUMED CCBM LIABILITIES" means the obligations of CCBM to be assumed by the Company, as set forth in Schedule 2.1(a)-2, and any other liabilities expressly defined as Assumed CCBM Liabilities elsewhere in this Agreement. "ASSUMED RMG LIABILITIES" means the obligations of RMG to be assumed by the Company, as set forth in Schedule 2.2(a)-2, and any other liabilities expressly defined as Assumed RMG Liabilities elsewhere in this Agreement. "ASSUMPTIONS" means the assumption by the Company pursuant to the terms hereof of the Assumed CCBM Liabilities and the Assumed RMG Liabilities. "AWARD" has the meaning set forth in Section 13.2(e). "BOARD" means the board of directors of the Company. 7 "BUSINESS DAY" means any day which is not a Saturday, Sunday or day on which banks are authorized by law to close in the State of New York, the State of Texas or the State of Wyoming. "CAPITAL REQUEST" has the meaning set forth in Section 2.5(a). "CARRIZO" means Carrizo Oil & Gas, Inc., a Texas corporation. "CARRIZO TRANSITION SERVICES AGREEMENT" means a Transition Services Agreement to be entered into between the Company and Carrizo concurrently with the execution of this Agreement in the form of Exhibit C attached hereto. "CCBM" has the meaning set forth in the recitals. "CCBM CONTRACTS" has the meaning set forth in Section 9.10. "CCBM CONTRIBUTED ASSETS" means the assets to be contributed by CCBM as set forth in Schedule 2.1(a)-1; provided, that the CCBM Contributed Assets shall not include any proceeds, revenues, deductions, credits, refunds, rights and causes of action or other similar assets attributable to the ownership or operation of the CCBM Contributed Assets prior to the Closing notwithstanding anything to the contrary in any Assignment, Assumption and Bill of Sale or other Related Agreement. "CCBM CONTRIBUTION" has the meaning set forth in Section 2.1(a). "CEILING AMOUNT" means $7,500,000. "CERTIFICATE OF DESIGNATIONS" means the Company's Certificate of Designations, Preferences and Rights of Series A Redeemable Preferred Stock filed with the Secretary of State of the State of Delaware on June 23, 2003. "CLOSING" has the meaning set forth in Article III. "CLOSING DATE" has the meaning set forth in Article III. "COMMISSION" means the United States Securities and Exchange Commission. "COMMITMENT AMOUNT" has the meaning set forth in Section 2.5(a). "COMMON STOCK" has the meaning set forth in the recitals. "COMPANY" has the meaning set forth in the preamble. "CONTRIBUTING PARTIES" means, collectively, CCBM and RMG. "CONTRIBUTED ASSETS" means, collectively, the CCBM Contributed Assets and the RMG Contributed Assets. "CONTRIBUTION" means, collectively, the CCBM Contribution and the RMG Contribution. 8 "CSFB PARTIES" means, collectively, DLJ MB Partners III GmbH & Co. KG, a limited company organized under the laws of Germany, DLJ Offshore Partners III, C.V., a partnership organized under the laws of the Netherlands Antilles, DLJ Offshore Partners III-1, C.V., a partnership organized under the laws of the Netherlands Antilles, DLJ Offshore Partners III-2, C.V., a partnership organized under the laws of the Netherlands Antilles, Millennium Partners II, L.P., a Delaware limited partnership, DLJ Merchant Banking Partners III, L.P., a Delaware limited partnership, and MBP III Plan Investors, L.P., a Delaware limited partnership. "CUSTOMARY FILINGS" means rights to consent which require notices to, filings with, or other actions by Governmental Entities or tribal entities in connection with the sale or conveyance of oil and gas leases or interests therein if they are customarily obtained subsequent to the sale or conveyance. "DEFENSIBLE TITLE" means, with respect to any Proven Property, such record and beneficial title that (x) except as disclosed in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) and Schedule 2.2(a) (with respect to the RMG Contributed Assets) entitles the party named to receive, from its ownership of such interest, a percentage of all Hydrocarbons produced, saved and marketed from each well or property included in the Proven Properties not less than the Net Revenue Interest set forth in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) and Schedule 2.2(a) (with respect to the RMG Contributed Assets) for such well or property, without reduction, suspension, or termination for the productive life of such well or property, except (i) as a result of elections not to participate in an operation under an applicable operating, unit or other agreement, (ii) as required to allow other working interest owners to make up past underproduction or processors or pipelines to make up past underdeliveries or (iii) readjustments of interest provided for under the terms of the applicable operating, unit or other agreement, in each case, after the date hereof; (y) except as disclosed in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) and Schedule 2.2(a) (with respect to the RMG Contributed Assets), obligates the party named to bear a percentage of the costs and expenses relating to operations on, and the maintenance and production of, such well or property, not greater than the Working Interest or operating interest set forth in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) and Schedule 2.2(a) (with respect to the RMG Contributed Assets) without increase for the productive life of such well or property or without a proportionate increase in the associated Net Revenue Interest, except as a result of an election of other parties not to participate in an operation under an applicable operating, unit or other agreement, contribution requirements with respect to defaulting co-owners, or readjustments of interest provided for under the terms of the applicable operating or unit agreement, in each case, after the date hereof; and (z) is free and clear of any Liens except Permitted Encumbrances. "DIRECTOR" means any member of the Board of the Company. "DISPUTE" shall have the meaning set forth in Section 13.3(a). "DISPUTE NOTICE" shall have the meaning set forth in Section 13.3(b). 9 "EMPLOYMENT AGREEMENTS" means the Employment Agreements to be entered into between the Company, each of Peter G. Schoonmaker and Gary Uhland concurrently with the execution of this Agreement in the form of Exhibits D-1 and D-2, respectively, attached hereto. "ENVIRONMENTAL LAWS" means all federal, state and local laws, regulations, and requirements presently in effect, including the common law, relating to pollution or protection of human health or the environment, including without limitation, laws relating to Releases or threatened Releases of Hazardous Materials into the indoor or outdoor environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the regulation, manufacture, processing, distribution, use, treatment, storage, Release, disposal, transport or handling of Hazardous Materials and all laws and regulations with regard to record keeping, notification, disclosure and reporting requirements respecting Hazardous Materials. "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. "EXCLUDED CCBM LIABILITIES" has the meaning set forth in Section 2.1(b). "EXCLUDED RMG LIABILITIES" has the meaning set forth in Section 2.2(b). "FIRST SOURCE AGREEMENTS" means, collectively, that certain Agreement for Purchase and Sale and that certain Earn-In Joint Venture Agreement, each dated as of May 30, 2003, among First Source Wyoming, Inc., First Sourcenergy Wyoming, Inc., Squaw Creek, Inc., Squaw Creek Development, Inc., Gastar Exploration, Ltd. and RMG. "GOOD AND LEGAL TITLE" means (i) as to any mineral rights or other real property, that there is a lease, conveyance or other form of assignment or transfer of record evidencing ownership by either CCBM or RMG, as the case may be, of such real property, and (ii) as to personal property, that either CCBM or RMG, as the case may be, has good title to such personal property. "GOVERNMENTAL ENTITY" means any court or tribunal in any jurisdiction (domestic or foreign) or any governmental or regulatory body, agency, department, commission, board, bureau or other authority or instrumentality (domestic or foreign). "HAZARDOUS MATERIALS" means all substances, of any quantity or concentration, defined as Hazardous Substances, Oil, Pollutants or Contaminants in the National Oil and Hazardous Substances Pollution Contingency Plan, 40 C.F.R. Sections 300.5, or defined as such by, or regulated as such under, any Environmental Law, and such term shall include, without limitation, PCBs, mercury and naturally-occurring radioactive material, petroleum, natural gas, liquefied natural gas, or synthetic gas, or any other substance which may be the basis for any Person to require investigation, cleanup, removal, treatment or remediation. "HYDROCARBONS" means, collectively, natural gas, petroleum and other liquid or gaseous hydrocarbons and related minerals and all products produced therefrom, in each case whether in a natural or a processed state. "INDEMNIFIED PARTY" shall have the meaning set forth in Section 13.2(a). 10 "INDEMNIFYING PARTY" means any Person required to indemnify any other Person pursuant to Section 13.2(b). "INDEBTEDNESS" means any obligation for borrowed money (including notes payable and drafts accepted representing extensions of credit whether or not representing obligations for borrowed money). "INITIAL CSFB CONTRIBUTION" shall have the meaning set forth in Section 2.4. "INVESTMENT COMPANY ACT" means the Investment Company Act of 1940, as amended. "INVESTORS" means, collectively, CCBM, RMG and the CSFB Parties. "LAW" means any statute, law, rule or regulation or any judgment, order, writ, injunction or decree of any Governmental Entity. "LIEN" means any mortgage, pledge, security interest, encumbrance, lien or charge of any kind (including any agreement to give any of the foregoing, any conditional sale or other title retention agreement, any lease in the nature thereof, and the filing of or agreement to give any financing statement or like instrument under the laws of any jurisdiction). "MAJORITY INTEREST" means those Investors who beneficially own in excess of 50% of the aggregate number of shares of the then-outstanding Common Stock plus (without duplication) all shares of Common Stock issuable upon the exercise of all then-outstanding Warrants. "MATERIAL ADVERSE CHANGE" means any change, event or occurrence which has a Material Adverse Effect; provided, however, that any change, event or occurrence resulting from (i) changes in the price of any Hydrocarbons, or other changes affecting the oil and gas industry generally or (ii) changes in general economic conditions, shall not constitute a Material Adverse Change. "MATERIAL ADVERSE EFFECT" means any material adverse effect on the business, properties, assets or condition, financial or otherwise, or results of operations of the Company and its subsidiaries, taken as a whole, or on the Contributed Assets, taken as a whole, since December 31, 2002. "NOTICE" shall have the meaning set forth in Section 13.7. "NET REVENUE INTEREST" means an interest (expressed as a percentage or decimal fraction) in and to all Hydrocarbons produced and saved from or attributable to a Proven Property. "OFFICER'S CERTIFICATE" means a certificate signed in the name of the Company, by an executive officer of the Company. "PERSON" means any natural person, corporation, limited partnership, general partnership, joint stock company, joint venture, association, company, limited liability company, trust, bank trust company, land trust, business trust, or other organization, whether or not a legal entity, and any Governmental Entity. 11 "PERMITS" means all licenses, permits, variances, exemptions, orders, franchises, approvals and other authorizations of or from Governmental Entities necessary for the conduct of the business of the Company as currently conducted and as proposed to be conducted by the Company after the Closing. "PERMITTED ENCUMBRANCES" means: (a) with respect to Proven Properties, lessors' royalties and any overriding royalties, reversionary interests, net profits interests, production payments, carried interests and other similar burdens to the extent that they do not, individually or in the aggregate, reduce the Net Revenue Interest of the party named below that shown in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) or Schedule 2.2(a) (with respect to the RMG Contributed Assets) or increase the Working Interest of the party named above that shown in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) or Schedule 2.2(a) (with respect to the RMG Contributed Assets) without a corresponding increase in the Net Revenue Interest; (b) with respect to Proven Properties, all leases, contracts, unit agreements, pooling agreements, operating agreements, and other contracts, agreements and instruments applicable to the Contributed Assets, to the extent that they do not, individually or in the aggregate, reduce the Net Revenue Interest of the party named below that shown in Schedule 2.1(a) (with respect to the CCBM Contributed Assets) or Schedule 2.2(a) (with respect to the RMG Contributed Assets) or increase the Working Interest of the party named above that shown in Schedule 2.1(a) or Schedule 2.2(a) without a corresponding increase in the Net Revenue Interest; (c) Liens for taxes or assessments that are not yet delinquent or, if delinquent, are being contested in good faith by appropriate actions as disclosed on Schedule 2.1(a) (with respect to the CCBM Contributed Assets) or Schedule 2.2(a) (with respect to the RMG Contributed Assets); (d) materialmen's, mechanic's, repairman's, employee's, contractor's, operator's and other similar Liens or charges arising in the ordinary course of business for amounts that are not yet delinquent (including any amounts being withheld as provided by law), or if delinquent, are being contested in good faith by appropriate actions as disclosed on Schedule 2.1(a) (with respect to the CCBM Contributed Assets) or Schedule 2.2(a) (with respect to the RMG Contributed Assets); (e) Customary Filings; (f) rights of reassignment arising upon final intention to abandon or release any of the Contributed Assets; (g) easements, rights-of-way, servitudes, permits, surface leases and other rights in respect of surface operations arising or incurred in the ordinary course of business that do not materially interfere with the use, operation or value of the Contributed Assets affected thereby; 12 (h) all rights reserved to or vested in any Governmental Entities to control or regulate any of the Contributed Assets in any manner and all obligations and duties under all applicable Laws or under any Permit; (i) any other Liens, defects or irregularities that do not, individually or in the aggregate, materially detract from the value of or materially interfere with the use or operation of the Contributed Assets subject thereto or affected thereby and that would be accepted by a reasonably prudent purchaser engaged in the business of owning and operating coalbed methane properties in the Powder River Basin of Wyoming and Montana; (j) consents to assignment and similar contractual provisions affecting the Contributed Assets, provided that, with respect to transfers to the Contributing Parties or their predecessors in the chain of title, such consents, where applicable, have been obtained; (k) preferential rights to purchase and similar contractual provisions affecting the Contributed Assets, provided that, with respect to transfers to Contributing Parties or their predecessors in the chain of title, such preferential rights, where applicable, have expired or been waived; (l) terms and conditions of governmental licenses and permits affecting the Contributed Assets; (m) other matters that the CSFB Parties and the Company waive in writing; (n) litigation referenced in Schedule 9.8 or disclosed in writing by the Contributing Parties prior to the execution of this Agreement; (o) gas imbalances associated with the Contributed Assets set forth in Schedule 9.13; and (p) matters specifically listed on Schedule 2.1(a) or Schedule 2.2(a). "PERMITTED TRANSFEREE" means, (a) with respect to any CSFB Party, (i) any Affiliate of any CSFB Party, (ii) any managing director, director, managing general partner, associate general partner, advisory general partner, general partner or limited partner of any CSFB Party, (iii) any Associate of any CSFB Party, and (iv) any trust, the beneficiaries of which, or any corporation, limited liability company or partnership, the shareholders, members or general or limited partners of which, include only one or more CSFB Parties, or any of their respective Associates, (b) with respect to CCBM, (i) Carrizo or any other Affiliate of CCBM (other than any Person deemed an Affiliate of CCBM through control of Carrizo or any other publicly traded parent, direct or indirect, of CCBM), (ii) any Associate of CCBM, (iii) any trust, the beneficiaries of which, or any corporation, limited liability company or partnership, the shareholders, members or general or limited partners of which, include only CCBM or any of its Associates, (c) with respect to RMG, (i) any Affiliate of RMG (other than any Person deemed an Affiliate of RMG through control of U.S. Energy or any other publicly traded parent, direct or indirect, of RMG), (ii) any Associate of RMG, (iii) any trust, the beneficiaries of which, or any corporation, limited liability company or partnership, the shareholders, members or general or limited partners of which, include only RMG or any of its Associates; provided, however, that 13 any transferee from any CSFB Party, CCBM or RMG pursuant to clauses (a), (b) or (c) above will act through DLJ Merchant Banking Partners III, L.P., CCBM and RMG, respectively. "PREFERRED STOCK" has the meaning set forth in the recitals. "PROCEEDINGS" means all proceedings, actions, claims, suits, investigations and inquiries by or before any arbitrator or Governmental Entity. "PRO RATA PORTION" has the meaning set forth in 0. "PROVEN PROPERTY" means the Contributed Assets comprised of discrete well locations, wells, groups of wells, well completions, multiple well completions, units, leases or other property or contractual interests which are classified as a proved developed producing, proved developed nonproducing or proved undeveloped properties or interests in Schedules 2.1(a) and 2.2(a). "RECORDS" means books, accounts, ledgers tax returns, financial and other records, including audit work papers, correspondence and contracts of every kind related to the Contributed Assets. "RELATED AGREEMENTS" means the Securityholders Agreement, the Employment Agreements, the AMI Agreement, the Transition Services Agreements, the First Source Agreements and the Assignments, Assumptions and Bill of Sales executed by each of CCBM and RMG. "RELEASE" means any release, spill, emission, discharge, leaking, pumping, injection, deposit, disposal, dispersal, leaching or migration into the indoor or outdoor environment (including, without limitation, ambient air, surface water, groundwater, land surface or subsurface strata) or into or out of any property, including the movement of Hazardous Materials through or in air, soil, surface water, groundwater or property. "REQUIRED CONSENTS" means all approvals and consents required to be obtained by the Company, CCBM or RMG with respect to the consummation of each of the transactions contemplated by this Agreement, including, without limitation, those set forth on Schedule 9.12 and Schedule 10.12. "RESPONSE" shall have the meaning set forth in Section 13.3(b). 14 "RMG" has the meaning set forth in the recitals. "RMG CONTRIBUTED ASSETS" means the assets to be contributed by RMG as set forth in Schedule 2.2(a)-1 hereto; provided, that the RMG Contributed Assets shall not include any proceeds, revenues, deductions, credits, refunds, rights and causes of action or other similar assets attributable to the ownership or operation of the RMG Contributed Assets prior to the Closing. For the avoidance of doubt, the RMG Contributed Assets shall not include the Acquired Assets but shall include all rights and interests of RMG arising under the First Source Agreements notwithstanding anything to the contrary in any Assignment, Assumption and Bill of Sale or other Related Agreement. "RMG CONTRACTS" has the meaning set forth in Section 10.10. "RMG CONTRIBUTION" has the meaning set forth in Section 2.2(a). "RMG PLEDGE" means the Pledge Agreement between RMG and the Company. "RMG TRANSITION SERVICES AGREEMENT" means a Transition Services Agreement to be entered into between the Company and RMG concurrently with the execution of this Agreement in the form of Exhibit E attached hereto. "SECURITIES" means, collectively, the Common Stock (including Common Stock issued upon exercise of the Warrants and/or pursuant to Section 2.3), Preferred Stock and Warrants. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SENIOR MANAGER" shall have the meaning set forth in Section 13.3(b). "SHARES" means, collectively, the shares of Preferred Stock and Common Stock. "SECURITYHOLDERS AGREEMENT" means the Securityholders Agreement among the Company and holders of Securities in the form attached hereto as Exhibit F, as amended and in effect from time to time. "SUBSEQUENT CSFB CONTRIBUTION" has the meaning set forth in Section 2.5(a). "TAXES" means all federal, state, county, local, foreign or other taxes, charges, fees, levies, imposts, duties, licenses or other governmental assessments, together with any interest, penalties, additions to tax or additional amounts imposed with respect thereto. "THIRD PARTY CLAIM" means a Claim that is not a Claim by the Company, the Investors or any of their Affiliates for their own losses. "THRESHOLD AMOUNT" means $75,000. "TRANCHE A PRICE" the meaning set forth in Section 2.3(a). "TRANCHE A SHARES" has the meaning set forth in Section 2.3(a). "TRANCHE B PRICE" the meaning set forth in Section 2.3(a). "TRANCHE B SHARES" has the meaning set forth in Section 2.3(a). "TRANSITION SERVICES AGREEMENTS" means, collectively, the RMG Transition Services Agreement and the Carrizo Transition Services Agreement. "WARRANTS" has the meaning set forth in the recitals. "WELLS" has the meaning set forth in Section 6.6(d). 15 "WORKING INTEREST" means, with respect any Contributing Party, the percentage interest of such Contributing Party of costs and expenses attributable to the maintenance, development and operation of a Proven Property, prior to giving effect to rights of non-consent hereafter exercised by others and claims with respect to non-payment by defaulting parties to operating agreements and similar contracts. ARTICLE II. ISSUANCE OF SECURITIES Section 2.1 Initial CCBM Contribution. (a) Subject to the terms and conditions of this Agreement, at the Closing, CCBM shall contribute, convey, assign, transfer and deliver to the Company all of its right, title and interest at the time of the Closing in and to the CCBM Contributed Assets (the "CCBM CONTRIBUTION"), and the Company shall assume the Assumed CCBM Liabilities. The CCBM Contribution and the assumption of the Assumed CCBM Liabilities will be effected by the execution and delivery by CCBM to the Company of a duly executed Assignment, Assumption and Bill of Sale together with such additional assignments as may be required by Governmental Entities to effect the assignment to the Company of CCBM's interest in the leases and other properties and interests included in the CCBM Contributed Assets. (b) Notwithstanding any other provision of this Agreement, the Company shall not assume or have any liability hereunder with respect to any other liabilities or obligations of CCBM not specifically included in the Assumed CCBM Liabilities, whether known or unknown, liquidated or unliquidated, contingent or fixed (the "EXCLUDED CCBM LIABILITIES"), including, without limitation: (i) liabilities to the extent arising out of the business operations of CCBM or its ownership of the CCBM Contributed Assets prior to the Closing Date; (ii) liabilities to the extent arising out of any businesses operated and assets owned by CCBM other than the CCBM Contributed Assets, whether incurred before or after the Closing Date; and (iii) liabilities or obligations for CCBM to pay any Taxes, including any Taxes incurred by CCBM arising out of its business operations or its ownership of the CCBM Contributed Assets prior to the Closing Date. (c) In consideration for all of the foregoing, at the Closing, subject to the terms and conditions of this Agreement, the Company will issue to CCBM 75,000 shares of Common Stock and will grant the option described in Section 2.3(a). Section 2.2 Initial RMG Contribution. (a) Subject to the terms and conditions of this Agreement, at the Closing, RMG shall contribute, convey, assign, transfer and deliver to the Company all of its right, 16 title and interest at the time of the Closing in and to the RMG Contributed Assets (the "RMG CONTRIBUTION"), and the Company shall assume the Assumed RMG Liabilities. The RMG Contribution and the assumption of the Assumed RMG Liabilities will be effected by delivery by RMG to the Company of a duly executed Assignment, Assumption and Bill of Sale together with such additional assignments as may be required by Governmental Entities to effect the assignment to the Company of RMG's interest in the leases included in the RMG Contributed Assets. (b) Notwithstanding any other provision of this Agreement, the Company shall not assume or have any liability hereunder with respect to any other liabilities or obligations of RMG not specifically included in the Assumed RMG Liabilities, whether known or unknown, liquidated or unliquidated, contingent or fixed (the "EXCLUDED RMG LIABILITIES"), including, without limitation: (i) liabilities to the extent arising out of the business operations of RMG or its ownership of the RMG Contributed Assets prior to the Closing Date; (ii) liabilities to the extent arising out of any businesses operated and assets owned by RMG other than the RMG Contributed Assets, whether incurred before or after the Closing Date; and (iii) liabilities or obligations for RMG to pay any Taxes, including any Taxes incurred by RMG arising out of its business operation or its ownership of the RMG Contributed Assets prior to the Closing Date. (c) In consideration for all of the foregoing, at the Closing, subject to the terms and conditions of this Agreement, the Company will issue to RMG 75,000 shares of Common Stock and will grant the option described in Section 2.3(b). Section 2.3 Option of the Contributing Parties to Purchase Additional Shares. (a) For so long as CCBM or any of its Permitted Transferees shall own of record Common Stock, CCBM shall have the continuing option, upon 10 Business Days' notice to the Company, to purchase in one or more transactions after the Closing Date (i) a Pro Rata Portion of up to 25,000 additional shares of Common Stock ("TRANCHE A SHARES") at a purchase price per share equal to $100 as increased by 10% per annum compounded quarterly beginning on the Closing Date and accruing daily through the date of the purchase of such shares (the "TRANCHE A PRICE"), and (ii) a Pro Rata Portion of up to 25,000 additional shares of Common Stock ("TRANCHE B SHARES, and together with Tranche A Shares, "ADDITIONAL SHARES") at a purchase price equal to $100 per share as increased by 20% per annum compounded quarterly beginning on the Closing Date and accruing daily through the date of the purchase of such shares (the "TRANCHE B PRICE"). Notwithstanding anything to the contrary contained herein, CCBM may not purchase Tranche B Shares until such time as CCBM has purchased all of the Tranche A Shares then available to it. (b) For so long as RMG or any of its Permitted Transferees shall own of record Common Stock, RMG shall have the continuing option upon 10 Business Days' 17 notice to the Company, to purchase in one or more transactions after the date of this Agreement (i) a Pro Rata Portion of up to 25,000 Tranche A Shares at a purchase price per share equal to the Tranche A Price and (ii) a Pro Rata Portion of up to 25,000 Tranche B Shares at a purchase price per share equal to the Tranche B Price. Notwithstanding anything to the contrary contained herein, RMG may not purchase Tranche B Shares until such time as RMG has purchased all of the Tranche A Shares then available to it. (c) For purposes of this Section 2.3, "PRO RATA PORTION" means a number of Tranche A Shares or Tranche B Shares, as the case may be, equal to 25,000 multiplied by a fraction, (i) the numerator of which is an amount equal to the product of (A) the number of shares of Common Stock and Preferred Stock purchased on or prior to such date by the CSFB Parties pursuant to this Agreement as of the date of purchase of any Additional Shares and (B) $100.00, and (ii) the denominator of which is equal to $30,000,000; provided, that such number shall be increased or decreased, as appropriate, in the event that prior to such purchase there shall have occurred any subdivision, split-up, combination or reverse split of shares of Common Stock. (d) The purchase price for all Additional Shares shall be payable in cash and shall be made by wire transfer of immediately available funds to an account or accounts designated by the Company in writing not later than at least two Business Days prior to the date of the purchase. (e) Except with respect to Permitted Transferees, the option to purchase Additional Shares pursuant to this Agreement may not be assigned without the prior written consent of a Majority Interest. Section 2.4 Initial CSFB Contribution. (a) Subject to the terms and conditions of this Agreement, at the Closing the CSFB Parties shall contribute as a capital contribution to the Company (the "INITIAL CSFB CONTRIBUTION"), and the Company shall accept from the CSFB Parties, the following cash contributions:
CSFB Party Cash Contribution - ---------- ----------------- DLJ Merchant Banking Partners III, L.P. 13,273,904 DLJ Offshore Partners III, C.V. 707,658 DLJ Offshore Partners III-1, C.V. 236,866 DLJ Offshore Partners III-2, C.V. 168,658 Millennium Partners II, L.P. 42,042 DLJ MB Partners III GmbH & Co. KG 111,916 MBP III Plan Investors, L.P. 3,098,956 ----------- TOTAL: $17,640,000
Such contributions shall be made by wire transfer of immediately available funds to an account or accounts designated by the Company in writing at least two Business Days prior to the Closing. 18 (b) In consideration of the foregoing, at the Closing, subject to the terms and conditions of this Agreement, the Company will issue to the CSFB Parties the number of Securities set forth below:
Shares of CSFB Party Common Stock Preferred Stock Warrants - ---------- ------------ --------------- -------- DLJ Merchant Banking Partners III, L.P. 37,625 97,823 97,823 DLJ Offshore Partners III, C.V 2,006 5,215 5,215 DLJ Offshore Partners III-1, C.V 671 1,746 1,746 DLJ Offshore Partners III-2, C.V 478 1,243 1,243 Millennium Partners II, L.P. 119 310 310 DLJ MB Partners III GmbH & Co. KG 317 825 825 MBP III Plan Investors, L.P. 8,784 22,838 22,838 ------- -------- -------- TOTALS: 50,000 130,000 130,000
Section 2.5 Subsequent CSFB Contribution. (a) At any time prior to July 1, 2004, the Company may request (a "CAPITAL REQUEST") that the CSFB Parties make and, subject to the terms and conditions of this Agreement, the CSFB Parties shall make, an additional cash capital contribution or contributions to the Company (each, a "SUBSEQUENT CSFB CONTRIBUTION"); provided: (i) the aggregate amount of all Subsequent Capital Contributions shall not exceed $11,760,000 (the "COMMITMENT AMOUNT"); (ii) no Subsequent Capital Contribution shall be less than $4,000,000 (unless at such time the Commitment Amount remaining shall be less than $4,000,000); (iii) the CSFB Parties shall have received not less than 20 Business Days' written notice of the Subsequent CSFB Contribution from the Chief Executive Officer of the Company; and (iv) a majority of the Board shall have authorized such Capital Request and approved of such Subsequent Capital Contribution for use in connection with (A) the drilling of coal bed methane wells, for remedial work on coal bed methane wells (in either case, located on the Contributed Assets or the Acquired Assets) or the creation or improvement of infrastructure to promote the gathering and production of coal bed methane from such wells or (B) an acquisition of assets; provided that such acquisition shall have been approved by the CSFB Parties. (b) In consideration of the foregoing, for each $980,000 in Subsequent Capital Contribution received from the CSFB Parties, the Company will issue to the CSFB Parties 10,000 shares of Preferred Stock and 10,000 Warrants. (c) The Subsequent CSFB Contribution shall be made by wire transfer of immediately available funds to an account or accounts designated by the Company in 19 writing not later than at least two Business Days prior to the date of such Subsequent CSFB Contribution. Section 2.6 Grant of Additional Warrants. In the event the Company shall at any time on or after June 30, 2005 elect to pay dividends on the Preferred Stock in kind, then, in accordance with Section 2(b) of the Certificate of Designations, for each additional share of Preferred Stock distributed as a dividend payment, the Company shall deliver a single Warrant to the holders of each share of Preferred Stock on which each in kind dividend is paid. The Warrants, if any, so distributed shall be exercisable for shares of Common Stock at a price per share equal to the exercise price of the outstanding Warrants on the day of such distribution. Section 2.7 Allocation Agreement. Each of the Company, RMG, CCBM and the CSFB Parties agree to the following allocations in the manner set forth on Exhibit G for all purposes including, without limitation, for purposes of U.S. federal, state and local income tax: (a) An allocation of the value of the Initial CSFB Contribution between the Warrants and the Preferred Stock. (b) An allocation of the value of the CCBM Contributed Assets, less the Assumed CCBM Liabilities, between the 75,000 shares of Common Stock and the option described in Section 2.3(a). (c) An allocation of the value of the RMG Contributed Assets, less the Assumed RMG Liabilities, between the 75,000 shares of Common Stock and the option described in Section 2.3(b). (d) An allocation of the value of the 75,000 shares of Common Stock and the option described in Section 2.3(a), increased by the amount of the Assumed CCBM Liabilities, among the CCBM Contributed Assets. (e) An allocation of the value of the 75,000 shares of Common Stock and the option described in Section 2.3(b), increased by the amount of the Assumed RMG Liabilities, among the RMG Contributed Assets. Section 2.8 Disclaimers. EXCEPT AS EXPRESSLY REPRESENTED OTHERWISE IN ARTICLES IX OR X, OR IN THE CONVEYANCE INSTRUMENTS TO BE DELIVERED BY EITHER CCBM OR RMG, AS THE CASE MAY BE, TO THE COMPANY HEREUNDER, WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, CCBM AND RMG, AS THE CASE MAY BE, EXPRESSLY DISCLAIM ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, ORAL OR WRITTEN, AS TO (i) TITLE TO ANY OF THE CONTRIBUTED ASSETS, (ii) THE CONTENTS, CHARACTER OR NATURE OF ANY DESCRIPTIVE MEMORANDUM, OR ANY REPORT OF ANY PETROLEUM ENGINEERING CONSULTANT, OR ANY GEOLOGICAL OR SEISMIC DATA OR INTERPRETATION, RELATING TO THE CONTRIBUTED ASSETS, PROVIDED, HOWEVER, NOTWITHSTANDING THE FOREGOING, RMG REPRESENTS AND WARRANTS, AND CCBM REPRESENTS AND WARRANTS THAT TO ITS KNOWLEDGE, THAT ANY HISTORICAL INFORMATION AS TO PRODUCTION AND SALES VOLUMES, VOLUMES OF 20 PRODUCED WATER AND PRICING OF HYDROCARBON SALES RELATED TO THE CCBM CONTRIBUTED ASSETS AND THE RMG CONTRIBUTED ASSETS, RESPECTIVELY PROVIDED TO ANY SUCH CONSULTANT FOR USE IN CONNECTION WITH THE PREPARATION OF ANY SUCH REPORT IS ACCURATE, (iii) THE QUANTITY, QUALITY OR RECOVERABILITY OF HYDROCARBONS IN OR FROM THE CONTRIBUTED ASSETS, (iv) ANY ESTIMATES OF THE VALUE OF THE CONTRIBUTED ASSETS OR FUTURE REVENUES GENERATED BY THE CONTRIBUTED ASSETS, (v) THE PRODUCTION OF HYDROCARBONS FROM THE CONTRIBUTED ASSETS, OR WHETHER PRODUCTION HAS BEEN CONTINUOUS, OR IN PAYING QUANTITIES, (vi) THE MAINTENANCE, REPAIR, CONDITION, QUALITY, SUITABILITY, DESIGN OR MARKETABILITY OF THE CONTRIBUTED ASSETS, OR (vii) ANY OTHER MATERIALS OR INFORMATION THAT MAY HAVE BEEN MADE AVAILABLE OR COMMUNICATED TO THE OTHER INVESTORS, THE COMPANY OR ANY OF THEIR AFFILIATES, OR ANY OF THEIR EMPLOYEES, AGENTS, CONSULTANTS, REPRESENTATIVES OR ADVISORS IN CONNECTION WITH THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT OR ANY DISCUSSION OR PRESENTATION RELATING THERETO, AND FURTHER DISCLAIM ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR CONFORMITY TO MODELS OR SAMPLES OF MATERIALS OF ANY EQUIPMENT, MACHINERY, TOOLS, FIXTURES AND OTHER TANGIBLE PROPERTY, IT BEING EXPRESSLY UNDERSTOOD AND AGREED BY THE PARTIES HERETO THAT THE COMPANY SHALL BE DEEMED TO BE OBTAINING EQUIPMENT, MACHINERY, TOOLS, FIXTURES AND OTHER TANGIBLE PROPERTY IN ITS PRESENT STATUS, CONDITION AND STATE OF REPAIR, "AS IS" AND "WHERE IS" WITH ALL FAULTS AND THAT THE COMPANY AND THE OTHER INVESTORS HAVE MADE OR CAUSED TO BE MADE SUCH INSPECTIONS AS THEY DEEM APPROPRIATE WITH RESPECT THERETO. ARTICLE III. CLOSING The issuance and delivery of the Securities to be purchased by the Investors shall take place at a closing (the "CLOSING") to be held at the Houston offices of Akin Gump Strauss Hauer & Feld LLP on such date (the "CLOSING DATE") which shall be on the day which is two consecutive Business Days after the date on which the last of the conditions set forth in Article V is fulfilled or waived or is capable of being fulfilled at the Closing or at such other time or place as the parties hereto shall agree. ARTICLE IV. CONDITIONS TO CLOSING Section 4.1 Closing Conditions of the Investors. Each Investor's obligation to acquire the Securities to be acquired by it hereunder on the Closing Date is subject to the satisfaction or waiver, on or before the Closing Date, of the conditions contained in this Section 4.1. 21 (a) The representations and warranties of the Company contained in this Agreement shall be true and correct in all respects at and as of the Closing Date, as if made at and as of such date (except that representations and warranties made as of a specific date need be true only as of that date). (b) The Company shall have performed in all material respects all of its obligations under this Agreement required to be performed by it on or prior to the Closing Date. (c) Each Investor shall have received (i) an Officer's Certificate signed by the President of the Company, dated the Closing Date, attaching (A) a true and complete copy of the Company's Certificate of Incorporation, together with all amendments thereto, as filed with the Secretary of State of the State of Delaware in the form attached hereto as Exhibit H, (B) a true and complete copy of the Certificate of Designations, as filed with the Secretary of State of the State of Delaware and in the form attached hereto as Exhibit I, (C) a true and complete copy of the Company's Bylaws in effect on the date thereof in the form attached hereto as Exhibit J, (D) certificates of good standing of the appropriate officials of the jurisdiction of formation of the Company and of each state or other jurisdiction in which the Company is qualified to transact business, and is transacting business, except those other jurisdictions where the failure to be so qualified would not have a Material Adverse Effect and (E) a true and correct copy of the resolutions of the Board authorizing and approving the execution of this Agreement and each Related Agreement and the performance of the transactions contemplated hereby and thereby and (ii) a Closing Certificate signed by the President of the Company, dated the Closing Date, in the form of Exhibit K-1 attached hereto. (d) The offering and sale of the Securities under this Agreement shall have complied with all applicable requirements of federal and state securities laws. (e) (i) There shall be no Proceedings pending or, to the Company's knowledge threatened, against or affecting the Company or any of its properties or rights, or any of its Affiliates, Associates, officers or Directors, before any Governmental Entity which (A) seeks to restrain, enjoin or prevent the consummation of the transactions contemplated by this Agreement or (B) questions the validity or legality of any such transaction, and (ii) to the Company's knowledge there shall be no valid basis for any such Proceeding. (f) The Company shall have duly received all Approvals, Permits and certificates, other than Customary Filings, by or of all Governmental Entities required for the issuance of the Securities by the Company, the execution and delivery of the Related Agreements and the consummation of the transactions contemplated hereby and thereby, and all of the foregoing shall be in full force and effect at the Closing Date. (g) The initial members of the Board shall have been appointed Directors of the Company, as specified in the Securityholders Agreement, effective upon the Closing. 22 (h) The Company and each of Peter G. Schoonmaker and Gary W. Uhland shall have entered into the Employment Agreements. (i) The Company and RMG shall have entered into the RMG Transition Services Agreement. (j) The Company and Carrizo shall have entered into the Carrizo Transition Services Agreement. (k) The Company and the Investors shall have entered into the Securityholders Agreement and the AMI Agreement. (l) The 2003 Capital Expenditures Budget, a copy of which is attached as Exhibit L hereto, shall have been approved by the Board. (m) The 2003 General and Administrative Expenses Budget, a copy of which is attached as Exhibit M hereto, shall have been approved by the Board. (n) The Company shall have delivered to the Investors a detailed statement setting forth the uses of the proceeds resulting from the offer and sale of the Securities pursuant to this Agreement, which statement shall be acceptable to the Investors. (o) The Company shall have delivered to the Investors a five-year financial forecast for the Company which forecast shall be based on assumptions believed reasonable by management for the Company and otherwise acceptable to the Investors; provided that, notwithstanding any other provisions hereof, it is recognized by the Investors that such projections and any reserve report delivered in connection with this Agreement as they relate to future events are not to be viewed as fact and that the actual results during the period or periods covered by the projections or reserve reports may differ from the projected results set forth therein by a material amount; and, without limiting the generality of the foregoing, no representation or warranty is made in this Agreement as to future prices of hydrocarbons or as to the timing or results of future exploration or production operations. (p) Each of CCBM and RMG shall have delivered to the Company possession of the certificates representing or evidencing the Common Stock issued to such parties pursuant hereto. (q) Each of the Contributions and the Initial CSFB Contribution shall be made concurrently and each Investor's obligation to make its respective contribution is conditioned upon the concurrent contribution of each other Investor. Section 4.2 Closing Conditions of the CSFB Parties. In addition to the conditions set forth in Section 4.1 above, the obligation of the CSFB Parties to make the Initial CSFB Contribution and to acquire Securities in connection therewith, is further subject to the satisfaction or waiver, on or prior to the Closing Date, of the conditions contained in this Section 4.2. 23 (a) Baker Botts L.L.P., counsel to CCBM, shall have delivered a legal opinion dated the Closing Date substantially in the form attached hereto as Exhibit N to the CSFB Parties. (b) Davis Graham & Stubbs LLP, counsel to RMG, shall have delivered a legal opinion dated the Closing Date substantially in the form attached hereto as Exhibit O to the CSFB Parties. (c) All conditions precedent to the consummation of the Acquisitions shall have been satisfied or waived except for the payment of the purchase price with respect thereto, and RMG shall have delivered true and correct copies of the First Source Agreements and such agreements shall have been validly and fully executed by the purchasers and sellers party thereto. (d) The representations and warranties of CCBM and RMG contained in this Agreement shall be true and correct in all respects at and as of the Closing Date, as if made at and as of such date (except that representations and warranties made as of a specific date need be true only as of that date). (e) CCBM and RMG shall have performed in all material respects all of their respective obligations under this Agreement required to be performed by them on or prior to the Closing Date. (f) The CSFB Parties shall have received all such counterpart originals or certified or other copies of such documents as they may reasonably request. (g) The CSFB Parties shall have been furnished with reasonably requested evidence of all Required Consents, other than Customary Filings, and each such Required Consent shall be unconditional or be subject to conditions which have been satisfied on or before the Closing Date. (h) There shall have occurred no Material Adverse Change. Section 4.3 Closing Conditions of CCBM. In addition to the conditions set forth in Section 4.1 above, the obligation of CCBM to acquire the Shares to be acquired by it hereunder on the Closing Date is further subject to the satisfaction or waiver, on or before the Closing Date, of the conditions contained in this Section 4.3. (a) The representations and warranties of the CSFB Parties and RMG contained in this Agreement shall be true and correct in all respects at and as of the Closing Date, as if made at and as of such date (except that representations and warranties made as of a specific date need be true only as of that date). (b) The CSFB Parties and RMG shall have performed in all material respects all of their respective obligations under this Agreement required to be performed by them on or prior to the Closing Date. 24 (c) CCBM shall have received all such counterpart originals or certified or other copies of such documents as it may reasonably request. Section 4.4 Closing Conditions of RMG. In addition to the conditions set forth in Section 4.1 above, the obligation of RMG to acquire the Shares to be acquired by it hereunder on the Closing Date is further subject to the satisfaction or waiver, on or before the Closing Date, of the conditions contained in this Section 4.3. (a) The representations and warranties of the CSFB Parties and CCBM contained in this Agreement shall be true and correct in all respects at and as of the Closing Date, as if made at and as of such date (except that representations and warranties made as of a specific date need be true only as of that date). (b) The CSFB Parties and CCBM shall have performed in all material respects all of their respective obligations under this Agreement required to be performed by them on or prior to the Closing Date. (c) RMG shall have received all such counterpart originals or certified or other copies of such documents as it may reasonably request. Section 4.5 Closing Conditions of the Company. The Company's obligation to issue the Securities to any Investor hereunder at any Closing is subject to the satisfaction or waiver, on or before the applicable Closing Date of the conditions contained in this Section 4.5. (a) The representations and warranties of such Investor contained in Article VIII hereof shall be true in all respects at and as of the applicable Closing Date, as if made at and as if such date (except that representations and warranties made as of a specific date need be true only as of that date). (b) Each of CCBM and RMG shall have delivered to the Company an Officer's Certificate in the form of Exhibit K-2, dated the Closing Date. (c) Such Investor shall have performed in all material respects all of its obligations under this Agreement required to be performed by it on or prior to the applicable Closing Date. (d) In the case of RMG and CCBM, each of RMG and CCBM, respectively, shall have delivered to the Company possession of the certificates representing the Common Stock issued to such Investor pursuant hereto. (e) The Company shall have duly received all Approvals, Permits and certificates, other than Customary Filings, by or of all Governmental Entities required for the issuance of the Securities by the Company, the execution and delivery of the Related Agreements and the consummation of the transactions contemplated hereby and thereby, and all of the foregoing shall be in full force and effect at the Closing Date. 25 ARTICLE V. CONDITIONS TO THE SUBSEQUENT CSFB CONTRIBUTION Section 5.1 Conditions to the Subsequent CSFB Contribution. The obligation of the CSFB Parties to make the Subsequent CSFB Contribution and to acquire the Securities to be acquired by them in connection therewith is subject to the prior satisfaction or waiver of the conditions contained in this Section 5.1. (a) The representations and warranties of the Company contained in this Agreement shall be true and correct at and as of the date of the Subsequent CSFB Contribution, as if made at and as of such date (except that representations and warranties made as of a specific date need be true only as of that date) except for such breaches that would not, individually or in the aggregate, have a Material Adverse Effect. (b) The Company shall have performed in all material respects all of its obligations under this Agreement and any Related Agreement required to be performed by it on or prior to the date of the Subsequent CSFB Contribution. (c) The representations and warranties of CCBM and RMG contained in this Agreement shall be true and correct at and as of the date of the Subsequent CSFB Contribution, as if made at and as of such date (except that representations and warranties made as of a specific date need be true only as of that date). (d) CCBM and RMG shall have performed in all material respects all of their respective obligations under this Agreement and any Related Agreement to which each is a party required to be performed by it on or prior to the date of the Subsequent CSFB Contribution. (e) There shall have occurred no Material Adverse Change nor any change, event or occurrence which has a material adverse effect on the prospects of the Company and its subsidiaries, taken as a whole, or on the Contributed Assets and the Acquired Assets, taken as a whole, since the Closing Date. (f) There shall not have occurred any breach by the Company in any material term or provision of the Preferred Stock or any of the Related Agreements. (g) Prior to any Subsequent CSFB Contribution, the Company shall have delivered a use of proceeds statement indicating that the proceeds of such contribution shall be used only in connection with (i) expenditures approved by a majority of the Board with respect to the drilling of coal bed methane wells, for remedial work on coal bed methane wells (in either case, located on the Contributed Assets or the Acquired Assets) or the creation or improvement of infrastructure to promote the gathering and production of coal bed methane from such wells or (ii) any acquisition approved by the CSFB Parties, which approval may be withheld in their sole and absolute discretion. 26 ARTICLE VI. COVENANTS Section 6.1 Cooperation, Approvals, Further Action. The Company and the each of the Investors covenants and agrees to cooperate and use all commercially reasonable efforts to take, or cause to be taken, all action and to do, or cause to be done, all things necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement, including cooperating fully with the other parties to obtain all Approvals that may be necessary or which may be reasonably requested by the Company or the Investors to consummate the transactions contemplated by this Agreement and the Related Agreements. In case at any time after the date hereof any commercially reasonable further action is reasonably necessary or desirable to carry out the purposes of this Agreement, the parties hereto shall take all such reasonably necessary action. Without limiting the foregoing, the parties hereto acknowledge that CCBM and RMG shall be responsible for obtaining any Required Consents prior to the Closing and CCBM and RMG agree to assist and cooperate with the Company in obtaining any approvals of any Governmental Entities with respect to the assignment of the leases included in the Contributed Assets. Section 6.2 Closing Conditions; Adverse Effect. Each of CCBM and RMG covenants and agrees, from the date hereof until the earlier of the Closing Date or the termination of this Agreement, (i) not to take any action that will, or is reasonably likely to, (A) cause any breach of its respective representations and warranties contained herein such that any condition to the Closing contained herein would not be satisfied or (B) adversely affect the Contributed Assets and (ii) not to amend or otherwise modify any term or provision of any Related Agreement, in each case, without the prior written consent of the CSFB Parties; provided, however, that such consent shall be deemed given unless the CSFB Parties notify CCBM and RMG to the contrary within three Business Days of receipt of a written request therefor. Section 6.3 Supplements to Schedules. Each of the parties hereto agree that any party hereto may supplement or amend any schedule required by Article VII, Article VIII, Article IX or Article X with respect to any matter hereafter arising which, if existing or occurring at the date of this Agreement, would have been required to be set forth or described in such schedules; provided, however, that no supplement or amendment of any schedule made pursuant to this Section 6.3 shall be deemed to cure any preexisting breach of any representation or warranty made in this Agreement unless the parties agree thereto in writing. 27 Section 6.4 Access. At all times from and after the date hereof until the Closing, each of CCBM and RMG shall afford the other Investors and their respective counsel and other authorized representatives reasonable access to its respective properties, employees and officers and subsidiaries and to all Records, in each case, as related to the Contributed Assets provided, however, that each of CCBM and RMG reserves the right to withhold any information if disclosure is prohibited by an agreement with a third party. The foregoing notwithstanding, each of CCBM and RMG shall use its commercially reasonable efforts to obtain any such third party consent required in connection with the provision to the other Investors of any information related to the Contributed Assets. Section 6.5 Confidentiality. Each Investor shall, and shall cause its representatives to, hold confidential all information relating to CCBM and RMG or any of their respective subsidiaries it has received from such party or any of its representatives and any information such Investor receives (whether before or after the date hereof) from CCBM or RMG or any of their respective representatives as a result of Section 6.4 above or such Investor's ownership of Securities; provided, however, that the foregoing shall not apply to (A) information that is or becomes generally available to the public other than as a result of a disclosure by such Investor or any of its Affiliates or representatives in violation of this Section 6.5, (B) information that is or becomes available to such Investor or any of its representatives on a nonconfidential basis from a source other than CCBM or RMG or their respective Affiliates or representatives, provided that such source is not known by such Investor to be bound by a confidentiality agreement with, or other obligation of secrecy to, the Investor to whom such duty is owed or any other party, (C) disclosures to any partner, Affiliate, subsidiary or parent company of such Investor for the purpose of evaluating its investment in the Company (in which case, such Investor shall cause each such Person to hold the information confidential in accordance with this Section 6.5) or (D) information that is required to be disclosed by such Investor or any of its representatives as a result of any applicable Law; provided further, that in the event information is required to be disclosed pursuant to clause (D) above, the Person proposing such disclosure shall provide the applicable other Investor, to the extent practicable an opportunity, reasonably in advance of such disclosure, to review and comment on the form and content of the proposed disclosure. The foregoing to the contrary notwithstanding, the obligations of confidentiality contained herein, as they relate to the transactions contemplated by this Agreement, shall not apply to the tax structure or tax treatment of such transactions, and each party hereto (and any of their respective employees, representatives, or agents) may disclose to any and all Persons, without limitation of any kind, the tax structure and tax treatment of the transactions contemplated by this Agreement and all materials of any kind (including opinions or other tax analysis) that are provided to such Person relating to the tax treatment and tax structure of such transactions (provided that such disclosure shall not include the name (or other identifying information not relevant to the tax structure or tax treatment) of any Person and shall not include information for which nondisclosure is reasonably necessary in order to comply with applicable securities laws). Section 6.6 Additional Affirmative Covenants of the Company. All covenants contained in this Section 6.6 shall be given independent effect. The provisions of this Section 6.6 are for the benefit of Investors for so long as they hold any Securities. 28 (a) The Company covenants that (i) all shares of Common Stock that may be issued upon the exercise of the Warrants and all of the Additional Shares that may be issued pursuant to this Agreement will, upon issuance and upon full payment therefor, be validly issued, fully paid and nonassessable (except to the extent specified in the Delaware General Corporation Law) and free from all taxes, liens and charges (other than under the Securityholders Agreement) with respect to the issuance thereof and (ii) the Company will at all times have authorized and reserved a sufficient number of shares of Common Stock to permit the (A) issuance of all of the Additional Shares and (B) during the period within which the Warrants may be exercisable for shares of Common Stock, the exercise of all Warrants. (b) Within 60 days after Closing, upon presentation of reasonably requested documentary proof the Company will (i) pay, or reimburse the CSFB Parties for the payment of, all reasonable out-of-pocket expenses arising in connection with the transactions and other agreements and instruments contemplated by this Agreement with respect to the Closing, including the reasonable fees and expenses of the CSFB Parties' counsel, advisors and consultants and (ii) reimburse RMG for the fees payable under that certain Financial Advisory Agreement, dated the 24th day of July, 2002, between U.S. Energy and Sanders Morris Harris Inc. which are actually incurred by U.S. Energy, provided such reimbursement shall not exceed $1,150,000 in the aggregate. (c) The Company will take all actions necessary to become duly qualified to own, hold and operate the Contributed Assets and the Acquired Assets, shall comply with all bonding requirements to own, hold and operate such assets and shall obtain insurance with respect to such assets of the type and in amounts customary for the oil and gas industry. (d) Prior to Closing, the Company shall cause to be delivered to the CSFB Parties title opinions and other title information with respect to the producing wells, group of wells and units and leases and well locations ("WELLS") contributed by the Contributing Parties and the Wells acquired upon consummation of the Acquisitions, in each case in form and substance reasonably acceptable to the CSFB Parties. Section 6.7 Taxes. Each Contributing Party shall be severally responsible for, and shall pay, when due, all unpaid ad valorem property, production, windfall profit, severance and similar taxes and assessments based upon or measured by the ownership of such party's Contributed Assets or the production of Hydrocarbons or the receipt of proceeds therefrom attributable to the period prior to the Closing Date. After the Closing Date, when the Company receives tax statements for the Contributed Assets from the appropriate taxing authorities for which the Contributing Parties are responsible in whole or in part, the Company shall deliver to each of the Contributing Parties a copy of such statements, together with the amount, if applicable, of each Contributing Party's pro rata share thereof, and each Contributing Party shall pay to the Company the amount for which it is responsible within three Business Days of receipt of such statement. For purposes of the immediately preceding sentence, a Contributing Party's pro rata share of such Taxes shall be based on (a) in the case of any such Taxes that are determined by reference to production, windfall profit or severance, the percentage of production, income or profits, as applicable, for the period to which such Taxes relates that is 29 produced or earned prior to the Closing Date and (b) in the case of any other such Taxes, the percentage of the actual period to which such Taxes relate that precedes the Closing Date. Section 6.8 Public Disclosures. Any public announcements regarding this Agreement, the Related Agreements or the transactions contemplated hereby and thereby, or the financial performance of the Company shall be made only with the mutual consent of all Investors, which consent shall not be unreasonably withheld or delayed, except as may be required, and to the extent required, by applicable law or stock exchange regulations, in which case the Investor required to issue the public announcement shall allow the other Investors reasonable time to comment on such release or statement in advance of its issuance. Section 6.9 Brokers' Fees. No broker, finder or investment banker (other than Sanders Morris Harris, the fees and expenses of which shall be paid by RMG) is entitled to any brokerage, finder's fee or other fee or commission payable by the Company or any subsidiary of the Company in connection with the transactions contemplated by this Agreement based upon arrangements made by and on behalf of Company or any subsidiary of the Company. Section 6.10 Company Records. Until the later of six years after the Closing Date and two years after the expiration of any related indemnification obligations of the Investors in connection with this Agreement, the Company shall: (a) (i) preserve and retain the Records, (ii) furnish copies of the Records, to the extent not retained by the Investors, to the Investors at the Investors' expense and (iii) make such Records available to the Investors and their respective officers, employees, consultants and representative upon reasonable notice and during normal business hours; provided, however, that (A) in the event that the Company transfers all or a portion of the Contributed Assets to any third party during such period, the Company may transfer to such third party all or a portion of the Records relating to the Contributed Assets being transferred, provided that such third party expressly assumes in writing the obligations of the Company set forth in this Section 6.10 and the Company first offers the Investors the opportunity, at the Investors' expense, to copy such Records, and (B) in the event that Buyer desires to destroy or dispose of all or any portion of the Records during such period, Buyer shall first offer the Investors the opportunity, at the Investors' expense, to obtain such Records prior to destruction or disposition thereof by the Company; and (b) permit reasonable access of representatives of the Investors to employees of the Company and its affiliates on a mutually convenient basis to obtain additional information with respect to the continuing obligations or rights, if any, of the Investors in connection with this Agreement. Section 6.11 Retention of Stock Certificates; Negative Pledge. The Company shall retain possession of the certificates representing the Common Stock issued to each of RMG and CCBM pursuant hereto until July 1, 2004; provided that in the event the Company shall bring a Claim prior to such date with respect to a breach of representation or warranty by RMG or CCBM, the Company shall retain possession of the certificates representing the Common Stock issued to RMG or CCBM, as the case may be, until the earlier of (i) the date such Claim shall be resolved pursuant to Section 13.2 without liability to RMG or CCBM, as the case may be, and 30 (ii) the date on which any Award with respect to such Claim shall be satisfied by RMG or CCBM, as the case may be. Prior to the return of their respective stock certificates pursuant hereto, neither RMG nor CCBM shall create, incur, assume or suffer to exist any lien upon or security interest in any of the Common Stock beneficially owned by such party and represented by such certificates. ARTICLE VII. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to each Investor as of the Closing Date that: Section 7.1 Organization; Qualification and Authority; Binding Obligations. The Company is a corporation duly formed and validly existing in good standing under the laws of the State of Delaware. The Company has been recently incorporated and has not engaged in any activities other than those related to this Agreement. The Company has no subsidiaries. The Company is duly qualified to transact business as a foreign corporation and is in good standing in each jurisdiction in which the character of its properties or the nature of its business makes such qualification necessary, except where the failure to so qualify or to be in good standing would not reasonably be expected to have a Material Adverse Effect. Subject to Customary Filings, the Company has the corporate power to own its properties and to carry on its business as it is now being conducted. The Company has all requisite corporate power and authority to enter into this Agreement and each Related Agreement to which it is a party and to issue and sell the Shares and the Warrants and to issue the Additional Shares upon payment therefor and Common Stock upon exercise of the Warrants and has the requisite power and authority to carry out the transactions contemplated hereby to be performed by it, and the execution, delivery and performance of this Agreement and each other agreement or instrument executed and delivered by the Company pursuant hereto or in connection herewith have been duly authorized by all necessary action. This Agreement and each other agreement or instrument executed and delivered by the Company pursuant hereto or in connection herewith constitute the legal, valid and binding obligations of the Company and, except as may be affected (i) by applicable bankruptcy, insolvency, moratorium, reorganization and other similar laws and judicial decisions affecting the rights of creditors generally and (ii) by general principles of equity and public policy (regardless of whether considered at law or in equity), are enforceable against the Company in accordance with their respective terms. Section 7.2 Authorized Shares and Related Matters. As of the date of this Agreement (a) the aggregate authorized Shares of the Company consists of 2,000,000 Shares, of which 1,000,000 are shares of Common Stock and 1,000,000 are shares of Preferred Stock; (b) prior to the issuances contemplated hereby, no shares of Common Stock or Preferred Stock are issued and outstanding; (c) except as expressly provided in this Agreement, the Warrants, the Certificate of Designations or the Securityholders Agreement, the Company does not have outstanding any securities convertible into or exchangeable for any Shares, any rights to subscribe for or to purchase or any options for the purchase of, or, except pursuant to this Agreement, any agreements providing for the issuance (contingent or otherwise) of, or any calls, commitments or claims of any other character relating to the issuance of, any Shares, or any securities convertible into or exchangeable for any Shares; and (d) except pursuant to the terms 31 of the Preferred Stock contemplated to be issued hereby, the Company is not subject to any obligation (contingent or otherwise) to repurchase or otherwise acquire or retire any Shares. Section 7.3 Defaults; Indebtedness. The Company is not in violation of and is not in default (a) under its certificate of incorporation or bylaws or any Related Agreement or (b) with respect to any Law and there exists no condition, event or act which constitutes, or which after notice, lapse of time, or both, would constitute, such a default under any of the foregoing. The Company has no outstanding Indebtedness. Section 7.4 No Violation. The execution and delivery of this Agreement by the Company and the Investors do not, and the consummation by the Company and the Investors of the agreements and transactions contemplated by this Agreement (including the Contributions and the Assumptions) will not, (a) conflict with, or result in any violation of or default or loss of any benefit under, any provision of the certificate of incorporation or bylaws of the Company, (b) violate any Approval, Law or Permit to which the Company is a party or to which the Company or any of its property is subject or (c) conflict with, or result in a breach or violation of, or accelerate the performance required by, the terms of any agreement, contract, indenture or other instrument to which the Company is a party or to which any of its property is subject, or constitute a default or loss of any right thereunder or an event which, with the lapse of time or notice or both, is likely to result in a default or loss of any right thereunder or the creation of any Lien upon any of the assets or properties of the Company, except, in the case of clause (b) and (c) above, for any such violations, conflicts, breaches or accelerations which would not, individually or in the aggregate, have a Material Adverse Effect. Section 7.5 Offering of Shares. Based in part on the representations and warranties of the Investors in Article VIII, the offer, sale and issuance of the Securities pursuant to this Agreement do not require registration of such securities under the Securities Act or registration or qualification under any applicable state "blue sky" or securities laws. The Company, directly or indirectly, has not taken and will not take any action which would subject the issuance or sale of any of the Securities to the provisions of Section 5 of the Securities Act or violate the provisions of any securities, "blue sky" law or similar law of any applicable jurisdiction. ARTICLE VIII. REPRESENTATIONS, AND WARRANTIES OF THE INVESTORS Each Investor severally but not jointly, represents and warrants solely with respect to itself to the Company and to the other Investors as of the Closing Date that: Section 8.1 Investment Matters. (a) Such Investor is acquiring Securities solely for its beneficial account, for investment purposes, and not with a view to, or for resale in connection with, any distribution of Securities in violation of applicable securities laws; (b) Such Investor understands that the Securities have not been registered under the Securities Act or any state securities laws by reason of specific exemptions under the provisions thereof, the availability of which depend in part upon the bona fide 32 nature of its investment intent and upon the accuracy of its representations made in this Article VIII; (c) Such Investor understands that the Company is relying in part upon the representations and agreements contained in this Article VIII for the purpose of determining whether the offer, sale and issuance of the Securities meets the requirements for such exemptions; (d) Such Investor is an "accredited investor" as defined in Rule 501(a) under the Securities Act; (e) Such Investor has such knowledge, skill and experience in business, financial and investment matters that it is capable of evaluating the merits and risks of an investment in Securities to which it is subscribing; (f) Such Investor understands that the Securities will be "restricted securities" under applicable federal securities laws and that the Securities Act and the rules of the Commission provide in substance that it may dispose of the Securities only pursuant to an effective registration statement under the Securities Act or an exemption therefrom, and it understands that the Company has no obligation or intention to register any of the Securities thereunder (except pursuant to the registration rights granted in the Securityholders Agreement); and (g) Such Investor has been furnished by the Company all information (or provided access to all information) regarding the business and financial condition of the Company, its expected plans for future business activities, the attributes of the Securities for which such Investor is subscribing and the merits and risks of an investment in such Securities which it has requested or otherwise needs to evaluate the investment in such Securities; that in making the proposed investment decision, such Investor is relying solely on such information, the representations, warranties and agreements of each other Investor and on investigations made by it and its representatives; and that the offer to sell the Securities hereunder was communicated to such Investor in such a manner that it was able to ask questions of and receive answers from the management of the Company concerning the terms and conditions of the proposed transaction and that at no time was it presented with or solicited by or through any leaflet, public promotional meeting, television advertisement or any other form of general or public advertising or solicitation. Section 8.2 Authority. (a) Such Investor has full power and authority to enter into and perform its obligations under this Agreement; and (b) This Agreement has been duly authorized, executed and delivered by a Person authorized to do so, constitutes the legal, valid and binding obligation of such Investor and, except as may be affected (i) by bankruptcy, insolvency, moratorium, reorganization and other similar laws and judicial decisions affecting the rights of creditors generally and (ii) by general principles of equity and public policy (regardless 33 of whether considered at law or in equity), is enforceable against such Investor in accordance with its terms. Section 8.3 No Conflicts. The execution, delivery and performance by such Investor of this Agreement and the consummation by such Investor of the transactions contemplated hereby will not, without the giving of notice or the lapse of time, or both, (i) violate any provision of Law to which such Investor is subject, or (ii) conflict with, or result in a breach or default under, any term or condition of its certificate of incorporation or bylaws, or partnership agreement or other organizational document, as applicable, or any agreement or other instrument to which such Investor is a party or by which such Investor is bound. Section 8.4 Other Agreements. Such Investor has not entered into any agreement, written or otherwise, to dispose of the Securities (or any interest therein) it receives pursuant to this Agreement. ARTICLE IX. REPRESENTATIONS AND WARRANTIES OF CCBM In addition to the representations and warranties contained in Article VIII hereof, CCBM, represents and warrants to the other Investors and the Company as of the Closing Date that: Section 9.1 Organization; Qualification and Authority; Binding Obligations. (a) CCBM (i) is a corporation duly formed and validly existing in good standing under the laws of the State of Delaware, (ii) is duly qualified to transact business as a foreign corporation and is in good standing in each jurisdiction in which the character of its properties or the nature of its business makes such qualification necessary, except where the failure to so qualify or to be in good standing would not reasonably be expected to have a Material Adverse Effect, (iii) has the corporate power to own its properties and to carry on its business as it is now being conducted, (iv) has all requisite corporate power and authority to enter into this Agreement and each Related Agreement to which it is a party and has the requisite power and authority to carry out the transactions contemplated hereby and thereby to be performed by it, and the execution, delivery and performance hereof and thereof have been duly authorized by all necessary action; (b) no Approval of any stockholders of CCBM or any stockholders of any Affiliate is required for consummation of the transactions contemplated by this Agreement or the Related Agreements; and (c) this Agreement, each Related Agreement to which it is a party and each other agreement or instrument executed and delivered by CCBM pursuant hereto or in connection herewith constitutes the legal, valid and binding obligations of CCBM and, except as may (i) be affected by applicable bankruptcy, insolvency, moratorium, reorganization and other similar laws and judicial decisions affecting the rights of creditors generally and (ii) by general principles of equity and public policy (regardless of whether considered at law or in equity), are enforceable against CCBM in accordance with their respective terms. 34 Section 9.2 Defaults; Outstanding Debt. CCBM has not violated nor is it in default under (a) its certificate of incorporation or bylaws, (b) any Indebtedness, (c) any indenture, mortgage, lease, or any other contract, agreement or instrument to which it is a party or by which it or any of its properties are bound or affected or (d) with respect to any order, writ, injunction or decree of any court or any federal, state, municipal or other domestic department, commission, board, bureau, agency or instrumentality, and to CCBM's knowledge there exists no condition, event or act which constitutes, or which after notice, lapse of time, or both, would constitute, such a default under any of the foregoing, except for such violations or defaults described in clauses (b), (c) or (d) above which would not, in the aggregate, have a Material Adverse Effect. Section 9.3 No Violation. The execution and delivery by CCBM of this Agreement and each Related Agreement to which it is a party does not, and the execution and delivery by Carrizo of the Carrizo Transition Services Agreement and the consummation of the agreements and transactions contemplated by this Agreement and such Related Agreements will not (a) conflict with, or result in any violation of or default or loss of any benefit under, any provision of the certificate of incorporation and bylaws of Carrizo, CCBM or any subsidiary thereof, (b) to CCBM's knowledge, violate any Approval, Law or Permit to which Carrizo, CCBM or any subsidiary thereof is a party or to which the Company or any subsidiary thereof or any of their respective property is subject or (c) subject to receipt of the Required Consents, conflict with, or result in a breach or violation of, or accelerate the performance required by, the terms of any agreement, contract, indenture or other instrument (including oil and gas leases) to which Carrizo, CCBM or any subsidiary thereof is a party or, to the knowledge of CCBM, to which any of the CCBM Contributed Assets are subject, or constitute a default thereunder or an event which, with the lapse of time or notice or both, is likely to result in a default thereunder or the creation of any Lien upon any of the assets or properties of CCBM or any subsidiary thereof, except, in the case of clauses (b) and (c) above, for any such violations, conflicts, breaches or accelerations not directly pertaining to the CCBM Contributed Assets which would not, individually or in the aggregate, have a Material Adverse Effect. Section 9.4 Consents. Neither the nature of CCBM nor any of its businesses or properties, nor any relationship between CCBM and any other Person is such as to require on behalf of CCBM any Approval, other than Customary Filings, of any Governmental Entity in connection with the valid execution, delivery and performance of this Agreement or fulfillment of or compliance with the terms and provisions hereof, other than Customary Filings and other filings which have been made or consents obtained or not required to be made until after the Closing Date. Section 9.5 Investment Company Status. CCBM is not and, upon the consummation of the transactions contemplated by this Agreement and the Related Agreements, will not be, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act. Section 9.6 Taxes. To the knowledge of CCBM, all ad valorem, property, production, severance and similar taxes and assessments based on or measured by the ownership of property or the production or removal of Hydrocarbons or the receipt of proceeds therefrom and relating to the CCBM Contributed Assets, to the extent such taxes and assessments have become due and payable as of the Closing, have been timely paid and all applicable tax returns required to be 35 filed have been filed and there are no material claims by any applicable taxing authority pending against CCBM or any Affiliate thereof applicable to the CCBM Contributed Assets. Section 9.7 Compliance with Law. CCBM and each of its subsidiaries (i) is not in violation of any applicable Law (including without limitation Laws relating to environmental matters, securities, properties, production, sales, gathering and transportation of Hydrocarbons, occupational safety and health and product safety), except for any violations which would not, individually or in the aggregate, have a Material Adverse Effect, (ii) has not received any written notice, which has not been dismissed or otherwise disposed of, that it has violated any applicable Laws, (iii) has not been charged or, to the knowledge of CCBM, formally threatened with or, to the knowledge of CCBM, under investigation with respect to any violation of any applicable Law and (iv) is not a party to or subject to the provisions of any judgment, order, writ, injunction, decree or award of any court, arbitrator, board, panel or Governmental Entity. Section 9.8 Proceedings. Except as disclosed on Schedule 9.8, there are no Proceedings pending or, to the knowledge of CCBM, threatened against CCBM or any of its subsidiaries relating to or against or affecting any CCBM Contributed Assets, any Assumed CCBM Liabilities or the Company or any of the Company's properties, at law or in equity, or before or by any Governmental Entity or before any arbitration board or panel, wherever located. Section 9.9 Title. CCBM has, and on the Closing Date the Company will have (a) Defensible Title to the CCBM Contributed Assets which constitute Proven Properties, free and clear of (i) all Liens arising by, through or under CCBM or any Affiliate thereof (other than in the case of nonoperated properties, Liens arising through the actions or omissions of the operator of which CCBM had no knowledge) and (ii) to the knowledge of CCBM, all other Liens, in any case, other than Permitted Encumbrances, and (b) Good and Legal Title in all of the CCBM Contributed Assets that do not constitute Proven Properties, free and clear of all Liens created by, through and under CCBM or any Affiliate thereof, but not otherwise, in the case of mineral rights or other real property, other than Permitted Encumbrances. Section 9.10 Contracts. Except as disclosed on Schedule 9.10, and except where the failure of any of the following statements to be true and correct would not have a Material Adverse Effect: (i) to the knowledge of CCBM, the leases, contracts, agreements, licenses and permits included in the CCBM Contributed Assets (the "CCBM CONTRACTS") to which CCBM is a party are in full force and effect and, to the knowledge of CCBM, all rental obligations with respect any leases have been paid when due; and (ii) CCBM is not in breach or default (and, to the knowledge of CCBM, no situation exists which with the passing of time or giving of notice would create a breach or default) of its obligations under the CCBM Contracts and none of the Contributions, the Assumptions, the execution or delivery of this Agreement or any Related Agreement or the consummation of the transactions contemplated by this Agreement or any Related Agreement will result in a breach or default of its obligations under the CCBM Contracts. To the knowledge of CCBM, no breach or default by any third party (or situation which with the passage of time or giving of notice would create a breach or default) exists under any CCBM Contract. CCBM has not received any notice of any claimed defaults, offsets or cancellations from any lessors with respect to the CCBM Contributed Assets. CCBM has made available to the other Investors, upon request, copies of all CCBM Contracts and any amendments thereto to which CCBM is a party. 36 Section 9.11 Permits. To the knowledge of CCBM (a) the operator of the CCBM Contributed Assets has all Permits required to own and operate the CCBM Contributed Assets, and such Permits are in full force and effect, and to CCBM's knowledge, there have not been any violations with respect to any such Permits nor is there any action pending or threatened that would change the terms of such Permits and (b) subject to Customary Filings, the execution and delivery by CCBM of this Agreement and each of the Related Agreements to which it is a party and the consummation by it of the transactions contemplated hereby will not result in any revocation cancellation, suspension or modification of any such Permits. Section 9.12 Consents, Preferential Rights, etc. Other than the applicable Required Consents set forth on Schedule 9.12, none of the CCBM Contribution, the execution or delivery by CCBM of this Agreement or any Related Agreement to which it is a party or the consummation of the agreements and transactions contemplated by this Agreement or any such Related Agreement requires any consent, approval or waiver from any Person that is not a Governmental Entity for the assignment to the Company of the CCBM Contributed Assets including, without limitation, with respect to any CCBM Contract, oil and gas lease, area of mutual interest or seismic data license that have not already been obtained (and such consents or waivers that have been obtained do not contain any requirements on the part of the Company or any Investor and are not conditional upon any future event occurring except conditions satisfied on or prior to Closing) and, to the knowledge of CCBM, all preferential rights to purchase, rights of first refusal and any similar rights affecting the CCBM Contributed Assets have been waived. Section 9.13 Marketing. To the knowledge of CCBM, except as disclosed on Schedule 9.13, no amounts of Hydrocarbons produced from the CCBM Contributed Assets are subject to a sales contract (except for contracts terminable without penalty by CCBM on not more than 30 days notice), and except as may be contained in any document described on Schedule 9.13, no Person has any call upon, option to purchase or similar rights under any agreement with respect to the CCBM Contributed Assets or to the production therefrom. CCBM has not in any respect collected, nor will CCBM in any respect collect, any proceeds from the sale of Hydrocarbons produced from the CCBM Contributed Assets that are subject to refund except as disclosed on Schedule 9.13. To the knowledge of CCBM, except as disclosed on Schedule 9.13, as of the date hereof, proceeds from the sale of Hydrocarbons from the CCBM Contributed Assets are being received in all respects by CCBM in a timely manner and were not being held in suspense for any reason. To the knowledge of CCBM, CCBM has not been nor will CCBM be obligated by virtue of any prepayment made under any production sales contract or any other contract containing a "take or pay" clause, or under any gas balancing, deferred production or similar arrangement to deliver gas or other minerals produced from or allocated to any of the CCBM Contributed Assets at some future time without receiving full payment therefor at the time of delivery. To the knowledge of CCBM, except as disclosed on Schedule 9.13, there are no material gas imbalances as between CCBM and any third party with respect to operations relating to the CCBM Contributed Assets. Section 9.14 Change in Condition. To the knowledge of CCBM, there has occurred no physical change in the CCBM Contributed Assets (other than operations and production in the ordinary course) or other casualty since December 31, 2002 that materially adversely affects the value, use or operation of any of the CCBM Contributed Assets (other than declines due to actual depletion). 37 Section 9.15 No Other Activities. To the knowledge of CCBM, except as contemplated by this Agreement, the Company has not engaged in any material business activity. Section 9.16 Contributed Assets. With the exception of the assets described on Schedule 9.16, CCBM is contributing to the Company, pursuant to this Agreement, all of its assets, real and intangible in, or relating to the production of oil and gas in, the States of Montana and Wyoming ARTICLE X. REPRESENTATIONS AND WARRANTIES OF RMG In addition to the representations and warranties contained in Article VIII hereof RMG represents and warrants to the other Investors and the Company as of the Closing Date that: Section 10.1 Organization; Qualification and Authority; Binding Obligations. (a) RMG (i) is a corporation duly formed and validly existing in good standing under the laws of the State of Wyoming, (ii) is duly qualified to transact business as a foreign corporation and is in good standing in each jurisdiction in which the character of its properties or the nature of its business makes such qualification necessary, except where the failure to so qualify or to be in good standing would not reasonably be expected to have a Material Adverse Effect, (iii) has the corporate power to own its properties and to carry on its business as it is now being conducted, (iv) has all requisite corporate power and authority to enter into this Agreement and each Related Agreement to which it is a party and has the requisite power and authority to carry out the transactions contemplated hereby and thereby to be performed by it, and the execution, delivery and performance hereof and thereof have been duly authorized by all necessary action; (b) no Approval of any stockholders of RMG or any stockholders of any Affiliate, is required for consummation of the transactions contemplated by this Agreement and each Related Agreement; and (c) this Agreement, each Related Agreement to which it is a party and each other agreement or instrument executed and delivered by RMG pursuant hereto or thereto or in connection herewith or therewith constitute the legal, valid and binding obligations of RMG and, except as may (i) be affected by applicable bankruptcy, insolvency, moratorium, reorganization and other similar laws and judicial decisions affecting the rights of creditors generally and (ii) by general principles of equity and public policy (regardless of whether considered at law or in equity), are enforceable against RMG in accordance with their respective terms. Section 10.2 Defaults; Outstanding Debt. RMG has not violated nor is it in default under (a) its certificate of incorporation or bylaws, (b) any Indebtedness, (c) any indenture, mortgage, lease, or any other contract, agreement or instrument to which it is a party or by which it or any of its properties are bound or affected or (d) with respect to any order, writ, injunction or decree of any court or any federal, state, municipal or other domestic department, commission, board, bureau, agency or instrumentality, and to RMG's knowledge there exists no condition, 38 event or act which constitutes, or which after notice, lapse of time, or both, would constitute, such a default under any of the foregoing, except for such violations or defaults described in clauses (b), (c) or (d) above which would not, in the aggregate, have a Material Adverse Effect. Section 10.3 No Violation. The execution and delivery by RMG of this Agreement and each Related Agreement to which it is a party does not, and the consummation of the agreements and transactions contemplated by this Agreement and such Related Agreements will not (a) conflict with, or result in any violation of or default or loss of any benefit under, any provision of the certificate of incorporation and bylaws of RMG or any subsidiary thereof, (b) to RMG's knowledge, violate any Approval, Law or Permit to which RMG or any subsidiary thereof is a party or to which the Company or any subsidiary thereof or any of their respective property is subject or (c) subject to receipt of the Required Consents, conflict with, or result in a breach or violation of, or accelerate the performance required by, the terms of any agreement, contract, indenture or other instrument (including oil and gas leases) to which RMG or any subsidiary thereof is a party or to which any of the RMG Contributed Assets are subject, or constitute a default thereunder or an event which, with the lapse of time or notice or both, is likely to result in a default thereunder or the creation of any Lien upon any of the assets or properties of RMG or any subsidiary thereof, except, in the case of clauses (b) and (c) above, for any such violations, conflicts, breaches or accelerations not directly pertaining to the RMG Contributed Assets which would not, individually or in the aggregate, have a Material Adverse Effect. Section 10.4 Consents. Neither the nature of RMG nor any of its businesses or properties, nor any relationship between RMG and any other Person is such as to require on behalf of RMG any Approval, other than Customary Filings, of any Governmental Entity in connection with the valid execution, delivery and performance of this Agreement or the Related Agreements or fulfillment of or compliance with the terms and provisions hereof or thereof, other than Customary Filings and other filings which have been made or consents obtained or not required to be made until after the Closing Date, except for any Approvals which, if not obtained, would not, individually or in the aggregate, have a Material Adverse Effect. Section 10.5 Investment Company Status. RMG is not and, upon the consummation of the transactions contemplated by this Agreement and the Related Agreements, will not be, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act. Section 10.6 Taxes. All ad valorem, property, production, severance and similar taxes and assessments based on or measured by the ownership of property or the production or removal of Hydrocarbons or the receipt of proceeds therefrom and relating to the RMG Contributed Assets, to the extent such taxes and assessments have become due and payable as of the Closing, have been timely paid and all applicable tax returns required to be filed have been filed and there are no material claims by any applicable taxing authority pending against RMG or any Affiliate thereof applicable to the RMG Contributed Assets. Section 10.7 Compliance with Law. RMG and each of its subsidiaries (i) is not in violation of any applicable Law (including without limitation Laws relating to environmental matters, securities, properties, production, sales, gathering and transportation of Hydrocarbons, occupational safety and health and product safety), except for any violations which would not, 39 individually or in the aggregate, have a Material Adverse Effect, (ii) has not received any written notice, which has not been dismissed or otherwise disposed of, that it has violated any applicable Laws, (iii) has not been charged or, to the knowledge of RMG, formally threatened with or, to the knowledge of RMG, under investigation with respect to any violation of any applicable Law and (iv) is not a party to or subject to the provisions of any judgment, order, writ, injunction, decree or award of any court, arbitrator, board, panel or Governmental Entity. Section 10.8 Proceedings. Except as disclosed on Schedule 10.8, there are no Proceedings pending or, to the knowledge of RMG, threatened against RMG or any of its subsidiaries relating to or against or affecting any RMG Contributed Assets, any Assumed RMG Liabilities or the Company or any of the Company's properties, at law or in equity, or before or by any Governmental Entity or before any arbitration board or panel, wherever located. Section 10.9 Title. RMG has, and on the Closing Date the Company will have, (a) Defensible Title to the RMG Contributed Assets that constitute Proven Properties, free and clear of all Liens other than Permitted Encumbrances and (b) Good and Legal Title in all of the RMG Contributed Assets that do not constitute Proven Properties free and clear of all Liens created by, through or under RMG or any affiliate thereof, but not otherwise, in the case of mineral rights or other real property other than Permitted Encumbrances. Section 10.10 Contracts. Except as disclosed on Schedule 10.10, and except where the failure of any of the following statements to be true and correct would not have a Material Adverse Effect: (i) the leases, contracts, agreements, licenses and permits included in the RMG Contributed Assets (the "RMG CONTRACTS") to which RMG is a party are in full force and effect and all rental obligations with respect any leases have been paid when due; and (ii) RMG is not in breach or default (and, to the knowledge of RMG, no situation exists which with the passing of time or giving of notice would create a breach or default) of its obligations under the RMG Contracts and none of the Contributions, the Assumptions, the execution or delivery of this Agreement or any Related Agreement or the consummation of the transactions contemplated by this Agreement or any Related Agreement will result in a breach or default of its obligations under the RMG Contracts. To the knowledge of RMG, no breach or default by any third party (or situation which with the passage of time or giving of notice would create a breach or default) exists under any RMG Contract. RMG has not received any notice of any claimed defaults, offsets or cancellations from any lessors with respect to the RMG Contributed Assets. RMG has made available to the other Investors, upon request, copies of all RMG Contracts and any amendments thereto to which RMG is a party. Section 10.11 Permits. (a) RMG has all Permits required to own and operate the RMG Contributed Assets that it operates as presently being owned and operated, and such Permits are in full force and effect, and to RMG's knowledge, there have not been any violations with respect to any such Permits nor is there any action pending or threatened that would change the terms of such Permits and (b) subject to Customary Filings, the execution and delivery by RMG of this Agreement and each of the Related Agreements to which it is a party and the consummation by it of the transactions contemplated hereby and thereby will not result in any revocation cancellation, suspension or modification of any such Permit. 40 Section 10.12 Consents, Preferential Rights, etc. Other than the applicable Required Consents set forth on Schedule 10.12, none of the RMG Contribution, the execution or delivery by RMG of this Agreement or any Related Agreement to which it is a party, or the consummation of the agreements and transactions contemplated by this Agreement or any such Related Agreement requires any consent, approval or waiver from any Person that is not a Governmental Entity for the assignment to the Company of the RMG Contributed Assets including, without limitation, with respect to any RMG Contract, oil and gas lease, area of mutual interest or seismic data license that have not already been obtained (and such consents or waivers that have been obtained do not contain any requirements on the part of the Company or any Investor and are not conditional upon any future event occurring except conditions satisfied on or prior to Closing) and all preferential rights to purchase, rights of first refusal and any similar rights affecting the RMG Contributed Assets have been waived. Section 10.13 Marketing. Except as disclosed on Schedule 10.13, no amounts of Hydrocarbons produced from the RMG Contributed Assets are subject to a sales contract (except for contracts terminable without penalty by RMG on not more than 30 days notice), and except as may be contained in any document described on Schedule 10.13, no Person has any call upon, option to purchase or similar rights under any agreement with respect to the RMG Contributed Assets or to the production therefrom. RMG has not in any respect collected, nor will RMG in any respect collect, any proceeds from the sale of Hydrocarbons produced from the RMG Contributed Assets that are subject to refund except as disclosed on Schedule 10.13. Except as disclosed on Schedule 10.13, As of the date hereof, proceeds from the sale of Hydrocarbons from the RMG Contributed Assets are being received in all respects by RMG in a timely manner and were not being held in suspense for any reason. RMG has not been nor will RMG be obligated by virtue of any prepayment made under any production sales contract or any other contract containing a "take or pay" clause, or under any gas balancing, deferred production or similar arrangement to deliver gas or other minerals produced from or allocated to any of the RMG Contributed Assets at some future time without receiving full payment therefor at the time of delivery. Except as disclosed on Schedule 10.13, there are no material gas imbalances as between RMG and any third party with respect to operations relating to the RMG Contributed Assets. Section 10.14 Change in Condition. There has occurred no physical change in the RMG Contributed Assets (other than operations and production in the ordinary course) or other casualty since December 31, 2002 that materially adversely affects the value, use or operation of any of the RMG Contributed Assets (other than declines due to actual depletion). Section 10.15 No Other Activities. To the knowledge of RMG, except as contemplated by this Agreement, the Company has not engaged in any material business activity. Section 10.16 Contributed Assets. With the exception of the assets described on Schedule 10.16, RMG is contributing to the Company, pursuant to this Agreement, all of its assets, real and intangible in, or relating to the production of oil and gas in, the States of Montana and Wyoming Section 10.17 Environmental Matters. Except as set forth on Schedule 10.17, (i) the Contributed Assets and the operations thereon are in compliance with all applicable 41 Environmental Laws, except where the failure to comply would not have a Material Adverse Effect; (ii) the Contributed Assets and the operations thereon are not subject to any existing, pending or, to the knowledge of RMG, threatened Proceedings under any Environmental Law; (iii) all Permits required to be obtained or filed with respect to the Contributed Assets or operations thereon under any Environmental Law have been obtained or filed and are valid, currently in full force and effect, and have not been violated; (iv) there has been no unauthorized release of any Hazardous Material, pollutant or contaminant into the environment affecting the Contributed Assets; (v) there has been no exposure of any Person or property to any Hazardous Material, pollutant or contaminant in connection with the properties, operations and activities related to the Contributed Assets; and (vi) RMG has made available to the other Investors all internal and external environmental audits, reports and studies and all correspondence on substantial environmental matters (in each case relevant to the Company and/or the Contributed Assets). Section 10.18 Operation of the Proven Properties. RMG has at all times developed, maintained and operated the Proven Properties in accordance with customary practices in the oil and gas production industry, in compliance with applicable laws, ordinances, rules, regulations and orders and in a prudent, good and workmanlike manner. All equipment used in connection with the operation of the Proven Properties is in good working order, ordinary wear and tear excepted, and has been constructed and maintained in accordance with sound oilfield operating practices. All such equipment is owned or co-owned by CCBM and/or RMG or leased or co-leased from non-affiliated lessors. ARTICLE XI. TRANSFER OF SECURITIES Section 11.1 Restriction on Transfer. The Securities shall not be transferable except a holder of Securities may transfer such Securities upon the conditions specified in this Article XI, which conditions are intended to ensure compliance with the provisions of the Securities Act in respect of the transfer thereof; provided, however, that any such transfer shall be subject to the restrictions contained in the Securityholders Agreement and any transferee, by acceptance of the Securities, shall be deemed to have agreed to be bound by and entitled to the benefits of such agreement. Section 11.2 Restrictive Legends. Each certificate for the Securities, and each certificate for any such securities issued to subsequent transferees of any such certificate shall be stamped or otherwise imprinted with a legend in substantially the following form: "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND THE OFFER AND SALE OF SUCH SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES OR BLUE SKY LAWS. THESE SECURITIES MAY NOT BE SOLD OR TRANSFERRED IN THE ABSENCE OF SUCH REGISTRATION OR AN EXEMPTION THEREFROM UNDER SAID ACT OR APPLICABLE STATE SECURITIES OR BLUE SKY LAWS. 42 ADDITIONALLY, THE TRANSFER OF THESE SECURITIES IS SUBJECT TO THE CONDITIONS SPECIFIED IN THE CONTRIBUTION AND SUBSCRIPTION AGREEMENT DATED, AS OF JUNE 23, 2003, AMONG THE ISSUER HEREOF AND CERTAIN OTHER PARTIES THERETO AND THE SECURITYHOLDERS AGREEMENT, DATED AS OF JUNE 23, 2003, AMONG THE ISSUER HEREOF AND CERTAIN OTHER PARTIES THERETO, AND NO TRANSFER OF THESE SECURITIES SHALL BE VALID OR EFFECTIVE UNTIL SUCH CONDITIONS HAVE BEEN FULFILLED. COPIES OF SUCH AGREEMENTS MAY BE OBTAINED AT NO COST BY WRITTEN REQUEST MADE BY THE HOLDER OF RECORD OF THIS CERTIFICATE TO THE SECRETARY OF THE ISSUER HEREOF." ARTICLE XII. TERMINATION Section 12.1 Termination. This Agreement may be terminated prior to the Closing: (a) by mutual agreement of the parties hereto; (b) by any Investor in the event of a breach by any other Investor of any representation or warranty contained in this Agreement or any covenant or agreement required by the terms of this Agreement to be performed prior to the Closing Date which would give rise to the failure of a condition set forth in Article IV which cannot be cured or, if curable, has not been cured within 15 Business Days following receipt by the breaching party of written notice of such breach; (c) by any Investor if a court of competent jurisdiction or other Governmental Entity shall have issued an order, decree or ruling or taken any other action (which order, decree or ruling the Company and the Investors shall use all commercially reasonable efforts to lift), in each case permanently restraining, enjoining, or otherwise prohibiting the transactions contemplated by this Agreement, and such order, decree, ruling or other action shall have become final and nonappealable; provided, however, that the right to terminate this Agreement under this Section 12.1(c) shall not be available to any party whose breach of this Agreement has been the cause of, or resulted in, such order, decree, ruling or other action; or (d) by any Investor if the Closing shall not have occurred within 45 days of the date hereof, provided, however, that the right to terminate this Agreement under this Section 12.1(d) shall not be available to any party whose breach of this Agreement has been the cause of, or resulted in, the failure of the Closing Date to occur within such period. Section 12.2 Effect of Termination. In the event of the termination of this Agreement, written notice thereof shall be given to all other parties hereto by the terminating party specifying the provision pursuant to which the termination is made, and this Agreement shall forthwith become null and void, except for liability of a party arising out of willful breach of, or misrepresentation under, this Agreement prior to such termination. 43 ARTICLE XIII. MISCELLANEOUS Section 13.1 Indemnification. (a) Subject to the limitations set forth herein, each of CCBM and RMG severally agrees to indemnify and hold the Company and the other Investors harmless from and against any liabilities, claims, losses, damages, costs and expenses of any kind (including, without limitation, the reasonable fees and disbursements of the Company's counsel and counsel to each of the Investors in connection with any investigative, administrative or judicial proceeding, whether or not the Company or either other Investor is designated as a party thereto) that may be incurred by the Company or either other Investor, relating to or arising out of (i) any breach of the representations and warranties made by such Contributing Party in Article IX and Article X hereof or, with respect to the representations made in Section 9.9 and Section 10.9, any breach which cannot be cured or, if curable, has not been cured within 60 calendar days following receipt by the breaching party of written notice of such breach, (ii) any operation of assets of such Contributing Party not contributed to the Company under this Agreement, (iii) any Excluded CCBM Liabilities (in the case of CCBM's obligation of indemnification) or Excluded RMG Liabilities (in the case of RMG's obligation of indemnification), as the 44 case may be, or (iv) ownership or operation of the CCBM Contributed Assets and the RMG Contributed Assets by CCBM and RMG, respectively, prior to the Closing Date including any liabilities arising with respect to such period (collectively, the "CLAIMS"). (b) Notwithstanding the provisions of this Section 13.1, (i) neither Indemnifying Party (as defined below) shall be required to indemnify or hold harmless any of the Indemnified Parties (as defined below) on account of any Claims under clause (i) of Section 13.1(a) unless and until the aggregate liability of such Indemnifying Party in respect of all such Claims exceeds the Threshold Amount; provided, however, that once such aggregate Claims exceed the Threshold Amount, the Indemnifying Party shall be required to indemnify and hold harmless the Indemnified Parties to the fullest extent permitted by law from all such Claims, excluding those within the Threshold Amount and (ii) neither Indemnifying Party's aggregate liability in respect of all such Claims under clause (i) of Section 13.1(a) will exceed the Ceiling Amount. (c) NO PARTY HERETO (OR ITS AFFILIATES) SHALL HAVE THE RIGHT TO INDEMNIFICATION HEREUNDER FOR ANY CONSEQUENTIAL, EXEMPLARY, SPECIAL, INCIDENTAL, SPECULATIVE, TREBLE OR PUNITIVE DAMAGES (INCLUDING ANY LOSS OF EARNINGS OR PROFITS, LOSS OF REVENUE OR INCOME, COST OF CAPITAL OR LOSS OF BUSINESS REPUTATION OR OPPORTUNITY) SUFFERED BY SUCH PARTY UNLESS SUCH DAMAGES WERE INCURRED BY A THIRD PARTY AND ARE THE SUBJECT OF A THIRD PARTY CLAIM FOR WHICH A PARTY HERETO MAY OTHERWISE BE INDEMNIFIED PURSUANT HERETO. (d) THE PARTIES HERETO INTEND THAT THE INDEMNITIES SET FORTH IN SECTION 13.2(a) BE CONSTRUED AND APPLIED AS 45 WRITTEN ABOVE NOTWITHSTANDING ANY RULE OF CONSTRUCTION TO THE CONTRARY. WITHOUT LIMITING THE FOREGOING, THE INDEMNITIES SHALL APPLY NOTWITHSTANDING ANY STATE'S "EXPRESS NEGLIGENCE RULE" OR SIMILAR RULE THAT WOULD DENY COVERAGE BASED ON AN INDEMNITEE'S SOLE, CONCURRENT OR CONTRIBUTORY ACTIVE OR PASSIVE NEGLIGENCE OR GROSS NEGLIGENCE OR STRICT LIABILITY. IT IS THE INTENT OF THE PARTIES THAT, TO THE EXTENT PROVIDED IN SECTION 13.2(a), THE INDEMNITIES SET FORTH HEREIN SHALL APPLY TO AN INDEMNITEE'S SOLE, CONCURRENT OR CONTRIBUTORY ACTIVE OR PASSIVE NEGLIGENCE, GROSS NEGLIGENCE OR STRICT LIABILITY. THE PARTIES AGREE THAT THIS PROVISION IS "CONSPICUOUS" FOR PURPOSES OF ALL STATE LAWS. Section 13.2 Indemnification Procedures. (a) Any Person seeking indemnification under Section 13.1 (the "INDEMNIFIED PARTY") with respect to a Claim that is not a Third Party Claim shall commence and resolve such Claim solely in accordance with the dispute resolution procedures set forth in Section 13.3. (b) If any Third Party Claim is asserted against any Indemnified Party and such Indemnified Party intends to seek indemnification hereunder from a party to this Agreement (the "INDEMNIFYING PARTY"), then such Indemnified Party shall give notice of the Third Party Claim to the Indemnifying Party as soon as practicable after the Indemnified Party has reason to believe that the Indemnifying Party will have an indemnification obligation with respect to such Third Party Claim and shall provide the Indemnifying Party with all papers served with respect to such Third Party Claim. Such notice shall describe in reasonable detail the nature of the Third Party Claim, an estimate of the amount of damages attributable to the Third Party Claim and the basis of the Indemnified Party's request for indemnification under this Agreement. The failure of the Indemnified Party to so notify the Indemnifying Party of the Third Party Claim shall not relieve the Indemnifying Party from any duty to indemnify hereunder unless and to the extent that the Indemnifying Party demonstrates that the failure of the Indemnified Party to promptly notify it of such Third Party Claim materially prejudiced its ability to defend such Third Party Claim; provided, that the failure of the Indemnified Party to notify the Indemnifying Party shall not relieve the Indemnifying Party from any liability which it may have to the Indemnified Party otherwise than under this Agreement. Thereafter, the Indemnified Party shall deliver to the Indemnifying Party, within five Business Days after the Indemnified Party's receipt thereof, copies of all notices and documents (including court papers) received by the Indemnified Party relating to the Third Party Claim. (c) The Indemnifying Party shall have the right to participate in, or assume control of, and the Indemnifying Party's insurance carrier shall have the right to participate in, the defense of the Third Party Claim at its own expense by giving prompt written notice to the Indemnified Party, using counsel of its choice reasonably acceptable 46 to the Indemnified Party. If it elects to assume control of the defense of such Third Party Claim, the Indemnifying Party shall defend such Third Party Claim by promptly and vigorously prosecuting all appropriate proceedings to a final conclusion or settlement. After notice from the Indemnifying Party to the Indemnified Party of its election to assume the defense of such Third Party Claim, the Indemnified Party shall have the right to participate in the defense of the Third Party Claim using counsel of its choice, but the Indemnifying Party shall not be liable to the Indemnified Party hereunder for any legal or other expenses subsequently incurred by the Indemnified Party in connection with its participation in the defense thereof unless (i) the employment thereof has been specifically authorized in writing by the Indemnifying Party, (ii) the Indemnifying Party fails to assume the defense or diligently prosecute the Third Party Claim or (iii) there shall exist or develop a conflict that would ethically prohibit counsel to the Indemnifying Party from representing the Indemnified Party. If requested by the Indemnifying Party, the Indemnified Party agrees to cooperate with the Indemnifying Party and its counsel in contesting any Third Party Claim that the Indemnifying Party elects to contest, including the making of any related counterclaim against the Third Party asserting the Third Party Claim or any cross-complaint against any Person, in each case only if and to the extend that any such counterclaim or cross-complaint arises from the same actions or facts giving rise to the Third Party Claim. The Indemnifying Party shall have the right, acting in good faith and with due regard to the interests of the Indemnified Party, to control all decisions regarding the handling of the defense without the consent of the Indemnified Party, but shall not have the right to admit liability with respect to, or compromise, settle or discharge any Third Party Claim or consent to the entry of any judgment with respect to such Third Party Claim without the consent of the Indemnified Party, which consent shall not be unreasonably withheld, unless such settlement, compromise or consent includes an unconditional release of the Indemnified Party from all liability and obligations arising out of such Third Party Claim and which would not otherwise adversely affect the Indemnified Party. (d) If the Indemnifying Party fails to assume the defense of a Third Party Claim within 30 days after receipt of written notice of the Third Party Claim, then the Indemnified Party shall have the right to defend the Third Party Claim by promptly and vigorously prosecuting all appropriate proceedings to a final conclusion or settlement. The Indemnifying Party shall have the right to participate in the defense of the Third Party Claim using counsel of its choice, but the Indemnified Party shall not be liable to the Indemnifying Party hereunder for any legal or other expenses incurred by the Indemnifying Party in connection with its participation in the defense thereof. If requested by the Indemnified Party, the Indemnifying Party agrees to cooperate with the Indemnified Party and its counsel in contesting any Third Party Claim that the Indemnified Party elects to contest, including the making of any related counterclaim against the Third Party asserting the Third Party Claim or any cross-complaint against any Person, in each case only if and to the extent that any such counterclaim or cross-complaint arises from the same actions or facts giving rise to the Third Party Claim. The Indemnified Party shall have the right, acting in good faith and with due regard to the interests of the Indemnifying Party, to control all decisions regarding the handling of the defense without the consent of the Indemnifying Party, but shall not have the right to compromise or settle any Third Party Claim or consent to the entry of any judgment with 47 respect to such Third Party Claim without the consent of the Indemnifying Party, which consent shall not be unreasonably withheld, unless such settlement compromise or consent includes an unconditional release of the Indemnifying Party from all liability and obligations arising out of such Third Party Claim. (e) In the event an Indemnifying Party is determined to be liable with respect to any Claim pursuant to Section 13.3, such Indemnifying Party, within five Business Days after any such determination, shall pay to the Company in cash the full amount for which it is determined liable (an "AWARD"); provided, however, in lieu of any such cash payment the Indemnifying Party may, at its option, tender to the Company all of its right, title and interest in and to that number of shares of Common Stock (rounded to the nearest whole share) equal to the Award divided by $100, free and clear of all Encumbrances which, if accepted by the Company shall constitute a full accord and satisfaction with respect to the Award. Section 13.3 Dispute Resolution. (a) Any controversy, dispute or claim arising out of or relating to this Agreement or the Related Agreements, or the transactions contemplated thereby (a "DISPUTE") shall be resolved in accordance with this Section 13.3. (b) Any party may give the other party written notice (a "DISPUTE NOTICE") of any Dispute which has not been resolved in the normal course of business. Within 15 Business Days after delivery of the Dispute Notice, the receiving party shall submit to the other party a written response (the "RESPONSE"). The Dispute Notice and the Response shall each include (i) a statement setting forth the position of the party giving such notice, a summary of the arguments supporting such position and, if applicable, the relief sought and (ii) the name and title of a senior manager of such party who has authority to settle the Dispute and will be responsible for the negotiations related to the settlement of the Dispute (the "SENIOR MANAGER"). (c) Within 10 days after delivery of the Response provided for in Section 13.3(b), the Senior Managers of both parties shall meet or communicate by telephone at a mutually acceptable time and place, and thereafter as often as they reasonably deem necessary, and shall negotiate in good faith to attempt to resolve the Dispute that is the subject of such Dispute Notice. If such Dispute has not been resolved within 30 days after delivery of the Dispute Notice, then the parties shall attempt to settle the Dispute pursuant to Section 13.3(d). (d) In the event the Dispute has not been resolved within 30 days after the delivery of the Dispute Notice, the Dispute shall be resolved by arbitration administered by the American Arbitration Association (the "AAA") in accordance with the terms of this Section 13.3(d), the Commercial Arbitration Rules of the AAA, and, to the maximum extent applicable, the United States Arbitration Act. Judgment on any matter rendered by arbitrators may be entered in any court having jurisdiction. Any arbitration shall be conducted before three arbitrators. The arbitrators shall be individuals knowledgeable in the subject matter of the Dispute. Each party shall select one arbitrator and the two 48 arbitrators so selected shall select the third arbitrator. If the third arbitrator is not selected within 30 Business Days after the request for an arbitration, then any party may request the AAA to select the third arbitrator. The arbitrators may engage engineers, accountants or other consultants they deem necessary to render a conclusion in the arbitration proceeding. To the maximum extent practicable, an arbitration proceeding hereunder shall be concluded within 90 Business Days of filing a Dispute with the AAA. Arbitration proceedings shall be conducted in Houston, Texas. Arbitrators shall be empowered to impose sanctions and to take such other actions as the arbitrators deem necessary to the same extent a judge could impose sanctions or take such other actions pursuant to the Federal Rules of Civil Procedure and applicable Law. At the conclusion of any arbitration proceeding, the arbitrators shall make specific written findings of fact and conclusions of law. The arbitrators shall have the power to award recovery of all costs and fees to the prevailing party. All fees of the arbitrators and any engineer, accountant or other consultant engaged by the arbitrators, shall be shared equally unless otherwise awarded by the arbitrators. Notwithstanding the foregoing, if the amount in controversy is less than $1,000,000, then, instead of selecting three arbitrators by the process described above, one arbitrator shall be selected in accordance with the rules of AAA. In this event the arbitration proceeding shall be conducted for all purposes as set forth in this Section 13.3(d), except that the proceeding shall be conducted by the one arbitrator, instead of the three. (e) All negotiations between the Senior Managers pursuant to this Section 13.3 shall be treated as compromise and settlement negotiations. Nothing said or disclosed, nor any document produced, in the course of such negotiations that is not otherwise independently discoverable shall be offered or received as evidence or used for impeachment or for any other purpose in any current or future arbitration or litigation. Section 13.4 Consent to Amendments. This Agreement may be amended and the observance of any term of this Agreement may be waived with (and only with) the written consent of the Company and each Investor. Section 13.5 Survival of Representations and Warranties. Unless this Agreement is terminated pursuant to Section 12.1, in which case the representations and warranties do not survive termination, all representations and warranties contained herein or made in writing by or on behalf of any party to this Agreement in connection herewith shall survive the execution and delivery of this Agreement until July 1, 2004, regardless of any investigation made by or on behalf of any party. No party may bring any Claim based upon a breach of the representations or warranties contained in this Agreement after such date. Section 13.6 Successors and Assigns; No Third Party Benefit. All covenants and agreements in this Agreement contained by or on behalf of the parties hereto shall bind and inure to the benefit of the respective successors and assigns of the parties hereto and, to the extent provided in this Agreement, to the benefit of any future holders of Shares issued pursuant to this Agreement, but in no event to the purchaser of Shares in any registered offering under the Securities Act or any "brokers' transactions" effected pursuant to Rule 144 of the Securities Act. Subject to the foregoing and except as provided in Section 13.1, nothing in this Agreement shall confer upon any person or entity not a party to this Agreement, or the legal representatives of 49 such person or entity, any rights or remedies of any nature or kind whatsoever under or by reason of this Agreement. No transfer of Securities shall relieve any party of its obligations hereunder, if the transferee of such Securities does not perform any assumed obligation. Section 13.7 Notices. Any and all notices, designations, consents, offers, acceptances, or other communications provided for herein (each a "NOTICE") shall be given in writing by registered or certified mail, personal delivery, overnight courier or facsimile, which shall be addressed, or sent, to the respective addresses as follows (or such other address as the Company or any Investor may specify to the Company and all other Investors by Notice): If to the Company, addressed to: Pinnacle Gas Resources, Inc. 1 E. Alger, Suite 206 Sheridan, Wyoming 82801 Attention: Peter G. Schoonmaker Gary W. Uhland Facsimile: (307) 673-9711 If to the CSFB Parties, addressed to: Credit Suisse First Boston Private Equity 1100 Louisiana Street, Suite 4600 Houston, Texas 77002 Attention: Steven A. Webster Robert L. Cabes Facsimile: (713) 890-1500 with a copy to (which does not constitute Notice): Credit Suisse First Boston Private Equity Eleven Madison Avenue, 16th Floor New York, New York 10010 Attention: Benjamin A. Silbert Facsimile: (917) 326-8076 with a copy to (which does not constitute Notice): Akin Gump Strauss Hauer & Feld LLP 711 Louisiana Street, Suite 1900 Houston, Texas 77002 Attention: James L. Rice III J. Michael Chambers Facsimile: (713) 236-0822 50 If to CCBM, addressed to: CCBM, Inc. 14701 St. Mary's Lane, Suite 800 Houston, Texas 77079 Attention: S.P. Johnson IV Facsimile: (281) 496-0884 with a copy to (which does not constitute Notice): Baker Botts L.L.P. One Shell Plaza 910 Louisiana Houston, Texas 77002 Attention: Gene J. Oshman Facsimile: (713) 229-7778 If to RMG, addressed to: Rocky Mountain Gas, Inc. 877 North 8th West Riverton, Wyoming 82501 Attention: Keith G. Larsen Facsimile: (307) 857-3050 with a copy to (which does not constitute Notice): Davis Graham & Stubbs LLP 1550 Seventeenth Street, Suite 500 Denver, Colorado 80202 Attention: Scot W. Anderson Facsimile: (303) 893-1379 Each such communication shall for all purposes of this Agreement be treated as effective or having been given when delivered if delivered personally, or, if sent by courier, on the next business day following the day of dispatch or, if sent by facsimile transmission, on the date of such transmission if confirmation of such transmission is received or if sent by registered or certified mail shall be deemed to have been received on the fifth Business Day after the date of such mailing. Section 13.8 Descriptive Headings. The descriptive headings of the several Sections of this Agreement are inserted for convenience only and do not constitute a part of this Agreement. Section 13.9 Satisfaction Requirement. If any agreement, certificate or other writing, or any action taken or to be taken, is by the terms of this Agreement required to be satisfactory to the Investors, the determination of such satisfaction shall be made collectively by the Investors in their reasonable judgment exercised in good faith. 51 Section 13.10 Governing Law. This Agreement shall be construed and enforced in accordance with, and the rights of the parties shall be governed by, the law of the State of Texas, without giving effect to the choice of law or conflicts principles thereof. Section 13.11 Entire Agreement. This Agreement and the Related Agreements contain the entire agreement among the parties with respect to the subject matter herein and therein and supersede all prior and contemporaneous arrangements or understandings with respect thereto. Section 13.12 Severability. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effective and valid under applicable Law, but if any provision of this Agreement is held to be prohibited or unenforceable in any jurisdiction, such provision will be ineffective only to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. [Signature Page to Follow] 52 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. PINNACLE GAS RESOURCES, INC. By: ----------------------------------- Name: Title: CCBM, INC. By: ----------------------------------- Name: Title: ROCKY MOUNTAIN GAS, INC. By: ----------------------------------- Name: Title: MILLENNIUM PARTNERS II, L.P. By: DLJ Merchant Banking III, Inc., a Managing General Partner By: ----------------------------------- Name: Title: DLJ MERCHANT BANKING III, INC., as Advisory General Partner on behalf of DLJ Offshore Partners III, C.V. By: ----------------------------------- Name: Title: DLJ MERCHANT BANKING III, INC., as Advisory General Partner on behalf of DLJ Offshore Partners III-1, C.V. and as attorney-in-fact for DLJ Merchant Banking III, L.P., as Associate General Partner of DLJ Offshore Partners III-1, C.V. By: ----------------------------------- Name: Title: DLJ MERCHANT BANKING III, INC., as Advisory General Partner on behalf of DLJ Offshore Partners III-2, C.V. and as attorney-in-fact for DLJ Merchant Banking III, L.P., as Associate General Partner of DLJ Offshore Partners III-2, C.V. By: ----------------------------------- Name: Title: DLJ MERCHANT BANKING PARTNERS III, L.P. By: DLJ Merchant Banking III, Inc., as Managing General Partner By: ----------------------------------- Name: Title: DLJ MB PARTNERS III GMBH & CO. KG By: DLJ Merchant Banking III, L.P., as Managing Limited Partner By: DLJ Merchant Banking III, LLC, as General Partner By: DLJ Merchant Banking III, Inc., as Managing Member By: ----------------------------------- Name: Title: MBP III PLAN INVESTORS, L.P. By: DLJ Merchant Banking III, Inc., as General Partner By: ----------------------------------- Name: Title: EX-10.2 4 h08461exv10w2.txt TRANSITION SERVICES AGREEMENT EXHIBIT 10.2 TRANSITION SERVICES AGREEMENT BETWEEN PINNACLE RESOURCES, INC. AND CARRIZO OIL & GAS, INC. This Transition Services Agreement ("Agreement") is made and entered into as of this 23rd day of June, 2003, by and between Pinnacle Gas Resources, Inc., ("Company"), a Delaware corporation, and Carrizo Oil & Gas, Inc., a Texas corporation ("Carrizo"). Company and Carrizo may be referred to individually herein as a "Party" and collectively as the "Parties". WITNESSETH: A. Company desires to engage Carrizo to provide certain transitional accounting, recordkeeping, audit, and similar services to Company, as further described in Section 1 below. C. Carrizo is agreeable to providing such services pursuant to the terms hereof. NOW, THEREFORE, in consideration of the premises, mutual covenants and agreements herein contained, the Parties hereto agree as follows: 1. SERVICES 1.1 Carrizo shall provide or cause to be provided the accounting, recordkeeping, audit, and similar services set forth on EXHIBIT A attached hereto and incorporated herein by reference, or as otherwise agreed in writing by Carrizo and Company, subject to the terms and conditions of this agreement (the "Services"). Carrizo will exercise its commercially reasonable efforts to make the Services available to Company, subject to the terms and conditions of this Agreement. These Services will be provided in a manner appropriate for Company, considering, among other relevant factors, the relative size of Company and its current status as a non-publicly traded corporation. Without limiting the generality of the foregoing, in no event shall Carrizo be required to provide Services to Company in any greater detail than it provides for itself. 1.2 For all Services, Carrizo agrees to provide both systems and personnel necessary to perform the Services; provided, however, that Carrizo shall have the right to, whenever it deems necessary or advisable, engage or contract for, or cause to be engaged or contracted for, on behalf of Company, the goods and services of third-party subcontractors, suppliers, vendors and other providers to perform any of the Services or any part of the Services. Carrizo will provide to Company all reasonably requested information regarding such third-party providers. Company hereby releases Carrizo, its affiliates, directors, officers, employees, representatives, advisors and agents ("Related Parties") from all liability arising from the non-performance, inadequate performance, faulty performance or other failure or breach by a third-party provider, NOTWITHSTANDING THE NEGLIGENCE OR GROSS NEGLIGENCE OF CARRIZO OR ANY OF ITS RELATED PARTIES OR WHETHER DAMAGES ARE ASSERTED IN CONTRACT OR TORT, UNDER FEDERAL, STATE OR FOREIGN STATUTE OR OTHERWISE. Carrizo shall, upon reasonable request by Company, use commercially reasonable efforts to cooperate with Company in making claims against a third-party provider for any delay or failure in the performance of the Services to the extent such delay or failure is due to the non-performance, inadequate performance, faulty performance or other failure or breach by the third-party provider. 1.3 Carrizo shall not be required to provide any Service to Company if Carrizo is prohibited by law or contractual restriction or limitation from providing such Service. If any Service is terminated by Company by written notice to Carrizo, with the consent of Company, or is no longer performed by Carrizo or any third party provider, there shall be no obligation to reinstate such Service, unless the Parties mutually agree in writing. The Parties agree that Carrizo will not be required to render any Services that would necessitate that it qualify to do business in any other jurisdiction where it would otherwise not be required to be so qualified. Nothing provided in this Agreement shall require Carrizo to violate any agreement with any third party, including any software license agreement. The Parties agree to maintain the confidentiality of all non-public information relating to the other Party and its affiliates regarding the Services and each Parties' business activities, except as may be required to be disclosed by law. Any amendment, supplement, variation, alteration or modification to any agreed to Services, plan of action or work order must be made in writing and signed by an authorized representative or agent of each of the Parties. Company shall provide direction to Carrizo where business decisions are required in the performance of the Services. Where necessary for the performance of the Services, Company shall designate Carrizo as its authorized agent. 1.4 If Carrizo is required to increase staffing, acquire equipment or to make any investments or capital expenditures in order to increase the level of use of any Service provided as a result of a request by Company to increase the level of use provided by Carrizo, Carrizo shall inform Company in writing of the need for such increases in staffing level, acquisitions of equipment, investments or capital expenditure required before any such costs or expenses are incurred. Upon mutual written agreement as to any such increase in staffing level, acquisition of equipment, investment or capital expenditure required, Company shall reimburse Carrizo for the actual increased costs and expenses incurred by Carrizo allocable to the Services. If Company does not agree to reimburse Carrizo for the actual increased costs and expenses to be incurred, Carrizo shall have no obligation to increase the level of such Service. 1.5 Notwithstanding the provisions of Section 3.1, if any costs and expenses are required to segregate data or systems of Company from data or systems of Carrizo prior to termination of this Agreement, Company shall reimburse Carrizo for the reasonable costs and expenses of such segregation actually incurred by Carrizo; provided, however, that Carrizo shall not undertake any such segregation without providing to Company a written estimate of the costs of such segregation and obtaining the prior written consent of Company thereto, which consent shall not be unreasonably withheld. 1.6 Except as agreed in writing by the Parties, Carrizo shall not be required to perform any Service requiring the use of, and shall not be required to install or use, any software or equipment modified or provided by Company. Carrizo shall not be required to modify or change any Carrizo's software or equipment to perform any Service. 1.7 Company shall designate in writing a representative (the "Company Representative"). The Company Representative shall have the authority, on behalf of Company, to enforce the provisions of this Agreement, to take any action necessary to cause or promote the orderly and expeditious prosecution of the Services, and to serve as the primary contact for communications between Carrizo and Company concerning the performance of the Services. Before any limitation placed by Company on the authority of the Company Representative may be effective, such limitation shall first be disclosed to Carrizo in writing, and if not so disclosed, shall not have any effect. 1.8 Carrizo shall designate in writing a representative (the "Carrizo Representative") who shall have the authority to act on Carrizo's behalf in connection with the performance of the Services, to enforce the provisions of this Agreement, and to serve as the primary contact for communications between Company and Carrizo concerning the performance of the Services. Before any limitation placed by Carrizo on the authority of the Carrizo Representative may be effective, such limitation shall first be disclosed to Company in writing, and if not so disclosed, shall not have any effect. 1.9 In the event Carrizo shall deem it necessary in the performance of a Service to involve a third party in connection therewith, other than such third party Services that are or were obtained in the ordinary course of business consistent with past practice, Carrizo shall provide to Company all pertinent information regarding such third party, and it shall obtain the written approval of Company to commencement of rendering of such Services by the third party. The cost of such additional third party Services shall be billed directly to Company from such third party without additional payments to Carrizo in connection therewith. Notwithstanding the foregoing, the prior written approval referred to above shall not be required in cases of emergency where the failure to obtain such third party Services could cause economic harm to Company in excess of the cost to be incurred in obtaining such third party Services. 2. PERFORMANCE OBLIGATIONS 2.1 During such time as Carrizo's or its affiliates' employees are rendering Services hereunder, those employees who are engaged in the performance of such Services shall, subject to Section 4.2 and subject to any such employee's right to terminate his or her employment and Carrizo's right to terminate such employee, remain employees of Carrizo or its affiliates and continue to be paid by and to enjoy the benefits to which they are entitled as employees of Carrizo or its affiliates. Employees of Carrizo or its affiliates when on the property of Company will conform to the rules and regulations of Company concerning safety, health and security. 2.2 Company agrees to make appropriate personnel available to answer any questions that Carrizo may have in relation to Carrizo's Services under this Agreement and to provide such additional information as Carrizo may reasonably require to perform the requested Services. 2.3 Upon the discovery of any facts which would reasonably indicate that Carrizo has materially failed to perform its obligations under this Agreement, Company shall: (i) promptly notify Carrizo of such facts by telephone, and (ii) shall thereafter provide Carrizo with written notice of such material breach within thirty (30) days after the discovery of such facts. 3. COMPENSATION 3.1 Company shall pay Carrizo on a monthly basis for the Services provided by Carrizo to Company in the prior month. Payments to Carrizo shall be made on the first business day of each month provided that Carrizo submits a monthly fee statement to Company, based on Carrizo's good faith estimate of such fees, at least 15 days prior to the first day of any month. Payment for monthly Services shall be net of any overpayments made in any prior month. 3.2 Carrizo shall maintain adequate accounting records, which in reasonable detail fairly reflect the Services contemplated hereunder, and shall maintain a system of internal controls, sufficient to provide reasonable assurances that the Services are provided in accordance with this Agreement. 3.3 All related books and accounts of Carrizo applicable to the performance of the Services hereunder shall at all reasonable times be open to inspection by auditors for Company for an additional period of eighteen months after the date of termination of this Agreement. 3.4 No contract or agreement requiring Carrizo to compensate outside vendors to perform the Services hereunder in an amount exceeding $20,000 shall be entered into without Company's prior approval. 3.5 All payments by Company to Carrizo under this Services Agreement shall be grossed-up by Company to cover any sales tax, value-added tax, goods and services tax or similar tax (but excluding any tax based upon the net income of Carrizo) payable with respect to the provision by Carrizo of Services. 4. INDEPENDENT CONTRACTOR STATUS 4.1 Carrizo and all affiliates and employees of either Carrizo or any of its affiliates providing Services hereunder shall be engaged in a capacity as an independent contractor with full control over the manner and method of performance of the Services, subject to the work authorizations of Company. 4.2 Carrizo shall retain the absolute right to reassign, discipline or dismiss any Carrizo employee or the employee of any affiliate or third party and Company shall not purport to exercise any such right, provided that at any time Company may require Carrizo to cause an employee to cease to provide Services to Company and leave any premises owned or occupied by Company if Company in its reasonable discretion so requests. 4.3 Carrizo is not required to hire any new employees to provide Services to Company during the term of this Agreement. If Carrizo is unable to provide Services to Company hereunder, Carrizo shall notify Company of such fact as promptly as practicable. In the event Carrizo retains an outside vendor to provide the Services, the provisions of this Agreement shall remain in full force and effect as to the Services provided by the outside vendor. 4.4 Company understands and agrees that (a) to the extent that Carrizo or any of its Related Parties may act as agent of Company, no fiduciary duty or other legal duty or obligation or special standard of care imposed on an agent toward a principal or any other person shall be imposed on Carrizo or any of its Related Parties by virtue of Carrizo's or any Related Parties' entry into agreements as agent, and (b) neither Carrizo nor any of its Related Parties shall have any obligation for compliance with any applicable laws governing the conduct of agents, legal representatives or other fiduciaries. Company understands and agrees that Carrizo's relationship to Company under this Agreement is strictly a contractual arrangement on the terms and conditions set forth in this Agreement, and Company hereby waives any and all rights that it may otherwise have under applicable law or legal precedents to make any claims or take any action against Carrizo or any of its Related Parties based on any theory of agency, fiduciary duty or other special standard of care. 5. INDEMNITY 5.1 Liabilities and Indemnity. (a) INDEMNITY BY COMPANY. TO THE FULLEST EXTENT ALLOWED BY LAW, COMPANY SHALL FULLY INDEMNIFY AND DEFEND CARRIZO AND ITS RELATED PARTIES (THE "CARRIZO INDEMNIFIED PARTIES") FROM AND AGAINST ANY AND ALL LIABILITIES, OBLIGATIONS, DEMANDS, CLAIMS, ACTIONS, CAUSES OF ACTION, LOSSES, DAMAGES, COSTS AND EXPENSES (INCLUDING REASONABLE ATTORNEYS' FEES AND EXPENSES) ("DAMAGES') DIRECTLY OR INDIRECTLY ARISING UNDER THIS AGREEMENT, EXCEPT TO THE EXTENT CAUSED BY THE WILLFUL MISCONDUCT OF CARRIZO OR ITS RELATED PARTIES. EXCEPT TO THE EXTENT EXPRESSLY PROVIDED IN THE IMMEDIATELY PRECEDING SENTENCE, THIS INDEMNIFICATION IS EXPRESSLY INTENDED TO APPLY NOTWITHSTANDING THE NEGLIGENCE OR GROSS NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT, ACTIVE OR PASSIVE) OR STRICT LIABILITY OF ANY INDEMNIFIED PERSONS OR WHETHER DAMAGES ARE ASSERTED IN CONTRACT OR TORT, UNDER FEDERAL, STATE OR FOREIGN STATUTE OR OTHERWISE. (b) INDEMNITY BY CARRIZO. CARRIZO SHALL FULLY INDEMNIFY AND DEFEND COMPANY AND ITS AFFILIATES FROM AND AGAINST ANY AND ALL DAMAGES DIRECTLY OR INDIRECTLY RELATED TO THIS AGREEMENT TO THE EXTENT CAUSED BY THE WILLFUL MISCONDUCT OF CARRIZO OR ITS RELATED PARTIES. 5.2 Indemnification Procedure. (a) Any person seeking indemnification under this Article 5 (the "Indemnified Party") with respect to a claim that is not a third party claim shall commence and resolve such Claim solely in accordance with the dispute resolution procedures set forth in this Article 5. (b) If any third party claim is asserted against any Indemnified Party and such Indemnified Party intends to seek indemnification hereunder from a Party (the "Indemnifying Party"), then such Indemnified Party shall give notice of the third party claim to the Indemnifying Party as soon as practicable after the Indemnified Party has reason to believe that the Indemnifying Party will have an indemnification obligation with respect to such third party claim and shall provide the Indemnifying Party with all papers served with respect to such third party claim. Such notice shall describe in reasonable detail the nature of the third party claim, an estimate of the amount of damages attributable to the third party claim and the basis of the Indemnified Party's request for indemnification under this Agreement. The failure of the Indemnified Party to so notify the Indemnifying Party of the third party claim shall not relieve the Indemnifying Party from any duty to indemnify hereunder unless and to the extent that the Indemnifying Party demonstrates that the failure of the Indemnified Party to promptly notify it of such third party claim materially prejudiced its ability to defend such third party claim; provided, that the failure of the Indemnified Party to notify the Indemnifying Party shall not relieve the Indemnifying Party from any liability which it may have to the Indemnified Party otherwise than under this Agreement. Thereafter, the Indemnified Party shall deliver to the Indemnifying Party, within five Business Days after the Indemnified Party's receipt thereof, copies of all notices and documents (including court papers) received by the Indemnified Party relating to the third party claim. (c) The Indemnifying Party shall have the right to participate in, or assume control of, and the Indemnifying Party's insurance carrier shall have the right to participate in, the defense of the third party claim at its own expense by giving prompt written notice to the Indemnified Party, using counsel of its choice reasonably acceptable to the Indemnified Party. If it elects to assume control of the defense of such third party claim, the Indemnifying Party shall defend such third party claim by promptly and vigorously prosecuting all appropriate proceedings to a final conclusion or settlement. After notice from the Indemnifying Party to the Indemnified Party of its election to assume the defense of such third party claim, the Indemnified Party shall have the right to participate in the defense of the third party claim using counsel of its choice, but the Indemnifying Party shall not be liable to the Indemnified Party hereunder for any legal or other expenses subsequently incurred by the Indemnified Party in connection with its participation in the defense thereof unless (i) the employment thereof has been specifically authorized in writing by the Indemnifying Party, (ii) the Indemnifying Party fails to assume the defense or diligently prosecute the third party claim or (iii) there shall exist or develop a conflict that would ethically prohibit counsel to the Indemnifying Party from representing the Indemnified Party. If requested by the Indemnifying Party, the Indemnified Party agrees to cooperate with the Indemnifying Party and its counsel in contesting any third party claim that the Indemnifying Party elects to contest, including the making of any related counterclaim against the third party asserting the third party claim or any cross-complaint against any person, in each case only if and to the extend that any such counterclaim or cross-complaint arises from the same actions or facts giving rise to the third party claim. The Indemnifying Party shall have the right, acting in good faith and with due regard to the interests of the Indemnified Party, to control all decisions regarding the handling of the defense without the consent of the Indemnified Party, but shall not have the right to admit liability with respect to, or compromise, settle or discharge any third party claim or consent to the entry of any judgment with respect to such third party claim without the consent of the Indemnified Party, which consent shall not be unreasonably withheld, unless such settlement, compromise or consent includes an unconditional release of the Indemnified Party from all liability and obligations arising out of such third party claim and which would not otherwise adversely affect the Indemnified Party. (d) If the Indemnifying Party fails to assume the defense of a third party claim within 30 days after receipt of written notice of the third party claim, then the Indemnified Party shall have the right to defend the third party claim by promptly and vigorously prosecuting all appropriate proceedings to a final conclusion or settlement. The Indemnifying Party shall have the right to participate in the defense of the third party claim using counsel of its choice, but the Indemnified Party shall not be liable to the Indemnifying Party hereunder for any legal or other expenses incurred by the Indemnifying Party in connection with its participation in the defense thereof. If requested by the Indemnified Party, the Indemnifying Party agrees to cooperate with the Indemnified Party and its counsel in contesting any third party claim that the Indemnified Party elects to contest, including the making of any related counterclaim against the third Party asserting the third party claim or any cross-complaint against any person, in each case only if and to the extent that any such counterclaim or cross-complaint arises from the same actions or facts giving rise to the third party claim. The Indemnified Party shall have the right, acting in good faith and with due regard to the interests of the Indemnifying Party, to control all decisions regarding the handling of the defense without the consent of the Indemnifying Party, but shall not have the right to compromise or settle any third party claim or consent to the entry of any judgment with respect to such third party claim without the consent of the Indemnifying Party, which consent shall not be unreasonably withheld, unless such settlement compromise or consent includes an unconditional release of the Indemnifying Party from all liability and obligations arising out of such third party claim. 5.3 Dispute Resolution. (a) Any controversy, dispute or claim arising out of or relating to this Agreement or the Related Agreements, or the transactions contemplated thereby (a "Dispute") shall be resolved in accordance with this Section 5.3. (b) Any party may give the other party written notice (a "Dispute Notice") of any Dispute which has not been resolved in the normal course of business. Within 15 Business Days after delivery of the Dispute Notice, the receiving party shall submit to the other party a written response (the "Response"). The Dispute Notice and the Response shall each include (i) a statement setting forth the position of the party giving such notice, a summary of the arguments supporting such position and, if applicable, the relief sought and (ii) the name and title of a senior manager of such party who has authority to settle the Dispute and will be responsible for the negotiations related to the settlement of the Dispute (the "Senior Manager"). (c) Within 10 days after delivery of the Response provided for in Section 5.3(b) the Senior Managers of both parties shall meet or communicate by telephone at a mutually acceptable time and place, and thereafter as often as they reasonably deem necessary, and shall negotiate in good faith to attempt to resolve the Dispute that is the subject of such Dispute Notice. If such Dispute has not been resolved within 30 days after delivery of the Dispute Notice, then the parties shall attempt to settle the Dispute pursuant to this Section 5.3(c). (d) In the event the Dispute has not been resolved within 30 days after the delivery of the Dispute Notice, the Dispute shall be resolved by arbitration administered by the American Arbitration Association (the "AAA") in accordance with the terms of this Section 5.3 (d), the Commercial Arbitration Rules of the AAA, and, to the maximum extent applicable, the United States Arbitration Act. Judgment on any matter rendered by arbitrators may be entered in any court having jurisdiction. Any arbitration shall be conducted before three arbitrators. The arbitrators shall be individuals knowledgeable in the subject matter of the Dispute. Each party shall select one arbitrator and the two arbitrators so selected shall select the third arbitrator. If the third arbitrator is not selected within 30 Business Days after the request for an arbitration, then any party may request the AAA to select the third arbitrator. The arbitrators may engage engineers, accountants or other consultants they deem necessary to render a conclusion in the arbitration proceeding. To the maximum extent practicable, an arbitration proceeding hereunder shall be concluded within 90 business days of filing a Dispute with the AAA. Arbitration proceedings shall be conducted in Houston, Texas. Arbitrators shall be empowered to impose sanctions and to take such other actions as the arbitrators deem necessary to the same extent a judge could impose sanctions or take such other actions pursuant to the Federal Rules of Civil Procedure and applicable law. At the conclusion of any arbitration proceeding, the arbitrators shall make specific written findings of fact and conclusions of law. The arbitrators shall have the power to award recovery of all costs and fees to the prevailing party. All fees of the arbitrators and any engineer, accountant or other consultant engaged by the arbitrators, shall be shared equally unless otherwise awarded by the arbitrators. Notwithstanding the foregoing, if the amount in controversy is less than $1,000,000, then, instead of selecting three arbitrators by the process described above, one arbitrator shall be selected in accordance with the rules of AAA. In this event the arbitration proceeding shall be conducted for all purposes as set forth in this Section 5.3 (d), except that the proceeding shall be conducted by the one arbitrator, instead of the three. (e) All negotiations between the Senior Managers pursuant to this Section 5.3 shall be treated as compromise and settlement negotiations. Nothing said or disclosed, nor any document produced, in the course of such negotiations that is not otherwise independently discoverable shall be offered or received as evidence or used for impeachment or for any other purpose in any current or future arbitration or litigation. 5.4 LIMITATIONS ON DAMAGES. TO THE FULLEST EXTENT ALLOWED BY LAW, NO PARTY NOR ANY OF ITS RELATED PARTIES SHALL BE LIABLE UNDER THIS AGREEMENT OR OTHERWISE FOR ANY EXEMPLARY, SPECIAL, PUNITIVE, INDIRECT, REMOTE, SPECULATIVE OR CONSEQUENTIAL DAMAGES (INCLUDING LOSSES OF ANTICIPATED PROFITS), WHETHER IN TORT (INCLUDING NEGLIGENCE OR GROSS NEGLIGENCE), STRICT LIABILITY, BY CONTRACT OR STATUTE, EXCEPT TO THE EXTENT ANY INDEMNIFIED PARTY SUFFERS SUCH DAMAGES TO AN UNAFFILIATED THIRD PARTY IN CONNECTION WITH A THIRD-PARTY CLAIM, IN WHICH CASE SUCH DAMAGES SHALL BE RECOVERABLE (TO THE EXTENT RECOVERABLE UNDER THIS AGREEMENT WITHOUT GIVING EFFECT TO THIS SECTION 5.4). 5.5 LIMITED RECOURSE. TO THE FULLEST EXTENT ALLOWED BY LAW, EXCEPT AS EXPRESSLY PROVIDED IN THIS AGREEMENT, (A) NO RELATED PARTY OF ANY PARTY WILL HAVE ANY LIABILITY OR RESPONSIBILITY FOR, RELATING TO OR IN CONNECTION WITH A PARTY'S FAILURE TO PERFORM ANY TERM, COVENANT, CONDITION OR PROVISION OF THIS AGREEMENT AND (B) IN PURSUING ANY REMEDY FOR ANY PARTY'S BREACH OF ANY TERM, COVENANT, CONDITION OR PROVISION OF THIS AGREEMENT OR OF ANY DUTY OR STANDARD OF CONDUCT BASED ON NEGLIGENCE, STRICT LIABILITY OR OTHER TORT OR VIOLATION OF APPLICABLE LAW, OR OTHERWISE, THE OTHER PARTIES WILL NOT HAVE RECOURSE AGAINST ANY PERSON OTHER THAN THE DEFAULTING OR BREACHING PARTY ITSELF NOR AGAINST ANY ASSETS OTHER THAT THE ASSETS OF THE DEFAULTING OR BREACHING PARTY ITSELF. 5.6 Limitation on Remedies. The Parties hereby acknowledge and agree that: (a) In the event Carrizo fails to provide the Services (or a portion thereof), in accordance herewith, the sole and exclusive remedy of Company shall be, at Company's election made in writing at the time the claim is first asserted, (i) to make a claim for indemnification pursuant to Section 5.1 (if available), (ii) to have the Service (or relevant portion) reperformed, without having to reimburse Carrizo for its direct internal cost of such reperformance, or (iii) to terminate this Agreement in accordance with Section 6.2. Such rights are Company's sole remedy for any non-performance, inadequate performance, faulty performance or other failure or breach by Carrizo under or relating to this Agreement. TO THE FULLEST EXTENT ALLOWED BY LAW, COMPANY HEREBY EXPRESSLY WAIVES ANY RIGHT COMPANY MAY OTHERWISE HAVE TO CLAIM, COLLECT OR RECEIVE DAMAGES, TO ENFORCE SPECIFIC PERFORMANCE OR TO PURSUE ANY OTHER REMEDY AVAILABLE IN CONTRACT, AT LAW, OR IN EQUITY IN THE EVENT OF ANY NON-PERFORMANCE, INADEQUATE PERFORMANCE, FAULTY PERFORMANCE OR OTHER FAILURE OR BREACH BY CARRIZO UNDER OR RELATING TO THIS AGREEMENT, NOTWITHSTANDING THE NEGLIGENCE (WHETHER SOLE, JOINT OR CONCURRENT OR ACTIVE OR PASSIVE) OR GROSS NEGLIGENCE OF CARRIZO OR ANY OTHER PERSON INVOLVED IN THE PROVIDING OF SERVICES AND WHETHER DAMAGES ARE ASSERT IN CONTRACT OR TORT, UNDER FEDERAL, STATE OR FOREIGN LAWS OR OTHER STATUTE OR OTHERWISE, EXCEPT THAT COMPANY SHALL HAVE THE RIGHT TO SEEK TO ENJOIN ANY WILLFUL MISCONDUCT; (b) Without limiting the generality of any other provision of this Agreement, it is not the intent of Carrizo or its affiliated to render professional advice or opinions, whether in regard to tax, legal, treasury, finance, intellectual property, employment or other matters; Company shall not rely on any Service rendered by or on behalf of Carrizo or its affiliates for such professional advice or opinions; and notwithstanding Company's receipt of any proposal, recommendation or suggestion in any way related to tax, legal, treasury, finance, intellectual property, employment or any other subject matter, Company shall seek all third party professional advice and opinions as it may desire or need, and in any event Company shall be solely responsible for and assume all risks associated with the Services, except to the limited extent set forth in this Section; and (c) A material inducement to the provision of the Services is the limitation of liability set forth herein and the release and indemnity provided by Company. 6. TERM AND TERMINATION. 6.1 This Agreement, upon execution hereof, shall be effective as of the date hereof and shall continue in effect for an initial term that ends at midnight in December 31, 2003, and shall extend for successive calendar quarter periods, unless terminated (i) by Company with at least thirty (30) days prior written notice to Carrizo, (ii) by Carrizo with at least ninety (90) days prior written notice to Company; provided, however, Carrizo shall complete any audited or unaudited statement of accounts or other reporting services related to the calendar quarter which includes the last day of the 90 day notice period, and this Agreement shall remain in effect in relation to the completion of such Services. 6.2 Subject to the provisions of Section 2.3, if either Party shall cause or suffer to exist any material breach of any of its obligations under this Agreement, including, but not limited to, any failure to deliver Services or to make payments when due, and said Party does not cure such default within thirty (30) after receiving written notice thereof from the non-breaching Party (unless the Party receiving the notice of default disputes the existence of such default by written notice to the non-breaching party, in which case the cure periods referred to above shall begin to run from and after the date of a final decision by a court of competent jurisdiction or arbitration panel finding that a default exists hereunder), the non-breaching Party may terminate this Agreement, including the provision of Services pursuant hereto, immediately by providing written notice of termination. 6.3 In the event of a termination of this Agreement, Carrizo shall be entitled to all outstanding amounts due from Company for Services provided under this Agreement up to the date of termination. Carrizo shall provide all records relating to the Services to Company upon termination of this Agreement. 6.4 Sections 3.2, 5, the confidentiality provisions of Section 1.3, and this Section 6.4 shall survive any termination of this Agreement. 7. ASSIGNMENT. Neither this Agreement nor any of the rights, benefits or obligations hereunder may be assigned or delegated (whether by operation of law or otherwise) without the prior written consent of the other party; provided, however, that the foregoing shall in no way restrict the performance of a Service by a subsidiary or a third party as otherwise allowed hereunder. 8. FORCE MAJEURE. Carrizo shall not be liable for any interruption of service, delay or failure to perform under this Agreement when such interruption, delay or failure results from causes beyond its reasonable control, including, but not limited to, any strikes, lockouts or other labor difficulties, acts of any government, riot, insurrection, war or other hostilities, terrorism, embargo, boycott, fuel or energy shortage, fire, flood, acts of God, acts of the public enemy, computer crimes, cyber-terrorism, wrecks or transportation delays, or inability to obtain necessary labor, materials or utilities; provided, however, that RMG shall use all reasonable commercially efforts to remedy such interruption, delay, or failure. In any such event, Carrizo's obligations hereunder and Company's obligations to pay for any Service so suspended or delayed hereunder shall be postponed for such time as Carrizo's performance is suspended or delayed on account thereof. Carrizo will notify Company promptly in writing upon learning of the occurrence of such event of force majeure. Upon the cessation of the force majeure event, Carrizo shall resume its performance as soon as reasonably practicable. The Parties agree that the terms of this Agreement shall be extended for a period of time equal to the period of time during which their obligations under this Agreement are suspended pursuant to this Section 8. 9. MISCELLANEOUS. 9.1 Entire Agreement. This Agreement, including the Exhibit attached hereto, constitutes the entire agreement between the Parties with respect to the subject matter herein and supersedes any and all prior or contemporaneous understandings, negotiations or agreements between the Parties and, subject to the provisions of Section 7, shall be binding upon and inure to the benefit of the Parties hereto and their respective legal representatives and permitted successors and assigns. 9.2 Amendments. Any amendment, supplement, variation, alteration or modification to the Agreement must be made in writing and duly executed by an authorized representative or agent of each of the Parties. 9.3 Severability. If any provision of this Agreement is held invalid or unenforceable, all other provisions will not be affected. With respect to the provisions held invalid or unenforceable, the Parties will, to the fullest extent allowed by law, amend this Agreement as necessary to effect the original intent of the Parties as closely as possible. 9.4 Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed to be an original, and all such counterparts shall be deemed to constitute one and the same instrument. 9.5 Governing Law. This Agreement shall be governed and controlled as to its validity, enforcement, interpretation, construction, effect and in all other respects by the laws of the State of Texas (without regard to the conflicts of laws provisions thereof) applicable to contracts made in that state. 9.6 Notices. Except as otherwise provided in this Agreement, whenever it is provided in this Agreement that any notice, demand, request, consent, approval, declaration or other communication shall or may be given to or served upon one of the Parties by the other Party, or whenever either Party desires to give or serve upon the other Party any communication with respect to this Agreement, each such notice, demand, request, consent, approval, declaration or other communication shall be in writing and either shall be delivered in person with receipt acknowledged or sent by registered or certified-mail, return receipt requested, postage prepaid, or by overnight mail or courier, or delivery service or by facsimile and confirmed by facsimile answer back, addressed as follows: If to Carrizo to: Carrizo Oil & Gas, Inc.. 14701 St. Mary's Lane, Suite 800 Houston, Texas 77079 Attention: S.P. Johnson Facsimile: (281) 496-0884 If to Company to: Pinnacle Gas Resources, Inc. 1 E. Alger, Suite 206 Sheridan, Wyoming 82801 Attention: Peter G. Schoonmaker Facsimile: (307) 673-9711 Attention: Gary W. Uhland 14701 St. Mary's Lane, Suite 800 Houston, Texas 77079 Facsimile: (281) 584-9268 or at such other address as may be substituted by written notice given as in this Section 9.6. The furnishing of any notice required under this Agreement may be waived in writing by the Party entitled to receive such notice. Every notice, demand, request, consent, approval, declaration or other communication under this Agreement shall be deemed to have been duly given or served on (i) the date on which personally delivered, with receipt acknowledged, (ii) the date on which sent by facsimile and confirmed by answer back, (iii) the next Business Day if delivered by overnight or express mail, courier or delivery service, or (iv) three Business Days after the same shall have been deposited in the United States mail, as the case may be. 9.7 Waiver. The waiver by any party hereto of a breach of any provision of this Agreement, shall not operate or be construed as a waiver of any subsequent breach. The failure of any party to require performance of any provision of this Agreement shall not affect any party's right to full performance thereof at any time thereafter. [balance of page intentionally left blank] IN WITNESS WHEREOF, the Parties hereto have executed this Agreement effective as of the date first above written. CARRIZO OIL & GAS, INC. BY: ------------------------------------------ Name: Title: PINNACLE GAS RESOURCES, INC. BY: ------------------------------------------ Name: Title: EXHIBIT A TO TRANSITION SERVICES AGREEMENT BETWEEN PINNACLE RESOURCES, INC. AND CARRIZO OIL & GAS, INC. Carrizo will provide the following accounting services to Pinnacle during the transition period: Organization Stage o Negotiate purchase of an accounting software system with associated hardware (coordinate with RMG) on behalf of Pinnacle o Prepare opening entries for general ledger o Design financial reports o Apply for and obtain Federal Identification Number o Open bank accounts o Order checks and associated forms o Obtain quotes for and initiate insurance policies as described below Accounting Function o Coordinate chart of accounts with RMG o Post detail cash transactions (deposits and cash disbursements) o Prepare account analysis (prepaid expenses, deposits, etc.) as necessary o Record monthly accrual entries prepared by RMG o Post monthly journal entries o Post general ledgers monthly o Prepare monthly trial balances o Perform normal monthly reconciliations (receivables, payables, etc.) o Calculate depreciation monthly o Calculate depletion and income tax accruals quarterly and post to general ledger (based on Reserve Report from Pinnacle) o Calculate "Ceiling Test" quarterly (based on Reserve Report from Pinnacle) o Calculate valuation of hedge positions quarterly and post to general ledger Financial Reporting o Prepare monthly Balance Sheet and Statement of Operations o Prepare quarterly GAAP Balance Sheet, Statement of Operations and Statement of Cash Flows o Prepare monthly Budget vs. Actual reports o Facilitate in obtaining management explanations for variances o Annual GAAP Financial Statements o Review valuation of assets with management quarterly o Distribute financial reports to Board Treasury o Maintain daily cash balance reports o Monitor lock box deposits o Prepare and distribute accounts payable checks o Initiate and record wire transfers as necessary o Fund payroll and revenue imprest accounts as directed by RMG o Reconcile bank accounts (daily cash to general ledger to bank) monthly o Manage cash balances - invest excess cash balances Insurance o Obtain insurance coverage quotes and request coverage for Pinnacle o General Liability o Workman's Compensation o Control of Well o Directors and Officers Liability o Limits to be set by or approved by Pinnacle Audit Function o Coordinate timing of quarterly reviews and annual audit with independent accountants o Prepare schedules and reports for independent accountants o Prepare reports for inclusion in investors quarterly and annual reports o Make original documents located in Houston available to independent accountants Federal /State Tax o Preparation of Texas payroll tax reporting o Preparation of Federal tax deposits o Preparation of Form 940 and Form 941 o Preparation of Form 1099's (RMG to identify payees and input source data) o Oversee preparation of Corporate Federal Income Tax Return (Form 1120) o Preparation of Franchise Tax Payroll o Process Texas employees payroll Financial Hedges o Obtain management approvals from Board for hedge strategy o Execute hedge arrangements as approved o Perform GAAP valuation of hedge positions quarterly Other o Maintain minute book o Coordinate board resolution requests as generated by management o Prepare loan compliance reports o Maintain warrant and options schedules o Calculate, coordinate board approvals and distribute dividends o Maintain banking relationships o Back up accounting records The following are SPECIFICALLY EXCLUDED from this agreement: o Preparation of annual budgets o Preparation of any forecast models o Responsibility for obtaining any additional financing o Engaging the Independent Accountants EX-31.1 5 h08461exv31w1.txt CEO CERTIFICATION PURSUANT TO SECTION 302 EXHIBIT 31.1 CEO CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, S.P. Johnson IV, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Carrizo Oil & Gas, Inc., 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and c) disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2003 /s/ S.P. Johnson IV ------------------------------------- S.P. Johnson IV President and Chief Executive Officer EX-31.2 6 h08461exv31w2.txt CFO CERTIFICATION PURSUANT TO SECTION 302 EXHIBIT 31.2 CFO CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Paul F. Boling, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Carrizo Oil & Gas, Inc., 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and b) disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 14, 2003 /s/ Paul F. Boling ----------------------------- Paul F. Boling Vice President and Chief Financial Officer EX-32.1 7 h08461exv32w1.txt CEO CERTIFICATION PURSUANT TO SECTION 906 EXHIBIT 32.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE) Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), I, S.P. Johnson, IV, President and Chief Executive Officer of Carrizo Oil & Gas, Inc., a Texas corporation (the "Company"), hereby certify, to my knowledge, that: (1) the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ S.P. Johnson, IV ------------------------------------------- Name: S.P. Johnson, IV Dated: August 14, 2003 President and Chief Executive Officer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code) and is not being filed as part of the Report or as a separate disclosure document. A signed original of this written statement required by Section 906 has been provided to Carrizo Oil & Gas, Inc. and will be retained by Carrizo Oil & Gas, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. EX-32.2 8 h08461exv32w2.txt CFO CERTIFICATION PURSUANT TO SECTION 906 EXHIBIT 32.2 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE) Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), I, Paul Boling, Vice President and Chief Financial Officer of Carrizo Oil & Gas, Inc., a Texas corporation (the "Company"), hereby certify, to my knowledge, that: (1) the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Paul F. Boling -------------------------------- Name: Paul F. Boling Vice President and Dated: August 14, 2003 Chief Financial Officer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code) and is not being filed as part of the Report or as a separate disclosure document. A signed original of this written statement required by Section 906 has been provided to Carrizo Oil & Gas, Inc. and will be retained by Carrizo Oil & Gas, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----