-----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, OahL8C9n2NQ6DvJpZZnJ+ETqc+TnFZqWOiCPQcfhy/Rj25VRoL9l+UtSt8SX+UVg zo0R7oP1aEs0MT3g4YykTA== 0000927356-99-001652.txt : 19991028 0000927356-99-001652.hdr.sgml : 19991028 ACCESSION NUMBER: 0000927356-99-001652 CONFORMED SUBMISSION TYPE: S-4 PUBLIC DOCUMENT COUNT: 23 FILED AS OF DATE: 19991027 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CARBON ENERGY CORP CENTRAL INDEX KEY: 0001096019 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 841515097 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-4 SEC ACT: SEC FILE NUMBER: 333-89783 FILM NUMBER: 99735288 BUSINESS ADDRESS: STREET 1: 1700 BROADWAY SUITE 1150 CITY: DENVER STATE: CO ZIP: 80290-1101 MAIL ADDRESS: STREET 1: 1700 BROADWAY SUITE 1150 CITY: DENVER STATE: CO ZIP: 80290-1101 S-4 1 FORM S-4 OF CARBON ENERGY CORPORATION As filed with the Securities and Exchange Commission on October 27, 1999 Registration No. [ ] - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM S-4 REGISTRATION STATEMENT Under The Securities Act of 1933 --------------- CARBON ENERGY CORPORATION (Exact name of registrant as specified in its charter) Colorado 1311 84-1515097 (State or other (Primary Standard (I.R.S. Employer jurisdiction of Industrial Classification Identification Number) incorporation or Code Number) organization) Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, CO 80290-1101 (303) 860-1575 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) --------------- Patrick R. McDonald President and Chief Executive Officer Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, CO 80290-1101 (303) 860-1575 (Name, address, including zip code, and telephone number, including area code, of agent for service) --------------- COPIES TO: Mark R. Levy, Esq. Holland & Hart LLP 555 17th Street, Suite 3200 Denver, Colorado 80202 (303) 295-8000 --------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after the Registration Statement becomes effective. --------------- If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
Title of each class of securities to be Amount to be Proposed maximum offering Proposed maximum Amount of registered registered(1) price per share aggregate offering price(2) registration fee(3) - -------------------------------------------------------------------------------------------------------------------- Common Stock, no par value. 1,765,900 N/A $8,388,025 $2,332
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (1) The estimated maximum number of shares of Carbon Energy Corporation common stock issuable upon consummation of the exchange offer for shares of CEC Resources Ltd. (2) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(f) under the Securities Act, based on the market value of the securities to be received by the Registrant in the transaction as established by the price of the common shares of CEC Resources Ltd. as reported on the American Stock Exchange on October 20, 1999. (3) Calculated pursuant to Section 6(b) of the Securities Act as .000278 of $8,388,025. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Subject to Completion, dated October 27, 1999 CARBON ENERGY CORPORATION OFFER TO EXCHANGE Shares of Common Stock of Carbon Energy Corporation for any and all Shares of Common Stock of CEC Resources Ltd. Our offer will expire at 5:00 P.M., Denver, Colorado time on , 1999, unless extended. Carbon Energy Corporation is offering to exchange one share of our common stock for each share of common stock of CEC Resources Ltd. If all CEC's shareholders accept our offer, in the aggregate we will issue approximately 1,521,400 shares of our common stock. CEC's Board of Directors has approved this transaction. CEC's common shares are traded on the American Stock Exchange under the symbol "CGS." On , 1999, the closing price for CEC's common shares was $ . Carbon's common stock is not currently traded on a national securities exchange or other public trading market. Carbon's common stock has been approved for listing on the American Stock Exchange, upon issuance of the shares after the exchange offer, under the symbol " ." You have until 5:00 p.m., Denver, Colorado time, on , 1999 to accept our offer, unless extended. At that time, our offer and your withdrawal rights will expire. This prospectus and the enclosed letter of transmittal describe how to accept our offer. Directors and executive officers of CEC who hold in the aggregate shares of CEC's common shares, representing approximately 40% of CEC's voting power, have stated their intention to accept our offer. After the exchange offer, CEC will be a subsidiary of Carbon. The Carbon common stock we are offering involves a high degree of risk. See "Risk Factors" beginning on page 12 of this prospectus for a discussion of the risks you should consider in connection with our offer and an investment in Carbon's common stock. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of the securities to be issued in the exchange offer or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense. The date of this prospectus is , 1999. The information in this prospectus is not complete and may be changed. We may not sell these securities until the Registration Statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. CARBON ENERGY CORPORATION PROSPECTUS Introduction Please read this prospectus carefully. It describes our and CEC's businesses and finances. We have prepared this prospectus so that you will have the information necessary to make a decision on the exchange offer. You should only rely on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to exchange shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of common stock. Table of Contents PROSPECTUS SUMMARY.......................................................... 3 RISK FACTORS................................................................ 12 SOURCES OF INFORMATION ABOUT CARBON AND CEC................................. 18 FORWARD-LOOKING STATEMENTS.................................................. 18 THE EXCHANGE OFFER.......................................................... 19 General.................................................................... 19 Background Of The Exchange Offer/Exchange Agreement........................ 19 CEC's Reasons For Recommending The Exchange Offer.......................... 21 Our Reasons For The Exchange Offer......................................... 22 Intentions Of The Directors And Officers Of CEC............................ 22 Interests Of Certain Persons In The Exchange Offer......................... 22 Description of Exchange Agreement.......................................... 24 Expiration Date............................................................ 25 Exchange Of CEC Stock For Carbon Common Stock.............................. 25 Exchange Agent............................................................. 26 Guaranteed Delivery Procedures............................................. 27 Conditions To The Exchange................................................. 27 Termination Of The Exchange Offer.......................................... 27 Withdrawal Rights.......................................................... 27 Fees And Expenses.......................................................... 28 Regulatory Matters......................................................... 28 Accounting Treatment....................................................... 28 Possible Effects of the Exchange Offer..................................... 29 Second Step Merger......................................................... 29 UNITED STATES FEDERAL INCOME TAX CONSEQUENCES............................... 30 Scope and Limitation Advice................................................ 30 Taxation of U.S. Shareholders.............................................. 30 Basic Treatment of Exchange Transaction for U.S. Shareholders.............. 30 Passive Foreign Investment Company Considerations for U.S. Shareholders.... 32 Taxation of Non-U.S. Shareholders.......................................... 32 Estate Tax for Non-U.S. Shareholders....................................... 33 Information Reporting and Backup Withholding............................... 33 CANADIAN FEDERAL INCOME TAX CONSEQUENCES.................................... 34 Holders Resident in Canada................................................. 35 Holders Not Resident in Canada............................................. 36
i UNAUDITED PRO FORMA FINANCIAL INFORMATION.................................. 37 INFORMATION ABOUT CEC...................................................... 41 Overview of Business...................................................... 41 CEC Selected Financial Data............................................... 42 CEC Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................... 42 Properties................................................................ 50 Legal Proceedings......................................................... 56 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................................................... 56 Quantitative and Qualitative Disclosures about Market Risk................ 56 INFORMATION ABOUT CARBON................................................... 57 Business.................................................................. 57 Carbon Selected Financial Data............................................ 58 Our Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................... 58 Properties................................................................ 63 Legal Proceedings......................................................... 69 Charges in and Disagreements with Accountants on Accounting and Financial Disclosure............................................................... 69 Quantitative and Qualitative Disclosures about Market Risk................ 69 OUR MANAGEMENT............................................................. 70 Executive Directors and Officers.......................................... 70 Committees of the Board of Directors...................................... 71 Executive Compensation.................................................... 71 Stock Option Grants and Exercises......................................... 72 1999 Stock Option and Restricted Stock Plans.............................. 73 Directors' Compensation................................................... 74 Indemnification and Limitation of Liability............................... 74 Employment Agreement...................................................... 74 PRINCIPAL SHAREHOLDERS OF OUR COMPANY...................................... 75 PRINCIPAL SHAREHOLDERS OF CEC.............................................. 76 CERTAIN RELATIONSHIPS AND TRANSACTIONS..................................... 77 DESCRIPTION OF OUR CAPITAL STOCK........................................... 77 Common Stock.............................................................. 77 Preferred Stock........................................................... 77 Certain Effects of Authorized but Unissued Stock.......................... 77 American Stock Exchange Listing........................................... 78 Transfer Agent............................................................ 78 COMPARISON OF SHAREHOLDERS' RIGHTS......................................... 79 LEGAL MATTERS.............................................................. 89 EXPERTS.................................................................... 89 WHERE YOU CAN FIND MORE INFORMATION........................................ 89 INDEX TO FINANCIAL STATEMENTS.............................................. F-1
ii PROSPECTUS SUMMARY This Summary highlights selected information that we present more fully in other sections of this prospectus. To understand this exchange offer, you should read the entire prospectus carefully, including the "Risk Factors" and the financial statements of Carbon Energy Corporation and its predecessor Bonneville Fuels Corporation and the financial statements of CEC Resources Ltd. included in this prospectus. Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, Colorado 80290-1101 (303) 860-1575 We are an independent oil and gas company engaged in the exploration, development and production of natural gas and crude oil, principally in the states of Colorado, Kansas, New Mexico, Texas, and Utah. Our business and assets are presently comprised of the assets and property of Bonneville Fuels Corporation ("BFC") which we acquired on October 29, 1999 with the concurrence of CEC. Yorktown Energy Partners III, L.P. ("Yorktown") formed Carbon for the purpose of acquiring BFC and making this exchange offer. CEC Resources Ltd. 1700 Broadway, Suite 1150 Denver, Colorado 80290-1101 (303) 860-1575 CEC is an independent oil and gas company engaged in the exploration, development and production of natural gas and crude oil and the acquisition and development of interests in oil and gas properties in the provinces of Alberta and Saskatchewan, Canada. CEC also owns an interest in one natural gas liquids extraction plant and several gas gathering and compression systems in Alberta. Summary of Exchange Offer Terms of Our Offer We are offering to exchange one share of our common stock for each share of CEC common stock held by you. All shares of CEC common stock properly tendered and not withdrawn will be exchanged at the one-for-one exchange rate, on the terms and subject to the conditions of the exchange offer. We will promptly return any shares of CEC common stock if the conditions of the exchange offer are not met. Expiration Date You have until 5:00 p.m., Denver time, on , 1999 to accept our offer, unless extended. At that time, our offer will expire. If we extend the expiration date, we will publicly announce the extension as soon as practicable after we make the extension and in any event no later than 9:00 a.m. Denver time on the next business day after the previously scheduled expiration date. Withdrawal Rights You may withdraw tenders of your shares of CEC common stock at any time before the exchange offer expires. If you change your mind again, you may retender your shares of CEC common stock by following the exchange offer procedures again prior to the expiration of the exchange offer. 3 Our offer may be terminated if any court or governmental authority issues an order restraining, enjoining or otherwise prohibiting consummation of the exchange offer. Procedures For Tendering Your Shares Of CEC Common Stock If you hold certificates for shares of CEC common stock, you must complete and sign the letter of transmittal designating the number of CEC shares you wish to tender and return the letter with your stock certificates and any other documents required by the letter of transmittal, by registered mail, return receipt requested, so that it is received by the exchange agent at one of the addresses listed in "The Exchange Offer--The Exchange Agent" before the expiration of the exchange offer on , 1999. If you hold shares of CEC common stock through a broker, you should receive instructions from your broker on how to participate. In this situation, you do not need to complete the letter of transmittal. Please contact your broker directly if you have not yet received instructions. Some financial institutions may also effect tenders by book-entry transfer through The Depository Trust Company. If you hold certificates for shares of CEC common stock or if you hold CEC shares through a broker, you may also comply with the procedures for guaranteed delivery. Guaranteed Delivery Procedures Holders of CEC common stock who wish to tender their shares and whose shares are not immediately available or who cannot deliver their certificates for CEC common stock, the letter of transmittal or any other documentation required by the letter of transmittal to the exchange agent prior to the expiration date must tender their shares of CEC common stock according to the guaranteed delivery procedures described in "The Exchange Offer--Guaranteed Delivery Procedures." Acceptance of CEC Common Stock and Delivery of Carbon Common Stock Subject to the satisfaction or waiver of the conditions to the exchange offer, we will accept for exchange any and all shares of CEC common stock that are properly tendered in the exchange offer and not withdrawn prior to the expiration date. The Carbon common stock to be delivered in exchange for your shares of CEC common stock will be delivered promptly following the expiration of our offer. No Dissenters' Rights No dissenters' rights are available to shareholders of CEC in connection with the exchange offer. Exchange Agent Harris Trust and Savings Bank is serving as the exchange agent in connection with our exchange offer. Possible Effects of the Exchange Offer The exchange of shares of CEC common stock in the exchange offer will reduce the number of holders of CEC common stock and the number of shares of CEC common stock that might otherwise trade publicly. Depending on the number of shares of CEC common stock exchanged, the liquidity and market value of the remaining shares of CEC common stock could be adversely affected. CEC's common stock is listed on the American Stock Exchange ("AMEX"). Depending on the number of shares of CEC common stock exchanged pursuant to the exchange offer, CEC common stock may no longer meet the requirements of the AMEX for continued listing. Because holders of approximately 40% of the outstanding shares of CEC have stated their 4 intentions to accept the exchange offer, we anticipate that CEC common stock will be delisted from the AMEX. If the shares of CEC common stock were to be delisted from the AMEX, the market for such shares could be adversely affected. It is possible that such shares might be traded on other securities markets. The extent of the public market for the shares of CEC common stock would, however, depend upon the number of holders and/or the aggregate market value of such shares remaining at that time, the interest in maintaining a market in such shares on the part of securities firms and the possible termination of registration of CEC common stock under the Securities Exchange Act of 1934 ("Exchange Act"). CEC's common stock is currently registered under the Exchange Act. Such registration may be terminated by CEC upon application to the Securities and Exchange Commission ("SEC") if the outstanding shares of CEC common stock are not listed upon a national securities exchange and if there are fewer than 300 holders of record of such shares. Termination of registration of the CEC common stock under the Exchange Act would reduce the information required to be furnished by CEC to its shareholders and to the SEC and would make certain provisions of the Exchange Act, such as the filing of periodic SEC reports, the requirement of furnishing a proxy statement pursuant to Section 14(a), and the short-swing profit recovery provisions of Section 16(b), no longer applicable to CEC shares. Background of the Exchange Offer/Exchange and Financing Agreement The information in this section regarding the deliberations of CEC's Board of Directors and the actions of CEC's management and legal and financial advisors is based on information furnished by CEC. CEC and Carbon believe there are attractive opportunities available for acquisitions of oil and gas properties and exploration and production in both the United States and Canada as a result of improving oil and gas prices, lower exploration and production costs, the divestiture of non-core properties by major oil companies and large independent oil companies and consolidation within the oil and gas industry. CEC's position as a small independent public oil and gas company limits its potential for growth unless steps are taken to increase its size and the value of its oil and gas reserves. In early May, 1999, CEC learned that Bonneville Pacific Corporation ("BPC") would be selling the stock of its Denver based 100% owned subsidiary, BFC. During May, June, July and early August, 1999, CEC participated in a sale process conducted by BPC for the sale of BFC. During that period, CEC conducted due diligence concerning BFC and its properties, submitted various offers for BFC and submitted comments on the form of the stock purchase agreement for the acquisition of BFC prepared by BPC. During this period, CEC also conducted discussions with Yorktown Partners LLC (an energy investment firm which is the manager of Yorktown Energy Partners III, L.P.) relating to the financing of the acquisition of BFC by Yorktown. These discussions resulted in a determination that Yorktown would provide equity financing through a United States corporation. As a result, Carbon was formed in September, 1999. On August 11, 1999, CEC and BPC signed the BFC stock purchase agreement. Under the BFC stock purchase agreement, CEC agreed to purchase all BFC outstanding stock from BPC at a price of $23,857,951 in cash, subject to certain adjustments, with debt less working capital of approximately $6,500,000 remaining at BFC (referred to as "net debt"). On October 14, 1999, Carbon, CEC and Yorktown signed the exchange and financing agreement providing for an assignment of the BFC stock purchase agreement to Carbon, the purchase of common stock of Carbon by Yorktown for $24,750,000, and the exchange offer made by this prospectus. This purchase of Carbon stock by Yorktown was at a price of $5.50 per share. On October 29, 1999, Carbon completed the purchase of BFC. The exchange offer gives each shareholder of CEC the opportunity to become a shareholder in Carbon which will be a substantially larger oil and gas company than CEC alone. Carbon owns BFC, and, it is anticipated 5 Carbon will own more than a majority of CEC. The formation of Carbon results from Yorktown's desire for making its investment in a United States corporation and unfavorable tax consequences that would have resulted by reincorporating CEC from an Alberta corporation with Canadian assets into a U.S. corporation with both Canadian and U.S. assets. For a more complete description of the background surrounding the purchase of BFC, the formation of Carbon and the making of the exchange offer, see "The Exchange Offer--Background of the Exchange Offer/Exchange Agreement". Recommendation of the Board of Directors of CEC CEC's Board of Directors believes that the terms of the exchange offer are fair to and in the best interest of CEC and its shareholders. In reaching its decision, CEC's Board considered a number of factors, including the following: . The acquisition of BFC and the exchange offer would result in Carbon being led by a highly regarded management team with a strong track record in the oil and gas industry. . The structure of the transaction with CEC's current shareholders having the opportunity to participate in the future value of both BFC and CEC as part of Carbon by accepting the exchange offer. . Reasons for the acquisition of BFC, including potential growth, the nature of BFC's properties and cost savings that may be realized in the operation of BFC by Carbon. . The terms of the BFC stock purchase agreement, including the parties' representations, warranties and covenants and the conditions to their respective obligations. . United States and Canadian tax consequences of the transaction. . The requirement of Yorktown that its equity financing be made through a United States corporation. . The valuation of CEC involved in the equity financing made by Yorktown; alternatives to Yorktown's proposal that had been considered or sought in the past; a previous search by CEC for a buyer, which was conducted prior to Patrick R. McDonald's becoming a significant shareholder, and resulted in no offers. . Valuation methods applicable to CEC, including discounted cash flow, multiple of cash flow and public stock market values. . Current financial market conditions and historical market prices, volatility and trading information with respect to CEC's common stock. . The likelihood of continuing consolidation in the energy industry and increased competition from larger, well-financed companies. . The reports from CEC's management as to the results of its due diligence investigation of BFC and its business. Intentions of the Board of Directors of CEC Directors and executive officers of CEC who hold, in the aggregate, 580,346 shares of outstanding CEC common stock, representing approximately 38.1% of CEC's outstanding shares, have stated their intention to accept our stock in the exchange offer. United States Federal Income Tax Consequences Subject to a number of qualifications and conditions, and to the accuracy of certain factual representations made by Carbon and CEC, Holland & Hart LLP, tax counsel to CEC, has rendered an opinion, that for U.S. federal income tax purposes, (1) the transactions contemplated by the exchange offer should constitute a tax-free B reorganization, assuming that Carbon acquires at least 80% of the outstanding stock of CEC pursuant to the 6 exchange offer, and (2) the transactions contemplated by the exchange offer likely constitute part of a tax-free Section 351 transaction even if the transactions contemplated by the exchange offer do not qualify as a B reorganization. See "United States Federal Income Tax Consequences." Tax counsel's opinion is not a substitute for each individual CEC shareholder's review of the tax consequences of the exchange by its own advisor. See "Risk Factors." Non-U.S. shareholders who receive Carbon stock in the exchange may be subject to U.S. tax with respect to their investment in Carbon common stock or may otherwise be affected by U.S. tax law. The summary of U.S. federal income tax consequences of the exchange set forth in "United States Federal Income Tax Consequences" does not cover all U.S. federal income tax aspects of the exchange and may not be applicable to every CEC shareholder exchanging shares. For these reasons, each CEC shareholder participating in the exchange is urged and expected to consult with and rely on its tax advisor regarding the U.S. federal income tax aspects of the exchange. Canadian Federal Income Tax Consequences Subject to the specific exceptions referred to under "Canadian Federal Income Tax Consequences" below, the exchange of CEC common stock for Carbon common stock will generally be tax-free to non-Canadian holders of CEC common stock for Canadian federal income tax purposes. Canadian holders of CEC common stock will not benefit from tax-free treatment for Canadian federal income tax purposes and will have to recognize a gain or loss equal to the difference between the fair market value of the Carbon common stock and the aggregate of the adjusted cost base of the CEC common stock and any reasonable costs of disposition. The tax considerations to you resulting from your individual position and the exchange may be complex. Carbon recommends that you read carefully the discussion under "Canadian Federal Income Tax Consequences" and consult with your own advisors as to the Canadian federal, provincial or territorial tax consequences. An opinion on these Canadian tax matters has been rendered by Bennett Jones, counsel to CEC. Their opinion is subject to the assumptions and qualifications set forth under "Canadian Federal Income Tax Consequences." Accounting Treatment We will account for the exchange offer as a purchase of CEC in accordance with generally accepted accounting principles. For a discussion of the application of purchase accounting to this transaction, see "The Exchange Offer--Accounting Treatment." Comparison of Shareholders' Rights CEC shareholders who accept our exchange offer will become shareholders of Carbon and be governed by our articles of incorporation and bylaws and the Colorado Business Corporation Act. There are a number of differences between our articles of incorporation and bylaws and the Colorado Business Corporation Act and the articles of association and bylaws of CEC and the Alberta Business Corporations Act. These differences are discussed under "Comparison Of Shareholders' Rights." Interests of Certain Persons in the Exchange Offer In considering whether to accept our offer, you should consider the interests various executive officers and directors have in the exchange offer. Patrick R. McDonald, President of CEC, and Kevin Struzeski, Chief Financial Officer-Treasurer of CEC, have entered into employment agreements with Carbon. In addition, Mr. McDonald and Mr. Struzeski have been granted restricted stock of Carbon and stock options to acquire shares of 7 its common stock. Mr. McDonald, Mr. Struzeski and other officers of CEC are to receive bonuses from CEC upon completion of the exchange offer if 50% or more of the CEC shares are exchanged for Carbon shares. The employment agreements replace employment agreements with CEC and were negotiated on an arms'-length basis with Yorktown. For a description of these interests, see "The Exchange Offer--Interests of Certain Persons in the Exchange Offer." Second Step Merger After the exchange offer, we may merge CEC with a wholly-owned Canadian subsidiary of Carbon. In such a merger, shareholders of CEC may receive cash, shares of our stock, other securities or a combination of some or all of the foregoing. If CEC common stock is listed on the AMEX on the record date for determining shareholders entitled to vote on the merger, no dissenters' rights will be available to CEC's shareholders in connection with the merger. In contrast, if CEC common stock is not listed on the AMEX on such record date, CEC shareholders will be entitled to dissenters' rights in connection with the merger. The continued listing of CEC common stock will depend upon the effect of the exchange offer on the shares of CEC held by persons other than Carbon, and it is currently contemplated that the CEC shares will be delisted from AMEX. We do not intend to do a second step merger if it would result in adverse United States income tax consequences to CEC shareholders who accepted our exchange offer. We will not engage in a second step merger without informing, and receiving approval from, our tax counsel. Summary Selected Financial Data of Carbon The following table summarizes financial data for our business. The data is derived from the financial statements of our predecessor, BFC, included elsewhere in this prospectus. In addition to this information, please read our financial statements and the financial statements of Bonneville Fuels Corporation starting on page F-7 and "Information About Carbon--Our Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 58.
As of or for the Six Months As of or for the Year Ended June 30, Ended December 31, ---------------- ------------------------------------------- 1999 1998 1998 1997 1996 1995 1994 ------- ------- ------- ------- ------- ------- ------- (In Thousands) Operating Data: Revenue............... $14,728 $ 8,026 $21,092 $16,539 $15,067 $12,675 $14,956 Net income (loss)..... 150 596 (1,941) 732 4,060 172 (2,950) Cash Flow Data: Cash provided by (used in) operating activities........... $(1,529) $ 2,092 $ 4,696 $ 3,193 $ 4,136 $ 3,016 $ 3,091 Cash used in investing activities........... (3,619) (2,396) (5,948) (4,442) (1,025) (859) (1,181) Cash provided by (used in) financing activities........... 2,850 600 3,450 1,019 (2,760) (2,090) (2,046) Balance Sheet Data: Total assets.......... $20,924 $16,642 $22,840 $16,054 $14,524 $13,177 $16,321 Working capital....... 1,488 1,246 812 1,491 1,725 628 405 Long term debt........ 8,700 3,000 5,850 2,400 1,700 4,760 6,850 Stockholder's equity(1)............ 9,464 10,196 9,313 9,591 8,859 6,774 6,552
- -------- (1) Includes debt to parent company (BPC) of $3,787 in 1995 and $3,737 in 1994, which was converted to equity in 1996. 8 Summary Selected Financial Data of CEC The following table summarizes financial data for CEC's business. The data is derived from the financial statements of CEC included elsewhere in this prospectus which were prepared in accordance with Canadian generally accepted accounting principles. In addition to this information, please read the financial statements of CEC starting on page F-27 and "Information About CEC-- CEC Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 42.
As of or for the Nine Months Ended August As of or for the 31, Year Ended November 30, ---------------- ------------------------------------------- 1999 1998 1998 1997 1996 1995 1994 ------- ------- ------- ------- ------- ------- ------- (in Canadian dollars) (In thousands) Operating Data: Revenues.............. $ 3,463 $ 2,364 $ 3,253 $ 3,309 $ 3,212 $ 3,794 $ 3,673 Net income (loss)..... (188) 268 240 605 526 870 1,033 Cash Flow Data: Cash provided by operating activities ..................... $ 1,389 $ 1,218 $ 1,366 $ 1,724 $ 1,656 $ 1,933 $ 2,145 Cash used in investing activities .......... (7,751) (489) (564) (1,265) (2,333) (2,064) (1,989) Cash provided by (used in) financing activities........... 4,696 (79) (209) (98) 604 -- -- Balance Sheet Data: Total assets.......... $15,981 $11,444 $11,235 $11,378 $10,166 $ 8,729 $ 7,852 Working capital....... 182 2,039 2,120 1,149 981 937 684 Long term debt........ 4,850 -- -- -- -- -- -- Stockholders' equity.. 8,380 8,880 8,722 8,691 $ 8,184 $ 7,054 $ 6,184
Summary Pro Forma Consolidated Condensed Financial Information The following is summary pro forma consolidated financial information of Carbon and is derived from the historical financial statements of BFC and CEC. This information assumes that the acquisition of BFC and the exchange offer of Carbon shares for CEC shares were consummated at the beginning of relevant periods. This information should be read in connection with the financial statements of Carbon and CEC, beginning on page F-1 of this prospectus and the unaudited pro forma consolidated financial information beginning on page 37 of this prospectus.
As of or for the As of or for the Year Ended Six Months Ended December 31, 1998 June 30, 1999 ----------------- ---------------- (In thousands) Operating Data: Revenues............................. $24,332 $16,273 Net loss............................. (928) (449) Balance Sheet Data: Total assets......................... $47,917 Working capital...................... 2,251 Long term debt....................... 11,106 Stockholders' equity................. 31,348
9 Comparative Per Share Data The table below sets forth, for the periods indicated, the following: . the pro forma basic and diluted net income (loss) and book value per share of Carbon common stock after giving effect to the closing of the exchange offer and assuming all shareholders of CEC accept our offer; and . the historical basic and diluted net income (loss) and book value per share of CEC common stock which is the same as the equivalent pro forma per share data because the exchange offer is on a one-to-one basis. Neither we nor CEC have declared or paid any cash dividends on our common stock. We currently expect to retain any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. The information presented in this table should be read in conjunction with the pro forma consolidated condensed financial information and the separate financial statements of Carbon and CEC included elsewhere in this prospectus.
As of or for the As of or for the six months year ended ended June 30, 1999(1) December 31, 1998(2) ---------------------- -------------------- Unaudited Carbon pro forma data: Net income (loss) per common share--basic.................... $(.07) $(.15) Net income (loss) per common share--diluted.................. $(.07) $(.15) Cash dividends paid per common share........................... -- -- Book value per common share...... $5.19 $5.18
- -------- (1) Net income (loss) per common share data assumes that the acquisition of BFC was consummated on January 1, 1999 and the exchange offer of Carbon shares for CEC shares was consummated on December 1, 1998. The book value per common share data assumes that the acquisition of BFC was consummated on June 30, 1999 and the exchange offer of Carbon shares for CEC shares was consummated on May 31, 1999. (2) Net income (loss) per common share data assumes that the acquisition of BFC was consummated on January 1, 1998 and the exchange offer of Carbon shares for CEC shares was consummated on December 1, 1997. The book value per common share data assumes that the acquisition of BFC was consummated on December 31, 1998 and the exchange offer of Carbon shares for CEC shares was consummated on November 30, 1998.
As of or for the As of or for the six months year ended ended May 31, 1999 November 30, 1998 ------------------ ----------------- CEC historical equivalent pro forma data (translated to US$): Net income (loss) per common share-- basic................................. $(.10) $ .11 Net income (loss) per common share-- diluted............................... $(.10) $ .11 Cash dividends paid per common share... -- -- Book value per common share............ $ 3.71 $3.71
10 CEC Per Share Market Information The common stock of CEC has traded on the American Stock Exchange regular list since July 6, 1995. The common stock initially began trading on the American Stock Exchange Emerging Companies Marketplace on March 24, 1995 about one month after it was divested by Columbus Energy Corp. to its shareholders by a rights offering. The reported high and low sales prices in U.S. dollars for the periods ending below were as follows:
High Low ------- ------- 1999: First quarter.......................................... $4.7500 $4.1250 Second quarter......................................... 4.8125 4.1250 Third quarter.......................................... 5.1250 4.1250 Fourth quarter (through October , 1999) 1998: First quarter.......................................... $6.2500 $4.8750 Second quarter......................................... 5.1250 4.8750 Third quarter.......................................... 5.6250 4.8750 Fourth quarter......................................... 5.6875 4.2500 1997: First quarter.......................................... $5.8750 $4.7500 Second quarter......................................... 5.2500 4.5000 Third quarter.......................................... 5.1875 4.8750 Fourth quarter......................................... 7.2500 4.8750
As of August 11, 1999, the day prior to announcement of the proposed acquisition of BFC stock under the BFC stock purchase agreement, the closing sales price of CEC common stock was $4.375. As of , 1999 the most recently reported closing sales price of CEC common stock was $ per share. As of August 31, 1999, there were approximately 57 holders of record of CEC common stock and an estimated 430 or more beneficial owners who hold their shares in brokerage accounts. 11 RISK FACTORS You should carefully consider the following risk factors and all other information contained in this prospectus before you decide to accept or reject the exchange offer. The risks and uncertainties we describe below are not the only risks we face. You should consider all of these risk factors along with the other information contained in the documents to which we have referred you. If any of the adverse events described in the following risk factors actually occur or we do not accomplish necessary events described in the risk factors, our business, financial condition and operating results could be materially and adversely affected, the trading price of our common stock could decline and you could lose all or part of your investment. There are a number of risks associated with the purchase of BFC and the exchange offer: We may not be able to successfully integrate BFC and CEC. Carbon acquired BFC in October, 1999. The integration and consolidation of the assets and operations of Carbon, BFC and CEC after the exchange offer will present significant management challenges for Carbon. Carbon cannot assure you that it will be able to successfully integrate the Carbon, BFC and CEC business operations or that the combined company will realize any of the anticipated benefits of the transactions. You or Carbon could incur United States income taxes. As described in the section of this prospectus entitled "United States Federal Income Tax Consequences," no ruling will be requested from the IRS regarding the United States income tax aspects of the exchange. Although Holland and Hart LLP, tax counsel for Carbon, has rendered the opinion set forth in the section of this prospectus entitled "United States Federal Income Tax Consequences," the opinion is limited in scope, is subject to a number of qualifications, limitations and conditions and is subject to the accuracy of certain factual representations made by Carbon. As discussed in "United States Federal Income Tax Consequences," holders of more than 80% of CEC shares must participate in the exchange in order for the exchange to constitute a tax-free B reorganization. If holders of less than 80% of the CEC shares accept the exchange offer, tax-free treatment is less certain, although it will still be likely that the exchange will qualify as a tax-free transaction. Moreover, an opinion of counsel is not binding on the IRS, and the IRS may successfully take a position contrary to tax counsel's opinion. For these reasons, each CEC shareholder participating in the exchange is urged and expected to consult with and rely on its tax advisor regarding the exchange. Shareholders of CEC who reside in Canada may incur Canadian income taxes by accepting the exchange offer. Canadian holders of CEC common stock will not benefit from tax-free treatment for Canadian federal income tax purposes and will have to recognize a gain or loss equal to the difference between the fair market value of the Carbon common stock and the aggregate of the adjusted cost base of the CEC common stock and any reasonable costs of disposition. The tax considerations to you resulting from your individual position and the exchange may be complex. You should read carefully the discussion under "Canadian Federal Income Tax Consequences" and consult with your own advisors as to the Canadian federal, provincial or territorial tax consequences. Yorktown is Carbon's controlling stockholder. After the exchange offer, Yorktown will own 74% of Carbon's common stock or more if some of CEC's shareholders do not accept the exchange offer. Accordingly, Yorktown will be able to determine virtually all matters submitted for shareholder approval. The nomination and election of Carbon's directors are subject to the terms of the exchange and financing agreement among Carbon, CEC and Yorktown. Upon termination of the 12 provisions of the exchange and financing agreement relating to the nomination and election of directors, Yorktown will be able to control the election of directors and to determine the corporate and management policies of Carbon. See "The Exchange Offer--Description of Exchange Agreement." No prior market for Carbon shares exists, and the market price for Carbon shares may decrease after the exchange offer. Prior to the exchange offer, there has been no public market for our shares. CEC shares have been traded on the AMEX, but the market was very thin and little trading occurred. There can be no assurance that an active trading market for our common stock will develop or be sustained. There is also uncertainty as to the prices at which our shares will trade. The possibility exists that the trading price for our shares may be lower than the prior market prices for CEC shares. Also, the price of CEC shares may decrease after the exchange offer if holders with a relatively large number of shares decide to sell the shares immediately or shortly after the exchange offer. CEC shareholders will not have a readily available market for CEC shares after the exchange offer. We anticipate that most CEC shareholders will tender their shares in exchange for Carbon shares. We therefore contemplate that CEC shares will be delisted from the AMEX and may not be traded or quoted on any public market. We depend heavily on our key personnel. We depend to a substantial extent on the expertise and services of our senior management personnel and upon the expertise and services of Patrick R. McDonald, who is our President and Chief Executive Officer and one of our directors. The loss of Mr. McDonald's or of any of our other senior management personnel's services could have a material adverse effect on us. We do not maintain key-man life insurance on any of our personnel. We may be unable to obtain additional financing. Due to our plans for active acquisition, development and exploration programs, we expect to experience substantial capital needs. We expect to be able to finance our planned acquisition, development and exploration programs for the next twelve months from cash generated by our operations and from bank financing. We cannot assure you as to the availability or terms of any additional financing that may be required or whether financing will continue to be available under existing or new credit facilities. If sufficient capital resources are not available to Carbon, its drilling and other activities may be curtailed. There are a number of risks related to our business: Risks relating to the acquisition of oil and gas properties may affect our future success. CEC has made several recent acquisitions, and Carbon plans to engage in future acquisitions of oil and gas properties. The successful acquisition of producing properties requires an assessment of recoverable reserves, future oil and gas prices, operating costs, potential environmental and other liabilities and other factors. Such assessments are necessarily inexact and their accuracy inherently uncertain. In connection with such an assessment, we perform a review of the subject properties that we believe to be generally consistent with industry practices. This usually includes on-site inspections and the review of reports filed with various regulatory entities. Such a review, however, will not reveal all existing or potential problems, nor will it permit a buyer to become sufficiently familiar with the properties to fully assess their deficiencies and capabilities. Inspections may not always be performed on every well, and geological, mechanical and environmental problems are not necessarily observable even when an inspection is undertaken. Although we perform a review of acquired properties that we believe is consistent with industry practices, existing or potential environmental problems with properties may not be discovered until after an acquisition has been completed. Even when problems are identified, the seller 13 maybe unwilling or unable to provide effective contractual protection against all or part of these problems. We cannot assure you that any of our acquisitions of property interests will be successful and, if an acquisition is unsuccessful, that the failure will not have an adverse effect on our future results of operations and financial condition. Carbon's technology systems may not be ready for the Year 2000. Carbon has not completed a comprehensive analysis of the operational problems and costs that would be reasonably likely to result from any failure of the technology systems of Carbon or of other third parties with which Carbon has significant relationships to be Year 2000 compliant by January 1, 2000. Carbon has made inquiries of the suppliers and manufacturers of its computer systems, including equipment supplied by third parties, and it has been advised that these systems are Year 2000 compliant except in the case of its property management software, which is currently under review regarding Year 2000 compliance. We cannot assure you that the Year 2000 issue will not have a material adverse effect on Carbon's financial condition, results of operations or cash flows. Examination of titles is limited prior to drilling. Carbon and CEC hold title to their properties pursuant to leases from third parties or, in the case of CEC, the Crown. We believe that Carbon and CEC have satisfactory title to their properties. Oil and gas interests are subject to customary interests and burdens, including overriding royalties and operating agreements. Their properties may also be subject to liens incident to operating agreements, as well as minor encumbrances, easements and restrictions. As is customary in the oil and gas industry, Carbon and CEC do not regularly investigate title to oil and gas leases acquired as undeveloped acreage. Rather, Carbon and CEC typically examine title before any drilling or development is undertaken. Our management believes the methods of title examination Carbon and CEC have adopted are reasonably calculated to insure that production from our properties, if obtained, will be readily salable for our account. Our management is not aware of any material pending or threatened claims affecting title to Carbon's or CEC's proved acreage. Carbon's and CEC's producing and non-producing properties are subject to customary royalty interests, liens for current taxes, and other burdens, none of which, in our management's opinion, materially interferes with the use of or adversely affects the value of such properties. Operating hazards are inherent in the oil and gas industry. The oil and gas business involves a variety of operating risks including the following risks: . fire; . explosion; . blow-out; . pipe failure; . casing collapse; . abnormally pressured formations; and . environmental hazards such as oil spills, gas leaks, ruptures and discharge of toxic substances. If any of these events were to occur, we could incur substantial losses due to: . injury and loss of life; . severe damage to and destruction of property, natural resources and equipment; . pollution and other environmental damage; . clean-up responsibilities; 14 . regulatory investigation and penalties; and . suspension of operations. We maintain insurance against some, but not all, potential risks; however, there can be no assurance that any insurance we obtain will be adequate to cover all losses or exposure for liability. Furthermore, we cannot predict whether insurance will continue to be available at premium levels that justify its purchase. Generally, we have elected not to obtain blow-out insurance when drilling a well because we have not operated in areas with abnormally high pressures or with known severe lost circulation problems. We may not be able to replace existing oil and gas reserves with new oil and gas reserves. In general, the rate of production from oil and natural gas properties decline as reserves are depleted. The rate of decline depends on reservoir characteristics. Except to the extent that we conduct successful exploration and development activities or acquire properties containing proved reserves, or both, our proved reserves will decline as reserves are produced. Our future oil and natural gas production is highly dependent upon our ability to economically find, develop or acquire reserves in commercial quantities. The business of exploring for or developing reserves is capital intensive. To the extent cash flow from operations is reduced and external sources of capital become limited or unavailable, our ability to make the necessary capital investment to maintain or expand our asset base of oil and natural gas reserves would be impaired. In addition, there can be no assurance that our future exploration and development activities will result in additional proved reserves or that we will be able to drill economical and productive wells. Furthermore, although our revenues could increase if prevailing prices for oil and natural gas increase significantly, our finding and development costs could increase. We face strong competition in the oil and gas industry. We operate in the highly competitive area of oil and natural gas exploration, acquisition and production. In seeking to acquire desirable producing properties or new leases for future exploration and in marketing our oil and natural gas production, as well as in seeking to acquire the equipment and expertise necessary to operate and develop those properties, we face intense competition from a large number of independent, technology-driven companies as well as both major and other independent oil and natural gas companies. Many of these competitors have financial and other resources substantially in excess of those available to us. Competitors may be able to pay more for exploratory prospects and productive oil and natural gas properties and may be able to define, evaluate, bid for and purchase a greater number of properties and prospects than our financial or human resources permit. Governmental regulation and environmental matters generally affect our business. Oil and natural gas operations are subject to various federal, state and local government laws and regulations, which may be changed from time to time in response to economic or political conditions. Matters subject to regulation include discharge permits for drilling operations, drilling bonds, reports concerning operations, spacing of wells, utilization and pooling of properties, environmental protection and taxation. From time to time, regulatory agencies have imposed price controls and limitations on production by restricting the rate of flow of oil and natural gas wells below actual production capacity in order to conserve supplies of oil and natural gas. We are also subject to changing and extensive tax laws, the effects of which cannot be predicted. The development, production, handling, storage, transportation and disposal of oil and natural gas, by-products thereof and other substances and materials produced or used in connection with oil and natural gas operations are subject to laws and regulations primarily relating to protection of human health and the environment. The discharge of oil, natural gas or pollutants into the air, soil or water may give rise to significant liabilities on our part to governments and third parties and may result in the assessment of civil or criminal penalties or require us to incur substantial costs of remediation. Legal requirements frequently are changed and subject to interpretation. We are unable to predict the ultimate cost of compliance with these requirements or the effect of these requirements on our operations. Existing laws or regulations, as currently interpreted or reinterpreted in the future, or future laws or regulations could materially adversely affect our business, results of operations and its financial condition. 15 When CEC becomes a subsidiary of Carbon, our Canadian operations will be subject to Canadian government and environmental regulations. The petroleum and natural gas industry operates in Canada under federal and provincial legislation and regulations governing land tenure, royalties, production rates, environmental protection, exports and other matters. Canadian federal authorities do not regulate the price of oil and gas in export trade, but instead rely on market forces to establish these prices. The quantities of oil and gas which may be removed from the provinces or exported from Canada is governed by legislation. Producers pay provincial royalties for production from Crown leases and freehold royalties on freehold leases. Provincial royalties are subject to a sliding scale which fluctuates with changes in productivity and prices. The sliding scale formula is designed to retain funds in the oil and gas industry when commodity prices are low, with increases in the royalty rates in times of high commodity prices when the industry's need for royalty rate relief is not as great. The Alberta government requires that gas royalties be paid on the basis of the Gas Reference Price (determined monthly on the basis of a weighted average field price) or on the basis of the producer's Corporate Average Price. This requirement discourages natural gas price discounting. CEC elected to use the Gas Reference Price, which Carbon will continue to use. The Alberta government permits gas gathering and processing costs (based on corporate average capital costs and deemed operating costs) to be deducted in computing the Crown royalty. Effective January 1, 1990, the Alberta government revised the Alberta Royalty Tax Credit formula to a sliding scale, based on oil and gas prices. In Alberta, certain, smaller, producers of oil or natural gas are entitled to a credit against the royalties payable to the Crown by virtue of the ARTC (Alberta Royalty Tax Credit) program. The ARTC program is based on a price- sensitive formula, and the ARTC rate varies between 75 percent and 25 percent, depending on commodity prices. The ARTC rate is applied to a maximum of $2,000,000 of Alberta Crown royalties payable. Crown royalties on production from producing properties acquired from corporations claiming maximum entitlement to ARTC will generally not be eligible for ARTC. The ARTC rate is established quarterly based on the average "par price," as determined by the Alberta Department of Energy for the previous quarterly period. On December 22, 1997, the Government of Alberta gave notice that they intended to review the ARTC program with expected changes to take effect prior to 2001. Although industry consultation has not yet occurred, among the major proposed changes will be a 10 year limitation on the ability to claim ARTC entitlements from production from any applicable well. The oil and gas industry is also subject to environmental regulation pursuant to legislation of the Canadian federal and provincial governments. Environmental legislation provides for restrictions and prohibitions on releases or emissions of various substances produced in association with certain oil and gas industry operations and can affect the location of wells and facilities and the extent to which exploration and development is permitted. In addition, legislation requires that well and facility sites and access be abandoned and reclaimed to the satisfaction of provincial authorities. A breach of any of these regulations may result in the imposition of fines and penalties, the suspension of operations and potential civil liability. The Environmental Protection and Enhancement Act imposes environmental standards and requires compliance with various legislative criteria (including reporting and monitoring) in Alberta. The Alberta Energy and Utilities Board, pursuant to its governing legislation, also plays a role with respect to the regulation of environmental impacts of oil and gas activities. We believe that CEC is in compliance with applicable environmental laws and regulations, and that the environmental regulations as presently in effect will not have a material effect upon our capital expenditures, or our competitive position in the industry. Consequently, we do not anticipate the need for any material capital expenditures for environmental control facilities for the current year. We believe that it is reasonably likely that the trend in environmental legislation and regulation will continue toward stricter standards. No assurance can be given as to the future capital expenditures which may be required for compliance with environmental regulations which come into force in the future. Uncertainty of estimates of oil and gas reserves. Estimates of our proved oil and gas reserves and the estimated future net revenues from them are based upon our own estimates or on third party reserve reports that rely upon various assumptions, including assumptions about oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The process of estimating oil and natural gas reserves is complex, requiring significant 16 decisions and assumptions in the evaluation of available geological, geophysical, engineering and economic data for each reservoir. As a result, estimates are inherently imprecise. Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves may vary substantially from our estimates or from estimates reflected in the reserve reports of third parties. Any significant variance in these assumptions could materially affect the estimated quantity and value of reserves. Our properties also may be susceptible to hydrocarbon drainage from production by other operators on adjacent properties. In addition, our proved reserves may be subject to downward or upward revision based upon production history, results of future exploration and development, prevailing oil and natural gas prices, mechanical difficulties, government regulation and other factors, many of which are beyond our control. Actual production, revenues, taxes, development expenditures and operating expenses with respect to our reserves likely will vary from the estimates used, and such variances may be material. The value of future net revenues as reflected in this prospectus, based on the SEC's required assumptions, should not be construed as the current market value of the estimated oil and natural gas reserves attributable to our properties. The estimated discounted future net cash flows from proved reserves generally are based on prices and costs as of the date of the estimate, whereas actual future prices and costs may be materially higher or lower. Actual future net cash flows also will be affected by increases in consumption by oil and natural gas purchasers and changes in governmental regulations or taxation. The timing of actual future net cash flows from proved reserves, and thus their actual present value, will be affected by the timing of both production and expenditures in connection with the development and production of oil and natural gas properties. Our production may not be marketable. The marketability of our production depends in part upon the availability, proximity and capacity of natural gas gathering systems, pipelines and processing facilities. We deliver nearly 100% of the natural gas we produce through gas gathering systems and gas pipelines that we do not own. Federal and state regulation of oil and natural gas production and transportation, tax and energy policies, changes in supply and demand and general economic conditions all could adversely affect our ability to produce and market our oil and natural gas. Any dramatic change in market factors could have a material adverse effect on our business, financial condition and results of operations. Our success might be adversely affected by the volatility of oil and gas prices. Our revenues, profitability, future growth and ability to borrow funds or obtain additional capital, as well as the carrying value of our properties, will be substantially dependent upon prevailing prices of oil and gas. Historically, the markets for oil and gas have been volatile, and they are likely to continue to be volatile in the future. Prices for oil and gas may fluctuate widely in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty and a variety of additional factors that are beyond our control. It is impossible to predict future oil and gas price movements with certainty. Declines in oil and gas prices may materially adversely affect our financial condition, liquidity, ability to finance planned capital expenditures and results of operations. Lower oil and gas prices also may reduce the amount of oil and gas that we can produce economically. Oil and gas price hedging and financial hedging arrangements may expose Carbon to financial loss in some circumstances. In order to reduce our exposure to short-term fluctuations in the prices of oil and gas, we periodically have entered into hedging arrangements. The hedging arrangements apply to only a portion of our production and provide only partial price protection against declines in oil and gas prices. These hedging arrangements will 17 remain in place following the transactions and may expose us to risk of financial loss in some circumstances, including instances where production is less than expected or where the other party to any hedging arrangement fails to perform. In addition, the hedging arrangements may limit the benefit to Carbon of increases in the prices of oil or gas. There are numerous risks relating to drilling activities. Our success will be materially dependent upon the continued success of our drilling program. Oil and gas drilling involves numerous risks, including the risk that no commercially productive oil or gas reservoirs will be encountered. The cost of drilling, completing and operating wells is often uncertain, and drilling operations may be curtailed, delayed or canceled as a result of a variety of factors, including: . unexpected drilling conditions, . pressure or irregularities in formations, . equipment failures or accidents, . adverse weather conditions, . compliance with governmental requirements, and . shortages or delays in the availability of drilling rigs and the delivery of equipment. Our future drilling activities may not be successful and, if drilling activities are unsuccessful, such failure will have an adverse effect on our future results of operations and financial condition. Although we have identified numerous drilling prospects, we cannot assure you that those prospects will be drilled or that oil or gas will be produced from them. Technological changes in the industry could reduce our competitiveness. The oil and gas industry experiences rapid and significant technological advancements and introduction of new products and services using new technologies. As others use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at substantial costs. In addition, our competitors may have greater financial, technical and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies sooner than us. There can be no assurance that we will be able to respond to such competitive pressures and implement such technologies on a timely basis or at an acceptable cost. One or more of the technologies we currently utilize may become obsolete in the future. In such cases, our business, financial condition and results of operations could be materially adversely affected. If we are unable to use the most advanced commercially available technology, our business, financial condition and results of operations could be materially and adversely affected. SOURCES OF INFORMATION ABOUT CARBON AND CEC Our business now consists only of BFC's business. Because BFC was acquired in October, 1999, much of the information in this prospectus with respect to BFC is derived from data and records prepared or developed under the prior management of BFC. The current management of Carbon cannot be certain about the accuracy of all such information. Information and data in this prospectus with respect to CEC has been developed or derived from CEC data and records. FORWARD-LOOKING STATEMENTS This prospectus contains certain forward-looking statements that involve risks and uncertainties. These statements relate to our future plans, objectives, expectations and intentions. These statements may be identified by the use of words such as "believes," "expects," "estimates," "anticipates," "intends," "plans" and similar expressions. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of various factors, including all the risks discussed in "Risk Factors" and elsewhere in this prospectus. 18 THE EXCHANGE OFFER General We are offering to exchange one share of our common stock for each share of CEC common stock. If all CEC shareholders accept our offer, in the aggregate we will issue approximately 1,521,400 shares of our common stock. Our common stock has been approved for listing on the AMEX, upon issuance of the shares after the exchange offer, under the symbol " ." CEC's Board of Directors has approved this exchange offer. The exchange offer is open to all holders of CEC common stock. We are sending this prospectus and related exchange offer documents to persons who held CEC common stock at the close of business on , 1999. On that date, there were shares of CEC common stock outstanding, which were held of record by approximately shareholders. We will also furnish this prospectus and related exchange offer documents to brokers, banks and similar persons whose names or the names of whose nominees appear on CEC's shareholder list or, if applicable, who are listed as participants in a clearing agency's security position listing for subsequent transmittal to beneficial owners of CEC common stock. Background Of The Exchange Offer/Exchange Agreement The information in this section regarding the deliberations of CEC's Board of Directors and the actions of CEC's management and legal and financial advisors is based on information furnished by CEC. As part of a strategy of increasing its natural gas and oil reserves through acquisitions and exploration and development, CEC has evaluated property and corporate acquisition opportunities in Alberta, Canada and the Rocky Mountain region of the United States. CEC believes there are attractive opportunities available for acquisitions and exploration and production in both the United States and Canada as a result of improving oil and gas prices, lower exploration and production costs, the divestiture of non-core properties in the industry generally and consolidation within the oil and gas industry. CEC's position as a small independent public oil and gas company limits its potential for growth unless steps are taken to increase its size and the value of its oil and gas reserves. In July, 1998, Patrick R. McDonald purchased shares of CEC and became President, Chief Executive Officer and a member of the Board of Directors. Mr. McDonald hired a team of professional oil and gas managers and began to develop CEC's Canadian natural gas properties through the acquisition of additional interests in the Carbon Gas Field in Alberta, Canada. Since July, 1998, CEC has completed five transactions resulting in an increase in CEC's proved natural gas and oil reserves in Canada. CEC's growth strategy included the acquisition and exploration and development of oil and gas properties in the United States. During 1998 and 1999, CEC management reviewed and evaluated oil and gas acquisition opportunities in the Rocky Mountain region of the United States. In early May, 1999, CEC learned that BPC planned to sell the stock of its Denver based 100% owned subsidiary, BFC. On May 10, 1999, CEC executed a confidentiality letter and received information relating to the oil and gas wells and reserves owned by BFC. In accordance with the schedule established by BPC, CEC submitted an initial non-binding expression of interest in purchasing BFC for a total of $24,500,000 in cash, plus net debt remaining at BFC equal to approximately $6,500,000. BPC advised CEC that several other parties had also submitted offers and that BFC would conduct a sale process designed to result in a transaction with the most preferred buyer. Contemporaneously, the management of Yorktown was also apprised of CEC's interest in BFC and was asked to consider providing the financing for the transaction. The Board of CEC was advised of and reviewed each of these actions. On May 21, 1999, CEC was notified that it should conduct additional due diligence and on May 27 and 28, 1999, CEC met with management of BFC and reviewed the business and operations of BFC. 19 On June 9, 1999, based on the results of due diligence, CEC advised BPC that, if BPC would negotiate on an exclusive basis, CEC would be willing to discuss a transaction to acquire BFC in the range of $28,500,000 in cash plus $6,500,000 in net debt remaining with BFC. Based on discussions with Yorktown, the offer was not subject to a financing contingency. BPC informed CEC that it would not accept CEC's offer to negotiate exclusively and requested that CEC continue to participate in the sale process. On June 18, 1999, BPC advised CEC that a final offer for BFC would be due June 28, 1999. On June 28, 1999, CEC submitted an offer to BPC in the amount of $20,000,000 in cash for the assets of BFC plus the assumption of $6,500,000 in net debt outstanding at March 31, 1999. CEC was informed in early July that BPC had elected to negotiate a stock purchase agreement with another party. In mid July, CEC inquired as to whether BPC's position had changed and whether BPC would be willing to discuss further CEC's June 28, 1999 offer. BPC indicated that it would consider that offer if CEC would submit for review comments on the form of the stock purchase agreement prepared by BPC and increase the price it was willing to pay for BFC. On July 22, 1999, the Board of Directors of CEC met at a regularly scheduled Board meeting. Among items discussed was the status of the BFC transaction, the status of the financing for the transaction to be provided by Yorktown and the reasons for CEC's interest in an acquisition of BFC. CEC's Board directed Mr. McDonald to continue discussions with BPC and Yorktown and to report back to the Board as to the results of those discussions. On July 27, 1999, CEC submitted comments on the form of the stock purchase agreement to BPC for review. During the period July 28 to July 30, BPC and CEC conducted additional negotiations relating to the terms of the proposed stock purchase agreement and the price to be paid for the stock of BFC. BPC advised that CEC's June 28 offer would not be sufficient to ensure the purchase of BFC. Based on discussions with the Board of CEC and Yorktown, on July 30, 1999 CEC agreed to increase its offer for BFC to $24,000,000 in cash for the stock of BFC plus $6,500,000 of net debt remaining with BFC. On July 31, 1999, CEC and BPC executed a Letter of Intent proposing to accept CEC's offer to purchase BFC and agreeing to negotiate a definitive stock purchase agreement. On August 11, 1999, CEC conducted a special Board of Directors meeting during which the status of the BFC transaction and the Yorktown financing was discussed and the purchase of BFC was approved. The Board of CEC reviewed the position of CEC within the oil and gas industry, its growth prospects in the United States and Canada, the present valuation of CEC as a small independent oil and gas company and its access to future capital to provide growth. The Board discussed the terms of the BFC stock purchase agreement, including the price, the representation and warranties of BPC, the requirement for additional due diligence and obligations of CEC. The Board also considered the financing as proposed generally by Yorktown, the valuation of CEC and other factors described in "--CEC's Reasons For Recommending The Exchange Offer." As indicated above, the Board reviewed the valuation of CEC and BFC by Yorktown based on what would be the economic equivalent of paying $5.50 per share of CEC. The Board believed that this price was fair and consistent with valuation of independent oil and gas companies of similar size based on the experience of the Board, the current market price for the stock of CEC and by various industry measures of value including discounted cash flow and multiple cash flow methods. The structure of the proposed transaction with BFC and Yorktown was reviewed and approved by the Board of CEC. Yorktown required that its investment be in a United States corporation. Because CEC would face unfavorable tax consequences if it became a U.S. corporation, it was decided to form Carbon as a Colorado corporation. With commitment for a financing and an understanding that an exchange offer by the new United States corporation controlled by Yorktown would be made for shares of CEC common stock; on August 11, 1999, CEC and BPC signed the BFC stock purchase agreement. CEC issued a press release on August 12, 1999, announcing execution of that agreement, describing the terms of the financing to be provided by Yorktown and describing the overall structures of the transactions. 20 On October 14, 1999, Carbon, CEC and Yorktown signed the exchange and financing agreement ("Exchange Agreement"). Under the Exchange Agreement, Yorktown agreed to acquire 4,500,000 shares of Carbon common stock at a purchase price of $24,750,000 in cash, which is $5.50 per share. Carbon agreed to use the proceeds for the purchase of BFC shares under the BFC stock purchase agreement and to add any remaining proceeds to the working capital of Carbon. CEC agreed to assign to Carbon its rights and obligations under the BFC stock purchase agreement for BFC stock, and Carbon agreed to assume the obligations and terms of CEC under the BFC stock purchase agreement. Also, Carbon, CEC and Yorktown agreed that Carbon would make an offer to all holders of shares of CEC to exchange one share of common stock of Carbon for each outstanding share of CEC, subject only to a few conditions. CEC and its Board of Directors approved this exchange offer. The Exchange Agreement also provided for the adoption of a stock option and restricted stock plan of Carbon, employment agreements with Mr. McDonald and Kevin D. Struzeski, Carbon's Treasurer and Chief Financial Officer. The Exchange Agreement further contained provisions regarding the composition of Board of Directors of Carbon. These provisions are described under "--Description of Exchange Agreement" below. On October , 1999, CEC assigned the BFC stock purchase agreement to Carbon. On October 29, 1999, Carbon completed the purchase of BFC for $ in cash. CEC's Reasons For Recommending The Exchange Offer CEC's Board of Directors believe that the terms of the exchange offer are fair to and in the best interests of CEC and its shareholders. In reaching its conclusion to approve the BFC stock purchase agreement, the exchange and financing agreement and the exchange offer, CEC's Board consulted with management, as well as its legal advisors, and considered the following factors: . The acquisition of BFC and the exchange offer would result in Carbon being led by a highly regarded management team with a strong track record in the oil and gas industry. . The structure of the transaction with CEC's current shareholders having the opportunity to participate in the future value of both BFC and CEC as part of Carbon by accepting the exchange offer. . Reasons for the acquisition of BFC, including potential growth, the nature of BFC's properties and cost savings that may be realized in the operation of BFC by Carbon. . The terms of the BFC stock purchase agreement, including the parties' representations, warranties and covenants and the conditions to their respective obligations. . United States and Canadian tax consequences of the transaction. . The requirement of Yorktown that its equity financing be made through a United States corporation. . The valuation of CEC involved in the equity financing made by Yorktown; alternatives to Yorktown's proposal that had been considered or sought in the past; a previous search by CEC for a buyer, which was conducted prior to Patrick R. McDonald's becoming a significant shareholder, and resulted in no offers. . Valuation methods applicable to CEC, including discounted cash flow, multiple of cash flow and public stock market values. . Current financial market conditions and historical market prices, volatility and trading information with respect to CEC's common stock. . The likelihood of continuing consolidation in the energy industry and increased competition from larger, well-financed companies. . The reports from CEC's management as to the results of its due diligence investigation of BFC and its business. 21 The foregoing discussion of the information and factors considered by CEC's Board of Directors is not intended to be exhaustive but is believed to include all material factors considered by CEC's Board. In reaching its determination to approve the stock purchase agreement, the exchange and financing agreement and the exchange offer, the CEC Board concluded that the potential benefits of the purchase of BFC stock and exchange offer outweighed the potential risks, but did not, in view of the wide variety of information and factors considered, assign any relative or specific weights to the foregoing factors, and individual directors may have given differing weights to different factors. Although directors, executive officers and other personnel of CEC have interests in the exchange offer, as described under "Interests of Certain Persons in the Exchange Offer," CEC's Board did not consider the potential benefits to be received by these individuals as a factor in reaching its decision to approve the BFC stock purchase agreement, the Exchange Agreement and the exchange offer. Our Reasons For The Exchange Offer As part of the Exchange Agreement in which Carbon obtained the right to purchase BFC stock from CEC, Carbon agreed to make the exchange offer. In approving the Exchange Agreement and the making of the exchange offer, Carbon's Board of Directors concluded that the purchase of the BFC stock and the acquisition of control of CEC pursuant to the exchange offer would result in Carbon being a more significant independent oil and gas company and having a management team with a strong track record in the oil and gas industry. Intentions Of The Directors And Officers Of CEC The directors and executive officers of CEC who own, in the aggregate, 580,346 shares of outstanding CEC common stock, representing approximately 38.1% of CEC's outstanding shares, have stated they intend to accept our offer. Interests Of Certain Persons In The Exchange Offer In considering whether to accept the exchange offer, you should be aware of the interests various executive officers and a director of CEC may have in the exchange offer. In this regard, you should consider, among other things, the employment agreements, stock options, restricted stock grants and bonuses described below. On , 1999, Patrick R. McDonald and Carbon entered into a three- year employment agreement, which provides for Mr. McDonald to be the President and Chief Executive Officer of Carbon at a base salary of not less than US$200,000 per year, to be adjusted on each July 1 for cost of living increases in the U.S. consumer price index. Carbon is to provide Mr. McDonald benefits that he currently receives as an executive of CEC, and is to maintain for his benefit a life insurance policy in the amount of $1 million and a disability insurance policy with terms mutually agreeable to us and Mr. McDonald. According to the employment agreement, Carbon is also to nominate and endorse Mr. McDonald as a director on Carbon's Board of Directors so long as he is an officer of Carbon. Either Carbon or Mr. McDonald may terminate the agreement if there is a change in control of Carbon. A change in control includes (1) the acquisition by a third party or a group of 50% or more of the combined voting power for election of Carbon's directors (excluding those owned by Yorktown or entities controlled by Yorktown), or (2) the acquisition of Carbon by merger after which Carbon shareholders do not own more than 2/3 of the outstanding voting securities of the surviving corporation in substantially the same proportion as they owned Carbon prior to the merger, or any sale or exchange or other disposition of all or substantially all of our assets, (3) or the sale or other disposition of more than 50% in fair market value of our assets other than in the ordinary course of business, whether in a single transaction or related transactions, or (4) there is a change in more than a majority of our Board of Directors as a result of a proxy contest waged by a third party unaffiliated with the officer who is the party to the employment agreement and not endorsed by that officer. In the event of a change in control not supported by a majority of our then-existing Board of Directors, Mr. McDonald is to be paid 400% of his compensation upon termination of the employment agreement. In the event of a change in control supported by our then-existing Board of Directors, Mr. McDonald is to be paid 300% of his compensation upon 22 termination of the employment agreement by us or 200% of his compensation upon termination of his employment by him. For this purpose, the term compensation means the average of Mr. McDonald's annual base salary and incentive compensation for the three years prior to the termination date (or such lesser period as he has been employed), taking his base salary and incentive compensation into account at their full annualized rates for any partial year or years. In addition, upon a change in control, any restrictions on outstanding incentive awards (including restricted stock and performance shares) granted to Mr. McDonald will lapse and such incentive awards will become 100% vested. Further, in the event of a change in control, any stock options and stock appreciation rights held by Mr. McDonald will become immediately exercisable and 100% vested. If Mr. McDonald's employment is terminated by us for any reason other than "cause" (as defined below) or upon the death or disability of Mr. McDonald or if Mr. McDonald terminates his employment because of a material breach of the employment agreement by Carbon or because of a change in the position of Mr. McDonald with Carbon, then Mr. McDonald is to be paid a lump sum payment equal to 300% of his compensation as defined above. Also, in that event, all his options and restricted stock become 100% vested. "Cause" means (1) repeated refusal to obey written directions of our Board or a superior officer, (2) repeated acts of substance abuse which are materially injurious to Carbon, (3) fraud or dishonesty which is materially injurious to Carbon, (4) breach of any material obligation of nondisclosure or confidentiality owed to Carbon, (5) commission of a criminal offense involving our money or property, or (6) commission of a criminal offense that constitutes a felony. If a payment to Mr. McDonald is subject to an excise tax under the Internal Revenue Code, we will pay to Mr. McDonald an additional amount to cover the excise tax on an after-tax basis. As required by his employment agreement, Carbon has granted under its 1999 stock option plan to Mr. McDonald an option to acquire 70,000 shares of our common stock at $5.50 per share. Carbon has also granted to Mr. McDonald 30,000 shares of restricted common stock under its 1999 restricted stock plan. The shares subject to the option and the restricted stock vest over three years, with one-third of the stock vested on October 14, 2000 (which is one year from the date of grant) and one-third of the stock vested on each of the second and third anniversaries of the date of grant. On , 1999, we entered into a two-year employment agreement with Mr. Struzeski, which provides for Mr. Struzeski to be the Chief Financial Officer of Carbon at a base salary of US$100,000 per year, together with all benefits offered by us to our employees generally. The employment agreement with Mr. Struzeski provides that either Carbon or Mr. Struzeski may terminate the contract if there is a change in control of Carbon. Change in control is defined in the same manner under this contract as our employment agreement with Mr. McDonald. In the event of a change in control not supported by a majority of our then-existing Board of Directors, Mr. Struzeski is to be paid 300% of his compensation upon termination of the employment agreement. In the event of a change in control supported by our then-existing Board of Directors, Mr. Struzeski is to be paid 200% of his compensation upon termination of his employment agreement by us or 100% of his compensation upon termination of his employment by him. For this purpose, compensation means the average of Mr. Struzeski's annual base salary and incentive compensation for the two years prior to the date of termination, (or, if he has been employed for less than two years, such lesser number of calendar years during any part of which he has been employed, with his base salary and incentive compensation taken into account at their full annualized rates for any partial year or years), prorated to be a monthly amount and multiplied by the remaining months of the term of his agreement (but not less than 12 months). Also, in the event of a change in control, the restrictions on any outstanding incentive awards (including restricted stock and performance shares) granted to Mr. Struzeski will lapse and such awards and all stock options and stock appreciation rights granted to him will become immediately exercisable and will become 100% vested. If Mr. Struzeski's employment is terminated by us for any reason other than "cause" (defined the same as in Mr. McDonald's employment agreement) or upon the death or disability of Mr. Struzeski or if Mr. Struzeski terminates his employment because of a change in the position of Mr. Struzeski with Carbon, Carbon is pay Mr. Struzeski an amount equal to his compensation (pro rated on a monthly basis) multiplied by the remaining months of his employment agreement. Also, in that event, all his options and restricted stock become 100% vested. 23 Carbon has also granted to Mr. Struzeski an option to acquire 25,000 shares of common stock at $5.50 per share under its 1999 stock option plan and 10,000 shares of restricted common stock under its 1999 restricted stock plan. The shares subject to the options and the restricted stock vest over three years, with one-third of the stock vested on October 14, 2000 (which is one year from the date of grant) and one-third of the stock vested on each of the second and third anniversaries of the date of grant. In recognition of Mr. McDonald's role in the purchase of BFC by Carbon and the exchange offer, the Board of Directors of CEC has determined that CEC will pay to Mr. McDonald a bonus of $200,000 Canadian (approximately $134,000 U.S.) when 50% or more of CEC shares are exchanged for Carbon shares. Similarly, other officers of CEC, including Mr. Struzeski, are to receive bonuses from CEC at the same time. Mr. Struzeski's bonus will be $ Canadian (approximately $ U.S.). Description of Exchange Agreement Under the Exchange Agreement, Yorktown agreed to acquire 4,500,000 shares of Carbon common stock at a purchase price of $24,750,000 in cash, or $5.50 per share. Carbon agreed to use these proceeds for the purchase of BFC shares under the BFC stock purchase agreement with any remaining proceeds to be added to its working capital. CEC agreed to assign to Carbon its rights and obligations under the BFC stock purchase agreement and Carbon agreed to assume those rights and obligations. Carbon, CEC and Yorktown agreed that Carbon would make the exchange offer to all CEC shareholders. CEC agreed that its Board would recommend acceptance of the exchange offer. The Exchange Agreement also provided for the adoption of our 1999 stock option plan and our 1999 restricted stock plan, and employment agreements with Mr. McDonald and Mr. Struzeski. Carbon, CEC and Yorktown agreed that the Board of Directors of Carbon would consist of five directors. Carbon, CEC and Yorktown agreed that the five directors initially would be David H. Kennedy, Lambros J. Lambros, Bryan H. Lawrence, Peter A. Leidel and Patrick R. McDonald. Upon completion of the exchange offer, if Harry A. Trueblood accepts the exchange offer for all CEC common stock owned beneficially by him, the number of Carbon directors will be six and Mr. Trueblood will be the sixth director. As long as Yorktown beneficially owns shares with 50% or more of the outstanding votes in the election of directors of Carbon, Yorktown has the right to designate for nomination two directors. If Yorktown owns beneficially shares with 25% or more but less than 50% of the outstanding votes in the election of directors of Carbon, then Yorktown has the right to designate for nomination one director. Yorktown has no right to designate directors for nomination under the Exchange Agreement if Yorktown owns beneficially shares with less than 25% of the outstanding votes in the election of directors of Carbon. So long as Mr. McDonald is an officer of Carbon, he is to be designated for nomination as a director of Carbon. Under the Exchange Agreement, a nominating committee of our Board was established. The nominating committee consists of one Yorktown designated director, Mr. McDonald so long as he is a director of Carbon, and two independent directors. The nominating committee is responsible for determining nominees for the positions of directors of Carbon or persons to be elected by the Board of Directors or shareholders of Carbon to fill any vacancy in the Board of Directors. The nominating committee is required to nominate for director each Yorktown director which Yorktown has the right to designate and has designated. The nominating committee is required to nominate Mr. McDonald if he is entitled to be nominated. The nominating committee will then nominate the remaining directors; at least two of the persons nominated will be independent directors. If the size of the Board is changed and there are not sufficient positions for the election of two independent directors after taking into account the directors designated by Yorktown and Mr. McDonald, then the nominating committee is not required to nominate two independent directors. If there is a vacancy in the position relating to a Yorktown director, the remaining Yorktown director has the right to designate any replacement to fill the vacancy. The nominating committee has the right to designate any replacement to fill any other vacancy. The Exchange Agreement requires that any change in the size or composition of the Board of Directors or the nominating committee be approved by a supermajority vote of the Board consisting of a majority of the entire Board which includes a majority of all Yorktown directors and at least one independent director. Yorktown and Mr. McDonald agreed to take such actions as shareholders of Carbon as necessary to effectuate the election of directors 24 nominated pursuant to the foregoing provisions. The provisions relating to election of directors cease to be effective on October 29, 2009 or, if earlier, when Yorktown owns beneficially shares with less than 25% of the outstanding votes in the election of directors and Mr. McDonald is no longer an officer of Carbon. We agreed to grant under our stock option plan substitute options for each option outstanding under the CEC stock option plan. Any option granted by us in substitution for an option granted under the CEC stock option plan will provide that it is being granted in full satisfaction of, and in substitution for, any and all options for CEC stock previously granted under the CEC stock option plan. The material terms and conditions will be the same as those relating to the specific options granted under the terms of CEC stock option plan. Expiration Date You have until 5:00 p.m., Denver time, on , 1999 to accept our offer, unless extended. At that time, our offer will expire. If we extend the expiration date, we will publicly announce the extension as soon as practicable after we make the extension, and in any event no later than 9:00 a.m. Denver time on the next business day after the previously scheduled expiration date. Without limiting the manner in which we may choose to make a public announcement, we will not have any obligation to publish or communicate the public announcement other than by making a release to the Dow Jones News Services. Exchange Of CEC Stock For Carbon Common Stock If you deliver a properly completed and executed letter of transmittal, which you received along with this prospectus, and stock certificates representing your shares of CEC common stock prior to the expiration date to the exchange agent at its address, then you will have accepted the exchange offer as to the number of shares reflected on the stock certificates delivered. Except as provided below, all signatures on a letter of transmittal must be guaranteed by a member firm of a registered national securities exchange or of the National Association of Securities Dealers, Inc., a commercial bank or trust company having an office or correspondent in the United States or an "eligible guarantor institution" within the meaning of Rule 17Ad-15 under the Securities Exchange Act of 1934, which is a member of one of the recognized signature guarantee programs identified in the letter of transmittal (each such institution is referred to in this prospectus as an "eligible institution"). Signatures on a letter of transmittal need not be guaranteed if: . the letter of transmittal is signed by the registered holder of the shares of the CEC common stock tendered therewith and the registered holder has not completed the box entitled "Special Exchange Instructions" on the letter of transmittal, or . the shares of the CEC common stock tendered therewith are for the account of an eligible institution. You must choose how to deliver the letter of transmittal, stock certificates and other necessary documents to the exchange agent, and you bear the risk of how you make this delivery. We recommend that you use an overnight or hand delivery service rather than a mail service. In all cases, you should allow sufficient time to assure timely delivery. You should send the letter of transmittal, stock certificates and other necessary documents to the exchange agent at the address provided in this prospectus and the letter of transmittal. If you want us to issue the Carbon common stock in a name other than the name in which your CEC stock certificates are registered, you must properly endorse or otherwise place in proper form for transfer your stock certificates so surrendered. The person requesting this exchange must pay to Carbon or the exchange agent any applicable transfer or other taxes required due to the issuance of this certificate. If your CEC certificates are registered in the name of your broker, dealer, commercial bank, trust company, or other nominee and you wish to tender your shares, you should contact the registered holder promptly and instruct the registered holder to tender on your behalf. If your stock certificates are registered in the name of the registered holder and you wish 25 to tender on your own behalf, you must, before completing and executing the letter of transmittal and delivering the letter of transmittal, stock certificates, and other necessary documents, either arrange to register your shares in your name or obtain a properly completed stock power from the registered holder. If the letter of transmittal is signed by a person other than the registered holder of any of the CEC common stock listed therein, the stock certificates reflecting ownership of this CEC common stock must be endorsed or accompanied by appropriate stock powers that authorize this person to tender the CEC common stock on behalf of the registered holder, in either case signed as the name of the registered holder or holders appears on these stock certificates. If the letter of transmittal, any stock certificates representing the CEC common stock tendered, or any stock powers are signed by trustees, executors, administrators, guardians, attorneys-in-fact, officers of a corporation or others acting in a fiduciary or representative capacity, these persons should so indicate when signing and, unless waived by us, submit with the letter of transmittal evidence satisfactory to us of their authority to so act. After the expiration date the exchange agent will send us written notice of the amount of the outstanding CEC common stock validly tendered in the exchange offer. Promptly after we receive this notice, if all the conditions to the offer are satisfied or waived, then we will exchange each validly tendered share of CEC common stock for shares of Carbon common stock at the exchange rate described above. We then will deliver by registered mail Carbon common stock representing the CEC common stock that has been tendered. All questions as to the validity, form, eligibility, acceptance and withdrawal of the tendered shares of the CEC common stock will be determined by us in our sole discretion, and our determination will be final and binding. We reserve the absolute right to reject any and all shares of the CEC common stock not properly tendered or any shares of the CEC common stock our acceptance of which would, in the opinion of our counsel, be unlawful. We reserve the absolute right to waive any irregularities or conditions of tenders as to particular shares of the CEC common stock. Unless waived by us, any defects or irregularities in connection with tenders of shares of the CEC common stock must be cured within the time we determine. Neither we, the exchange agent nor any other person shall be under any duty to give notification of defects or irregularities with respect to tenders of shares of the CEC common stock or withdrawal of shares nor shall any of them incur any liability for failure to give any notification. Tenders of shares of the CEC common stock will not be deemed to have been made until such defects or irregularities have been cured or waived. As soon as practicable following the expiration date, the exchange agent will return without cost any stock certificates representing the CEC common stock that were not properly tendered and as to which defects or irregularities have not been cured or waived to the tendering holder of these stock certificates, unless otherwise provided in the letter of transmittal. If any of the stock certificates representing your CEC common stock have been mutilated, lost, stolen or destroyed, you should contact the exchange agent at the address below for further instruction. Exchange Agent Harris Trust and Savings Bank has been appointed as exchange agent of the exchange offer. Questions and requests for assistance, requests for additional copies of this prospectus or of the letter of transmittal and requests for notice of guaranteed delivery (see below) should be directed to the exchange agent addressed as follows: By Registered or By Hand Delivery: By Overnight Delivery: Certified Mail: Harris Trust and Savings Harris Trust and Savings Harris Trust and Savings Bank Bank Bank Corporate Trust Corporate Trust P.O. Box 830 Operations Operations Chicago, IL 60606-0830 311 West Monroe Street 311 West Monroe Street 11th Floor 11th Floor Chicago, IL 60606 Chicago, IL 60606 26 Guaranteed Delivery Procedures CEC's shareholders who wish to tender their shares of the CEC common stock and whose stock certificates representing the CEC common stock are not immediately available or who cannot deliver the letter of transmittal, their stock certificates, or any other required documents to the exchange agent prior to the expiration date, may effect a tender if: . the tender is made through an eligible institution, and . prior to the expiration date, the exchange agent receives from this eligible institution a properly completed and duly executed notice of guaranteed delivery, which you received along with this prospectus, that sets forth the name and address of the holder of the CEC common stock, the certificate number or numbers of the CEC common stock, and the number of shares of the CEC common stock tendered thereby, and . states that the tender is being made thereby, and . guarantees that, within three business days after the expiration date, the letter of transmittal, the stock certificates representing the CEC common stock to be tendered in proper form for transfer, and any other necessary documents will be deposited by the eligible institution with the exchange agent, and . a properly completed and executed letter of transmittal, together with the stock certificates representing all the tendered CEC common stock in proper form for transfer, and all other necessary documents are received by the exchange agent within three business days after the expiration date. Conditions To The Exchange We will be under no obligation to accept shares of CEC common stock tendered if prior to the expiration date any court or other governmental entity shall have issued an order restraining, enjoining or otherwise prohibiting consummation of the exchange offer. Termination Of The Exchange Offer Our exchange offer, as well as the Exchange Agreement may be terminated at any time prior to the expiration date if: . the parties to the Exchange Agreement agree to the termination, or . by any party if any court or governmental authority of competent jurisdiction shall have issued a final order restraining, enjoining or otherwise prohibiting consummation of the transactions contemplated by the Exchange Agreement. If the exchange offer is terminated without our acceptance of any shares of the CEC common stock tendered, we will promptly return all shares tendered to the appropriate CEC shareholders. Withdrawal Rights You may withdraw tenders of your shares of the CEC common stock at any time before the exchange offer expires. If you change your mind again, you may retender your shares of the CEC common stock by following the exchange offer procedures again prior to the expiration of the exchange offer. For a withdrawal to be effective, a written notice of withdrawal must be received by the exchange agent at one of its addresses set forth in the section of this prospectus titled "--The Exchange Agent." The notice of withdrawal must: . specify the name of the person having tendered the shares of the CEC common stock to be withdrawn, . identify the number of shares of the CEC common stock to be withdrawn, and . specify the name in which physical share certificates representing the CEC common stock are registered, if different from that of the withdrawing holder. 27 If certificates for the CEC common stock have been delivered or otherwise identified to the exchange agent, then, before the release of such certificates, the withdrawing holder must also submit the serial numbers of the particular certificates to be withdrawn and a signed notice of withdrawal with signatures guaranteed by an eligible institution unless such holder is an eligible institution. Any shares of the CEC common stock withdrawn will be deemed not to have been validly tendered for exchange for purposes of our offer. Any shares which have been tendered for exchange but which are not exchanged for any reason will be promptly returned to the holder who tendered the shares. Properly withdrawn shares may be retendered by following one of the procedures described in this prospectus and the letter of transmittal. Except as otherwise provided above, any tender of shares of the CEC common stock made under the exchange offer is irrevocable. Fees And Expenses We will bear the expenses of soliciting tenders. The principal solicitation is being made by mail; however, additional solicitation may be made by telegraph, telephone or in person by our officers and regular employees and the officers and regular employees of our affiliates. We have not retained any dealer-manager in connection with the exchange offer and will not make any payments to brokers, dealers or others soliciting acceptances of the exchange offer. We, however, will pay the exchange agent reasonable out-of-pocket expenses in connection therewith. We will pay the cash expenses to be incurred in connection with the exchange offer, which are estimated in the aggregate to be approximately . Such expenses include registration fees, fees and expenses of the exchange agent for our offer and, accounting and legal fees and printing costs, among others. We will pay all transfer taxes, if any, applicable to the exchange of Carbon common stock for the CEC common stock in the exchange offer. If, however, a transfer tax is imposed for any reason other than the exchange of Carbon common stock for CEC common stock in the exchange offer, then the amount of any transfer taxes will be payable by the tendering shareholder. If satisfactory evidence of payment of such taxes or exemption therefrom is not submitted with the letter of transmittal, the amount of such transfer taxes will be billed directly to the CEC stockholder. Regulatory Matters We believe that the exchange offer may be made without notification being given or information being furnished to the Federal Trade Commission or the Antitrust Division of the Department of Justice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and that no waiting period requirements under the Hart-Scott-Rodino Act are applicable to our offer. Accounting Treatment For accounting purposes, neither Carbon nor CEC will recognize a gain or loss as a result of the exchange offer. The exchange offer of Carbon shares for CEC shares and the purchase of BFC by Carbon will be accounted for by Carbon as a purchase in accordance with generally accepted accounting principles. The purchase method requires that the cost of the acquisition (i.e., cash, stock and net liabilities assumed), plus deferred taxes related thereto, be allocated among the assets and liabilities acquired based upon their fair value. The purchase method, when applied to oil and gas exploration and production companies, prohibits the allocation of the purchase price to goodwill. Any resulting excess in the book value of the oil and gas properties will be written off in accordance with the ceiling test followed in the full cost method of accounting. The assets and liabilities and results of operations of CEC will be consolidated into the assets and liabilities and results of operations of Carbon after consummation of the exchange offer. 28 Possible Effects of the Exchange Offer The exchange of shares of CEC common stock in the exchange offer will reduce the number of holders of CEC common stock and the number of shares of CEC common stock that might otherwise trade publicly. Depending on the number of shares of CEC common stock exchanged, the liquidity and market value of the remaining shares of CEC common stock could be adversely affected. CEC's common stock is listed on the AMEX. Depending on the number of shares of CEC common stock exchanged pursuant to the exchange offer, the CEC common stock may no longer meet the requirements of the AMEX for continued listing. Currently, AMEX will normally consider suspending trading in shares of an issuer when any one or more of the following conditions exist: . the number of shares publicly held exclusive of holdings of officers, directors and controlling shareholders such as Yorktown (or other family or concentrated holdings) is less than 200,000; or . the total number of public shareholders is less than 300; or . the aggregate market value of shares publicly held is less than $1,000,000 Upon completion of the exchange offer, it is likely that the CEC common stock will be delisted from the AMEX. If the shares of CEC common stock are delisted from the AMEX, the market for such shares could be adversely affected. It is possible that such shares might not be traded on other public securities exchanges. The extent of any public market for the shares of CEC common stock would, however, depend upon the number of holders and/or the aggregate market value of such shares remaining at that time, the interest in maintaining a market in such shares on the part of securities firms and the possible termination of registration of CEC common stock under the Exchange Act. The trading in CEC common stock prior to the exchange offer was thin and inactive; it can be expected that there will be no public market for CEC common stock after the exchange offer. CEC's common stock is currently registered under the Exchange Act. Such registration may be terminated by CEC upon application to the SEC if the outstanding shares of CEC common stock are not listed upon a national securities exchange and if there are fewer than 300 holders of record of such shares. Termination of registration of the CEC common stock under the Exchange Act would reduce the information required to be furnished by CEC to its shareholders and to the SEC and would make certain provisions of the Exchange Act, such as the short-swing recovery provisions of Section 16(b) and the requirement of furnishing a proxy statement pursuant to Section 14(a), no longer applicable to such shares. Second Step Merger After the exchange, we may merge CEC with a wholly-owned Canadian subsidiary of Carbon. In such a merger, shareholders of CEC may receive cash, shares of our stock, other securities or a combination of some or all of the foregoing. Whether we decide to proceed with a merger depends upon a number of factors which cannot be ascertained at the present time. These factors include the number of shares which are tendered in our offer, the relative attractiveness of completing the merger compared to investing our resources in other investments, the availability of financing to fund the cash portion of the consideration required to effect the merger, and the U.S. and Canadian tax consequences of the merger. The more CEC shares tendered in the exchange offer, the more likely it is that we will effect the merger as less cash will be required to pay for the remaining shares. The merger will have no effect on CEC shareholders who accept our current exchange offer. It will affect, however, CEC shareholders who do not accept our offer. If we proceed with a merger, we may give those shareholders cash for their shares of CEC common stock. We do not intend to do a second step merger if it would result in adverse United States income tax consequences to CEC shareholders who accepted our exchange offer. We will not engage in a second step merger without informing, and receiving approval from, our tax counsel. If CEC common stock is listed on the AMEX on the record date for determining shareholders entitled to vote on the merger, no dissenters' rights will be available to CEC's shareholders in connection with the merger. In contrast, if CEC's common stock is not listed on the AMEX on such record date, CEC's shareholders will be entitled to dissenters' rights in connection with the merger. 29 UNITED STATES FEDERAL INCOME TAX CONSEQUENCES Scope and Limitation Advice. In the opinion of Holland & Hart, LLP, tax counsel to CEC, the following are the material United States federal income tax considerations arising from and relating to the exchange of CEC common stock for Carbon common stock that are generally applicable to you if you are a "U.S. Shareholder" and, in some cases, if you are a "non-U.S. Shareholder." You are a U.S. Shareholder if you are a United States citizen or resident, domestic corporation, domestic partnership, estate subject to United States federal income tax on its income regardless of source, or trust, but only if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more United States fiduciaries have the authority to control all the substantial decisions of the trust. You are a non-U.S. Shareholder if you are not a U.S. Shareholder. This discussion does not address all aspects of U.S. federal income taxation that may be relevant to you, particularly if you are subject to special treatment under United States federal income tax laws. For example, this discussion does not address the potential application of the alternative minimum tax; or the tax consequences to certain types of investors subject to special treatment under U.S. federal income tax laws, such as: banks, life insurance companies, tax-exempt organizations, broker-dealers or holders of Carbon common or CEC common stock who received such stock as compensation. In addition, this discussion does not address any aspect of state, local or foreign tax laws. This discussion is based on the Internal Revenue Code of 1986, as amended (the "Code"), existing and proposed regulations, IRS rulings and pronouncements, reports of congressional committees, judicial decisions and current administrative rulings and practice, all as of October 20, 1999, which are subject to change. Any such change could be retroactive and change the tax consequences discussed below. No advance ruling from the Internal Revenue Service with respect to these matters has been requested. The following does not address all aspects of federal income taxation that may be relevant to you in light of your individual circumstances and tax situation. You are urged and expected to consult your own tax advisors as to the particular tax consequences to you. Taxation of U.S. Shareholders. The following discussion applies to you if you are a U.S. Shareholder and: . you hold CEC common shares and/or will hold Carbon common stock as "capital assets," defined below, within the meaning of Section 1221 of the Code; . your ownership, receipt or disposition of CEC common shares and/or Carbon common stock is not attributable to a permanent establishment in a country other than the United States for purposes of an income tax treaty to which the United States is a party; and . you are not a resident of a country other than the United States for purposes of an income tax treaty to which the United States is a party. If you are a U.S. Shareholder and do not meet all of the foregoing criteria, you should consult your tax advisors regarding your particular U.S. federal income tax consequences. Basic Treatment of Exchange Transaction for U.S. Shareholders. For U.S. federal income tax purposes, the tax-free nature of the exchange of CEC common shares for Carbon common stock can be established in two separate ways. First, the exchange may, if certain requirements are satisfied, qualify as a so-called "B Reorganization" under relevant U.S. federal income tax law. A transaction generally constitutes a B Reorganization if, among other things, an acquiring corporation (Carbon) has "control" of a target corporation (CEC) immediately 30 following an exchange of the target corporation's shares for the acquiring corporation's shares, but only if stock representing "control" of the target corporation (CEC) was acquired solely for voting stock. For this purpose, "control" means at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. Assuming that Carbon acquires at least 80% of the outstanding stock of CEC solely in exchange for the stock of Carbon, and that the representations made by Carbon and CEC to tax counsel are accurate, tax counsel is of the opinion that the exchange should qualify for tax-free treatment as a B Reorganization. Even if the exchange does not satisfy the requirements for a tax-free B Reorganization, there nevertheless may be a second means of characterizing the exchange as tax-free. Specifically, if certain requirements are satisfied, it is likely that the exchange may qualify as a tax-free transaction under Section 351 of the Code. Under Section 351 of the Code, persons transferring property to a corporation in exchange for stock of the corporation generally do not recognize gain or loss on the transfer of their property to the corporation. However, this favorable treatment applies only if, among other things, immediately following the exchange, the persons transferring property to the corporation hold at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of the corporation. In addition, in order for multiple transferors to be taken into account in computing this 80% control test, the transferors must transfer property to the corporation as part of the same plan or arrangement. Although the matter is not free from doubt, tax counsel believes that Yorktown's contribution of cash to Carbon and CEC shareholders' subsequent exchange of CEC common stock for Carbon common stock likely constitute transfers pursuant to the same plan or arrangement for purposes of Section 351 of the Code. Accordingly, and based upon the representations of Carbon and CEC, in tax counsel's opinion, the exchange of CEC common stock for Carbon common stock likely constitutes part of a tax-free Section 351 transaction. It is possible that the IRS would view Yorktown's contribution of cash to Carbon and the subsequent exchange as separate, unrelated events, in which case tax- free treatment would be unavailable under Section 351 of the Code. Neither CEC nor Carbon has requested, nor will request, a ruling by the Internal Revenue Service that the exchange of shares will be treated as tax free. No assurance can be given that the Internal Revenue Service will not challenge the tax-free nature of the exchange for U.S. federal income tax purposes. If such a challenge were sustained by a court, each U.S. Shareholder of CEC would recognize a capital gain or loss, assuming CEC is not a "passive foreign investment company" (described below) to the extent of the difference between the fair market value of the Carbon shares received by such shareholder and such shareholder's tax basis of the CEC shares surrendered therefor. If the exchange is tax-free as a B Reorganization or a Section 351 transaction, the following should be the material United States federal income tax consequences of the exchange of CEC common shares for Carbon common shares: . You should not recognize gain or loss on the exchange of CEC common shares solely for Carbon common stock; . The tax basis of the Carbon common stock received should be the same as the basis of the CEC common shares constructively surrendered in exchange therefor; . The holding period for the shares of Carbon common stock should include the holding period of CEC common shares surrendered in exchange therefor; and Under Code Section 367(b) and the regulations thereunder, U.S. Shareholders participating in the exchange are required to file an "exchange notice" with the IRS. This exchange notice must be filed on or before the last date for filing a federal income tax return (taking into account any extensions of time for such filing) for the U.S. Shareholder's taxable year in which the exchange takes place. The exchange notice must be filed with the IRS office with which the U.S. Shareholder would be required to file a federal income tax return for the year. This filing requirement will apply whether the exchange is treated as tax-free B reorganization or a tax-free Section 351 transaction. You should consult your tax advisors regarding the Section 367(b) exchange notice and its required content. 31 Passive Foreign Investment Company Considerations for U.S. Shareholders. For U.S. federal income tax purposes, CEC generally would be classified as a Passive Foreign Investment company, or PFIC, for any taxable year during which either: (1) 75 percent or more of its gross income is passive income, as defined for U.S. federal income tax purposes; or (2) on average for such taxable year, 50 percent or more of its assets by value produce or are held for the production of passive income. The classification of CEC as a PFIC could have adverse tax consequences with respect to the exchange that may be substantial for U.S. Shareholders. However, CEC has represented that the factual conditions that give rise to PFIC status have not existed with respect to CEC during any taxable year ending at or prior to consummation of the exchange. Therefore, based on this factual representation, the PFIC rules will not affect U.S. Shareholders who participate in the exchange. Taxation of Non-U.S. Shareholders. The following discussion applies to you if you are a non-U.S. Shareholder: . who holds CEC common shares or will hold Carbon common stock as capital assets within the meaning of Section 1221 of the Code; . who does not actually or constructively own, nor at any time in the preceding five-year period actually or constructively owned, five percent or more of the stock of CEC; . whose ownership, receipt or disposition of CEC common shares and/or Carbon common stock is not attributable either to the conduct of a trade or business in the United States or to a permanent establishment in the United States; and . who are not residents of the United States for purposes of United States federal income tax law or an income tax treaty to which the United States is a party. If you are a non-U.S. Shareholder who does not meet one or more of the foregoing criteria, you are urged and expected to consult your own tax advisors regarding your particular U.S. federal income tax consequences. Generally, you will not be subject to U.S. federal income tax on gain recognized, if any, upon the exchange of the shares of CEC common shares for the shares of Carbon common stock, unless: . the gain is effectively connected with the conduct of a trade or business within the United States by you; . the gain is attributable to a permanent establishment in the United States; . if you are a nonresident alien and hold CEC common shares as a capital asset, you are present in the United States for 183 or more days in the taxable year and certain other circumstances are present; or . you are subject to tax pursuant to the provisions of the Code applicable to some United States expatriates. Generally, dividends received by you with respect to Carbon common stock will be subject to United States withholding tax at a rate of 30 percent, which rate may be subject to reduction by an applicable income tax treaty. For example, 15 percent is the applicable rate with respect to dividends paid to residents of Canada who qualify for the benefits of the income tax treaty between the U.S. and Canada. If the dividends you receive are effectively connected with the conduct of a U.S. trade or business or are attributable to a permanent establishment in the U.S. of yours, they will be taxed at the graduated rates that are applicable to U.S. citizens, resident aliens and domestic corporations and will not be subject to United States withholding tax if you give an appropriate statement to the withholding agent in advance of the dividend payment. A non-U.S. Shareholder that is a corporation may be subject to an additional branch profits tax on effectively connected dividends. Generally, foreign persons are not subject to U.S. federal income tax on gain recognized, if any, upon the sale of shares of U.S. companies. However, the gain on such sales can be taxable, including gain on the sale of Carbon common stock, if: . the gain is effectively connected with conduct of a trade or business within the United States; 32 . you are a nonresident alien individual and hold the Carbon common stock as a capital asset, you are present in the United States for 183 or more days in the taxable year and other specific circumstances are present; . you are subject to tax pursuant to the provisions of the Code applicable to U.S. expatriates; or . Carbon likely is or will be a "United States real property holding corporation," a "USRPHC," for federal income tax purposes, as such term is defined by Section 897(c) of the Code. If Carbon is a USRPHC, then the gain from the disposition of its stock by a non-U.S. shareholder can be taxable in the United States. However, if Carbon's common stock is regularly traded on an established securities market, within the meaning of Section 897(c)(3) of the Code, an exception to this gain recognition rule is available. Carbon believes that as of the date of the exchange, Carbon common stock will be treated as being traded on an established exchange. However, this exception is available to non-U.S. shareholders only if the non-U.S. shareholder has not owned, directly or indirectly, pursuant to attribution rules, more than 5% of the Carbon stock at any time during the five-year period ending on the date of the disposition. Estate Tax for Non-U.S. Shareholders. Carbon common stock owned, or treated as such, by an individual may be includible in his or her gross estate for United States federal estate tax purposes and thus if you are an individual you may be subject to United States federal estate tax, unless an applicable estate tax treaty provides otherwise. Information Reporting and Backup Withholding. Carbon must report annually to the IRS and to you and all other shareholders the amount of dividends paid that year, and the tax withheld with respect to such dividends, if any. These information reporting requirements apply regardless of whether withholding tax is reduced by an applicable income tax treaty. Copies of these information returns reporting such dividends and withholding are made available to the tax authorities in the country in which a non-U.S. Shareholder resides under the provisions of an applicable income tax treaty or other agreement with the tax authorities in that country. In general, information reporting requirements may apply to dividend distributions on Carbon common stock, or the proceeds of a sale, exchange, retraction or redemption of Carbon common stock. A 31% backup withholding tax may apply to these payments unless you are a corporation, non-U.S. Shareholder or come within specific exempt categories and, when required, demonstrate your exemption or provide a correct taxpayer identification number, certify as to no loss of exemption from backup withholding and otherwise comply with applicable requirements of the backup withholding rules. If you are required to provide your correct taxpayer identification number and fail to do so, you may be subject to penalties imposed by the IRS. United States backup withholding tax generally will not apply to dividends paid on Carbon common stock that are subject to the 30% or reduced treaty rate of withholding previously discussed if the beneficial owner certifies its non- U.S. status under penalties of perjury, otherwise establishes an exemption or, with respect to payments made after December 31, 1999, satisfies certain documentary evidence requirements for establishing that it is a non-U.S. holder. Under current law, dividends paid on Carbon common stock to you at an address outside the United States are generally exempt from backup withholding tax, but not from 30% withholding tax, as discussed above. On October 14, 1997 the IRS issued final regulations which affect your United States taxation. Under these regulations, for dividends paid after December 31, 1999, a non-United States person must generally provide proper documents indicating their status to a withholding agent in order to avoid backup withholding tax. However, dividends paid to exempt recipients, not including individuals, will not be subject to backup withholding even if such documentation is not provided, if the withholding agent is allowed to rely on certain presumptions concerning the recipient's non-United States status (i.e. payment to an address outside the United States). 33 If you are a non-U.S. Shareholder, payments of proceeds from the sale of Carbon common shares by you made to or through a non-United States office of a broker generally will not be subject to information reporting or backup withholding. However, payments made to or through a non-United States office of a United States broker or a non-United States office of a non-United States broker that has certain specified connections with the United States, are generally subject to information reporting, but not backup withholding unless you certify your non-United States status under penalties of perjury or otherwise establish your entitlement to an exemption. Payments of proceeds from the sale of Carbon common stock by you made to or through a U.S. office of a broker are generally subject to both information reporting and backup withholding at a rate of 31% unless you certify your non-United States status under penalties of perjury or otherwise establish your entitlement to an exemption. Any amounts withheld under the backup withholding rules from a payment to you will be allowed as a credit against your United States federal income tax, provided that the required information is furnished to the IRS. Under Code Section 367(b) and the regulations thereunder, non-U.S. Shareholders participating in the exchange might technically be required to file an "exchange notice" with the IRS. You should consult your tax advisors regarding the Section 367(b) exchange notice, its timing, its required content, and the effect of failure to file such notice. CANADIAN FEDERAL INCOME TAX CONSEQUENCES Subject to the qualifications and assumptions contained herein in the opinion of Bennett Jones, Canadian counsel to CEC, the following is a general summary of the material Canadian federal income tax consequences generally applicable to holders of CEC common stock who dispose of CEC common stock pursuant to the exchange offer. This summary: (i) is based on the current provisions of the Income Tax Act (Canada) (the "Canadian Tax Act"), the regulations thereunder (the "Regulations") and counsel's understanding of the current administrative practices of Revenue Canada, Customs, Excise and Taxation. This summary also takes into account the amendments to the Canadian Tax Act and Regulations publicly announced by the Canadian Minister of Finance prior to the date hereof (the "Proposed Amendments") and assumes that all such Proposed Amendments will be enacted in their present form. However, no assurances can be given that the Proposed Amendments will be enacted in the form proposed, or at all. Except for the foregoing, this summary does not take into account or anticipate any changes in law, whether by legislative, administrative or judicial decision or action, nor does it take into account provincial, territorial or foreign income tax legislation or considerations, which may differ from the Canadian federal income tax consequences described herein; and (ii) applies only to persons who, within the meaning of the Canadian Tax Act, acquire, hold and dispose of CEC common stock and Carbon common stock as capital property, deal at arm's length with CEC and Carbon and are not "financial institutions" for the purposes of the mark-to-market rules. CEC common stock and Carbon common stock will generally be considered to be capital property to a holder thereof provided that the holder does not hold any such shares in the course of carrying on a business of buying and selling shares and has not acquired such shares in a transaction considered to be an adventure in the nature of trade. Certain holders who are resident in Canada and who might not otherwise be considered to hold CEC common stock as capital property may be entitled to have such shares treated as capital property by making the election provided by subsection 39(4) of the Canadian Tax Act. 34 The tax consequences of the exchange will in all likelihood differ from one holder to the next. Therefore, we urge you to consult your tax advisor regarding the tax consequences unique to your situation. Holders Resident in Canada The following portion of the summary is applicable only to holders of CEC common stock who are resident or deemed to be resident in Canada for the purposes of the Canadian Tax Act (a "Canadian Holder"). Disposition of CEC Common Stock On the exchange of CEC common stock for Carbon common stock, a Canadian Holder will be considered to have disposed of the CEC common stock for proceeds of disposition equal to the fair market value at the time of the exchange of the Carbon common stock received by the holder. A Canadian Holder will realize a capital gain or capital loss, as appropriate, equal to the amount by which such proceeds of disposition, net of any reasonable costs associated with the disposition, exceed or are less than, as appropriate, the holder's adjusted cost base of the CEC common stock. The cost to the Canadian Holder of the Carbon common stock received by such holder will be equal to the fair market value of such shares at the time of the exchange. The computation of the adjusted cost base of Carbon common stock is discussed below in this section under the heading "Disposition of Carbon Common Stock." The general tax treatment of capital gains and losses is discussed in this section under the heading "Capital Gains and Losses." Disposition of Carbon Common Stock A disposition or deemed disposition by a Canadian Holder of Carbon common stock will generally give rise to a capital gain or capital loss, as appropriate, equal to the amount by which the proceeds of disposition of the Carbon common stock, net of any reasonable costs associated with the disposition, exceed or are less than, as appropriate, the holder's adjusted cost base of the Carbon common stock. In that regard, the cost to the holder of the Carbon common stock acquired on the exchange will be averaged with the adjusted cost base of any other Carbon common stock then owned by such holder as capital property for the purposes of determining the adjusted cost base of such Carbon common stock. The general tax treatment of capital gains and losses is discussed below in this section under the heading "Capital Gains and Losses". Capital Gains and Losses A Canadian Holder's taxable capital gain or allowable capital loss from the disposition of CEC common stock or Carbon common stock will be equal to three- quarters of the amount of the holder's capital gain or capital loss, as appropriate, in respect of such disposition. A Canadian Holder must include any such taxable capital gain in income for the taxation year of disposition, and may, subject to the detailed provisions of the Canadian Tax Act, deduct any such allowable capital loss from taxable capital gains in the year in which such allowable capital loss is realized. Subject to the detailed rules contained in the Canadian Tax Act, any remaining allowable capital loss may generally be applied to reduce net taxable gains realized by the holder in the three preceding and in all subsequent taxation years. If a Canadian Holder is a corporation, the amount of any capital loss arising from a disposition or deemed disposition of CEC common stock or Carbon common stock may be reduced by the amount of dividends received or deemed to have been received by it on such shares to the extent and under circumstances prescribed by the Canadian Tax Act. Similar rules may apply where a corporation is a member of a partnership or a beneficiary of a trust that owns CEC common stock or Carbon common stock. Capital gains realized by a Canadian Holder who is an individual may be subject to alternative minimum tax under the Canadian Tax Act, depending on the individual's circumstances. A Canadian Holder that is a "Canadian-controlled private corporation," as defined in the Canadian Tax Act, may be liable to pay an additional refundable tax of 6 2/3% on certain investment income, including amounts in respect of taxable capital gains. 35 Eligibility for Investment The Carbon common stock issued pursuant to the offer, when listed on a prescribed stock exchange, which includes the American Stock Exchange, will be qualified investment under the Canadian Tax Act for trusts governed by registered retirement savings plans, registered retirement income funds and deferred profit sharing plans. However, such shares will constitute "foreign property," as defined in the Canadian Tax Act, for the purposes of such plans. Subsequent Transaction As described in "The Exchange Offer--Second Step Merger", Carbon may, in certain circumstances, merge CEC with a wholly-owned Canadian subsidiary of Carbon (the "Second Step Merger"). The consequences under the Canadian Tax Act to a holder whose CEC common stock is not exchanged under the exchange offer and is disposed of in connection with the Second Step Merger will depend upon the circumstances of the merger including, without limitation, the consideration received by the holder and the person from whom such consideration is received. If a holder receives Carbon common stock or cash in consideration for the disposition of CEC common stock to Carbon, the holder will realize a capital gain (or a capital loss) to the extent that the proceeds received for such common stock, net of any reasonable costs associated with the disposition, exceed (or are less than) the adjusted cost base of the CEC common stock disposed of. If in the course of the Second Step Merger, CEC common stock is acquired by CEC from an individual holder (including upon the exercise by an individual holder of certain dissent rights), the individual holder will be deemed to have received a taxable dividend in the amount by which the amount received (other than in respect of interest awarded by a Court) exceeds the paid-up capital of such CEC common stock. This amount will be excluded from the former individual holder's proceeds of disposition for the purposes of computing any taxable gain on the disposition. If the former individual holder is a resident of Canada, the deemed dividend will be treated in the same manner as a regular taxable dividend received from CEC. Corporations or trusts or partnerships which have corporations as beneficiaries or partners should consult their own tax advisors with respect to the income tax consequences where CEC common stock is acquired by CEC. Upon the merger of CEC and a wholly-owned Canadian affiliate of Carbon, the Canadian Tax Act deems the CEC common stock to be disposed of and the shares of the amalgamated corporation to be acquired for an amount equal to the adjusted cost base to the former holders of the CEC common stock. Consequently, no capital gain or capital loss would be realized by the former holders upon such amalgamation. A subsequent disposition of the shares of the amalgamated corporation acquired on the amalgamation may give rise to a capital gain, a capital loss, or if such shares are repurchased by the amalgamated corporation, a deemed dividend. If on such amalgamation the former holder receives property other than shares of the amalgamated corporation (such as Carbon shares or cash) or exercises a dissent right pursuant to the Alberta Business Corporations Act and receives cash in consideration for his CEC common stock, such former holder will have a capital gain (or a capital loss) to the extent that the proceeds received for such CEC common stock (other than in respect of interest awarded by a Court), net of any reasonable costs associated with the disposition, exceed (or are less than) the adjusted cost base of the CEC common stock disposed of by the former holder. Holders Not Resident in Canada The following portion of the summary is applicable only to holders of CEC common stock who are not and will not be resident nor deemed to be resident in Canada for the purposes of the Canadian Tax Act and any applicable tax treaty at any time they hold such shares, who do not use or hold and are not deemed to use or hold their CEC common stock in carrying on a business in Canada, and in the case of a holder who carries on an insurance business in Canada and elsewhere, whose shares are not "designated insurance property" and are not effectively connected with an insurance business carried on in Canada at any time (a "Non-Resident Holder"). 36 A Non-Resident Holder will not be subject to tax in respect of capital gains realized on the disposition of CEC common stock provided that the CEC common stock is not "taxable Canadian property" of the Non-Resident Holder immediately before the exchange. The CEC common stock will not constitute "taxable Canadian property" of a Non-Resident Holder provided that such shares are listed on a prescribed stock exchange (which currently includes the American Stock Exchange), and the holder, persons with whom such holder does not deal at arm's length, or the holder together with all such persons, has not owned (or had under option) 25% or more of the issued shares of any class or series of the capital stock of CEC at any time within five years preceding the date of the exchange, and the shares were not acquired in a transaction which deemed them to be "taxable Canadian property." The Canadian federal income tax consequences to a Non-Resident Holder who does not tender to the offer of the transactions described in this summary under "Subsequent Transaction" may be substantially different than those described above and may include, without limitation, the recognition of a gain which is subject to tax in Canada and/or the receipt of deemed dividends and/or interest which would be subject to Canadian withholding tax. If CEC common stock ceases at any time to be listed on a prescribed exchange, the stock will at that time be considered "taxable Canadian property" to the Non- Resident Holder. Non-Resident Holders who are considering not tendering to the exchange offer are urged to consult their tax advisors as to the potential consequences to them of such transactions. UNAUDITED PRO FORMA FINANCIAL INFORMATION The following unaudited pro forma financial information is derived from the historical financial statements of BFC and CEC. The historical financial statements are adjusted to reflect the following: The Carbon Unaudited Pro Forma Condensed Balance Sheet as of June 30, 1999 has been prepared assuming that the acquisition of BFC was consummated on June 30, 1999 and the exchange offer of Carbon shares for CEC shares was consummated on May 31, 1999. The Carbon Unaudited Pro Forma Statement of Income for the twelve months ended December 31, 1998 has been prepared assuming that the acquisition of BFC was consummated on January 1, 1998 and the exchange offer of Carbon shares for CEC shares was consummated on December 1, 1997. The Carbon Unaudited Pro Forma Statement of Income for the six months ended June 30, 1999 has been prepared assuming that the acquisition of BFC was consummated on January 1, 1999 and the exchange offer of Carbon shares for CEC shares was consummated on December 1, 1998. The historical financial statements of CEC were prepared in Canadian dollars in accordance with Canadian generally accepted accounting principles. CEC's historical balance sheet as of May 31, 1999 and statements of income for the year ended November 30, 1998 and the six months ended May 31, 1999 have been adjusted to present the results in accordance with United States generally accepted principles and have been translated to U.S. dollars. The Unaudited Pro Forma Balance Sheet reflects the preliminary allocation of the purchase price of the BFC acquisition to the assets and liabilities of Carbon. This statement also reflects the preliminary allocation of the exchange offer of Carbon shares for CEC shares to the assets and liabilities of Carbon. The valuation of the exchange offer for pro forma purposes was calculated using the average of the three quoted closing prices for CEC shares prior and subsequent to the announcement date of the signing of the BFC purchase and sales agreement. The final allocation of the purchase price for the BFC acquisition and the CEC exchange and the resulting effect on depreciation, depletion and amortization expense will differ from the preliminary estimates because the final allocation will be based on the purchase price allocation of assets and liabilities based upon adjustments to the final purchase price. The Carbon Unaudited Pro Forma Financial Information should be read in conjunction with the accompanying notes thereto, and the historical financial statements and notes thereto for Carbon, BFC, and CEC included elsewhere in this prospectus. The pro forma information presented is not necessarily indicative of the financial position or results of operations that would have actually occurred had the acquisition of BFC and the exchange offer of Carbon shares for CEC shares been consummated on the dates previously assumed. The pro forma information presented is not intended to be a projection of future financial position or results of operation. 37 CARBON ENERGY CORPORATION UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET June 30, 1999 (in US dollars, in thousands)
BFC CEC Carbon Acquisition Carbon 06/30/99 05/31/99 06/30/99 Adjustments Pro Forma -------- -------- -------- ----------- --------- Current assets: Cash.................. $ 444 $ -- $24,860 $(24,058)(a) $ 1,246 Accounts receivable... 2,482 676 -- -- 3,158 Investment margin accounts............. 1,209 -- -- -- 1,209 Prepaid expenses and other................ 113 -- -- -- 113 ------- ------- ------- -------- ------- Total current assets............. 4,248 676 24,860 (24,058) 5,726 Property and equipment: Oil and gas properties........... 35,968 14,358 -- (9,511)(b)(c)(d)(e) 40,815 Liquids extraction plant................ -- 1,000 -- (582)(d) 418 Compression/gathering. -- 450 -- (121)(d) 329 Furniture, equipment and other............ 557 120 -- (356)(c)(d) 321 ------- ------- ------- -------- ------- 36,525 15,928 -- (10,570) 41,883 Accumulated depletion, depreciation and amortization......... (20,155) (6,741) -- 26,896 (c)(d) -- ------- ------- ------- -------- ------- Property and equipment, net..... 16,370 9,187 -- 16,326 41,883 Other assets: Deposits and other.... 271 37 -- -- 308 Deferred loan costs, net.................. 35 -- -- (35)(c) ------- ------- ------- -------- ------- Total other assets.. 306 37 -- (35) 308 ------- ------- ------- -------- ------- Total assets............ $20,924 $ 9,900 $24,860 $ (7,767) $47,917 ======= ======= ======= ======== ======= Current liabilities: Accounts payable and accrued exp.......... $ 1,882 $ 219 $ -- $ 300 (b) $ 2,401 Undistributed revenue. 878 196 -- -- 1,074 ------- ------- ------- -------- ------- Total current liabilities........ 2,760 415 -- 300 3,475 Long-term debt.......... 8,700 2,406 -- -- 11,106 Future site restoration costs.................. -- 137 -- -- 137 Deferred income taxes... -- 1,292 -- 559 (e) 1,851 Stockholders' equity: Share capital......... -- 1,024 -- (1,024)(c) -- Paid in capital....... 3,475 24,860 3,013 (b)(c)(d)(i) 31,348 Retained earnings..... 5,989 4,626 -- (10,615)(c)(d) -- ------- ------- ------- -------- ------- Total stockholders' equity............. 9,464 5,650 24,860 (8,626) 31,348 ------- ------- ------- -------- ------- Total liabilities and stockholders' equity... $20,924 $ 9,900 $24,860 $ (7,767) $47,917 ======= ======= ======= ======== =======
The accompanying notes are an integral part of these financial statements 38 CARBON ENERGY CORPORATION UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENT Six Months Ended June 30, 1999 (in US dollars, in thousands)
CEC BFC CEC Acquisitions Six Months Six Months Six Months Ended Ended Ended(h) Acquisition Carbon 06/30/99 05/31/99 05/31/99 Adjustments Pro Forma ---------- ---------- ------------ ----------- --------- Revenues: Oil and gas sales..... $ 4,560 $1,395 $112 $ -- $ 6,067 Field services........ -- 37 -- -- 37 Gas marketing and transportation....... 9,950 -- -- -- 9,950 Electricity sales..... -- -- -- -- -- Other................. 218 1 -- -- 219 ------- ------ ---- ------ ------- 14,728 1,433 112 -- 16,273 Expenses: Oil and gas production costs................ 1,930 235 43 -- 2,208 Field services........ -- 27 -- -- 27 Gas marketing and transportation....... 9,742 -- -- -- 9,742 Costs of electricity.. -- -- -- -- -- DD&A.................. 1,213 651 72 1,128 (f) 3,064 Exploration expense... 638 -- -- (638)(g) -- Impairment expense.... 60 -- -- (60)(g) -- General and administrative....... 791 702 -- -- 1,493 Interest expense...... 204 39 27 -- 270 ------- ------ ---- ------ ------- 14,578 1,654 142 430 16,804 Income (loss) before taxes.................. 150 (221) (30) (430) (531) Tax expense (benefit): Current............... -- (14) (2) -- (16) Deferred.............. -- (58) (8) -- (66) ------- ------ ---- ------ ------- -- (72) (10) -- (82) ------- ------ ---- ------ ------- Net income (loss)....... $ 150 $ (149) $(20) $ (430) $ (449) ======= ====== ==== ====== ======= Earnings per share: Basic................. $ (.10) $ .03 $ (.07) Fully diluted......... (.10) .03 (.07) Average number of common shares outstanding: Basic................. 1,534 4,520 6,054 Fully diluted......... 1,534 4,520 6,054
The accompanying notes are an integral part of these financial statements. 39 CARBON ENERGY CORPORATION UNAUDITED PRO FORMA CONSOLIDATED INCOME SHEET Year Ended December 31, 1998 (in US dollars, in thousands)
CEC BFC CEC Acquisitions Year Ended Year Ended Year Ended Acquisition Carbon 12/31/98 11/30/98 11/30/98(h) Adjustments Pro Forma ---------- ---------- ------------ ----------- --------- Revenues: Oil and gas sales..... $ 6,758 $2,007 $1,033 $ -- $ 9,798 Field services........ -- 167 -- -- 167 Gas marketing and transportation....... 12,610 -- -- -- 12,610 Electricity sales..... 1,331 -- -- -- 1,331 Other................. 393 33 -- -- 426 ------- ------ ------ ------- ------- 21,092 2,207 1,033 -- 24,332 Expenses: Oil and gas production costs................ 3,004 482 433 -- 3,919 Field services........ -- 100 -- -- 100 Gas marketing and transportation....... 12,674 -- -- -- 12,674 Costs of electricity.. 1,137 -- -- -- 1,137 DD&A.................. 2,086 737 602 1,403 (f) 4,828 Exploration expense... 556 -- -- (556)(g) -- Impairment expense.... 1,858 -- -- (1,858)(g) -- General and administrative....... 1,655 671 -- -- 2,326 Interest expense...... 238 -- 212 -- 450 ------- ------ ------ ------- ------- 23,208 1,990 1,247 (1,011) 25,434 Income (loss) before taxes.................. (2,116) 217 (214) 1,011 (1,102) Tax expense (benefit): Current............... (225) 13 (13) -- (225) Deferred.............. 50 41 (40) -- 51 ------- ------ ------ ------- ------- (175) 54 (53) -- (174) ------- ------ ------ ------- ------- Net income (loss)....... $(1,941) $ 163 $ (161) $ 1,011 $ (928) ======= ====== ====== ======= ======= Earnings per share: Basic................. $ .11 (.26) $ (.15) Fully diluted......... .11 (.26) (.15) Average number of common shares outstanding: Basic................. 1,545 4,520 6,065 Fully diluted......... 1,549 4,516 6,065
The accompanying notes are an integral part of these financial statements. 40 NOTES TO UNAUDITED PRO FORMA FINANCIAL INFORMATION (a) To reflect the purchase of BFC stock for cash by Carbon. (b) Adjustment to reflect estimated acquisition and other deal costs of $300,000 to be incurred by Carbon. Paid in capital reflective of Yorktown's investment is $24,750,000. (c) Adjustment to eliminate the historical basis of BFC assets and to reflect the adjusted basis of the assets acquired resulting from the purchase method of accounting. The allocated basis of the BFC assets are $30,560,000 for oil and gas properties and $239,000 for furniture, equipment and other. (d) Adjustment to eliminate the historical basis of CEC assets and to reflect the adjusted basis of the assets acquired resulting from the purchase method of accounting. The allocated basis of the CEC assets are $9,955,000 for oil and gas properties and $82,000 for furniture, equipment and other. Paid in capital reflective of the CEC exchange is $6,688,000. (e) Adjustment to reflect the increase in deferred taxes resulting from the exchange of CEC shares for Carbon shares. The purchase accounting adjustment resulted in an increase in the difference of book basis over tax basis for the CEC assets. (f) Adjustment to reflect the impact on historical depletion attributed to the acquisition of BFC and the exchange offer to current CEC shareholders. The depletion amounts were calculated on the units-of-production method based on estimates of total proved reserves. Separate cost pools were established for CEC and BFC due to accounting rules that require cost centers be established on a country-by-country basis. Based on the preliminary purchase price allocation and the discounted future net cash flows attributable to the CEC and BFC properties calculated using November 30, 1998 oil and gas prices for CEC and December 31, 1998 prices for BFC, a ceiling test deficit would exist on the properties. As a result of improved oil and gas prices subsequent to year-end, the CEC and BFC properties had a cushion for ceiling test purposes using May 31, 1999 oil and gas prices for CEC and June 30, 1999 prices for BFC. Depreciation on the liquids extraction plant and other assets are calculated using the straight-line method and the underlying assets estimated useful lives. (g) To adjust for the capitalization of certain items under the full cost method of accounting utilized by Carbon as compared to the successful efforts method utilized by BFC. (h) Between December 1998 and April 1999, CEC purchased producing oil and gas properties and natural gas gathering and compression facilities in Alberta, Canada. These acquisitions were accounted for as purchases and considered material in the aggregate by management for pro forma disclosure purposes. The results of operations are presented as though the acquisition had occurred at the beginning of the period being reported on. Revenues and expenses subsequent to the purchase dates have been included in the 1999 operating results of CEC and are not included in this column. These results of operations are not indicative of the results that would have occurred if the acquisitions had been in effect for the entire periods presented and are not intended to be a projection of future results. (i) Adjustment to reflect bonuses of $200,000 related in large part to the acquisition of BFC and the exchange offer for CEC. INFORMATION ABOUT CEC Overview of Business CEC is an independent oil and natural gas company incorporated on May 31, 1955 under the Business Corporations Act (Alberta) in Canada. CEC was acquired by the former parent of Columbus Energy Corp. ("Columbus") in 1969 and by Columbus on July 31, 1984. It remained a wholly-owned subsidiary of Columbus until spun-off from Columbus by a rights offering in February 1995. CEC engages in the exploration, development and production of crude oil and natural gas and acquires and develops leaseholds and other interests in oil and gas properties in the provinces of Alberta and Saskatchewan. CEC owns working interests in 16 oil wells located in Saskatchewan, Canada and 47 natural gas wells located in Alberta, Canada. CEC also has ownership interests in a natural gas processing plant and several gas gathering and compression systems in Alberta. Prior to the end of 1998, substantially all of CEC's oil and gas properties were operated by other industry companies. With certain acquisitions completed in fiscal 1999, CEC has increased the percent of oil and gas 41 properties which it operates. CEC's business strategy is to grow through exploitation of existing oil and gas properties by development of proved non- producing and proved undeveloped reserves; acquisitions of complementary working interests in existing and adjacent properties; and optimization of gathering, compression and processing facilities. CEC will also conduct oil and gas exploration activities in its core area of operations. In addition CEC will evaluate acquisition and merger opportunities in Canada and the United States. CEC employs a staff of professional oil and gas engineers, geologists, land personnel and accountants to direct this effort. CEC's principal office is located at Suite 1605, 700 6th Avenue S.W., Calgary, Alberta, Canada T2P 0T8. CEC also has a United States office located at 1700 Broadway, Suite 1150, Denver, Colorado 80290. CEC Selected Financial Data The table below sets forth selected historical financial and operating data for CEC as of the dates and for the periods indicated. The historical financial data for the nine months ended August 31, 1999 and August 31, 1998 were derived from CEC's unaudited financial statements. The historical financial data for each of the years in the five-year period ended November 30, 1998 were derived from CEC's financial statements, which were audited by PricewaterhouseCoopers LLP and were prepared in accordance with Canadian generally accepted accounting principles. Currency amounts are in Canadian dollars unless otherwise stated. The information set forth below should be read in conjunction with "CEC Management's Discussion and Analysis of Financial Condition and Results of Operations" and CEC's Financial Statements and notes thereto, included elsewhere in this document.
As of or for the Nine Months Ended As of or for the August 31, Year Ended November 30, ---------------- ----------------------------------------- 1999 1998 1998 1997 1996 1995 1994 ------- ------- ------- ------- ------- ------ ------ (In thousands, except per share data) Operating Data: Revenues.............. $ 3,463 $ 2,364 $ 3,253 $ 3,309 $ 3,212 $3,794 $3,673 Net earnings (loss)... (188) 268 240 605 526 870 1,033 Earnings (loss) per share................ (0.12) 0.17 0.16 0.38 0.35 0.58 0.69 Average common shares outstanding (3)...... 1,529 1,542 1,545 1,580 1,505 1,500 1,500 Cash Flow Data: (1)(2) Cash provided by operating activities. $ 1,389 $ 1,218 $ 1,366 $ 1,724 $ 1,656 $1,933 $2,145 Cash used in investing activities........... (7,751) (489) (564) (1,265) (2,333) (2,064) (1,989) Cash provided by (used in) financing activities........... 4,696 (79) (209) (98) 604 -- -- Balance sheet data: Total assets.......... $15,981 $11,235 $11,235 $11,378 $10,166 $8,729 $7,852 Working capital....... 182 2,120 2,120 1,149 981 937 684 Long-term debt, excluding current maturities........... 4,850 -- -- -- -- -- -- Stockholders' equity.. 8,380 8,722 8,722 8,691 8,184 7,054 6,184
- -------- (1) See discussion of cash flows in "CEC Management's Discussion and Analysis of Financial Condition and Results of Operations" below. (2) In 1998, CEC elected to adopt Canadian Institute of Chartered Accountants ("CICA") 1540, Cash Flow Statements. Cash flow data for years ended November 30, 1998, 1997 and 1996 have been restated to reflect presentation in conformance with CICA 1540. (3) Restated for a five-to-one stock split on October 27, 1994. CEC Management's Discussion and Analysis of Financial Condition and Results of Operations The discussion below summarizes CEC's financial condition and results of operations and should be read in conjunction with the financial statements and related notes. The financial related comments contained in this section are derived from financial statements prepared in accordance with Canadian GAAP. 42 Results of Operations--Nine Months Ended August 31, 1999 Compared to the Nine Months Ended August 31, 1998 Revenues for the nine months ended August 31, 1999 totaled $3,463,000, a 46% increase from the prior year period. The increase was due primarily to increased natural gas and plant liquid volumes, including production resulting from CEC's acquisitions and higher natural gas, oil and plant liquid prices. The net loss in the first nine months of 1999 was $188,000 compared to net income of $268,000 in the first nine months of 1998. The decrease was primarily due to increased general and administrative expenses, increased depletion, depreciation and amortization expenses partially offset by higher oil, natural gas and plant liquid revenues. Oil and Gas Revenues. The following table shows comparative revenue, sales volume, average prices and percentage changes between periods, for natural gas, oil, and plant liquids for the first nine months of 1999.
Nine Months Ended August 31, -------------------- % 1999 1998 Change ------ ------ ------ Natural gas revenue M$............................... 2,934 1,716 71% Oil revenue M$....................................... 385 367 5% Natural gas liquids revenues M$...................... 365 297 23% Natural gas sales volumes: Millions of cubic feet............................. 1,115 889 25% Mcf/day............................................ 4,069 3,244 Oil sales volumes: Barrels............................................ 18,395 19,797 -7% Barrels/day........................................ 67 72 Natural gas liquids sales volumes: Barrels............................................ 23,802 20,206 18% Barrels/day........................................ 87 74 Average price received: Natural gas--$/Mcf................................. 2.63 1.93 36% Oil--$/Bbl......................................... 20.91 18.51 13% Plant liquids--$/Bbl............................... 15.34 14.69 4%
Average daily oil and plant liquid production for the first nine months of 1999 were 67 and 87 barrels, respectively. Average daily gas production for the first nine months of 1999 was 4,069 mcf. This is an increase of 21% on a barrels of oil equivalent ("boe") basis compared to the same period in 1998. CEC's continued success with the exploitation of properties acquired during 1999 and current development activity have resulted in increasing production for three successive quarters. Exploration activities are expected to continue for the balance of 1999. Average oil prices increased 13% from $18.51 per barrel in the first 9 months of 1998 to $20.91 in 1999. Average plant liquids prices increased 4% from $14.69 per barrel for the first nine months of 1998 to $15.34 in 1999. Average natural gas prices increased 36% from $1.93 per mcf for the first nine months of 1998 to $2.63 in 1999. Royalty expense consists primarily of Crown Royalties as well as smaller amounts of freehold and gross overriding royalties. CEC is eligible for the Alberta Royalty Tax Credit ("ARTC") which varies inversely with prevailing prices for oil and gas sales in Alberta. For the first nine months of 1999 and 1998 the net Crown Royalty rate was 6%. Field Services Business Segments. CEC receives operating service revenue generated by its share of processing fees at the Carbon field liquid extraction plant. Because of CEC's acquisitions in the East Carbon area, the amount of unrelated third party gas processed through the plant has declined, resulting in a decline in field service revenue for 1999 relative to 1998. 43 Lease Operating Expense. Lease operating expenses totaled $585,000 or $2.57 per boe for the first nine months of 1999 compared to $563,000 or $2.99 per boe in the prior year period. This reduction in per boe expense is due to overall lower 1999 lease operating expenses on CEC's properties, including acquired properties, and the fact that lease operating expenses for 1998 were higher due to well workovers at CEC's Hoffer properties. Field netbacks commonly reported by Canadian energy companies equate to oil and gas sales less royalties and lease operating expenses. Resources' average field netback increased significantly for the first nine months of 1999 to $12.28 per boe compared to $8.50 per boe for the first nine months of 1998 primarily due to the positive revenue and lease operating expense variances previously discussed. CEC has always followed the U.S. practice of converting its natural gas to boe based on the heating value ratio of six mcf of natural gas to one barrel of oil. A ratio of 10:1 which historically has more closely approximated price ratios, is used by nearly all Canadian public companies. If natural gas volume had been converted to boe using the Canadian practice of a 10:1 ratio, then reported field netbacks would have been $18.22 and $12.40 per boe for the first nine months of 1999 and 1998 respectively. General and Administrative Expenses. General and administrative ("G&A") expenses, net of third party reimbursements, for the first nine months of 1999 totaled $1,522,000, a $907,000 or 148% increase from the same period in 1998. The increase in G&A expense was primarily due to the hiring of full time employees, partially offset by a reduction in charges for management services provided by Columbus Energy under a management contract which was terminated March 31, l999. Depletion, Depreciation and Amortization Expense. Depletion, depreciation and amortization expense for the nine month period ended August 31, l999 totaled $1,597,000, a increase of $911,000 or 133% from the 1998 level. Depletion expense increased primarily due to increased gas sales and a downward adjustment to CEC's 1998 year end developed non-producing and proved undeveloped natural gas reserves that resulted in an increased depletion rate per boe in 1999 compared to 1998. For the first nine months of 1999 the depletion rate was $6.29 per boe, compared to $3.20 per boe for the same period in 1998. Interest Expense. Interest and other expenses increased to $136,000 for the first nine months of 1999, a $159,000 increase from the prior year period. Interest expense increased as a result of incurring long-term debt in 1999 to partially fund acquisitions. See "Acquisitions" and "Liquidity and Capital Resources". CEC's average interest rate for the first nine months of 1999 was 7.25%. Acquisitions In December 1998 CEC acquired for $2.3 million working interests in 16 natural gas wells, associated natural gas gathering and compression facilities and undeveloped lands in the East Carbon Field (Wayne-Rosedale), located in Alberta, Canada from Neutrino Resources, Ltd. The acquisition was funded with cash and bank financing. The acquisition increased CEC's working interest ownership in the East Carbon Field from 33 1/3% to 64%. CEC estimates that as of November 30, 1998, the remaining proved reserves before royalty of the acquired properties are approximately 51,000 barrels of oil and natural gas liquids and approximately 2.3 billion cubic feet of natural gas. In March 1999, CEC acquired for $800,000 a 100% working interest in one natural gas well, associated natural gas gathering facilities and underdeveloped lands in the East Carbon Field, located in Alberta, Canada from Westdrum Energy Ltd. and C. & D. Oil and Gas Ltd. The acquisition was funded with bank financing. CEC estimates that as of March 1, 1999, the remaining proved reserves before royalty of the acquired property are approximately 19,000 barrels of oil and natural gas liquids and approximately 720,000 mcf of natural gas. 44 In March 1999, CEC acquired for $2.1 million working interests in 17 natural gas wells, associated natural gas gathering and compression facilities in the East Carbon Field, located in Alberta, Canada from Cometra Energy (Canada) Ltd. The acquisition was funded with bank financing. The acquisition increased CEC's working interest ownership in the East Carbon Field from 64% to 97%. CEC estimates that as of March 1, 1999, the remaining proved reserves before royalty of the acquired properties are approximately 48,000 barrels of oil and natural gas liquids and approximately 2.1 billion cubic feet of natural gas. In April 1999, CEC acquired for $125,000 working interests in 13 natural gas wells, associated natural gas gathering and compression facilities and undeveloped lands in the East Carbon Field, located in Alberta, Canada from Springroad Resources, Inc. The acquisition was funded with bank financing. The acquisition increased CEC's working interest ownership in the East Carbon Fields from 97% to approximately 100%. CEC estimates that as of March 1, 1999, the remaining proved reserves before royalty of the acquired properties are approximately 4,000 barrels of oil and natural gas liquids and approximately 180,000 mcf of natural gas. On August 12, 1999, CEC entered into the BFC Stock Purchase Agreement to acquire all of the stock of BFC, a company with working interests in approximately 290 oil and natural gas wells and over 150,000 net acres located in Colorado, Kansas, New Mexico, Texas and Utah. The purchase price for the stock of BFC is approximately $24,000,000, subject to adjustments, plus net debt of approximately $6,500,000 remaining at BFC. Exploration Activities Under the full cost method of accounting, all exploration costs associated with continuing efforts to acquire or review prospects including outside geological and seismic consultants are capitalized. A total of $201,000 of exploration costs were capitalized during the first nine months of 1999 compared to $40,000 in the first nine months of 1998. Liquidity and Capital Resources CEC has positive working capital, a history of strong cash flow from operating activities relative to its modest market capitalization and has secured a financing commitment with Canadian Imperial Bank of Commerce ("CIBC"). The principal sources of CEC's funds are cash flows from operating activities and available borrowings under CEC's financing commitment. For the first nine months of 1999, net cash from operating activities was $1,389,000 compared to $1,218,000 for the same period in 1998. The increase is primarily due to increased oil and gas sales, a positive net change in operating assets and liabilities, partially offset by increased general and administrative expenses. Net cash used in investing activities was $7,751,000 for the first nine months of 1999 compared to $489,000 in 1998. This increase was primarily due to acquisitions in the East Carbon Area and a deposit related to the BFC acquisition. "See Acquisitions". Net cash provided by financing activities in the first nine months of 1999 was $4,696,000 which was primarily due to the proceeds from long-term debt, partially offset by the acquisition of 23,000 shares of CEC's common stock. Net cash used in financing activities in the first nine months of 1998 was $79,000 due to the acquisition of 83,000 shares of CEC's common stock partially offset by the issuance of 70,000 shares of CEC's common stock. In December 1998, CEC received a financing commitment from CIBC. The purpose of the loan is to provide financing for the acquisition of oil and gas reserves and for normal operating requirements. The loan is secured by CEC's oil and gas assets. The interest rate on outstanding borrowings is the CIBC Prime Rate plus 3/4%. The initial commitment was a $2.5 million revolving loan. In March, 1999, the commitment was increased to a $5.0 million revolving loan. In October 1999, the commitment was increased to a $6.5 million revolving loan. The commitment will be reduced to $5.75 million upon closing of the BFC acquisition. "See Acquisitions." The revolving phase of the loan will expire on April 30, 2000 and may be renewed by CIBC. If 45 the revolving commitment is not renewed by CIBC, the loan would be converted into a term loan and will be permanently reduced by way of consecutive monthly principal payments over a period not to exceed 36 months. This loan is secured by all of CEC's assets. Borrowings under the loan during 1999 have resulted in increased interest expense during 1999 compared to 1998. Income Taxes In 1997, the Company adopted CICA 3465, Income Taxes. Since 1993, CEC had paid current taxes to Revenue Canada based on its taxable income after utilization, to the extent allowed, of its tax pool carry forwards. Currently payable taxable income for future periods is dependent upon the level and type of capital expenditures incurred in those future periods as well as percentage limitations for utilization of existing tax pools. For 1999, the Company anticipates little or no current income tax liability based upon current and anticipated 1999 activity. For 1998, federal and provincial taxes were $41,000. Exchange Rate of the Canadian Dollar All dollar amounts in this report are in Canadian dollars except where otherwise indicated. The following table sets forth the rates of exchange for the Canadian dollar, expressed in United States dollars:
Nine Months Ended August 31, ------------- 1999 1998 ------ ------ Rate at end of period....................................... 0.6685 0.6361 Average rate during period.................................. 0.6657 0.6880 High........................................................ 0.6894 0.7105 Low......................................................... 0.6440 0.6343
On September 30, 1999, the noon buying rate in Canadian dollars was 0.6803 U.S.=$1.00 Canadian. Year 2000 Issues The Year 2000 issue is the result of computer programs being written using two digits rather than four, or other methods, to define the applicable year. Computer programs that have date sensitive software may recognize a date using "00" as the year 1900, rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including among other things, a temporary inability to price transactions, send invoices or engage in similar normal business activities. In addition to affecting mainframe and mid-range computer systems, this problem potentially impacts computer chips integrated in security, plant automation, and pipeline control and metering systems. CEC is currently completing an external review of all Year 2000 issues by contacting and/or sending out questionnaires to all of its natural gas purchasers, gathering system and plant operators, downstream pipeline operators, equipment and service providers, operators of its oil and gas properties, financial institutions and vendors providing payroll and medical benefits and services. The preliminary phase of this review has been completed. Based upon this review, a schedule of revisions (if any) to existing systems as well as requisite contingency plans will be designed and implemented. CEC utilizes a service bureau for its accounting processing. The service bureau has represented that the oil and gas accounting system utilized by the service bureau is Year 2000 compliant. CEC has selected an accounting system and is in the process of bringing all accounting services and processing in- house. The oil and gas accounting system vendor has represented that the software is Year 2000 compliant. CEC is also dependent upon personal computer based software programs and files that may not be Year 2000 compliant. CEC has set a revised deadline of November 1999, to be internally compliant with Year 2000 specifications. 46 Management expects costs for CEC to become Year 2000 compliant will not be significant. CEC does not believe that any loss of revenue will occur as a result of the Year 2000 problem. However, despite CEC's efforts to identify and remedy Year 2000 problems, there may be related failures that disrupt CEC's business temporarily. In addition, the timetable for CEC's planned completion of its own Year 2000 modifications and the estimated costs to accomplish this are management's best estimates. These assessments involve many assumptions concerning future events, including the continued availability of certain resources, particularly personnel able to locate, reprogram or replace, and test CEC's hardware and software in accordance with CEC's established schedule. There can be no guarantee that CEC's estimates will prove accurate, and actual results could differ significantly because of the non-compliance of third parties of business importance to CEC. Results of Operations--Year 1998 Compared to 1997 and 1997 Compared to 1996 Oil and Gas Revenues. The following table shows comparative revenues, sales volumes, average prices and the percentage changes between periods for natural gas, oil, and plant liquids for 1998, 1997, and 1996.
Year ended November Year ended November 30, 30, -------------------- -------------------- % % 1998 1997 Change 1997 1996 Change ------ ------ ------ ------ ------ ------ Natural gas revenues M$.............. 2,367 2,281 4% 2,281 2,168 5% Oil Revenues M$...................... 491 591 -17% 591 380 55% Plant liquids revenues M$............ 377 579 -35% 579 545 7% Natural gas sales volumes: Millions of cubic feet............. 1,147 1,244 -8% 1,244 1,502 -17% Mcf/day............................ 3,142 3,408 3,408 4,115 Oil sales volumes: Barrels............................ 26,552 22,624 17% 22,624 14,436 57% Barrels/day........................ 73 62 62 40 Plant liquids sales volumes: Barrels............................ 25,805 26,301 -2% 26,301 28,223 -7% Barrels/day........................ 71 72 72 77 Average price received: Natural gas--$/Mcf................. 2.06 1.83 13% 1.83 1.44 27% Oil--$/Barrel...................... 18.49 26.10 -29% 26.10 26.34 -1% Plant liquids--$/Barrel............ 14.61 22.03 -35% 22.03 19.28 14%
Natural gas revenues in 1998 were 4% higher than in 1997. Natural gas prices were 13% higher and natural gas sales volumes were 8% lower due to a gas processing plant and compressor down time and normal well productivity decline. Revenues from oil were 17% lower in 1998 compared to 1997 because of a 29% decrease in oil prices, partially offset by a 17% increase in volume. Natural gas processing plant liquids sales volumes declined slightly from 1997 to 1998 due to lower natural gas production. Revenues were lower due to lower oil and natural gas liquids prices in 1998 versus 1997. Natural gas revenues for 1997 were 5% higher than 1996 because of 27% higher average prices which more than offset 17% lower gas sales volume due to well productivity decline. Revenues from oil were 55% higher in 1997 compared to 1996 because of a 57% increase in sales volumes due to a new oil well. Plant liquids sales volumes decreased 7% and natural gas liquids prices increased 14% in 1997 compared to 1996. Royalty expense consists primarily of Crown royalties in addition to freehold and gross overriding royalties. CEC is eligible for the ARTC that varies inversely with prevailing prices for oil and gas sales in Alberta. For 1998 the net Crown royalty rate was 6% of oil and gas sales compared to 8% in 1997. This decrease was attributed to a 13% increase from 1997 to 1998 in the gas sales price received by CEC coupled with a 4% decrease from 1997 to 1998 in the reference price used to calculate Crown royalty expense. 47 Field Services Business Segment. CEC receives operating service revenue generated by its share of processing fees at the Carbon area liquid extraction plant. CEC also processes its own gas, and that portion of the processing fee revenue attributable thereto is not reported in this segment and offsets an identical amount of process expense otherwise chargeable to lease operations. The Carbon plant also processes gas of unrelated third parties which in 1998 amounted to approximately 37% of the plant's volumes and represents the majority of field services profit. CEC also derives revenues and net cash flow from separate gathering and compression facilities in which it has ownership. Amounts applicable to CEC's own production have likewise been eliminated from both revenue and expense of these operations. Lease Operating Expense. Lease operating expenses for 1998 were 22% as a percentage of oil and gas sales compared to 17% for 1997 and 20% for 1996. The increase in 1998 compared to 1997 is attributed to well workovers and a full year of production of oil wells in CEC's Hoffer area and additional compression in the East Carbon area. This increase was partially offset by variable expense decreases related to production declines. Lease operating expenses per boe sold were $2.92, $2.27 and $2.12 for 1998, 1997 and 1996, respectively. This trend is attributed to increased well workovers and fixed costs allocated to a declining production base. CEC has always followed the U.S. practice of converting its natural gas to boe based on the heating value ratio of six mcf of natural gas to one barrel of oil rather than a ratio of 10 to 1 which historically has approximated price ratios. The latter ratio is used almost exclusively by Canadian public companies. CEC's share of processing fees charged to its wells have been deducted from its field services revenues where CEC's one-third Carbon plant ownership is involved. Field netbacks which are commonly reported by Canadian energy companies equate to oil and gas sales less royalties and lease operating expenses. CEC's average field netback was $9.23/boe in 1998, $9.69/boe in 1997 and $7.68/boe in 1996. If natural gas had been converted to oil using the Canadian practice of a 10:1 ratio, then reported field netbacks would have been $13.45/boe in 1998, $14.32/boe in 1997 and $11.67/boe in 1996. General and Administrative Expenses. G&A expenses relate to the direct costs of CEC which do not originate from either its operation of properties or the providing of services. Historically CEC had incurred certain direct and indirect G&A costs for management services provided by Columbus Energy. These costs were primarily for labor, related benefits and other overhead costs. G&A costs increased by $223,000 in 1998 compared to 1997 primarily due to the hiring of full time employees, which was partially offset by a reduction in Columbus expenses. The management agreement with Columbus was terminated on March 31, 1999. Depreciation, Depletion and Amortization Expense. DD&A costs of oil and gas assets are determined based upon the units of production method. Natural gas gathering, compression and processing facilities are depreciated on a straight line method. For 1998, the depletion rate of oil and gas properties was $4.02 per boe for CEC, compared to $3.01 per boe for 1997, and $2.15 per boe for 1996. The 1998 increase in the depletion rate was primarily due to a downward adjustment to CEC's year end proved reserves. The above calculated amounts for 1998, 1997 and 1996 include $62,000, $33,000 and $30,000 respectively, for estimated future site restoration costs. Interest Expense. Interest expense in 1998 compared and 1997 was minimal due to the fact that the company maintained significant cash balances and no borrowings. Exploration Activities Under the full cost method of accounting, all exploration costs associated with continuing efforts to acquire or review prospects and outside geological and seismic consulting work are capitalized. A total of $54,000 of exploration costs were capitalized during 1998. These charges include seismic and consulting costs in the 48 Carbon, East Carbon and Harmon areas of Alberta. A total of $230,000 of exploration costs were capitalized during 1997. These charges included seismic costs in the Maxim area of Saskatchewan and in the East Carbon area of Alberta. Exploration costs capitalized in 1996 were $181,000, primarily in the Hoffer area of Saskatchewan and for seismic cost in the Carbon field. Income Taxes In 1997, CEC adopted CICA 3465, Income Taxes. Since 1993, CEC has paid current taxes to Revenue Canada based on its taxable income after utilization, to the extent allowed, of its tax pool carryforwards. Currently payable taxable income for future periods is dependent upon the level and type of capital expenditures that are incurred in these periods as well as percentage limitations for utilization of existing tax pools. For 1998, current income taxes are estimated to be $19,000. For the 1997 and 1996 fiscal years CEC paid no current federal tax because additions to deductible property tax pools and carryover balances were sufficient to result in no taxable income. Effects of Changing Prices The Canadian economy experienced considerable inflation during the late 1970's and early 1980's but in recent years inflation has been fairly stable at relatively low levels. CEC, along with most other business enterprises, was then and will be affected in the future by any recurrence of such inflation. Changing prices, or a change in the Canadian dollar's purchasing power, distorts the traditional measures of financial performance which are generally expressed in terms of the actual number of dollars exchanged and do not take into account changes in the purchasing power of the monetary unit. This results in the reporting of many transactions over an extended period as though the dollars received or expended were of common value, which does not accurately portray financial performance. Inflation, as well as a recessionary period, can cause significant swings in the interest rates that companies pay on bank borrowings. These factors are anticipated to continue to affect CEC's operations both positively and negatively for the foreseeable future. Oil and gas prices fluctuate over time as a function of market economics. Refer to the price change table in the discussion "Oil and Gas Operations Comparisons 1998, 1997 and 1996" for information on product price fluctuation over the past three years. This table depicts the effect of changing prices on CEC's revenue stream. Operating expenses have been relatively stable but are a critical component of profitability since they represent a larger percentage of revenues when lower product prices prevail. Competition in the industry can significantly affect the cost of acquiring leases, although in recent years this factor has been less important as more operators have withdrawn from active exploration programs. Exchange Rate of the Canadian Dollar All dollar amounts set forth in the CEC report are in Canadian dollars except where otherwise indicated. The following table sets forth the rates of exchange for the Canadian dollar, expressed in United States dollars:
Year Ended November 30, ---------------------------------- 1998 1997 1996 1995 1994 ------ ------ ------ ------ ------ Rate at end of period........................ 0.6563 0.7021 0.7414 0.7362 0.7272 Average rate during period................... 0.6785 0.7251 0.7331 0.7278 0.7347 High......................................... 0.7105 0.7292 0.7515 0.7474 0.7632 Low.......................................... 0.6343 0.7019 0.7215 0.7025 0.7167
49 Properties Estimated Oil and Gas Reserve Quantities and Revenues The estimated reserve amounts and future net revenues for 1998 were determined by Sproule Associates Limited, an independent geological and petroleum engineering firm, and for 1997 and 1996 by Reed Ferrill & Associates, an independent petroleum engineering firm. CEC owned only Canadian reserves during the periods. CEC's reserves are sensitive to natural gas and oil sales prices and their effect on economic production rates and are based on the spot market price in effect at year end and the sales prices of long-term contracts in effect prior to year-end. Price declines decrease reserve values by lowering the future net revenues attributable to the reserves and reducing the quantities of reserves that are recoverable on an economic basis. Price increases have the opposite effect. A significant decline in prices of oil or natural gas could have a material adverse effect on CEC's financial condition and results of operations. Proved developed reserves are proved reserves that are expected to be recovered from existing wells using existing equipment and operating methods. Proved undeveloped reserves are proved reserves that are expected to be recovered from new wells drilled to known reservoirs on undrilled acreage for which the existence and recoverability of such reserves can be estimated with reasonable certainty, or from existing wells where a relatively major expenditure is required to establish production. Future prices received from production and future production costs may vary, perhaps significantly, from the prices and costs assumed for purposes of these estimates. There can be no assurance that the proved reserves will be developed within the periods indicated or that prices and costs will remain constant. There can be no assurance that actual production will equal the estimated amounts used in the preparation of reserve projections. The present values shown should not be construed as the current market value of the reserves. The 10% discount factor used to calculate present value, which is specified by the Securities and Exchange Commission, is not necessarily the most appropriate discount rate, and present value, no matter what discount rate is used, is materially affected by assumptions as to timing of future production, which may prove to be inaccurate. For properties operated by CEC, expenses exclude CEC's share of overhead charges. In addition, the calculation of estimated future net revenues does not take into account the effect of various cash outlays, including among other things general and administrative costs and interest expense. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures. Oil and natural gas reserve engineering must be recognized as a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact way, and estimates of other engineers might differ materially from those shown above. The accuracy of any reserve estimate is a function of the quality of available data and engineering and geological interpretation and judgment. Results of drilling, testing and production after the date of the estimate may justify revisions. Accordingly, reserve estimates are often materially different from the quantities of oil and natural gas that are ultimately recovered. The meaningfulness of such estimates depends primarily on the accuracy of the assumptions upon which they were based. In general, the volume of production from oil and gas properties CEC owns declines as reserves are depleted. Except to the extent CEC acquires additional properties containing proved reserves or conducts successful exploration and development activities or both, the proved reserves will decline as reserves are produced. 50 Changes in Proved Oil and Gas Reserves
Natural Gas Oil and Liquids (Millions (Thousands of of Cubic Barrels) Feet) --------------- ----------- Proved Reserves: November 30, 1995................................. 363 23,115 Revision to previous estimates.................. (9) (2,664) Extensions, discoveries, and other additions.... 366 414 Sales and abandonments.......................... 0 (217) Production...................................... (40) (1,468) ---- ------ November 30, 1996................................. 680 19,180 Revision to previous estimates.................. (271) (2,020) Extensions, discoveries, and other additions.... 7 331 Production...................................... (46) (1,217) ---- ------ November 30, 1997................................. 370 16,274 Revision to previous estimates.................. (56) (9,510) Extensions, discoveries, and other additions.... 57 400 Production...................................... (49) (1,123) ---- ------ November 30, 1998................................. 322 6,041 ==== ====== Proved developed reserves (producing and non- producing): November 30, 1996................................. 513 16,068 November 30, 1997................................. 287 13,180 November 30, 1998................................. 285 4,439
Proved Developed Producing Reserves At November 30, 1998, CEC had approximately 3.9 billion cubic feet of proved developed producing gas reserves which represents 65% of CEC's total proved gas reserves. CEC also has approximately 144,000 barrels of oil and 81,000 barrels of natural gas liquids catagorized as proved developed producing reserves which together represent 70% of CEC's total proved oil reserves. Proved Developed Non-Producing Reserves At November 30, 1998, CEC had approximately 500 million cubic feet of proved developed non-producing gas reserves representing 9% of its total proved gas reserves. CEC's oil and liquids reserves in this category are approximately 60,000 barrels or 19% of its total proved oil reserves. The reserves in this category are primarily reserves behind the casing in existing wells and recompletion of those zones will be required to place them on production. Also included are any wells which have been completed and were awaiting connection to a gas pipeline as of year end, provided such pipeline connection does not require significant investment. Proved Undeveloped Reserves At November 30, 1998, CEC's proved undeveloped reserves total approximately 1.6 billion cubic feet of gas, or 26% of its total proved natural gas reserves, and approximately 38,000 barrels of oil and liquids, or 11% of its total proved oil reserves. These reserves are attributable to wells which have been completed and were awaiting pipeline connection as of the end of the year where such pipeline connection would require significant investment and also undrilled locations offsetting production in the Carbon, East Carbon, Harmon and Rowley areas of Alberta. 51 Probable Reserves At November 30, 1998, CEC's probable natural gas reserves are approximately 600 million cubic feet. CEC's oil and natural gas liquids reserves in this category are approximately 6,000 barrels. The reserves in this category are primarily reserves which may reasonably be assumed to exist because of geophysical or geological indications and drilling performed in the regions which contain proven reserves. The reserves in this category are not included in the schedule of Standardized Measure of Discounted Future Net Cash Flow (the "Standardized Measure"). Comparison of Proved Reserves The following table compares CEC's estimated proved reserves at November 30, 1997 and 1998.
Oil and Natural Liquids Gas (Thousands (Millions of of Cubic Barrels) Feet) ---------- --------- Proved Reserves: November 30, 1997 Proved developed producing............................... 252 5,342 Proved developed non-producing........................... 35 7,838 Proved undeveloped....................................... 83 3,094 --- ------ Total.................................................. 370 16,274 === ====== November 30, 1998 Proved developed producing............................... 225 3,896 Proved developed non-producing........................... 60 543 Proved undeveloped....................................... 37 1,602 --- ------ Total.................................................. 322 6,041 === ======
The decrease in proved developed producing reserves from 1997 to 1998 is primarily due to 1998 production. The majority of the decrease in proved developed non-producing and proved undeveloped reserves is due to the following factors: The unsuccessful completion of a well in the East Carbon area resulted in more stringent reservoir engineering interpretations of log characteristics and analogous production in two natural gas zones. The unsuccessful completion also disproved a geological hypothesis that was formerly presumed in the determination of proved undeveloped reserves in these two natural gas zones. In 1998, a zone in the East Carbon area was remapped due to new offset well information, resulting in geologic interpretations that did not support the assignment of proved reserves for a location. Standardized Measure The Standardized Measure schedule is presented below pursuant to the disclosure requirements of the Securities and Exchange Commission and Statement of Financial Accounting Standards No. 69, "Disclosures About Oil and Gas Producing Activities" (SFAS 69). Future cash flows are calculated using year-end oil and gas prices and operating expenses, and are discounted using a 10% discount factor. Under SEC guidelines, Future Net Revenues shown below must be calculated using prices that were in effect on November 30 of each year and are projected forward based on existing contracts or the spot market price on that date. Accordingly, the Future Net Revenues have been calculated using the spot market sales price in effect at year end and the sales prices of long-term contracts in effect prior to year end. 52 The prices utilized in this calculation for Future Net Revenues at November 30, 1998 are summarized as follows: Natural Gas 1998....................... $ 2.80/mcf 1999....................... 2.69/mcf 2000....................... 2.60/mcf 2001....................... 2.58/mcf 2002-forward............... 2.49/mcf Ngl........................ $12.67/barrel Oil........................ $16.94/barrel
The standardized measure is intended to provide a standard of comparable measurement of CEC's estimated proved oil and gas reserves based on economic and operating conditions existing as of November 30, 1998, 1997 and 1996. Pursuant to SFAS 69, the future oil and gas revenues are calculated by applying to the proved oil and gas reserves the oil and gas prices at November 30 of each year relating to such reserves. Future price changes are considered only to the extent provided by contractual arrangements in existence at year end. Production and development costs are based upon costs at each year end. Future income taxes are computed by applying statutory tax rates as of the year end with recognition of tax basis, resource allowance, tax pool carryforwards and earned depletion carryforwards as of that date and relating to the proved properties. Discounted amounts are based on a 10% annual discount rate. Changes in the demand for oil and gas, price changes and other factors make such estimates inherently imprecise and subject to revision. Standardized Measure of Discounted Future Net Cash Flows Relating to Estimated Proved Oil and Gas Reserves (thousands of dollars)
1998 1997 1996 ------- ------- ------- Future oil and gas revenue.......................... $20,403 $31,984 $59,858 Future cost: Production cost................................... (4,619) (7,620) (10,521) Crown royalty..................................... (1,772) (5,515) (9,982) Development cost.................................. (682) (1,260) (1,712) Future income taxes................................. (2,559) (3,039) (9,144) ------- ------- ------- Future net cash flows............................... 10,771 14,550 28,499 Discount at 10%..................................... (2,599) (4,584) (10,800) ------- ------- ------- Standardized measure of discounted future net cash flows.............................................. $ 8,172 $ 9,966 $17,699 ======= ======= =======
As required by SFAS 69, the tax computation does not consider CEC's annual interest expense and general and administrative expenses or future drilling and equipment costs. Because of these factors, the tax provisions shown do not represent the much lower future tax expense expected as long as CEC remains an active operating company. 53 Change in Standardized Measure of Discounted Future Net Cash Flows from Estimated Proved Oil and Gas Reserves For the Three Years Ended November 30, 1998 (thousands of dollars)
November 30, ---------------------- 1998 1997 1996 ------- ------- ------ Standardized measure--beginning of year................. $ 9,966 $17,699 $9,286
Sale of oil and gas net of production costs.......... (2,248) (2,482) (2,250) Net changes in prices, crown royalty and production costs .............................................. 8,457 (8,672) 11,238 Extensions, discoveries and other additions.......... 787 358 4,936 Sales and abandonments............................... -- 0 (129) Revisions to previous estimates...................... (11,135) (2,207) (3,590) Previously estimated development costs incurred during the period .................................. -- 90 411 Changes in development costs......................... 586 316 (49) Accretion of discount................................ 1,131 2,242 1,066 Other................................................ 794 (758) 133 Change in future income tax.......................... (166) 3,380 (3,353) ------- ------ ------- Net increase (decrease).............................. (1,794) (7,733) 8,413 ======= ====== ======= Standardized measure--end of year.................... $ 8,172 $9,966 $17,699 ======= ====== =======
Production CEC's net oil and gas production for each of the past three years is shown on the following table:
Year ended November 30, -------------------- 1998 1997 1996 ------ ------ ------ Oil--barrel.......................................... 25,000 22,000 15,000 Ngl--barrel.......................................... 24,000 24,000 25,000 Gas--Mmcf............................................ 1,124 1,217 1,468
Average price and cost per unit of production for the past three years are as follows (gas prices include net hedging gains and losses):
Year Ended November 30, -------------------- 1998 1997 1996 ------ ------ ------ Average sales price per barrel of oil............... $18.49 $26.10 $26.34 Average sales price per mcf of gas.................. 2.06 1.83 1.44 Average sales price per barrel of Ngl............... 14.61 22.03 19.28 Average production cost per boe..................... 3.01 2.33 2.17
Natural gas is converted to oil at the ratio of six mcf of natural gas to one barrel of oil. Production costs include only lease operating expenses. Gas sales are generally made pursuant to gas purchase contracts with unrelated third parties. Our gas sales are subject to price adjustment provisions of the gas purchase contracts as well as general economic and political conditions affecting the production and price of natural gas. Developed Properties and Acreage A summary of the gross and net interest in producing wells and gross and net interest in producing acres as of November 30, 1998 is shown in the following table:
Gross Net ------- ------- Oil Gas Oil Gas --- --- --- --- Wells..................................................... 16 47 5 19 === === === === Acres..................................................... 18,876 6,993 ====== =====
54 Undeveloped Acreage The following table sets forth CEC's ownership in undeveloped acreage as of November 30, 1998:
Gross Acres Net Acres ----------- --------- Alberta............................................. 7,360 3,242 Saskatchewan........................................ 9,840 4,710 ------ ----- Total Undeveloped Acreage....................... 17,200 7,952 ====== =====
Drilling Activities CEC engages in exploratory and development drilling on its own and in association with other oil and gas companies. The table below sets forth information regarding CEC's drilling activity for the last three years. The net interest shown is CEC's working interest.
Year Ended November 30, ------------------------------- 1998 1997 1996 --------- ---------- ---------- Gross Net Gross Net Gross Net ----- --- ----- ---- ----- ---- EXPLORATORY Wells Drilled: Oil........................................... -- -- -- -- 3 1.50 Gas........................................... -- -- 1 0.60 2 0.67 Dry........................................... -- -- -- -- 1 0.20 DEVELOPMENT Wells Drilled: Oil........................................... -- -- 1 0.50 -- -- Gas........................................... -- -- 1 1.00 6 2.83 Dry........................................... -- -- -- -- -- -- TOTAL Wells Drilled: Oil........................................... -- -- 1 0.50 3 1.50 Gas........................................... -- -- 2 1.60 8 3.50 Dry........................................... -- -- -- -- 1 0.20 --- --- --- ---- --- ---- -- -- 3 2.10 12 5.20 === === === ==== === ====
Current Operations Activity CEC engages in the exploration, development and production of crude oil and natural gas and acquires and develops leaseholds and other interests in oil and gas properties in the provinces of Alberta and Saskatchewan. CEC owns working interests in 16 oil wells located in Saskatchewan, Canada and 47 natural gas wells located in Alberta, Canada. CEC also has ownership interests in a natural gas processing plant and several gas gathering and compression systems in Alberta. Prior to the end of 1998, substantially all of CEC's oil and gas properties were operated by other industry companies. With certain acquisitions completed in fiscal 1999, CEC has increased the percent of oil and gas properties which it operates. CEC's business strategy is to grow through exploitation of existing oil and gas properties by development of proved non-producing and proved undeveloped reserves; acquisitions of complementary working interests in existing and adjacent properties; and optimization of gathering, compression and processing facilities. CEC will also conduct oil and gas exploration activities in its core area of operations. In addition CEC will evaluate acquisition and merger opportunities in Canada and the United States. Acquisition Activities. See "CEC Management's Discussion and Analysis of Financial Condition and Results of Operations"--"Acquisitions." 55 Legal Proceedings There are no material legal proceedings pending or, to our knowledge, threatened against CEC. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure PricewaterhouseCoopers LLP were engaged as CEC's independent auditors for the 1998 fiscal year. On April 16, 1999, CEC, upon approval of its Board of Directors, determined that the appointment of PricewaterhouseCoopersLLP should not be renewed and that Arthur Andersen LLP should be proposed to CEC's shareholders as its independent auditors for the 1999 fiscal year. The President and Chief Executive Officer of CEC, as well as the Chief Financial Officer, both of whom joined CEC during the last half of 1998, have a previous relationship with Arthur Andersen LLP as a result of work at another oil and gas company. In addition for fiscal 1999, Arthur Andersen LLP proposed a fee structure for the year end audit, quarterly reviews and accounting consultation that was economically beneficial to CEC. During CEC's two most recent fiscal years and subsequent interim period preceding this determination, there were no disagreements with the former auditors on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. The auditors' report during CEC's two most recent fiscal years preceding this determination did not contain an adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope or accounting principles. Quantitative and Qualitative Disclosures about Market Risk Interest Rate Risk In 1999, CEC established a $6.5 million credit facility with a Canadian bank as described in "CIBC Relationship" under "CEC Management's Discussion and Analysis of Financial Condition and Results of Operations". The interest rate for borrowings under this facility are variable. Foreign Currency Risk CEC's operations, except for certain administration functions performed in its Denver, Colorado office, are conducted in Canada. CEC does not use financial instruments relating to currency and exchange rates. For information on the exchange rate of the Canadian dollar, refer to "Exchange Rate of the Canadian Dollar" under "CEC Management's Discussion and Analysis of Financial Condition and Results of Operations." Commodity Price Risk CEC uses certain financial instruments in an attempt to manage commodity price risk. CEC attempts to manage these risks by minimizing its commodity price exposure through the use of derivative contracts as described in Note 9 to the November 30, 1998 Financial Statements of CEC and Note 5 to the August 31, 1999 Financial Statements of CEC. Gains and losses on these contracts are deferred and recognized in income as an adjustment to oil and gas sales revenues during the period in which the physical product to which the contracts relate is actually sold. Oil and gas commodity markets are influenced by global as well as regional supply and demand. Worldwide political events can also impact commodity prices. Management's policy is to mitigate its exposure to fluctuations in sales prices received for natural gas production through the use of various hedging tools. These tools include, but are not limited to: commodity futures and option contracts; fixed-price swaps; basis swaps; and term sales contracts. Contract terms generally range from one month to three years. While we mitigate our exposure to declining natural gas sales prices, we may be subject to lost opportunity costs resulting from increasing natural gas prices in excess of those committed. Should production from existing facilities under existing operating conditions not fulfill committed contracts, we may be required to acquire natural gas in the open market, while volumes produced in excess of those contracted are sold at market prices. 56 INFORMATION ABOUT CARBON Business Carbon was incorporated on September 14, 1999 under the Colorado Business Corporation Act and has its principal executive offices in Denver, Colorado. Our business is currently comprised of the assets and properties of BFC, which were acquired on October 29, 1999 in a stock purchase. On August 11, 1999, CEC entered into a stock purchase agreement with BPC which provided for the purchase by CEC from BPC of all outstanding shares of BFC for $23,857,951 in cash, subject to certain adjustments. The purchase of BFC stock under the stock purchase agreement was completed by Carbon rather than CEC. Rights and obligations of CEC under the stock purchase agreement were assigned to Carbon. Yorktown purchased 4,500,000 shares of Carbon for $24,750,000. The funds from this purchase were used to acquire the BFC shares under the stock purchase agreement and pay expenses incurred in connection with the purchase and related transactions. As described above, we now own all of the stock of BFC. As the parent company of BFC, we provide management and other services to BFC. Carbon itself has not engaged in other activities, except for the acquisition of BFC and preparations for the exchange offer made by this prospectus. BFC was an independent oil and gas company engaged in the exploration, development, and production of natural gas and crude oil. All of the properties and activities described below were acquired or conducted by the prior management of BFC. Through our acquisition of BFC, our activities are currently concentrated in the Piceance and Uintah Basins in northwestern Colorado and eastern Utah, the San Juan Basin in northwest New Mexico, the Permian Basin in southeast New Mexico and western Texas, and southwestern Kansas. BFC owns working interests in approximately 292 oil and gas wells, of which, approximately 190 wells are operated by BFC. BFC employs a staff of oil and gas professionals to manage its operations. Our oil and gas properties are located in the western United States and are principally natural gas properties as discussed below and in "Properties." Piceance and Uintah Basins The Piceance and Uintah Basins have been core production areas since BFC's inception. The productive formations are the Morrison, Dakota, Mancos, Castle Gate, Mesa Verde and Wasatch formations. All of these formations produce natural gas; however, in some areas, the Castle Gate sands formations are known to contain oil reserves. We operate 132 wells and own working interests in 146 wells in the Piceance Basin in Colorado and the Uintah Basin in Utah. Carbon has not drilled any wells in these basins during 1999, however, additional drilling locations have been identified for further analysis and possible future drilling. We have leasehold rights in approximately 164,000 gross and 122,500 net acres of which approximately 41,500 gross and 37,500 net acres are undeveloped. San Juan Basin Production in the San Juan Basin of northwest New Mexico is predominantly natural gas. The primary productive formations on our acreage is the Dakota, Gallup, Pictured Cliffs, and Fruitland (Coal Sands). We operate 41 wells and own working interests in 42 wells in the San Juan Basin. We have lease rights in approximately 5,200 gross and 2,600 net acres, all of which are developed. Permian Basin Our well interests in the Permian Basin are both operated and non-operated in nature. We own working interests in 76 wells in the Permian Basin and operate 11 of these wells. During 1999 we have participated in the drilling of five wells, all of which were completed or are in the process of being completed as producing gas wells. Additional wells are scheduled for drilling during the balance of 1999. We have lease rights in approximately 23,500 gross and 11,500 net acres, of which 1,400 gross and 1,000 net acres are undeveloped. 57 Southwestern Kansas The main exploratory efforts of the company are concentrated in southwestern Kansas. We own working interests in 28 wells and operate 4 wells in this area. We are conducting regional geologic and geophysical work to identify additional drilling prospects. We are also currently conducting leasing to acquire acreage covering the most attractive prospects. We have lease rights in approximately 33,000 gross and 25,500 net acres of which 30,000 gross and 24,500 net acres are undeveloped. Carbon Selected Financial Data The table below sets forth our selected historical financial and operating data as of the dates and for the periods indicated. All the historical financial data in the table is that of our predecessor, BFC. The historical financial data for the six months ended June 30, 1998 and June 30, 1999 were derived from BFC's unaudited financial statements. The historical financial data for each of the years in the five-year period ended December 31, 1998 were derived from BFC's financial statements, which were audited by Hein + Associates LLP. Currency amounts are in U.S. dollars unless otherwise stated. The information set forth below should be read in conjunction with "Our Management's Discussion and Analysis of Financial Condition and Results of Operations" and BFC's Financial Statements and notes thereto, included elsewhere in this prospectus.
As of or for the Six Months Ended As of or for the June 30, Year Ended December 31, ------------------ --------------------------------------------- 1999 1998 1998 1997 1996 1995 1994 -------- -------- ------- ------- ------- ------- ------- (in thousands) Operating Data: Revenues............... $ 14,728 $ 8,026 $21,092 $16,539 $15,067 $12,675 $14,956 Net earnings (loss).... 150 596 (1,941) 732 4,060 172 (2,950) Cash Flow Data: Cash provided by (used in) operating activities............ $(1,529) $ 2,092 $ 4,696 $ 3,193 $ 4,136 $ 3,016 $ 3,091 Cash used in investing activities............ (3,619) (2,396) (5,948) (4,442) (1,025) (859) (1,181) Cash provided by (used in) financing activities............ 2,850 600 3,450 1,019 (2,760) (2,090) (2,046) Balance Sheet Data: Total assets........... $20,924 $16,642 $22,840 $16,054 $14,524 $13,177 $16,321 Working capital........ 1,488 1,246 812 1,491 1,725 628 405 Long-term debt, excluding current maturities............ 8,700 3,000 5,850 2,400 1,700 4,760 6,850 Stockholder's equity(1)............. 9,464 10,196 9,313 9,591 8,859 6,774(1) 6,552(1)
- -------- (1) Includes debt to parent company (BPC) of $3,787 in 1995 and $3,737 in 1994, which was converted to equity in 1996. Our Management's Discussion and Analysis of Financial Condition and Results of Operations Our financial statements and related notes included in this prospectus are those of our predecessor, BFC. The discussion below summarizes our financial condition and results of operations and should be read in connection with the financial statements and related notes of BFC. Results of Operations--Six Months Ended June 30, 1999 Compared to the Six Months Ended June 30, 1998 The period-to-period comparisons set forth below are based upon the results of operation of BFC under its prior management. As a result of that and the anticipated acquisition of CEC through the exchange offer, we believe that the period-to-period comparisons set forth below may not be indicative of our future results of operation. Revenues for the first six months of 1999 totaled $14,728,000, a $6,702,000 or 84% increase from the prior year period amount of $8,026,000. The increase was due primarily to higher natural gas production from existing wells and newly drilled wells, from higher natural gas prices and increased marketing service activity. Net income in the first six months of 1999 was $150,000 compared to net income of $596,000 in the first six 58 months of 1998. The decrease in net income is primarily due to increased lease operations expense, increased general and administrative expense and increased exploration expense, partially offset by increased gas sales and increased margins on marketing service activity. Oil and Gas Revenues. The following table shows comparative revenues, sales volumes, average prices and percentage changes between periods, for natural gas and oil for the first six months of 1999 and 1998.
Six Months Ended June 30, ---------------------- 1999 1998 % Change ------ ------ -------- Natural gas revenues M$........................... 4,111 2,938 40% Oil revenues M$................................... 449 530 -15% Natural gas sales volumes: Millions of cubic feet.......................... 2,121 1,607 32% MCF/day......................................... 11,718 8,878 Oil sales volumes: Barrels......................................... 33,700 37,200 -9% Barrels/day..................................... 186 206 Average price received: Natural gas--$/Mcf.............................. 1.94 1.76 10% Oil--$/Barrel................................... 13.33 14.25 -6%
Natural gas revenues for the first six months of 1999 increased 40% over the first six months of 1998 because of a 10% price increase and a 32% increase in sales volumes. The increase in sales volumes were primarily due to successful drilling and recompletion results in various basins, particularly in western Kansas and in the Permian Basin of New Mexico, partially offset by production declines on existing properties. Oil revenues were 15% lower for the first six months of 1999 compared to the first six months of 1998 because of a 6% price decrease and a 9% decline in sales volumes. Average daily oil and gas production for the first six months of 1999 totaled 186 barrels of oil per day and 11,718 mcf of gas per day, an increase of 27% on an barrel of oil equivalent basis (6:1) from the same period in 1998. Carbon's current drilling activity and continued success with the exploitation of properties has resulted in increasing production for the first six months of 1999. Exploitation and drilling activities are expected to continue for the balance of 1999. Average oil prices decreased 6% from $14.25 per barrel in the first six months of 1998 to $13.33 in 1999. Average natural gas prices increased 10% from $1.76 per mcf for the first six months of 1998 to $1.94 per mcf in 1999. Oil and Gas Production Costs. Oil and gas production costs consist of lease operating expense and severance taxes. Oil and gas production costs for the first six months of 1999 were 42% as a percentage of oil and gas sales compared to 39% for the first six months of 1998. Oil and gas productions costs for the first six months of 1999 and 1998 were $4.98 and $4.47 respectively, per boe. The primary reason for the overall increase was the accrual of natural gas gathering system well connect fees of $250,000 in 1999. The fees are a result of a 1997 agreement which contained a contingency clause whereby certain costs would be reimbursed to the party providing the well connections if various production levels were not attained. These levels will not be attained. Gas and Electrical Marketing. Gas and electrical marketing revenue increased 127.5% in the first six months of 1999 compared to the first six months of 1998. Gas and electrical marketing related expenses increased 120.9% in the first six months of 1999 compared to the first six months of 1998. The primary reason for the increase is a management contract in place during the first quarter of 1999 for the purchase and sale of a high volume of natural gas. The contract was not in place in the first quarter of 1998, and was terminated on April 30, 1999. 59 General and Administrative Expenses. G&A expenses related to the direct costs of BFC which do not originate from either its operation of properties or the providing of services and are presented net of amounts billed to unrelated third parties. G&A expenses increased by $520,000 for the first six months of 1999, compared to 1998. The primary reason for the increase is due to increased staffing related to new capital programs. Depreciation, Depletion, Amortization and Impairment Expense. DD&A of oil and gas assets are determined based upon the units of production method. This expense is primarily dependent upon the historical capitalized costs incurred to find, develop, and recover oil and gas reserves. For the first six months of 1999 the depletion rate was $3.42 per boe (6:1) compared to $3.54 per boe for the first six months of 1998. For the first six months of 1999 impairment losses were $60,000, relating to a property drilled in Oklahoma in 1998. There were no impairment losses recorded for the first six months of 1998. Interest Expense. For the first six months of 1999, interest expense was $251,000 compared to $85,000 for the first six months of 1998. The increase is primarily due to higher levels of borrowing to finance drilling activity. BFC capitalized $20,000 of interest in the first six months of 1999 which related to calendar year 1998 interest charges and $44,000 of interest in the first six months of 1999 related to drilling activity. Exploration Expense. Exploration expense was recorded under the successful efforts method of accounting and primarily consists of unsuccessful drilling costs and Geological and Geophysical ("G&G") costs. For the first six months of 1999 exploration expense was $638,000 compared to $183,000 for the first six months of 1998. Unsuccessful drilling costs amounted to $199,000 for the first six months of 1999 compared to $25,000 for the first six months of 1998. Liquidity and Capital Resources Management considers our liquidity to be favorable compared to other oil and gas companies based on the fact BFC has positive working capital and a credit facility with U.S. Bank. The purpose of the loan is to provide financing for the acquisition of oil and gas reserves and for normal operating requirements. The facility is collateralized by certain oil and gas properties of the Company and is scheduled to convert to a term note July 1, 2001. This term loan is scheduled to have a maturity of either the economic half life of BFC's remaining reserves on the date of the conversion, or July 1, 2006, whichever is earlier. The borrowing base is based upon the lender's evaluation of BFC's proved oil and gas reserves, generally determined semi-annually. The future minimum principal payment under the term note will be dependent upon the bank's evaluation of BFC's reserves at that time. The borrowing base was $16.9 million at June 30, 1999 with interest at a variable rate that approximated 6.70% at June 30, 1999. BFC has issued letters of credits totaling $2.5 million which further reduce the amount available for borrowing under the base. In October, 1999, we sold 4,500,000 shares of our common stock to Yorktown for $24,750,000 of which $23,857,951 was used to purchase the stock of BFC on October 29, 1999 and the remaining proceeds have been added to our working capital. For the six months ended June 30, 1999, net cash used in operating activities was $1,529,000 compared to net cash provided by operating activities of $2,092,000 for the same period in 1998. This decrease is primarily due to changes in operating assets and liabilities. Cash used in investing activities was $3,619,000 for the six months ended June 30, 1999 compared to $2,396,000 for the same period in 1998. This increase was primarily due to additions of oil and gas properties. Net cash provided by financing activities for the six months ended June 30, 1999 was $2,850,000 due to an increase in net bank borrowings used to fund capital expenditures. 60 Income Taxes. Carbon accounts for income taxes under the liability method which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. BFC's operations were formerly included in BPC's consolidated tax return. Income taxes were allocated to BFC as if BFC was a separate taxpayer. BFC has not accrued an estimate for income taxes for the six months ended June 30, 1999 as it is anticipated that estimates of taxes due for the period are offset by intangible drilling costs. Year 2000 Compliance The Year 2000 issue is the result of computer programs being written using two digits rather than four, or other methods, to define the applicable year. Computer programs that have date sensitive software may recognize a date using "00" as the year 1900, rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including among other things, a temporary inability to price transactions, send invoices or engage in similar normal business activities. In addition to affecting mainframe and mid-range computer systems, this problem potentially impacts computer chips integrated in security, plant automation, and pipeline control and metering systems. Our company has made inquiries of the suppliers and manufacturers of its computer systems, including equipment supplied by third parties, and has been advised that such systems are Year 2000 compliant except for our property management software that is currently under review regarding Year 2000 compliance. Management expects costs for Carbon to become Year 2000 compliant will not be significant. However, despite Carbon's efforts to identify and remedy Year 2000 problems, there may be related failures that disrupt Carbon's business temporarily. In addition, the timetable for Carbon's planned completion of its own Year 2000 modifications and the estimated costs to accomplish this are management's best estimates. These assessments include many assumptions concerning future events including the continued availability of certain resources, particularly personnel able to locate, reprogram or replace, and test Carbon's hardware and software in accordance with Carbon's established schedule. There can be no guarantee that Carbon's estimates will prove accurate, and actual results could differ significantly because of the non- compliance of third parties of business importance to Carbon. Results of Operations--1998 Compared to 1997 and 1997 Compared to 1996 Oil and Gas Revenues. The following table shows comparative revenue, sales volumes, average prices and the percentage change between periods for natural gas and oil for 1998, 1997 and 1996.
Year ended December Year ended December 31, 31, --------------------- --------------------- 1998 1997 %Change 1997 1996 %Change ------ ------ ------- ------ ------ ------- Natural gas revenues M$(1).......... 5,896 5,202 13% 5,202 4,038 29% Oil Revenues M$..................... 862 1,227 -30% 1,227 1,224 0% Natural gas sales volumes: Millions of cubic feet(1)......... 3,272 2,908 13% 2,908 2,435 19% MCF/day........................... 8,964 7,967 7,967 6,671 Oil sales volumes: Barrels........................... 65,000 63,000 3% 63,000 58,000 9% Barrels/day....................... 178 173 173 159 Average price received: Natural gas--$/Mcf(1)............. 1.78 1.79 -1% 1.79 1.64 9% Oil--$/Barrel..................... 13.26 19.48 -32% 19.48 21.10 -8%
61 - -------- (1) Exclusive of a production payment used to pay down a related note. Volumes attributed to this activity were 238,313 mcf in 1997 and 308,580 mcf in 1996. Natural gas revenues for 1998 increased 13% compared to 1997 primarily due to a 13% increase in sales volumes. Oil revenue for 1998 decreased 30% compared to 1997 primarily due to a 32% decrease in sales prices. The increases to sales volumes were primarily due to successful drilling and recompletion activity, partially offset by production declines on previously existing properties. Natural gas revenue for 1997 increased 29% compared to 1996 primarily due to a 19% increase in sales volumes and a 9% price increase. Oil revenue for 1997 was essentially flat compared to 1996 as a 9% increase in sales volumes was offset by 8% price decline. The increases in sales volumes were primarily due to successful drilling and recompletion activity, partially offset by production declines on previously existing properties. Oil and Gas Production Costs. Oil and gas production costs consist of lease operating expense and severance taxes. Oil and gas production costs for 1998 were 44% as a percentage of oil and gas sales compared to 43% for 1997 and 40% for 1996. Oil and gas production costs for 1998, 1997 and 1996 were $4.92, $5.16 and $4.92 respectively, per boe. The increase in 1997 from 1996 was largely the result of increased spending for environmental remediation purposes. In addition, severance taxes increased 40% in 1997 compared to 1996. Gas and Electrical Marketing. Gas and electrical marketing revenue increased 45% in 1998 compared to 1997 while gas and electrical marketing expenses increased 53% in 1998 compared to 1997. Certain high margin contracts expired early in 1997. The related margins were not present during most of 1997, nor in 1998. Gas and electrical marketing revenue increased 1% in 1997 compared to 1996 while related expenses increased 31% in 1997 compared to 1996. Certain high margin contracts which were in effect in 1996, expired early in 1997. The related margins were not present during most of 1997. General and Administrative Expenses. G&A expenses relate to the direct costs of BFC which do not originate from either its operation of properties or the providing of services and are presented net of amounts billed to unrelated third parties. G&A expenses increased by $1,065,000 in 1998 compared to 1997. In 1998 a court approved retention compensation accrual of $425,000 was recorded. The remainder of the increase is primarily due to costs associated with additional staffing related to anticipated increases in drilling activity. G&A expenses increased by $118,000 in 1997 compared to 1996. DD&A Depreciation, Depletion, Amortization and Imparment Expense. Depreciation, Depletion, Amortization and Impairment ("DD&A") of oil and gas assets are determined based upon the units of production method. This expense is primarily dependent upon historical capitalized cost incurred to find, develop and recover oil and gas reserves. For 1998 the depletion rate was $3.42 per boe compared to $3.24 per boe in 1997 and $2.40 per boe in 1996. The increase in 1997 compared to 1996 was primarily due to increased production from high DD&A properties and from an additional $200,000 recorded in 1997 for future plugging and abandonment charges. Impairment losses were $1,858,000 in 1998 compared to $312,000 in 1997. The increase is primarily due to a decline in the estimated value of producing properties due to oil and gas prices that were substantially lower at year end 1998 compared to year end 1997, and from downward revisions of previous oil and gas reserve estimates. There were no recorded impairment losses in 1996. Interest Expense. Interest expense was $238,000 in 1998 compared to $83,000 in 1997 and $272,000 in 1996. The increase in 1998 is primarily due to increased borrowings for drilling and development activity and because of lower prices received from oil and gas sales. The decrease in interest expense from 1997 compared to 1996 is primarily due to lower borrowings for drilling and development activities. 62 Exploration Expense. Exploration expense was recorded under the successful efforts method of accounting and consists primarily of unsuccessful drilling costs and G&G costs. Exploration expense in 1998 was $556,000 compared to $772,000 in 1997 and $419,000 in 1996. The amount related to unsuccessful drilling was lower in 1998 compared to 1997, while G&G costs increased in 1998 compared to 1997 because of increased exploration activities. The amount related to unsuccessful drilling was higher in 1997 compared to 1996, and G&G costs increased in 1997 compared to 1996 because of increased exploration activities. Income Taxes. BFC accounts for income taxes under the liability method which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. BFC's operations were formerly included in BPC's consolidated tax return. Income taxes were allocated to BFC as if BFC was a separate taxpayer. Effects of Changing Prices The U.S. economy experienced considerable inflation during the late 1970's and early 1980's but in recent years inflation has been fairly stable at relatively low levels. BFC, along with most other business enterprises, was then and will be affected in the future by any recurrence of such inflation. Changing prices, or a change in the dollar's purchasing power, distorts the traditional measures of financial performance which are generally expressed in terms of the actual number of dollars exchanged and do not take into account changes in the purchasing power of the monetary unit. This results in the reporting of many transactions over an extended period as though the dollars received or expended were of common value, which does not accurately portray financial performance. Inflation, as well as a recessionary period, can cause significant swings in the interest rates that companies pay on bank borrowings. These factors are anticipated to continue to affect BFC's operations both positively and negatively for the foreseeable future. Oil and gas prices fluctuate over time as a function of market economics. Refer to the price change table in the discussion "Oil and Gas Operations Comparisons for 1998, 1997 and 1996" for information on product price fluctuation over the past three years. This table depicts the effect of changing prices on BFC's revenue stream. Operating expenses have been relatively stable but are a critical component of profitability since they represent a larger percentage of revenues when lower product prices prevail. Competition in the industry can significantly affect the cost of acquiring leases, although in recent years this factor has been less important as more operators have withdrawn from active exploration programs. Properties We have approximately 234,000 gross acres and 152,000 net acres of land in inventory. The majority of our proved reserves are concentrated in four areas--the Piceance/Uintah Basins, the Permian Basin, the San Juan Basin and Southwestern Kansas. All wells and acreage are located in the continental United States. Estimated Oil and Gas Reserve Quantities and Revenues The estimated reserve amounts and future net revenues were determined by Ryder Scott, an independent petroleum engineering firm, for 1998, 1997 and 1996. 63 BFC's reserves are sensitive to natural gas and oil prices and their effect on future net revenues and the quantities of reserves that are recoverable at economic producing rates are based on fixed price contracts or on the spot market price in effect on December 31, 1998, 1997 and 1996. Price declines decrease reserve values by lowering the future net revenues attributable to the reserves and reducing the quantities of reserves that are recoverable on an economic basis. Price increases have the opposite effect. A significant decline in prices of oil or natural gas could have a material adverse effect on the company's financial condition and results of operations. Proved developed reserves are proved reserves that are expected to be recovered from existing wells using existing equipment and operating methods. Proved undeveloped reserves are proved reserves that are expected to be recovered from new wells drilled to known reservoirs on undrilled acreage for which the existence and recoverability of such reserves can be estimated with reasonable certainty, or from existing wells where a relatively major expenditure is required to establish production. Future prices received from production and future production costs may vary, perhaps significantly, from the prices and costs assumed for purposes of these estimates. There can be no assurance that the proved reserves will be developed within the periods indicated or that prices and costs will remain constant. There can be no assurance that actual production will equal the estimated amounts used in the preparation of reserve projections. The present values shown should not be construed as the current market value of the reserves. The 10% discount factor used to calculate present value, which is specified by the Securities and Exchange Commission, is not necessarily the most appropriate discount rate, and present value, no matter what discount rate is used, is materially affected by assumptions as to timing of future production, which may prove to be inaccurate. For properties operated by BFC, expenses exclude BFC's share of overhead charges. In addition, the calculation of estimated future net revenues does not take into account the effect of various cash outlays, including among other things general and administrative costs and interest expense. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures. Oil and natural gas reserve engineering must be recognized as a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured in an exact way, and estimates of other engineers might differ materially from those shown above. The accuracy of any reserve estimate is a function of the quality of available data and engineering and geological interpretation and judgment. Results of drilling, testing and production after the date of the estimate may justify revisions. Accordingly, reserve estimates are often materially different from the quantities of oil and natural gas that are ultimately recovered. The meaningfulness of such estimates depends primarily on the accuracy of the assumptions upon which they were based. In general, the volume of production from oil and gas properties we own declines as reserves are depleted. Except to the extent we acquire additional properties containing proved reserves or conduct successful exploration and development activities or both, the proved reserves will decline as reserves are produced. 64 Changes in Proved Oil and Gas Reserves
Oil Natural (Thousands Gas (Millions of Barrels) of Cubic Feet) ----------- -------------- Proved Reserves: December 31, 1995.................................. 207 19,807 Revision to previous estimates................... 34 8,008 Extensions, discoveries, and other additions..... 44 1,441 Production....................................... (58) (2,744) ---- ------ December 31, 1996.................................. 227 26,512 Revision to previous estimates................... 3 (1,569) Extensions, discoveries, and other additions..... 131 1,343 Production....................................... (63) (3,146) ---- ------ December 31, 1997.................................. 298 23,140 Revision to previous estimates................... (101) 976 Extensions, discoveries, and other additions..... 34 5,011 Production....................................... (65) (3,272) ---- ------ December 31, 1998.................................. 166 25,855 ==== ====== Proved developed reserves (producing and non- producing): December 31, 1996.................................. 188 25,483 December 31, 1997.................................. 298 22,623 December 31, 1998.................................. 166 25,855
Proved Developed Producing Reserves At December 31, 1998, BFC had approximately 16.8 billion cubic feet of proved developed producing gas reserves which represents 65% of BFC's total proved gas reserves. BFC also had approximately 162,000 barrels of oil and natural gas liquids of proved developed producing reserves which together represent 98% of BFC's total proved oil reserves. Proved Developed Non-Producing Reserves At December 31, 1998, BFC had approximately 8.6 billion cubic feet of proved developed non-producing gas reserves representing 33% of its total proved gas reserves. BFC's oil and liquids reserves in this category are approximately 3,800 barrels or 2% of its total proved oil reserves. The reserves in this category are primarily reserves for wells which have been completed and were awaiting connection to a gas pipeline as of year end, provided such pipeline connection does not require significant investment. Also included are reserves behind the casing in existing wells and recompletion of those zones will be reqired to place them on production. Proved Undeveloped Reserves At December 31, 1998, BFC's proved undeveloped reserves total approximately 517 million cubic feet of gas, or 2% of its total proved natural gas reserves, and no barrels of oil and liquids. These reserves are attributable to wells which have been completed and were awaiting pipeline connection as of the end of the year where such pipeline connection would require significant investment and also undrilled locations offsetting production in various fields. Probable Reserves At December 31, 1998, BFC's probable natural gas reserves are approximately 948 million cubic feet. BFC's oil and gas liquids reserves in this category are approximately 6,400 barrels. 65 The reserves in this category are primarily reserves which may reasonably be assumed to exist because of geophysical or geological indications and drilling performed in the regions which contain proven reserves. The reserves in this category are not included in the schedule of Standardized Measure of Discounted Future Net Cash Flow (the "Standardized Measure"). Comparison in Proved Reserves The following table compares BFC's estimated proved reserves as of December 31, 1997 and 1998.
Oil and Liquids (Thousands of Natural Gas barrels) (Millions of cubic feet) --------------- ------------------------ Proved Reserves: December 31, 1997 Proved developed producing........... 298 16,998 Proved developed non-producing....... -- 5,625 Proved undeveloped................... -- 517 --- ------ Total.............................. 298 23,140 === ====== December 31, 1998 Proved developed producing........... 162 16,775 Proved developed non-producing....... 4 8,563 Proved undeveloped................... 0 517 --- ------ Total.............................. 166 25,855 === ======
The decrease in proved developed producing reserves from 1997 to 1998 is primarily due to 1998 production. Standardized Measure The Standardized Measure schedule is presented below pursuant to the disclosure requirements of the Securities and Exchange Commission and Statement of Financial Accounting Standards No. 69, "Disclosures About Oil and Gas Producing Activities" (SFAS 69). Future cash flows are calculated using year-end oil and gas prices and operating expenses, and are discounted using a 10% discount factor. Under SEC guidelines, Future Net Revenues shown below must be calculated using prices that were in effect on December 31 of each year and are projected forward based on existing contracts or the spot market price on that date. Accordingly, the Future Net Revenues have been calculated using the appropriate sales price in effect on December 31, 1998, 1997 and 1996. Oil and gas prices at December 31, 1998, 1997, and 1996 of $10.69, $16.91, and $25.60, respectively, per barrel of oil and $1.84, $1.81, and $3.17 respectively, per mcf of gas were used in the estimation of BFC's reserves and future net cash flows. The standardized measure is intended to provide a standard of comparable measurement of BFC's estimated proved oil and gas reserves based on economic and operating conditions existing as of December 31, 1998, 1997 and 1996. Pursuant to SFAS 69, the future oil and gas revenues are calculated by applying to the proved oil and gas reserves the oil and gas prices at December 31 of each year relating to such reserves. Future price changes are considered only to the extent provided by contractual arrangements in existence at year end. Production and development costs are based upon costs at each year end. Future income taxes are computed by applying statutory tax rates as of the year end with recognition of tax basis and earned depletion carryforwards as of that date relating to the proved properties. Discounted amounts are based on a 10% annual discount rate. Changes in the demand for oil and gas, price changes and other factors make such estimates inherently imprecise and subject to revision. 66 Standardized Measure of Discounted Future Net Cash Flows Relating to Estimated Proved Oil and Gas Reserves (thousands of dollars)
December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- Future oil and gas revenue................. $ 49,428 $ 46,859 $ 89,985 Future production and development costs.... (18,507) (18,155) (26,608) -------- -------- -------- Future net cash flows...................... 30,921 28,704 63,377 Discount at 10%............................ (10,426) (9,075) (23,366) -------- -------- -------- Standardized measure of discounted future net cash flows............................ $ 20,495 $ 19,629 $ 40,011 ======== ======== ========
As required by SFAS 69, the tax computation does not consider BFC's annual interest expense and general and administrative expenses or future drilling and equipment costs. Because of these factors, the tax provisions shown do not represent the much lower future tax expense expected as long as BFC remains an active operating company. Change in Standardized Measure of Discounted Future Net Cash Flows from Estimated Proved Oil and Gas Reserves for the Three Years Ended December 31, 1998 (thousands of dollars)
December 31, ------------------------- 1998 1997 1996 ------- ------- ------- Standardized measure-beginning of year........ $19,629 $40,011 $10,233 Sales and transfers of oil and gas produced, net of production costs...................... (3,754) (3,650) (2,977) Net changes in prices and production costs.... (999) (20,485) 19,056 Extensions, discoveries and other additions recovery, less related costs................. 4,699 756 3,226 Purchases of reserves in place................ 147 1,610 436 Revisions of future development costs......... 87 1,069 (1,200) Revisions of previous quantity estimates...... 279 (1,098) 12,475 Accretion of discount......................... 1,963 4,001 1,023 Other......................................... (1,556) (2,585) (2,261) ------- ------- ------- Net increase (decrease)....................... 866 (20,382) 29,778 ------- ------- ------- Standardized measure-end of year.............. $20,495 $19,629 $40,011 ======= ======= =======
Production The following table sets forth annual net production for each of the three years ended December 31, 1998. Net production includes volumes related to a production payment used to pay a related note. Volumes attributable to this activity were 238,312 mcf in 1997 and 308,580 mcf in 1996.
Year ended December 31, -------------------- 1998 1997 1996 ------ ------ ------ Oil--Barrels......................................... 65,000 63,000 58,000 Gas--Mmcf............................................ 3,272 3,146 2,744
67 Average price and cost per unit of production for the past three years are as follows (gas prices are exclusive of hedging results):
Year Ended November 30, -------------------- 1998 1997 1996 ------ ------ ------ Average sales price per barrel of oil............... $13.26 $19.48 $21.10 Average sales price per mcf of gas.................. $ 1.76 $ 1.99 $ 1.64 Average production cost per boe..................... $ 4.92 $ 5.16 $ 4.92
Natural gas is converted to oil at the ratio of six mcf of natural gas to one barrel of oil. Production costs include only lease operating expenses and severance taxes. We operate most of the wells in which we own interests and also hold working interests in some wells operated by third parties. Gas sales are generally made pursuant to gas purchase contracts with unrelated third parties. Our gas sales are subject to price adjustment provisions of the gas purchase contracts as well as general economic and political conditions affecting the production and price of natural gas. Developed Properties and Acreage The following tables set forth the total gross and net productive oil and gas wells and gross and net developed acres as of December 31,1998. All wells and acreage are located in the continental United States.
Gross Net ------- ------- Oil Gas Oil Gas --- --- --- --- Wells..................................................... 28 258 10 167 === === === === Acres..................................................... 116,000 85,000 ======= =======
Undeveloped Acreage The following table sets forth the gross and net undeveloped acres as of December 31, 1998. All undeveloped acreage is located in the continental United States.
Gross Acres Net Acres ----------- --------- 84,000 61,000
Drilling Activities BFC engages in exploratory and development drilling on its own and in association with other oil and gas companies. The table below sets forth information regarding BFC's drilling activity for the last three fiscal years. The net interest shown is BFC's working interest.
Year Ended December 31 -------------- 1998 1997 1996 ---- ---- ---- EXPLORATORY Wells Drilled: Productive............................................... 5 -- -- Dry...................................................... 2 8 2 DEVELOPMENT Wells Drilled: Productive............................................... 6 2 4 Dry...................................................... 3 1 -- TOTAL Wells Drilled: Productive............................................... 11 2 4 Dry...................................................... 5 9 2 --- --- --- 16 11 6
68 Current Operations Activity See "Information Concerning Our Company--Business" for a description of present activities. Legal Proceedings There are no material legal proceedings pending or, to our knowledge, threatened against us. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Hein + Associates, LLP audited BFC's consolidated financial statements for the years ending December 31, 1992--1998. Management expects to engage Hein + Associates to audit BFC's financial statements for the ten months ending October 31, 1999. Carbon's new Board of Directors has appointed Arthur Andersen LLP to be Carbon's accountants for the two month period ended December 31, 1999. Quantitative and Qualitative Disclosures about Market Risk Interest Rate Risk Our exposure to market risk for changes in interest rates relates primarily to our long-term debt obligations. See Notes 3 and 10 to the December 31, 1998 Financial Statements of BFC. Foreign Currency Risk To date our cash flows have been in U.S. dollars only, negating the need to hedge against any foreign currency risks. Commodity Price Risk BFC uses certain financial instruments in an attempt to manage commodity price risk. BFC attempts to manage these risks by minimizing its commodity price exposure through the use of derivative contracts as described in Note 6 to the December 31, 1998 Financial Statements of BFC. Gains and losses on these contracts are deferred and recognized in income as an adjustment to oil and gas sales revenues during the period in which the physical product to which the contracts relate is actually sold. Oil and gas commodity markets are influenced by global as well as regional supply and demand. Worldwide political events can also impact commodity prices. Management's policy is to mitigate its exposure to fluctuations in sales prices received for natural gas production through the use of various hedging tools. These tools include, but are not limited to: commodity futures and option contracts; fixed-price swaps; basis swaps; and term sales contracts. Contract terms generally range from one month to three years. While we mitigate our exposure to declining natural gas sales prices, we may be subject to lost opportunity costs resulting from increasing natural gas prices in excess of those committed. Should production from existing facilities under existing operating conditions not fulfill committed contracts, we may be required to acquire natural gas in the open market, while volumes produced in excess of those contracted are sold at market prices. 69 OUR MANAGEMENT Executive Officers and Directors Our executive officers and directors are:
Name Age Position - ---- --- ------------------------------------- Patrick R. McDonald................... 42 President and Director Kevin D. Struzeski.................... 40 Treasurer and Chief Financial Officer David H. Kennedy...................... 50 Director Lambros J. Lambros.................... 64 Director Bryan H. Lawrence..................... 57 Director Peter A. Leidel....................... 43 Director Harry A. Trueblood, Jr................ 74 Director(1)
- -------- (1) Mr. Trueblood will become a director upon completion of the exchange offer. Each current director has served since his appointment on September 14, 1999. Brief descriptions of the background and business experience of our executive officers and directors are set forth below. Patrick R. McDonald. Mr. McDonald became our President on September 14, 1999. He has been President and Chief Executive Officer of CEC since July 1998. From 1987 until 1997 Mr. McDonald was Chairman and President of Interenergy Corporation, Denver, Colorado. Since January 1998, he has been the sole member of McDonald Energy, LLC. Mr. McDonald is a petroleum geologist. Kevin D. Struzeski. Mr. Struzeski became our Treasurer and Chief Financial Officer on September 14, 1999. He has been Chief Financial Officer-Treasurer for CEC since November 1998. Mr. Struzeski was employed as Accounting Manager, MediaOne Group from 1997 to 1998 and prior to that he was employed as Controller, Interenergy Corporation from 1995 to 1997 and Accounting Manager, Snyder Oil from 1993 to 1995. David H. Kennedy. Mr. Kennedy has served as a director of Carbon since September 14, 1999. From March, 1981 through December 31, 1998, Mr. Kennedy was a managing director of First Reserve Corp. and was responsible for investing and monitoring part of its portfolio of energy investments. Since January 1, 1999, Mr. Kennedy has acted as a consultant to and investor in the energy industry. He serves as a director of Maverick Tube Corporation, whose common stock is traded on the Nasdaq market, and as a director of Berkley Petroleum Corp. and Pursuit Resources Corp., oil and gas companies whose stocks are listed on the Toronto Stock Exchange. Lambros J. Lambros. Mr. Lambros has served as a director of Carbon since September 14, 1999. Mr. Lambros has been involved in private investments since January 1, 1994. He has served as a director of M&T Bank from 1984 to present. Bryan H. Lawrence. Mr. Lawrence is a founder and a senior manager of Yorktown Partners LLC which was established in September, 1997, and manages investment partnerships formerly affiliated with Dillon, Read & Co. Inc. Mr. Lawrence had been employed at Dillon, Read & Co. Inc. since 1966, serving as a Managing Director until the merger of Dillon Read with SBC Warburg in September, 1997. Mr. Lawrence also serves as a Director of D&K Healthcare Services, Inc., Hallador Petroleum Company, TransMontaigne Inc., and Vintage Petroleum, Inc. (each a United States public company) and certain non-public companies in the energy industry in which Yorktown partnerships hold equity interests. Peter A. Leidel. Mr. Leidel is a co-founder and manager of Yorktown Partners LLC which was established in September, 1997, and manages investment partnerships affiliated with Dillon, Read & Co. Inc. Yorktown 70 Partners LLC is the manager of four private equity partnerships that invest in the energy industry, with aggregate committed capital of approximately $700 million. Previously, he was a partner of Dillon, Read & Co. Inc.'s venture capital fund and has invested in a variety of private companies with a particular focus on energy investments since 1983. He was previously in corporate treasury positions at Mobil Corporation and worked for KPMG Peat Marwick and the U.S. Patent and Trademark Office. Mr. Leidel is a director of Cornell Corrections, (ASE-CRN), Willbros Group (NYSE-WG), Fintube, Meenan Oil Co., Roemer-Swanson Energy, Athanor Resources, Inc., Tanglewood Companies, and Metal Supermarkets. Harry A. Trueblood, Jr. Mr. Trueblood has served as the President and Chief Executive Officer of CEC from 1972 until July 1, 1998. Mr. Trueblood has served as Chairman and CEO of Columbus Energy Corp., the former parent of CEC, since 1982 and was a founder and former President and/or Chairman and CEO of Consolidated Oil & Gas, Inc., the former parent of both Columbus Energy and CEC from 1958 to 1998. Messrs. Lawrence and Leidel were designated as nominees for directors by Yorktown pursuant to the Exchange Agreement. Mr. McDonald was also designated as a director pursuant to that agreement. See "The Exchange Offer--Description of Exchange Agreement." Committees of the Board of Directors Our Board of Directors has established a compensation committee, an audit committee and a nominating committee. Members of the compensation committee are Messrs. Leidel (Chairman), Kennedy and Lambros. Mr. Trueblood will become a member of the Compensation Committee upon completion of the exchange offer. The compensation committee reviews and approves our compensation and benefits for our executive officers and makes recommendations to the Board of Directors regarding these matters. Members of the audit committee are Messrs. Kennedy (Chairman) and Lambros. The functions of the audit committee are: . Review the scope of the audit procedures utilized by our independent auditors; . Review with the independent auditors our accounting practices and policies; . Consult with our independent auditors during the year; and . Report to our Board of Directors with respect to these matters and to recommend the selection of independent auditors. The nominating committee is responsible for determining, on behalf of the Board of Directors of Carbon, nominees for the position of director of Carbon, or persons to be elected by the Board of Directors or shareholders to fill any vacancy in the Board of Directors of Carbon. The existence of the nominating committee is required by the Exchange Agreement among Carbon, CEC and Yorktown. The Exchange Agreement requires that the nominating committee be comprised of one Yorktown director, Mr. McDonald, so long as he is a director of Carbon, and two independent directors. The Yorktown directors who serve on the nominating committee are selected by a majority vote of the Yorktown directors. A majority of the independent directors are to designate the independent directors to serve on the nominating committee. Mr. Lawrence (Chairman) is the Yorktown director on the nominating committee, Mr. McDonald serves on the committee, and the two independent directors on the committee are Messrs. Kennedy and Lambros. Executive Compensation The following table depicts information regarding the annual and long-term compensation paid during each of the last three years by CEC to the President and Chief Executive Officer, who is the only executive officer of Carbon to earn in excess of U.S. $100,000 in salary and bonus in fiscal 1998 from either CEC or BFC. 71 Summary Compensation Table
Long Term Compensation Number of Securities Underlying Fiscal Salary Bonus Options Name and Principal Position Year (U.S.$) (U.S.$) Granted - --------------------------- ------ ------- ------- ------------ Patrick R. McDonald, President........... 1998 $50,000(1) 0 78,000
- -------- (1) Appointed July 1, 1998 We currently pay to Patrick R. McDonald, our President, an annual salary of US $200,000. Stock Option Grants And Exercises The following table sets forth information concerning individual grants of stock options made by CEC during fiscal 1998 to CEC's President and Chief Executive Officer. The stock options were granted at the market price on the date of grant. Option Grants In Fiscal 1998
Potential Realizable Value at Assumed Annual Rates of Stock Number of % of Total Price Securities Options Appreciation for Underlying Granted to Option Term (2) Options Employees ----------------- Granted in Fiscal Exercise Price Expiration 5% 10% Name (1) Year (U.S. $/Share) Date (U.S.$) (U.S.$) ---- ---------- ---------- -------------- ---------- -------- -------- Patrick R. McDonald..... 78,000 66.1 $5.50 7/1/03 $145,902 $331,000
- -------- (1) Options were originally granted to acquire CEC common stock at the closing price of CEC's common stock on the date of the grant. These options are being replaced with Carbon options on the same terms. (2) These columns present hypothetical future realizable values of the options, obtainable upon exercise of the options net of the option's exercise price, assuming CEC's common stock appreciates at a 5% and 10% compound annual rate over the term of the options. The 5% and 10% rates of market price appreciation are presented as examples pursuant to rules of the SEC and do not reflect management's prediction of the future market price of our common stock. No gain to the optionees is possible without an increase in the market price of the common stock above the option price. There can be no assurance that the potential realizable values shown in this table will be achieved. The potential realizable values presented are not intended to indicate the value of the options. No options were exercised by CEC's President and Chief Executive Officer during fiscal 1998. The following table summarizes information with respect to the value of that officer's unexercised stock options at November 30, 1998: Fiscal Year End Option Values
Number of Securities In-the-Money Underlying Unexercised Value of Unexercised Options at Year End Options at Year End (2) ------------------------- ------------------------- Name Exercisable Unexercisable Exercisable Unexercisable - ---- ----------- ------------- ----------- ------------- Patrick R. McDonald......... 0 78,000(1) 0 0
- -------- (1) Options were granted by CEC to acquire its common stock. These options are replaced with options to acquire our stock. (2) The in-the-money value of unexercised options is equal to the excess of the per share market price of CEC's stock at November 30, 1998 over the per share exercise price multiplied by the number of unexercised options. However, the per share exercise price was higher than the market price of CEC's stock at fiscal year end. 72 1999 Stock Option and Restricted Stock Plans Our 1999 Stock Option Plan was adopted by the directors as of October 14, 1999. Under the 1999 plan, we may grant options to purchase up to 700,000 shares of our common stock. Grants under the Stock Option Plan may consist of (1) options intended to qualify as incentive stock options under the Internal Revenue Code and (2) non-qualified stock options that are not intended to so qualify. Persons eligible to receive incentive stock options under the plans are only our employees; non-qualified stock options may be granted to employees, directors and consultants. The Stock Option Plan terminates on September 1, 2009. We also have a 1999 Restricted Stock Plan which was adopted by our Board of Directors on October 14, 1999. The Restricted Stock Plan has 300,000 shares of our common stock available for grants. Under the Restricted Stock Plan, the administrator may issue shares of our common stock to the grantee, and those shares are subject to restrictions and forfeiture in accordance with the terms of a stock restriction agreement. Under the current form of agreement, the restricted stock may be subject to vesting requirements and forfeiture of unvested shares if the grantee ceases to be an employee or a member of the Board of Directors, except as may be provided in an employment agreement. Grants under the Restricted Stock Plan may be made to an employee, director or consultant of our company or any subsidiary. The Restricted Stock Plan terminates on September 1, 2009. Each plan is administered by the Board of Directors or a committee appointed by the Board consisting of two or more non-employee directors and our President. The Board or administrating committee determines the persons to be granted options, the exercise price per share for each option, the expiration date of each option and other terms which may be set forth in an option agreement. Likewise, the Board or administrating committee determines the persons to be granted restricted stock and nature of any forfeitures and related restrictions regarding that stock. The Board of Directors currently administers both plans. The exercise price of an incentive stock option granted under to the plans cannot be less than 100% of the fair market value of the common stock on the date of the grant. The Board determines the exercise price of a non-qualified stock option; in the case of the 1999 plan, the exercise price of a non- qualified stock option cannot be less than 85% of the fair market value of the common stock on the date of grant. The term of any stock option cannot exceed ten years. However, the exercise price of an incentive stock option granted to any person who at the time of grant owns stock representing more than 10% of the total combined voting power of all classes of our capital stock or any of our affiliates must be at least 110% of the fair market value of our common stock on the date of grant and the term of such an incentive stock option cannot exceed five years. Options granted under the plans vest at the rate specified in any option agreement. The exercise price may be paid in cash or other shares of our common stock, as determined by the Board of Directors or the administering committee. In the event of a proposed sale of all or substantially all our assets, or the merger of Carbon with another corporation, or any other capital reorganization in which persons who were stockholders of our company immediately before the capital reorganization owned less than two-thirds of the outstanding voting securities of the surviving company following the capital reorganization, the plan administrator is to make appropriate provisions for the protection of outstanding options by the substitution of appropriate stock of our company or any surviving corporation or, alternatively, our Board of Directors may terminate an outstanding option by permitting the option to be exercisable as to all shares subject to the option, whether or not previously vested, for a period of thirty days (or not less than 10 days in the case of the 1999 plan) after a notice to the option holder. All outstanding options under the 1999 plan become immediately exercisable and full, whether or not there were vesting requirements, upon the occurrence of a change in control. All restricted stock outstanding under the 1999 Restricted Stock Plan also become fully vested upon a change of control. For this purpose, a change in control occurs (1) at the time a third person or group becomes the beneficial owner of shares with 50% or more of the total number of votes cast for the election of our directors; (2) on the date our shareholders approve a merger or consolidation (unless our shareholders continue to own after the merger or consolidation more than two-thirds of the voting securities of the resulting corporation in substantially the same proportion as their 73 ownership of our voting securities before the merger or consolidation) or any sale or other disposition of all or substantially all of our assets, or (3) a sale or other disposition of more than 50% in fair market value of our assets outside the ordinary course of business, or (4) if at the time there is a change in more than a majority of our Board of Directors as a result of a proxy contest (unless any option holder or the holder of restricted stock, as the case may be, or the person's affiliate has waged the proxy contest or endorsed the change in our Board). In determining whether clause (1) of this definition has been satisfied, Yorktown and entities controlled by Yorktown Partners LLC (the managing general partner of Yorktown) are excluded. Directors' Compensation Each of our directors who is neither an officer nor an employee will be paid a director's fee of $1,500 per quarter. Also, in consideration of their joining our Board of Directors, David Kennedy and Lambros J. Lambros, who are considered to be independent directors, each were granted on October 14, 1999, granted a nonqualified stock option to purchase 10,000 shares of our common stock at $5.50 per share. Shares subject to these options vest one-half on the first anniversary and one-half on the second anniversary of the date of grant, and these options have a ten-year term. Indemnification and Limitation of Liability Our Bylaws provide that we will indemnify our directors and executive officers and may indemnify our other officers, employees and other agents to the fullest extent permitted by Colorado law. We have also entered into indemnification agreements with each of our directors and executive officers. All indemnification agreements are identical. These agreements provide, among other things, for indemnification and advancement of expenses to the fullest extent permitted by law in connection with any legal proceeding in which the person was made a party because the person was a director or executive officer of Carbon, place the burden of proof on us in regard to whether an individual has met the required standard of conduct for indemnification, cover procedural matters such as the hiring of counsel and require us to pay the expenses of the director or executive officer in enforcing any required indemnification or advancement of expenses. In addition, our Articles of Incorporation provide that to the fullest extent permitted by Colorado law, our directors will not have personal liability to us or our stockholders for monetary damages for any breach of fiduciary duties as a director. This does not eliminate the duties themselves, and in appropriate circumstances, equitable remedies such as injunction or other forms of nonmonetary relief remain available under Colorado law. This provision does not eliminate the liability of a director for (1) any breach of the director's duty of loyalty to us or our stockholders; (2) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (3) unlawful dividends, stock repurchases or redemptions; or (4) any transaction from which the director derived an improper personal benefit. This does not affect a director's responsibilities under other laws such as the federal or state securities laws. There is no pending litigation or proceeding involving a director or officer as to which indemnification is being sought. We are not aware of any pending or threatened litigation that may result in claims for indemnification by any director or officer. Insofar as indemnification for liabilities arising under the Securities Act of 1933 (the "Securities Act") may be permitted to directors, officers or persons controlling us pursuant to the foregoing provisions or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission, such indemnification is against public policy as expressed in the Securities Act, and is, therefore, unenforceable. Employment Agreement On October 31, 1999, we entered into a three-year employment contract with Mr. McDonald. The employment agreement with Mr. McDonald is described under "The Exchange Offer--Interests of Certain Persons in the Exchange Offer." 74 PRINCIPAL SHAREHOLDERS OF OUR COMPANY The following table contains information regarding ownership of our common stock (the only class of stock outstanding) as of November 1, 1999 by (1) each director, (2) our President, (3) all of our directors and executive officers as a group, and (4) each shareholder who, to our knowledge, was the beneficial owner of five percent or more of the outstanding shares. The table also shows the ownership of our common stock by these persons as adjusted to reflect the exchange offer, assuming that CEC shareholders accept the exchange offer for all outstanding CEC shares. All information is based on information provided by such persons to us. Unless otherwise indicated, their addresses are the same as our address and each person identified in the table holds sole voting and investment power with respect to the shares shown opposite such person's name.
Amount and Amount and Nature of Nature of Beneficial Beneficial Percent Ownership Name and Address Ownership Prior After Percent of Beneficial Owner Prior to Offer to Offer Offer After Offer - ------------------- -------------- -------- ---------- ----------- Yorktown Energy Partners III, L.P................. 4,500,000 98.7% 4,500,000 74.0% 410 Park Avenue, Suite 1900 New York, NY 10025 Patrick R. McDonald and McDonald Energy, LLC..... 30,000(4) (1) 315,100(4)(5) 5.1% 1700 Broadway, Suite 1150 Denver, CO 80290 Harry A. Trueblood, Jr.... -- -- 308,696(5) 5.1% 1660 Lincoln Street Suite 2400 Denver, CO 80264 David H. Kennedy.......... 10,000 (1) 10,000 (1) 18 Pasture Lane Darien, CT 06820 Lambros J. Lambros........ 10,000 (1) 10,000 (1) 131 Gosmen Road Norfolk, CT 06058 Bryan H. Lawrence......... 4,500,000(2) 98.7% 4,500,000(2) 74.0% 410 Park Avenue, Suite 1900 New York, NY 10025 Peter A. Leidel........... 4,500,000(3) 98.7% 4,500,000(3) 74.0% 410 Park Avenue, Suite 1900 New York, NY 10025 All directors and execu- tive officers as a group (7 persons including the above)................... 4,560,000 100% 5,173,796(6) 83.4%
- -------- (1) Less than 1%. (2) These shares owned by Yorktown Energy Partners III, L.P. As a member of Yorktown Partners LLC, the manager of Yorktown Energy Partners III, L.P., Mr. Lawrence may be deemed to be a beneficial owner of these shares. Mr. Lawrence disclaims beneficial ownership of these shares. (3) These shares owned by Yorktown Energy Partners III, L.P. As a member of Yorktown Partners LLC, the manager of Yorktown Energy Partners III, L.P., Mr. Leidel may be deemed to be a beneficial owner of these shares. Mr. Leidel disclaims beneficial ownership of these shares. (4) Includes 30,000 shares of restricted stock, one-half of which vests in October, 2000 and one-half of which vests in October, 2001. (5) See "Principal Shareholders of CEC" for information on ownership of CEC shares which may be exchanged for Carbon shares in the exchange offer. We will substitute Carbon stock options for outstanding CEC stock options. (6) Includes 121,000 shares underlying exercisable options to be issued by us in substitution of CEC stock options. 75 PRINCIPAL SHAREHOLDERS OF CEC The table below provides information regarding ownership of CEC common stock (which is CEC's only class of outstanding stock) as of November 1, 1999 by (1) each director of CEC, (2) CEC's President and Chief Executive Officer, (3) all CEC's directors and executive officers as a group, and (4) each shareholder who, to our knowledge, was the beneficial owner of five percent or more of the common stock of CEC. All information is taken from or based on filings made by such persons with the SEC or provided by such persons to CEC. Except as indicated in the footnotes, each person identified in the table holds sole voting and investment power with respect to the shares shown opposite such person's name.
Amount and Nature of Name and Address Beneficial Percent of Beneficial Owner Ownership of Class - ------------------- ---------- -------- Patrick R. McDonald and McDonald Energy, LLC............. 285,100(1) 17.6% Harry A. Trueblood, Jr................................... 308,696(2) 20.1% Carl Seaman.............................................. 217,209(3) 14.3% 63 Hunting Ridge Road Greenwich, CT 06831 James C. Crawford........................................ 21,500(4) 1.4% Loyola G. Keough......................................... 15,000(5) (6) Craig W. Sandahl......................................... 115,050(4) 7.5% 13875 Virginia Foothills Drive Reno, NV 89511 Peter N. T. Widdrington.................................. 22,000(4) 1.4% All directors and executive officers as a group (8 persons including the above)............................ 812,346(7) 46.3%
- -------- (1) Patrick R. McDonald is the sole member of McDonald Energy, LLC. Includes 117,100 shares owned by CEC Resources Holdings, LLC of which McDonald Energy, LLC has 58.3% interest. (2) Does not include 33,911 shares which are owned by Lucile B. Trueblood, Mr. Trueblood's wife, which she acquired as her separate property and as to which Mr. Trueblood disclaims any beneficial ownership. Includes 140,000 shares owned by the Harry A. Trueblood Charitable Remainder Unitrust dated June 1, 1998 to which shares Mr. Trueblood disclaims ownership; but as the only trustee, does hold sole voting rights to such shares. Also includes 11,000 shares underlying exercisable stock options. (3) Includes 79,957 shares owned by Carl and Associates, a partnership in which Mr. Seaman owns an 80% partnership interest and as to which Mr. Seaman shares voting and investment power. Does not include 2,032 shares which are owned by Linda Seaman, Mr. Seaman's wife, which she acquired as her separate property and as to which Mr. Seaman disclaims any beneficial ownership. (4) Includes 21,000 shares underlying exercisable stock options. (5) Includes 15,000 shares underlying exercisable stock options. (6) Less than 1%. (7) Includes 232,000 shares underlying exercisable stock options. 76 CERTAIN RELATIONSHIPS AND TRANSACTIONS In October 1999, Yorktown purchased an aggregate of 4,500,000 shares of our common stock for $24,750,000 in cash. Also, in October, 1999, each of our two independent directors, Messrs. Kennedy and Lambros, purchased 10,000 shares from us at a cash price of $5.50 per share. DESCRIPTION OF OUR CAPITAL STOCK Our authorized capital stock consists of 20,000,000 shares of common stock, no par value, and 10,000,000 shares of preferred stock, no par value. Common Stock The holders of common stock are entitled to one vote for each share held of record on all matters submitted to a vote of the shareholders. Subject to preferences that may be applicable to any then outstanding preferred stock, holders of common stock are entitled to receive ratably such dividends as may be declared by the Board of Directors out of funds legally available therefor. In the event of a liquidation, dissolution or winding up of Carbon, holders of the common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preference of any then outstanding preferred stock. Holders of common stock have no preemptive rights and no right to convert their common stock into any other securities. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are, and all shares of common stock to be outstanding upon completion of the exchange offer will be, fully paid and nonassessable. A quorum for purposes of a meeting of shareholders consists of a majority of the shares entitled to vote at the meeting. After a quorum has been established, a matter is approved by the shareholders if votes cast favoring the matter exceed the votes cast against the matter. Directors are elected by a plurality vote, with the nominees having the highest number of votes cast in favor of their election being elected to the Board of Directors. As a result, a majority of the outstanding shares has the ability to elect all of our directors. Under Colorado law, the affirmative vote of a majority of the shares entitled to vote is required to approve: . A sale, lease, exchange or other disposition of all or substantially all of our property and assets, with or without our good will, other than in the usual and regular course of our business. . A plan of merger of Carbon with or into another entity, or a share exchange for which shareholder approval is required. . Dissolution of Carbon. At November 1, 1999, there were 4,560,000 shares of our common stock outstanding. Preferred Stock The Board of Directors has the authority, without further vote or action by the shareholders, to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, conversion rights, voting rights, terms of redemption, liquidation preferences, sinking fund terms and the number of shares constituting any series or the designation of such series. The issuance of preferred stock could adversely affect the voting power of holders of common stock and the likelihood that such holders will receive dividend payments and payments upon liquidation and could have the effect of delaying, deferring or preventing a change in control of Carbon. There are no shares of preferred stock issued, and we have no present plans to issue any shares of preferred stock. Certain Effects Of Authorized But Unissued Stock Under our Articles of Incorporation and, upon completion of the exchange offer and assuming 100% acceptance of the exchange offer, there will be approximately 13,978,600 shares of common stock and 77 approximately 10,000,000 shares of preferred stock available for future issuance without stockholder approval (except that as part of the criteria for maintaining a listing on the Amex, we are required to obtain stockholder approval of certain issuances of stock). These additional shares may be utilized for a variety of corporate purposes including future public offerings to raise additional capital or to facilitate corporate acquisitions. One of the effects of the existence of unissued and unreserved common stock and preferred stock may be to enable the Board of Directors to issue shares to persons friendly to current management which could render more difficult or discourage an attempt to obtain control of Carbon by means of a merger, tender offer, proxy contest or otherwise, and thereby protect the continuity of our management. Such additional shares also could be used to dilute the stock ownership of persons seeking to obtain control of Carbon. The Board of Directors is authorized without any further action by the shareholders to determine the rights, preferences, privileges and restrictions of the unissued Preferred Stock. The purpose of authorizing the Board of Directors to determine such rights and preferences is to eliminate delays associated with a stockholder vote on specific issuances. The Board of Directors may issue preferred stock with voting and conversion rights which could adversely affect the voting power of the holders of common stock, and which could, among other things, have the effect of delaying, deferring or preventing a change in control of Carbon. We do not currently have any plans to issue additional shares of common stock or preferred stock other than shares of common stock which may be issued upon the exercise of options which have been granted or which may be granted in the future to our employees. American Stock Exchange Listing Our common stock has been approved for quotation on the AMEX under the symbol . Transfer Agent We have appointed Harris Trust and Savings Bank, Chicago, Illinois, as the transfer agent and registrar for our common stock. 78 COMPARISON OF SHAREHOLDERS' RIGHTS Shareholders of CEC who tender their shares in the exchange offer will become shareholders of Carbon. CEC is a corporation organized under and governed by Alberta, Canada law. Carbon is a corporation organized under and governed by Colorado law. The principal attributes of Carbon common stock and CEC common stock are comparable, but there are material differences in shareholder rights. The following is a summary of these material differences which arise from the differences between the Colorado Business Corporation Act, the "CBCA," and the Alberta Business Corporations Act, the "ABCA," and between the Articles of Incorporation and Bylaws of Carbon and the Articles of Association and Bylaws of CEC. This summary is qualified in its entirety by the terms of the Articles of Association and Bylaws of CEC and the Articles of Incorporation and Bylaws of Carbon. CEC CARBON Capitalization Authorized Capital Stock. The Authorized Capital Stock. The authorized capital stock of CEC authorized capital stock of Carbon consists of an unlimited number of consists of 20,000,000 shares of Common Shares and an unlimited common stock and 10,000,000 shares number of Class A Preferred Shares. of preferred stock. Restrictions On Ownership There are no restrictions on There are no restrictions on ownership of CEC shares. ownership of Carbon shares. Shareholder Voting Rights Generally Rights of Common Shareholders. CEC's Rights of Common Articles of Amendment provide that Shareholders. Carbon's Articles of the holders of Common Shares: Incorporation provide that the common stock has exclusive voting rights on all matters requiring the vote of shareholders, except as otherwise specifically provided by the CBCA or by the terms of any outstanding preferred stock. Holders of common stock are also entitled to receive dividends and distribution of assets upon any dissolution of Carbon, subject to the preferential rights of any preferred stock. . are entitled to receive notice of and to attend and to vote at any meeting (one vote per share); . are entitled to receive dividends subject to dividends attached to other classes of shares which rank ahead in priority; . are entitled to distribution of assets on any dissolution or winding up of the Corporation subject to the preferential right of other classes of shares which rank ahead in priority. Rights of Preferred Shareholders. The Carbon Board of Directors has the exclusive authority to issue the preferred stock in one or more series and to determine the preferences, limitations and relative rights, including voting rights, of any preferred stock. Rights of Preferred Shareholders. CEC's Board of Directors have the authority with regard to the Class A Preferred Shares: . to issue in one or more series from time to time; . to change the rights restriction and privileges and conditions from time to time. The Class A Preferred Shares rank on parity with all other series of preferred shares and ahead of the Common Shares with respect to dividends and dissolution or winding up. The Class A Preferred shareholders are not entitled to receive notice of, attend or vote at any meetings of shareholders. 79 CEC CARBON No Preemptive Rights. No shareholder No Preemptive Rights. No shareholder is entitled as of right to subscribe is entitled to acquire unissued for, purchase or receive any part of shares of the corporation or any new or additional issue of securities convertible into shares shares of any class, or any bonds, or carrying a right to subscribe for debentures or other securities or to acquire such shares. convertible into shares of any class. Quorum. A majority of the votes to Quorum. A majority of the votes be cast at any meeting of entitled to be cast on a matter by a shareholders of a quorum which is voting group constitute a quorum of constituted by two persons person that voting group for action on that present(or their proxies) entitled matter at any meeting of the to vote at the meeting and together shareholders. holding not less than ten percent of the outstanding shares entitled to vote at a meeting. Voting. At any meeting of Voting. Except as otherwise provided shareholders every question shall, in the CBCA, action by a voting unless required by the ABCA, be group on a matter other than the determined by the majority of the election of directors is approved if votes cast on the question. a quorum exists and if the votes cast within the voting group favoring the action exceed the votes cast within the voting group opposing the action. While only common stock is outstanding, the common stock as a class is the sole voting group of Carbon. Proxy. A shareholder may appoint a Proxy. A shareholder may appoint a proxy by signing and transmitting an proxy by signing and transmitting an appointment form. A proxy is only appointment form, which is effective valid at the meeting in respect of when received by the corporation. which it is given or any adjournment Proxy appointments are effective for of that meeting. 11 months unless otherwise specified and are revocable except as may be permitted or provided by law. No Cumulative Voting No Cumulative Voting Rights. Cumulative voting rights are Rights. Cumulative voting rights are not permitted in the election of not permitted in the election of directors. directors. Shareholder Voting by Written Consent Written Consent. CEC shareholders Written Consent. Carbon shareholders may act by unanimous written consent may act by unanimous written consent in lieu of a meeting of the in lieu of a meeting of the shareholders. shareholders. Annual Shareholder Meeting Annual Meeting. A meeting of the Annual Meeting. A meeting of the shareholders is held annually to shareholders is held annually to consider the financial statements elect directors to succeed those and reports, electing directors, directors whose terms expire and for appointing auditors and for the the transaction of other business. transacting of business properly brought before the meeting. Special Shareholders Meetings Initiation of Special Meetings. The Initiation of Special Meetings. The CEC bylaws provide that special Carbon bylaws provide that special shareholders' meetings may be called shareholders meetings may be called by the Board of Directors, the by the President or by the Board of Chairman of the Board, the Managing Directors and shall be called by the Director or the President at any President or Secretary upon written, time. signed and dated demand of holders of shares representing not less than 10% of all votes entitled to be cast on any issue proposed to be considered at the meeting. 80 CEC CARBON Scope of Special Meeting. Business Scope of Special Meetings. Business transacted at any special transacted at any special shareholders' meeting is limited to shareholders meeting is limited to the purposes stated in the notice of the purposes stated in the notice of the meeting. the meeting. Notice. Notice of any annual or Notice. Pursuant to the Carbon special meeting shall be sent not bylaws, notice of any annual or less than 21 days and not more than special meeting of the shareholders 50 days before the meeting. will be given to each shareholder entitled to vote at the meeting not less than 10 nor more than 60 days prior to the meeting. Inspection Rights General Inspection Rights. The General Inspection Rights. Any directors and shareholders of CEC, Carbon shareholder who has been a their agents and legal shareholder for at least three representatives may examine the months, or who holds at least 5% of following records during the usual the outstanding shares of any class, business hours of CEC free of may inspect and copy the following charge: records of Carbon upon delivery of a written demand made in good faith and for a proper purpose and given to Carbon at least five business days prior to the inspection: . the articles and by-laws and all amendments; . any USA and any amendments; . excerpts from Board minutes or . any USA and any amendments; records of actions taken by the Board; . minutes of meetings and resolutions of shareholders; . accounting records; and . copies of all notices . the names and addresses of shareholders. . the securities register The requesting shareholder must . copies of the financial describe with reasonable statements, particularity the purpose and the records which the shareholder desires to inspect. The records must be directly connected with the described purpose. . reports and information . a register of disclosures in relation to material contracts In addition, any shareholder may inspect or copy the following records of Carbon upon written demand at least five business days before the inspection: . its Articles of Incorporation; . its Bylaws; . the minutes of all shareholder meetings and records of all actions taken by shareholders without a meeting, for the past three years; . all written communications to all or any class of shareholders as a group within the past three years; . a list of names and business addresses of Carbon's directors and officers; . a copy of the most recent corporate report delivered to the Secretary of State; and . the financial statements described below. 81 CEC CARBON Financial Statements: See above. Financial Statements. The CBCA requires Carbon, upon written request of any shareholder, to mail to that shareholder its most recent annual financial statements, if any, and its most recent published financial statements, if any, reasonably detailing its assets and liabilities and results of operations. Liability of Shareholders Limited Liability. Shareholders are Limited Liability. Shareholders are generally not personally liable for generally not personally liable for the acts or debts of CEC. the acts or debts of Carbon. No Capital Assessment: A shareholder No Capital Assessment. A shareholder is required to pay the consideration is required to pay the consideration stated by the Board of Directors for stated by the Board of Directors for shares issued to that person. A shares issued to that person. (In shareholder of CEC is not liable to the case of the exchange offer, the CEC or its creditors for capital consideration for each Carbon share assessments or calls. is one CEC share.) A shareholder of Carbon is not liable to Carbon or its creditors for capital assessments or calls. Number and Election of Directors Number: The CEC Articles of Number. The Carbon Articles of Incorporation require a minimum of Incorporation name five initial three and a maximum of nine directors. However, the number of directors. However, the number of directors can be changed by a Board directors can be changed by the of Directors resolution, so long as shareholders amending the Articles, such a resolution does not have the but no decrease shall shorten the effect of shortening the term of any term of the incumbent director. incumbent director. Election. Shareholders shall, by Election. The Board of Directors is ordinary resolution at each annual elected at the annual shareholders' meeting, elect the Board of meeting. At each annual meeting, the Directors. number of candidates equaling the number of directors to be elected receiving the highest number of votes are elected to the Board of Directors. Residence of Directors Residence. At least half of the Residence. There are no requirements directors must be resident as to the place of residence of Canadians. directors of Carbon. Removal of Directors Removal. The shareholders may by Removal. Any director can be removed ordinary resolution passed at a from office, either with or without special meeting remove any director cause, at a meeting of shareholders from office. If a director is when the votes cast in favor of elected by any class of removal exceeds the votes against shareholders, only that class of removal. If a director is elected by shareholders may participate in a a voting group of shareholders, only vote for removal. that voting group may participate in a vote for removal. 82 CEC CARBON Vacancies on the Board of Directors Expiration of Terms. The ABCA Expiration of Terms. The Carbon provides that if directors are not bylaws and CBCA provide that even elected at a meeting of after the expiration of a director's shareholders, the incumbent term, he or she continues to serve directors continue in office until until his or her successor is their successors are elected. elected and qualifies. Vacancies in General. Any vacancies Vacancies in General. Any vacancies on the Board of Directors are filled on the Board of Directors are filled by: by: . the shareholders; or . the Board of Directors, if a quorum is present, by a simple . the Board of Directors, or a majority. simple majority vote of the remaining directors if their number is insufficient to constitute quorum. . a vote of the shareholders. Any vacant directorship held by a director elected by a particular Any vacant directorship held by a class of shareholders may be filled director elected by a particular by either: shareholder voting group may be filled by either: . the shareholders of that particular class if there are no . shareholders of that voting group remaining directors of that class; entitled to vote; or or . a simple majority of any one or . the directors elected by that more remaining directors elected class. by that same voting group. Standard of Conduct General Standard of General Standards of Conduct for Conduct. Directors and officers are Directors and Officers. Directors required to discharge their and officers are required to respective duties: discharge their respective duties: . in good faith with a view to the . in good faith; best interests of the Corporation; and . with the care an ordinary person in a like position would exercise under similar circumstances; and . exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances. . in a manner that he or she reasonably believes is in the best interests of the corporation. Conflicting Interest Conflicting Interest Transactions. Under the ABCA, if a Transactions. Under the CBCA, no material contract is made between loan, guaranty, contract or the Corporation and one or more of transaction between Carbon and a its directors or officers, or director or between Carbon and any between a corporation and another entity in which a Carbon director is person of which a director of a director or officer or has a officer of the corporation is a financial interest is void or director or officer or in which he voidable, can be enjoined or gives has a material interest, the rise to an award of damages solely contract is neither void or voidable because of the conflicting interest by reason only of that relationship of the director if: and a director is not liable to account to the corporation for that profit if: . after disclosure of material facts of the relationship or interest in the transaction, the transaction is approved by the affirmative vote of disinterested directors; or . the director or officer disclosed his interest; . the contract was approved by the directors or shareholders; and . after disclosure of material facts of the relationship or interest in the transaction, the transaction is approved a vote of shareholders; or . it was reasonable and fair to the Corporation at the time it was approved. . the conflicting interest transaction is fair to Carbon. 83 CEC CARBON Limitation of Liability of Directors and Officers Limitation on Personal Liability of Limitation on Personal Liability of Directors. Pursuant to the CEC Arti- Directors. The CBCA permits Colorado cles of Incorporation, CEC directors corporations to limit or eliminate are not liable to the Corporation or personal liability of the a director its shareholders for anything except to the corporation or to its share- as set out in the ABCA. Those in- holders for monetary damages for a stances where directors in any event breach of fiduciary duty as a direc- remain liable to the Corporation or tor, except for certain specified its shareholders for monetary dam- instances. Those instances where di- ages are: rectors in any event remain liable to the corporation or its sharehold- . any breach of a directors' duty to ers for monetary damages are: act honestly and in good faith with a view to the best interests . any breach of the director's duty of the Corporation; of loyalty to the corporation or its shareholders, . any breach where a director did not exercise the care, diligence . acts or omissions not in good and skill that a reasonably pru- faith or which involve intentional dent person would exercise in com- misconduct or a knowing violation parable circumstances; of the law . unlawful dividends or other dis- . the unlawful purchase, redemption tributions; or or other acquisitions of shares; . any transaction from which the di- rector directly or indirectly de- . the unlawful commission on the rived an improper personal bene- sale of shares; fit. . the unlawful payment of any divi- Pursuant to the Carbon Articles of dends; Incorporation, Carbon directors are not personally liable to the corpo- . any unlawful financial assistance; ration or its shareholders, either directly or indirectly, for monetary . any unlawful payment of an indem- damages for the breach or breaches nity to a director or officer of of fiduciary duty as a director to the Corporation; the full extent permitted by law. . any unlawful payment to a share- holder; and . up to six months wages for non- payment of wages to employees. Indemnification of Directors and Officers ABCA Provisions. Pursuant to the CBCA Provisions. Pursuant to the ABCA, CEC must indemnify a director CBCA, Carbon must indemnify a person or officer in respect of all costs, who was wholly successful, on the charges and expenses reasonably in- merits or otherwise, in the defense curred in his defense of any civil, of any proceeding to which the per- criminal or administrative action or son was a party because the person proceeding if: is or was a director or officer, against reasonable expenses incurred . he was substantially successful on by him or her in connection with the the merits; proceeding. The CBCA also permits Carbon to indemnify and advance ex- . he acted honestly and in good penses to a director or officer, who faith and had reasonable grounds was made a party to a proceeding be- for believing his conduct was law- cause that person is a director or ful; and officer, against liability incurred in the proceeding if: . he is fairly and reasonably enti- tled to indemnity. The Court may grant approval to . the person conducted himself or grant indemnity for a derivative ac- herself in good faith; tion if he acted honestly and in good faith and had reasonable . the person reasonably believed grounds for believing his conduct that his or her conduct was in was lawful. Carbon's best interest or not op- posed to Carbon's best interest; and . in the case of any criminal pro- ceeding, the person had no reason- able cause to believe his or her conduct was unlawful. The CBCA will not allow Carbon to indemnify a director or officer for liability to the corporation in an action brought by a shareholder on behalf of Carbon or for liability to the corporation for deriving an im- proper personal benefit. 84 CEC CARBON Carbon Bylaws and Indemnification A court may nevertheless order Agreement. CEC's bylaws permit indemnification as the court deems indemnification subject to the above proper, except that indemnification as set out in the ABCA. is limited to reasonable expenses of a proceeding where the director or officer has been held liable in an action brought by a shareholder or for deriving an improper personal benefit. Carbon Bylaws and Indemnification Agreements. Carbon's bylaws and indemnification agreements with each director and officer mandate that Carbon indemnify and advance expenses to the director or officer to the full extent permitted by law. Exclusiveness. See above Exclusiveness. Carbon may provide, by shareholder or Board of Directors resolution or by way of contract, for indemnification or advancement of expenses not expressly provided for in the CBCA, if not inconsistent with public policy. Appraisal Rights Right to Dissent. Under the ABCA, a Right to Dissent. Under the CBCA, a CEC shareholder, whether or not Carbon shareholder, whether or not entitled to vote, is entitled to entitled to vote, is entitled to dissent and obtain payment of the dissent and obtain payment of the fair value of their shares if the fair value of their shares in the Corporation resolves to: event of the consummation of a: . amend its articles changing the . plan of merger requiring approval share structure; by the shareholders, or a short- form merger of a corporation with its parent corporation; or . amend its articles to remove or change any business restrictions; . share exchange, by operation of . amalgamate with another law, with an acquiring corporation; corporation; or . be continued into another . sale, lease, exchange or other jurisdiction; or disposition of substantially all of the corporation's property requiring shareholder approval; or . sell, lease or exchange all or substantially all its property. . reverse stock-split that reduces the number of shares owned by the shareholder to a fraction of a share for which the corporation pays cash. No Right to Dissent. There is no No Right to Dissent. Under the CBCA, comparable section under the ABCA. except in the case of a reverse stock split described above, a Carbon shareholder may not dissent and obtain payment for their shares if the securities are: (1) listed on a national securities exchange, such as the American Stock Exchange, or a national market system of the National Association of Securities Dealers automated quotation system or (2) held of record by more than 2,000 shareholders. 85 CEC CARBON Vote Required in Extraordinary Transactions Merger or Share Exchange. The Board Merger or Share Exchange. The Board of Directors submits a plan of of Directors submits a plan of merger or share exchange to the merger or share exchange to the shareholders for approval. The plan shareholders for approval. The plan must be approved by special must be approved by a majority of resolution ( 2/3) of the outstanding the outstanding votes entitled to be votes entitled to be cast within cast within each voting group each voting group entitled to vote entitled to vote separately on the separately on the plan. plan. Separate voting by a class or series of shares as a voting group is required: . on a plan of merger, if the plan contains a provision that would require approval by the class or series as a separate voting group if the provision was contained in an amendment to the corporation's Articles of Incorporation (see below for information on the vote to amend the Articles of Incorporation); or . on a plan of share exchange, by each class or series of shares included in the share exchange. There is no comparable section with However, approval of the regard to any "surviving shareholders of any surviving corporation" in the ABCA. corporation in a merger is not required if: . the Articles of Incorporation of the surviving corporation prior to the merger will not be changed after the merger; . shareholders with shares prior to the merger will hold the same number of shares after the merger, with the same designations, preferences, limitations and relative rights; . the number of voting shares outstanding immediately after the merger plus the number issuable as a result of the merger does not exceed by more than 20% the total number of voting shares of the surviving corporation prior to the merger; and . the number of participating shares outstanding immediately after the merger plus the number issuable as a result of the merger, does not exceed by more than 20% the total number of participating shares outstanding prior to the merger. Merger of Parent and Wholly-Owned Merger of Parent and 90% Held Subsidiary. The directors of a Subsidiary. No shareholder approval holding corporation and one or more of the parent company is required if of its wholly-owned subsidiaries may a parent corporation owning at least approve an amalgamation of the 90% of a subsidiary corporation resolutions provided that: merges the subsidiary into itself. . shares of each subsidiary will be cancelled; . the articles of amalgamation will be the same as the holding company; and . no securities shall be issued by the amalgamated corporation in connection with the amalgamation 86 CEC CARBON Sale of Assets. Under the ABCA, the Sale of Assets. Under the CBCA, the sale, lease or exchange of all or sale, lease, exchange or other substantially all the property of a disposition of all, or substantially corporation other than in the all, of Carbon's property (which may ordinary course of business requires include goodwill) other than in the approval by special resolution ( ordinary course of business requires 2/3) of the outstanding votes approval of a majority of the entitled to be cast within each outstanding votes entitled to be voting group entitled to vote cast within each voting group separately on the plan. entitled to vote separately on the plan. Dissolution. The Board of Directors Dissolution. The Board of Directors recommends to the CEC shareholders recommends to the Carbon approval of any proposal for shareholders approval of any voluntary dissolution of the proposal for voluntary dissolution Corporation, and by special of the corporation, and the plan resolutions of each shareholder must be approved by a majority of class, the plan must be approved by the outstanding votes entitled to be 2/3 of the outstanding votes cast within each voting group entitled to be cast within each entitled to vote separately on the voting group entitled to vote plan. separately on the plan. Change in Control Under Colorado/Alberta Law The ABCA contains no special voting The CBCA contains no special voting or other requirements that result or other requirements that result from a change in control. from a change in control. Oppression Remedy Under the ABCA, a complainant may The CBCA does not provide for any apply to the Court for an order in statutory oppression remedy. respect of a corporation or any of However, shareholders have legal and its affiliates: equitable remedies for improper acts or omissions by directors or officers. . any act or omission of the Corporation or any of its affiliates effects a result; . the business or affairs of the Corporation or its affiliates have been conducted in a manner; or . the powers of the directors of the Corporation of any of its affiliates have been exercised in a manner that is oppressive or unfairly prejudicial to or unfairly disregards the interests of any securityholder, creditor, director or officer, the Court may make an order to rectify the matter complained of. Amendment to Governing Documents Amendment to Articles. CEC Amendment to Articles. Carbon shareholders can approve amendments shareholders can approve amendments to the Articles of Incorporation at to the Articles of Incorporation at a meeting by 2/3 of the votes cast a meeting by a majority of the votes with respect to the amendment. Such cast on the amendment. A class or items would include: series of shares are entitled to vote as a separate voting group on an amendment if the amendment would, among other things: . a name change; . changing or removing the business restrictions; . increase or decrease the aggregate number of authorized shares of the class or series; . increase or decrease the aggregate number of shares that CEC is authorized to issue; . exchange or reclassify all or part of the shares of the class or series; . changing share structure or creating a new class of shares; . change the preferences, . increasing or decreasing the limitations or relative rights of number of directors. the shares of the class or series; 87 CEC CARBON . change the shares into a different number of shares of the same class or series; or . create a new class of shares having rights or preferences with respect to distributions or dissolution that are superior or equal to the shares of the class or series. Amendment to Bylaws. Either the Amendment to Bylaws. Either the Board of Directors or the Board of Directors or the shareholders may make a proposal to shareholders may adopt amendments to adopt amendments to the by-laws. The the Bylaws of Carbon. Shareholder directors shall submit a by-law, or approval of such an amendment at a an amendment or a repeal of a by-law meeting requires a majority of the to the shareholders at the next votes cast on the subject. meeting of shareholders, and the shareholders, may by ordinary resolution, confirm, reject or amend the by-law, amendment or repeal. 88 LEGAL MATTERS The validity of the issuance of the shares of common stock being offered hereby will be passed upon for us by Holland & Hart LLP, Denver, Colorado. Holland and & Hart LLP has rendered an opinion as to the material United States federal income tax considerations relating to the exchange offer and Bennett Jones has rendered an opinion as to the material Canadian federal income tax consequences of the exchange offer. These opinions have been filed as exhibits to the registration statement of which this prospectus is a part. EXPERTS The financial statements of Carbon Energy Corporation as of October 20, 1999 and for the period from inception (September 14, 1999) through October 20, 1999, included in this prospectus and elsewhere in the registration statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their report with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said report. BFC's audited financial statements included in this prospectus and elsewhere in the registration statement have been audited by Hein + Associates LLP, independent public accountants, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of said firms as experts in giving said reports. The financial statements of CEC Resources Ltd. as of November 30, 1998 and 1997 and for each of the three years in the period ended November 30, 1998 included in this Prospectus have been so included in the reliance on the report of PricewaterhouseCoopers LLP, independent accountants, given on the authority of said firm as experts in auditing and accounting. WHERE YOU CAN FIND MORE INFORMATION We have filed with the Securities and Exchange Commission, a registration statement on Form S-4 under the Securities Act of 1933 with respect to the common stock offered by this prospectus. This prospectus does not contain all of the information in the registration statement and the exhibits and schedules. For further information about us and our common stock, please refer to the registration statement and the exhibits and schedules filed. Statements contained in this prospectus as to the contents of any contract or document filed as an exhibit to the registration statement are qualified by reference to such exhibit as filed. A copy of the registration statement, and the exhibits and schedules thereto, may be inspected without charge at the public reference facilities maintained by the SEC in Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all or any part of the registration statement may be obtained from such offices upon the payment of the fees prescribed by the SEC. Information regarding the operation of the public reference room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a Website that contains registration statements, reports, proxy and other information regarding registrants that file electronically with the SEC. The address of this Website is sec.gov. 89 INDEX TO FINANCIAL STATEMENTS
Page ---- Carbon Energy Corporation Report of Independent Public Accountants.................................. F-2 Balance Sheet as of October 20, 1999...................................... F-3 Statement of Stockholder's Equity......................................... F-4 Statement of Cash Flow for period from inception (September 14, 1999) through October 20, 1999................................................. F-5 Notes to the Financial Statements......................................... F-6 Bonneville Fuels Corporation (predecessor to Carbon Energy Corporation) Independent Auditor's Report.............................................. F-7 Consolidated Balance Sheets at December 31, 1998 and 1997................. F-8 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996...................................................... F-9 Consolidated Statement of Stockholders' Equity for the period from January 1, 1996 through December 31, 1998........................................ F-10 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996...................................................... F-11 Notes to Consolidated Financial Statements................................ F-12 Consolidated Balance Sheets at June 30, 1999 and 1998 (unaudited)......... F-17 Consolidated Statement of Operations for the six months ended June 30, 1998 and 1998 (unaudited)................................................ F-19 Consolidated Statements of Cash Flows for the six months ended June 30, 1999 (unaudited)......................................................... F-20 Consolidated Statement of Stockholders' Equity and Retained Earnings for the six months ended June 30, 1999 (unaudited)........................... F-21 Notes to Consolidated Financial Statements................................ F-22 CEC Resources Ltd. Auditors' Report.......................................................... F-27 Balance Sheets at November 30, 1998 and 1997.............................. F-28 Statements of Income for the years ended November 30, 1998, 1997 and 1996. F-30 Statements of Stockholders' Equity for the years ended November 30, 1998, 1997 and 1996............................................................ F-31 Statements of Cash Flows for the years ended November 30, 1998, 1997 and 1996..................................................................... F-32 Notes to the Financial Statements......................................... F-33 Balance Sheets at August 31, 1999 (unaudited) and November 30, 1998....... F-44 Statements of Income for nine months ended August 31, 1999 and 1998 (unaudited).............................................................. F-45 Statement of Stockholders' Equity for the nine months ended August 31, 1999 (unaudited)......................................................... F-46 Statements of Cash Flow for the nine months ended August 31, 1999 and August 31, 1998 (unaudited).............................................. F-47 Notes to Financial Statements............................................. F-48
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Carbon Energy Corporation: We have audited the accompanying balance sheet of CARBON ENERGY CORPORATION (a Colorado corporation) as of October 20, 1999, and the related statements of stockholder's equity and cash flow for the period from inception (September 14, 1999) to October 20, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Carbon Energy Corporation as of October 20, 1999, and its cash flow for the period from inception (September 14, 1999) to October 20, 1999, in conformity with generally accepted accounting principles. Arthur Andersen LLP Denver, Colorado October 21, 1999 F-2 CARBON ENERGY CORPORATION BALANCE SHEET As of October 20, 1999 ASSETS Cash....................................................................... $550 ---- Total assets............................................................... $550 ==== STOCKHOLDER'S EQUITY Preferred stock, no par value: 10,000,000 shares authorized, none outstanding........................... $-- Common stock, no par value: 20,000,000 shares authorized, 100 outstanding............................ 550 ---- Total stockholder's equity................................................. $550 ====
The accompanying notes are an integral part of these financial statements. F-3 CARBON ENERGY CORPORATION STATEMENT OF STOCKHOLDER'S EQUITY For the Period From Inception (September 14, 1999) Through October 20, 1999
Common Stock ------------- Shares Value Total ------ ------ ----- Balances, September 14, 1999................................ -- $-- $-- Shares issued (note 2)...................................... 100 550 550 --- ---- ---- Balances, October 20, 1999.................................. 100 $550 $550 === ==== ====
The accompanying notes are an integral part of these financial statements. F-4 CARBON ENERGY CORPORATION STATEMENT OF CASH FLOW For the Period From Inception (September 14, 1999) Through October 20, 1999 Cash flow from financing activities: Issuance of common stock................................................ $550 ---- 550 ---- Net increase in cash...................................................... 550 Cash at the beginning of the period....................................... -- ---- Cash at the end of the period............................................. $550 ====
The accompanying notes are an integral part of these financial statements. F-5 CARBON ENERGY CORPORATION NOTES TO THE FINANCIAL STATEMENTS (1) Nature of Business Carbon Energy Corporation ("Carbon") was incorporated under the laws of the State of Colorado on September 14, 1999. Carbon is an independent oil and gas company engaged in the exploration, development and production of natural gas and crude oil. Carbon has been formed for the purpose of acquiring Bonneville Fuels Corporation ("BFC"), a wholly owned subsidiary of Bonneville Pacific Corporation ("BPC"). BFC is an oil and gas company incorporated in Colorado. Carbon was also formed for the purpose of exchanging Carbon shares for shares of CEC Resources Ltd. ("CEC"), an independent oil and gas company, incorporated in Alberta, Canada. (2) Capital Stock During October 1999, Carbon issued 100 shares of common stock at U.S. $5.50 to Yorktown Energy Partners III, L.P. ("Yorktown"). This has been the only activity to date since the inception of Carbon. (3) Acquisitions On August 11, 1999, CEC and BPC signed a stock purchase agreement, whereby CEC agreed to purchase all of the outstanding BFC stock from BPC at a price of $23,857,951 in cash, subject to certain adjustments, with debt less working capital of approximately $6,500,000 remaining at BFC. On October 14, 1999, Carbon, CEC and Yorktown signed an exchange and financing agreement providing for an assignment of the BFC stock purchase agreement to Carbon, the purchase of Carbon common stock by Yorktown for $24,750,000 and an exchange offer whereby Carbon will exchange one share of Carbon common stock for one share of CEC common stock. F-6 INDEPENDENT AUDITOR'S REPORT Board of Directors Bonneville Fuels Corporation Denver, Colorado We have audited the accompanying consolidated balance sheets of Bonneville Fuels Corporation (a wholly-owned subsidiary of Bonneville Pacific Corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholder's equity, and cash flows for each of the years in the three-year period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bonneville Fuels Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Hein + Associates LLP Denver, Colorado February 26, 1999 F-7 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) CONSOLIDATED BALANCE SHEETS
December 31, -------------------------- 1998 1997 ------------ ------------ ASSETS ------ Current Assets: Cash............................................... $ 2,742,000 $ 544,000 Accounts receivable, trade......................... 4,972,000 2,818,000 Investment margin accounts......................... 534,000 63,000 Prepaid expenses and other......................... 241,000 241,000 ------------ ------------ Total current assets........................... 8,489,000 3,666,000 ------------ ------------ Property and Equipment, at cost: Oil and gas properties, using the successful efforts method: Unproved properties.............................. 2,745,000 1,953,000 Proved properties................................ 29,679,000 26,624,000 Furniture and equipment............................ 497,000 293,000 ------------ ------------ 32,921,000 28,870,000 Less accumulated depreciation, depletion and amortization.................................... (18,891,000) (16,863,000) ------------ ------------ Property and equipment, net.................... 14,030,000 12,007,000 ------------ ------------ Other Assets: Deposits and other................................. 276,000 317,000 Deferred loan costs, net........................... 45,000 64,000 ------------ ------------ Total other assets............................. 321,000 381,000 ------------ ------------ Total Assets......................................... $ 22,840,000 $ 16,054,000 ============ ============ LIABILITIES AND STOCKHOLDER'S EQUITY ------------------------------------ Current Liabilities: Accounts payable and accrued expenses.............. $ 6,866,000 $ 1,470,000 Accrued production taxes payable................... 335,000 257,000 Undistributed revenue.............................. 476,000 448,000 ------------ ------------ Total current liabilities...................... 7,677,000 2,175,000 ------------ ------------ Long-term Debt....................................... 5,850,000 2,400,000 Taxes Payable to BPC................................. -- 1,888,000 Commitments and Contingencies (Notes 2, 4, and 6) Stockholder's Equity: Common stock, $.01 par value; 1,000 shares authorized, issued and outstanding................ -- -- Additional paid in capital......................... 3,475,000 1,812,000 Retained earnings.................................. 5,838,000 7,779,000 ------------ ------------ Total stockholder's equity..................... 9,313,000 9,591,000 ------------ ------------ Total Liabilities and Stockholder's Equity........... $ 22,840,000 $ 16,054,000 ============ ============
See accompanying notes to these consolidated financial statements. F-8 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, ------------------------------------ 1998 1997 1996 ----------- ----------- ----------- Revenues: Oil and gas sales....................... $ 6,758,000 $ 6,429,000 $ 5,262,000 Gas marketing and transportation........ 12,610,000 9,135,000 9,550,000 Electricity sales....................... 1,331,000 506,000 -- Other................................... 393,000 469,000 255,000 ----------- ----------- ----------- 21,092,000 16,539,000 15,067,000 ----------- ----------- ----------- Expenses: Oil and gas production costs............ 3,004,000 2,779,000 2,095,000 Gas marketing and transportation........ 12,674,000 8,553,000 6,910,000 Cost of electricity..................... 1,137,000 497,000 -- Depreciation, depletion and amortization expense................................ 2,086,000 1,942,000 1,205,000 Exploration expense..................... 556,000 772,000 419,000 Impairment expense...................... 1,858,000 312,000 -- General and administrative expense...... 1,655,000 590,000 472,000 Interest expense........................ 238,000 83,000 272,000 ----------- ----------- ----------- 23,208,000 15,528,000 11,373,000 ----------- ----------- ----------- Income (Loss) Before Extraordinary Items and Taxes.............................. (2,116,000) 1,011,000 3,694,000 Extraordinary Gain on Extinguishment of Debt Owed to Parent Company, net of taxes of zero.................................. -- -- 1,788,000 ----------- ----------- ----------- Income (Loss) Before Taxes................ (2,116,000) 1,011,000 5,482,000 Tax Expense (Benefit): Current................................. (225,000) 279,000 1,422,000 Deferred................................ 50,000 -- -- ----------- ----------- ----------- Net Income (Loss)......................... $(1,941,000) $ 732,000 $ 4,060,000 =========== =========== ===========
See accompanying notes to these consolidated financial statements. F-9 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY For the Period from January 1, 1996 Through December 31, 1998
Common Stock Additional ---------------- Paid-in Retained Shares Par Value Capital Earnings Total ------ --------- ---------- ----------- ----------- Balances, January 1, 1996.................... 1,000 $-- $ -- $ 2,987,000 $ 2,987,000 Intercompany payables converted to equity by Parent................ -- -- 1,812,000 -- 1,812,000 Net income............. -- -- -- 4,060,000 4,060,000 ----- ---- ---------- ----------- ----------- Balances, December 31, 1996.................... 1,000 -- 1,812,000 7,047,000 8,859,000 Net income............. -- -- -- 732,000 732,000 ----- ---- ---------- ----------- ----------- Balances, December 31, 1997.................... 1,000 -- 1,812,000 7,779,000 9,591,000 Intercompany payables converted to equity by Parent................ -- -- 1,663,000 -- 1,663,000 Net loss............... -- -- -- (1,941,000) (1,941,000) ----- ---- ---------- ----------- ----------- Balances, December 31, 1998.................... 1,000 $-- $3,475,000 $ 5,838,000 $ 9,313,000 ===== ==== ========== =========== ===========
See accompanying notes to these consolidated financial statements. F-10 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, -------------------------------------- 1998 1997 1996 ----------- ----------- ------------ Cash Flows from Operating Activities: Net income (loss).................... $(1,941,000) $ 732,000 $ 4,060,000 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Deferred taxes..................... 50,000 -- -- Gain on debt extinguishment........ -- -- (1,788,000) Depreciation, depletion and amortization expense.............. 2,067,000 1,942,000 1,205,000 Impairment of property and equipment......................... 1,858,000 312,000 -- Amortization of loan costs......... 19,000 19,000 20,000 Changes in operating assets and liabilities: Decrease (increase) in: Accounts receivable, trade..... (2,154,000) (21,000) (1,440,000) Investment margin account...... (471,000) 152,000 (61,000) Prepaid expenses and other..... (50,000) (36,000) (32,000) Other assets................... 41,000 (26,000) 37,000 Increase (decrease in): Accounts payable and accrued expenses...................... 5,396,000 59,000 609,000 Accrued production taxes payable....................... 78,000 (77,000) (30,000) Undistributed revenues......... 28,000 (194,000) 204,000 Deferred gain and other liabilities................... -- 52,000 (74,000) Taxes payable to Parent........ (225,000) 279,000 1,426,000 ----------- ----------- ------------ Net cash provided by operating activities........................ 4,696,000 3,193,000 4,136,000 ----------- ----------- ------------ Cash Flows from Investing Activities: Capital expenditures for oil and gas properties.......................... (5,948,000) (4,442,000) (1,025,000) ----------- ----------- ------------ Net cash used in investing activities........................ (5,948,000) (4,442,000) (1,025,000) Cash Flows from Financing Activities: Proceeds from note payable........... 4,650,000 3,600,000 400,000 Payments on note payable............. (1,200,000) (2,900,000) (3,460,000) Production payment received.......... -- 319,000 300,000 ----------- ----------- ------------ Net cash provided by (used in) financing activities.............. 3,450,000 1,019,000 (2,760,000) ----------- ----------- ------------ Net Increase (Decrease) in Cash and Equivalents........................... 2,198,000 (230,000) 351,000 Cash, beginning of year................ 544,000 774,000 423,000 ----------- ----------- ------------ Cash, end of year...................... $ 2,742,000 $ 544,000 $ 774,000 =========== =========== ============ Supplemental Disclosures of Cash Flow Information: Cash paid for interest............... $ 236,000 $ 83,000 $ 303,000 =========== =========== ============ Noncash investing and financing activities--Intercompany payable contributed to capital by Parent.... $ 1,663,000 $ -- $ 1,812,000 =========== =========== ============
See accompanying notes to these consolidated financial statements. F-11 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Nature of Operations and Significant Accounting Policies: Nature of Operation--Bonneville Fuels Corporation (BFC), a wholly-owned subsidiary of Bonneville Pacific Corporation (BPC), was incorporated in the State of Colorado in April 1987 and began doing business in June 1987. The Company owns four subsidiaries, Bonneville Fuels Marketing Corporation (BFMC), Bonneville Fuels Management Corporation (BFM Corp.), Bonneville Fuels Operating Corporation (BFO), and Colorado Gathering Corporation (CGC). Collectively, these entities are referred to as the Company. The Company's principal operations include exploration for and production of oil and gas reserves, marketing of natural gas, and gathering of natural gas. The Company from time to time also purchases and resells electricity. Principles of Consolidation--The consolidated financial statements include the accounts of BFC and its four wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in the accompanying consolidated financial statements. Cash Equivalents--The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Gas Marketing--The Company's marketing contracts are generally month-to- month or up to eighteen months, and provide that the Company will sell gas to end users which is produced from the Company's properties and acquired from third parties. Investment Margin Account--This account generally represents net cash margin deposits held by a brokerage firm for the Company's trading accounts. Oil and Gas Producing Activities--The Company follows the "successful efforts" method of accounting for its oil and gas properties, all of which are located in the continental United States. Under this method of accounting, all property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending determination of whether the well has found proved reserves. If an exploratory well has not found proved reserves, the costs of drilling the well are charged to expense. The costs of development wells are capitalized whether productive or nonproductive. Geological and geophysical costs and the costs of carrying and retaining undeveloped properties are expensed as incurred. Depreciation and depletion of capitalized costs for producing oil and gas properties is computed using the units-of-production method based upon proved reserves for each field. In 1997, the Company began to accrue for future plugging, abandonment, and remediation using the negative salvage value method whereby costs are expensed through additional depletion expense over the remaining economic lives of the wells. Management's estimate of the total future costs to plug, abandon, and remediate the Company's share of all existing wells, including those currently shut in is approximately $3,500,000, net of salvage values. The total amount expensed for this liability was $206,000 and $200,000, for the years ended December 31, 1998 and 1997, respectively. The Company follows Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for Impairment of Long-Lived Assets. This statement limits net capitalized costs of proved and unproved oil and gas properties to the aggregate undiscounted future net revenues related to each field. If the net capitalized costs exceed the limitation, impairment is provided to reduce the carrying value of the properties in the field to estimated actual value. The impairment is included as a reduction of gross oil and gas properties in the accompanying balance sheets. In 1998, 1997, and 1996, the Company recorded impairments of $1,858,000, $312,000, and $-0-, respectively. Factors causing the impairment of oil and gas properties in 1998 were the F-12 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) decline in oil prices worldwide and the re-estimation of reserve values on certain producing properties. The primary factor causing the impairments in 1997 was the reevaluation of certain undeveloped leases. Gains and losses are generally recognized upon the sale of interests in proved oil and gas properties based on the portion of the property sold. For sales of partial interests in unproved properties, the Company treats the proceeds as a recovery of costs with no gain recognized until all costs have been recovered. Energy Marketing Arrangements--In 1998, BFC entered into an agreement to manage certain natural gas contracts of an unrelated entity. For some contracts, BFC takes title to the gas purchased to service these contracts prior to the sale under the contracts. For these contracts, BFC consolidates all revenue, expenses, receivables and payables associated with the contracts. In contracts where title is not taken, BFC only records the margin associated with the transaction. Other Property and Equipment--Depreciation of other property and equipment is calculated using the straight-line method over the estimated useful lives (ranging from 3 to 25 years) of the respective assets. The cost of normal maintenance and repairs is charged to operating expenses as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of properties sold, or otherwise disposed of, and the related accumulated depreciation or amortization are removed from the accounts, and any gains or losses are reflected in current operations. Deferred Loan Costs--Costs associated with the Company's note payable have been deferred and are being amortized using the effective interest method over the original term of the note. Gas Balancing--The Company uses the sales method of accounting for amounts received from natural gas sales resulting from production credited to the Company in excess of its revenue interest share. Under this method, all proceeds from production credited to the Company are recorded as revenue until such time as the Company has produced its share of related estimated remaining reserves. Thereafter, additional amounts received are recorded as a liability. Income Taxes--The Company accounts for income taxes under the liability method which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. BPC includes the Company's operations in its consolidated tax return. Income taxes are allocated by BPC as if the Company were a separate taxpayer. Accounting for Hedged Transactions--The Company periodically enters into futures, forwards, and swap contracts as hedges of commodity prices associated with the production of oil and gas and with the purchase and sale of natural gas in order to mitigate the risk of market price fluctuations. Changes in the market value of futures, forwards, and swap contracts are not recognized until the related production occurs or until the related gas purchase or sale takes place. Realized losses from any positions which were closed early are deferred and recorded as an asset or liability in the accompanying balance sheet, until the related production, purchase or sale takes place. Gains and losses incurred on these contracts are included in oil and gas revenue or in gas marketing costs in the accompanying statements of operations. Accounting Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in these financial statements and the accompanying notes. The actual results could differ from those estimates. F-13 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Reclassifications--Certain reclassifications have been made to conform the 1997 and 1996 financial statements to the presentation in 1998. These reclassifications had no effect on net income. Parent Company Bankruptcy and Related Transactions: In 1991, BPC filed a petition for re-organization under Chapter 11 of the U.S. Bankruptcy Code and in June 1992, a Trustee was appointed for the case. As a result of BPC's bankruptcy, the Company established, prior to 1994, an allowance for doubtful accounts from BPC equal to the receivable. In 1995, claims filed against the estate of BPC were amended to total $1,788,000 to reflect additional amounts due related to pre-petition transactions. As a condition of granting a loan in 1991, the lender required that BPC convert intercompany debt of $3,600,000 to equity. In Board meetings at both the Company and BPC, the officers of each company were authorized and directed to complete this financing. In their respective internal financial statements, both the Company and BPC treated the intercompany debt as converted to equity. In 1993, it was discovered that the BPC Board resolution to ratify the conversion had not been duly executed. The Company, therefore, continued to disclose the intercompany debt as a liability. On December 20, 1996, the Bankruptcy Court authorized the Trustee to offset the mutual debts of the Company and BPC. After the offset, the Company was to convert any remaining intercompany debt to equity. The Company had established, prior to 1994, an allowance for doubtful accounts from BPC equal to the receivable. The amount of the offset equal to the allowance was recorded as an extraordinary gain on extinguishment of debt, with the remainder being recorded as a contribution of capital. In 1998, BPC approved the conversion of $1,663,000 in taxes payable to equity. Also in 1998, BPC emerged from bankruptcy. Long-Term Debt: The Company has an asset-based line-of-credit with a bank which provides for borrowing up to the borrowing base (as defined). The borrowing base was $13,200,000 at December 31, 1998. At December 31, 1998, outstanding borrowings amounted to $5,150,000, with interest at a variable rate that approximated 7% at December 31, 1998. The Company has issued letters of credit totaling $3,100,000 which further reduces the amount available for borrowing under the base. This facility is collateralized by certain oil and gas properties of the Company and is scheduled to convert to a term note on July 1, 2001. This term loan is scheduled to have a maturity of either the economic half life of the Company's remaining reserves on the date of conversion, or July 1, 2006, whichever is earlier. The borrowing base is based upon the lender's evaluation of BFC's proved oil and gas reserves, generally determined semi-annually. The future minimum principal payments under the term note will be dependent upon the bank's evaluation of the Company's reserves at that time. The Company also has an accounts receivable-based credit facility which includes a revolving line-of-credit with the bank which provides for borrowings up to $1,500,000. Outstanding borrowings under this facility at December 31, 1998 amounted to $700,000. This facility bears interest at prime (7.75% at December 31, 1998). This facility is collateralized by certain trade receivables of BFC and has a maturity date of July 1, 1999. The credit agreement contains various covenants which prohibit or limit the subsidiary's ability to pay dividends, purchase treasury shares, incur indebtedness, repay debt to the Parent, sell properties or merge with another entity. Additionally, the Company is required to maintain certain financial ratios. F-14 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Commitments: Office Lease--The Company leases office space under a noncancellable operating lease. Total rental expense was approximately $139,000, $58,000, and $58,000 for the years ended December 31, 1998, 1997, and 1996, respectively. Beginning in 1998, the Company has a new lease agreement which provides for total minimum rental commitments of: 1999............................................................. $147,000 2000............................................................. 153,000 2001............................................................. 159,000 2002............................................................. 166,000 -------- $625,000 ========
Income Taxes: The components of the net deferred tax assets are as follows:
As of December 31, ------------------------ 1998 1997 ----------- ----------- Excess of tax basis over book basis of oil and gas properties............................... $ 1,873,000 $ 1,439,000 ----------- ----------- Deferred tax assets........................... 1,873,000 1,439,000 Less valuation allowance...................... (1,873,000) (1,389,000) ----------- ----------- Net deferred tax assets....................... $ -- $ 50,000 =========== ===========
The effective tax rate of the Company differed from the Federal statutory rate primarily due to changes in the valuation allowance on the deferred tax assets. Concentrations of Credit Risk and Price Risk Management: Concentrations of Credit Risk--Substantially all of the Company's accounts receivable at December 31, 1998 result from crude oil and natural gas sales and/or joint interest billings to companies in the oil and gas industry. This concentration of customers and joint interest owners may impact the Company's overall credit risk, either positively or negatively, since these entities may be similarly affected by changes in economic or other conditions. In determining whether or not to require collateral from a customer or joint interest owner, the Company analyzes the entity's net worth, cash flows, earnings, and credit ratings. Receivables are generally not collateralized. Historical credit losses incurred on trade receivables by the Company have been insignificant. The Company's revenues are predominantly derived from the sale of natural gas and management estimates that over 85% of the value of the Company's properties is derived from natural gas reserves. Energy Financial Instruments--BFC uses energy financial instruments and long-term user contracts to minimize its risk of price changes in the spot and fixed price natural gas and crude oil markets. Energy risk management products used include commodity futures and options contracts, fixed-price swaps, and basis swaps. Pursuant to company guidelines BFC is to engage in these activities only as a hedging mechanism against price volatility associated with pre-existing or anticipated gas or crude oil sales in order to protect profit margins. As of December 31, 1998, BFC has financial and physical contracts which hedge 6 bcf (billion cubic feet) of production through December 2001. F-15 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The difference between the current market value of the hedging contracts and the original market value of the hedging contracts was a favorable $701,000 and an unfavorable $60,000 as of December 31, 1998 and 1997, respectively. These amounts are not reflected in the accompanying financial statements. In the event energy financial instruments do not qualify for hedge accounting, the difference between the current market value and the original contract value would be currently recognized in the statement of operations. In the event that the energy financial instruments are terminated prior to the delivery of the item being hedged, the gains and losses at the time of the termination are deferred until the period of physical delivery. Such deferrals were immaterial in all periods presented. Financial Instruments: SFAS Nos. 107 and 127 requires certain entities to disclose the fair value of certain financial instruments in their financial statements. Accordingly, management's best estimate is that the carrying amount of cash, receivables, notes payable, accounts payable, undistributed revenue, and accrued expenses approximates fair value of these instruments. See Note 6 for a discussion regarding the fair value of energy financial instruments. Management Retention Bonuses and Employment Contracts: The Company has accrued bonuses as of December 31, 1998 of $164,000 in accordance with a management retention program approved by the bankruptcy court. The Company has also entered into certain employment contracts with key employees that provide for certain benefits to the employees upon termination without cause. Subsequent Event: Subsequent to year-end, BPC engaged a financial advisor to pursue various strategic opportunities. BPC is considering all options including the continued operation of all its subsidiaries or the sale of the entire company or any part thereof. No adjustment to the financial statements has been made to reflect this uncertainty. F-16 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A wholly owned subsidiary of Bonneville Pacific Corporation) CONSOLIDATED BALANCE SHEET (Unaudited)
June 30 -------------------------- ASSETS 1999 1998 ------ ------------ ------------ Current Assets: Cash Unrestricted................................... $ 444,244 $ 840,165 Restricted..................................... 1,208,687 120,688 ------------ ------------ Total cash................................... 1,652,931 960,853 Accounts receivable Gas marketing.................................. 804,314 515,190 Oil and gas sales.............................. 1,425,002 972,559 Joint interest, net of allowance for doubtful accounts...................................... 246,564 185,017 Other.......................................... 6,393 1,156 ------------ ------------ Total accounts receivable.................... 2,482,273 1,673,922 Prepaid expenses, inventories and other.......... 113,452 169,872 ------------ ------------ Total current assets......................... 4,248,656 2,804,647 Property and Equipment, at cost Oil and gas properties........................... 35,968,225 30,905,211 Notes receivable--oil and gas.................... 0 0 Gas gathering system............................. 0 0 Furniture and equipment.......................... 556,468 405,000 Less depreciation, depletion and amortization.... (20,155,003) (17,802,953) ------------ ------------ Total property and equipment................. 16,369,690 13,507,258 ------------ ------------ Other Assets: Deposits and other............................... 270,528 275,914 Deferred loan cost, net.......................... 35,394 54,595 ------------ ------------ Total other assets........................... 305,922 330,509 ------------ ------------ Total Assets....................................... $ 20,924,268 $ 16,642,414 ============ ============
See accompanying notes to these financial statements. F-17 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A wholly owned subsidiary of Bonneville Pacific Corporation) CONSOLIDATED BALANCE SHEET (Unaudited)
June 30 ----------------------- LIABILITIES AND STOCKHOLDER EQUITY 1999 1998 ---------------------------------- ----------- ----------- Current Liabilities: Accounts payable and accrued expenses................... $ 1,882,536 $ 1,186,259 Undistributed revenue and other......................... 878,046 372,179 ----------- ----------- Total current liabilities........................... 2,760,582 1,558,438 ----------- ----------- Long Term Liabilities: Long term debt.......................................... 8,700,000 3,000,000 Accrued income taxes due parent......................... 0 1,888,430 ----------- ----------- Total long term liabilities......................... 8,700,000 4,888,430 ----------- ----------- Stockholder's Equity: Common stock............................................ 10 10 Additional paid in capital.............................. 3,475,038 1,812,207 Retained earnings....................................... 5,988,638 8,383,329 ----------- ----------- Total stockholder's equity.......................... 9,463,686 10,195,546 ----------- ----------- Total Liabilities and Stockholder's Equity.......... $20,924,268 $16,642,414 =========== ===========
See accompanying notes to these financial statements. F-18 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A wholly owned subsidiary of Bonneville Pacific Corporation) CONSOLIDATED STATEMENT OF OPERATIONS For the six months ended June 30 (Unaudited)
June 30 ----------------------- 1999 1998 ----------- ---------- Operating Revenue Sales: Oil and gas.......................................... $ 4,559,639 $3,468,321 Marketing services................................... 9,950,108 4,375,930 Other................................................ 218,481 181,302 ----------- ---------- Total operating income............................. 14,728,228 8,025,553 ----------- ---------- Operating Expenses Lease operations..................................... 1,574,391 1,080,016 Severance taxes...................................... 355,136 283,460 Marketing service cost............................... 9,742,051 4,409,099 DD & A............................................... 1,213,215 951,474 Impairment of proved and unproved properties......... 60,213 0 General and administrative........................... 1,414,801 895,429 (net recoveries)..................................... (624,445) (429,117) Provision for uncollectibles......................... 1,175 0 Exploration expense.................................. 638,350 183,478 ----------- ---------- Total operating expenses........................... 14,374,887 7,373,839 ----------- ---------- Net Income Before Interest and Other................... 353,341 651,714 Interest: Income............................................... 48,289 29,204 (Expense)............................................ (251,454) (84,991) ----------- ---------- Net Income Before Income Taxes......................... 150,176 595,927 Provision for income taxes............................. 0 0 ----------- ---------- Net Income............................................. $ 150,176 $ 595,927 =========== ==========
See accompanying notes to these financial statements. F-19 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A wholly-owned subsidiary of Bonneville Pacific Corporation) CONSOLIDATED STATEMENTS OF CASH FLOWS For the six months ended June 30 (Unaudited)
1999 1998 ----------- ----------- Cash Flows from Operating Activities: Net Income......................................... $ 150,176 $ 595,926 Adjustment to reconcile net income to cash provided by operating activities: Depreciation, depletion and amortization......... 1,263,828 941,874 Gain on debt extinguishment...................... Amortization of loan cost........................ 9,600 9,600 Other............................................ 0 0 Changes in operating assets and liabilities: (Increase) decrease in: Investment Margin Account........................ (674,309) (58,183) Accounts receivable.............................. 2,490,127 1,146,627 Prepaid expenses, inventories and other.......... 83,263 67,905 Increase (decrease) in:.......................... Accounts payable--trade.......................... (5,253,704) (536,156) Contingent liabilities........................... 0 0 Undistributed revenue............................ 402,507 (75,592) ----------- ----------- Net cash provided by operations.................. (1,528,512) 2,092,001 Cash Flows from Investing Activities: Additions to oil and gas properties................ (3,544,203) (2,328,249) Other net property and equipment................... (additions) disposals.............................. (59,130) (112,032) (Increases) decreases in other assets.............. (15,975) 43,870 ----------- ----------- Net cash used in investing activities.............. (3,619,308) (2,396,411) Cash Flows from Financing Activities: Net bank borrowings (payments)..................... 2,850,000 600,000 ----------- ----------- Net cash used in financing activities.............. 2,850,000 600,000 ----------- ----------- Net Increase (decrease) in Unrestricted Cash......... (2,297,820) 295,590 Unrestricted Cash Balance at Beginning of Period..... 2,742,064 544,575 ----------- ----------- Cash Balance at End of Period........................ $ 444,244 $ 840,165 =========== ===========
See accompanying notes to these consolidated financial statements. F-20 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A wholly owned subsidiary of Bonneville Pacific Corporation) CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY AND RETAINED EARNINGS For the six months ended June 30, 1999, and the year ended December 31, 1998 (Unaudited)
Common Stock Additional ------------- Paid In Retained Shares Amount Capital Earnings Total ------ ------ ---------- ------------ ------------ Balance December 31, 1997. 1,000 $10 $1,812,197 $ 7,779,310 $ 9,591,517 Intercompany payables converted to Equity by Parent................... $1,662,841 $1,662,841 Net income (loss)......... ($1,940,848) ($1,940,848) ----- --- ---------- ------------ ------------ Balance December 31, 1998. 1,000 $10 $3,475,038 $ 5,838,462 $ 9,313,510 Net income................ 150,176 $ 150,176 ----- --- ---------- ------------ ------------ Balance June 30, 1999..... 1,000 $10 $3,475,038 $ 5,988,638 $ 9,463,686 ===== === ========== ============ ============
See accompanying notes to these consolidated financial statements. F-21 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Nature of Operations and Significant Accounting Policies: Nature of Operation--Bonneville Fuels Corporation (BFC), a wholly-owned subsidiary of Bonneville Pacific Corporation (BPC), was incorporated in the State of Colorado in April 1987 and began doing business in June 1987. BFC owns four subsidiaries, Bonneville Fuels Marketing Corporation (BFMC), Bonneville Fuels Management Corporation (BFM Corp.), Bonneville Fuels Operating Corporation (BFO), and Colorado Gathering Corporation (CGC). Collectively, these entities are referred to as the Company. The Company's principal operations include exploration for and production of oil and gas reserves, marketing of natural gas, and gathering of natural gas. From time to time the Company also purchases and resells electricity. These financial statements are prepared in accordance with generally accepted accounting principles and require the use of management's estimates. These statements contain all adjustments (consisting only of normal recurring accruals) which, in the opinion of management, are necessary to present fairly the financial positions of BFC as of June 30, 1999 and 1998 and the results of its operations and of its cash flows for the periods presented. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year. Principles of Consolidation--The consolidated financial statements include the accounts of BFC and its four wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in the accompanying consolidated financial statements. Cash Equivalents--The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Gas Marketing--The Company's marketing contracts are generally month-to- month or up to eighteen months, and provide that the Company will sell gas to end users which is produced from the Company's properties and acquired from third parties. Investment Margin Account--This account generally represents net cash margin deposits held by a brokerage firm for the Company's trading accounts. Oil and Gas Producing Activities--The Company follows the "successful efforts" method of accounting for its oil and gas properties, all of which are located in the continental United States. Under this method of accounting, all property acquisition costs and costs of exploratory and development wells are capitalized when incurred, pending determination of whether the well has found proved reserves. If an exploratory well has not found proved reserves, the costs of drilling the well are charged to expense. The costs of development wells are capitalized whether productive or nonproductive. Geological and geophysical costs and the costs of carrying and retaining undeveloped properties are expensed as incurred. Depreciation and depletion of capitalized costs for producing oil and gas properties is computed using the units-of-production method based upon proved reserves for each field. In 1997, the Company began to accrue for future plugging, abandonment, and remediation using the negative salvage value method whereby costs are expensed through additional depletion expense over the remaining economic lives of the wells. Management's estimate of the total future costs to plug, abandon, and remediate the Company's share of all existing wells, including those currently shut in, is approximately $3,500,000, net of salvage values. The total amount expensed for this liability was $100,000 and $-0-, for the periods ended June 30, 1999 and 1998, respectively. F-22 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The Company follows Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for Impairment of Long-Lived Assets. This statement limits net capitalized costs of proved and unproved oil and gas properties to the aggregate undiscounted future net revenues related to each field. If the net capitalized costs exceed the limitation, impairment is provided to reduce the carrying value of the properties in the field to estimated actual value. The impairment is included as a reduction of gross oil and gas properties in the accompanying balance sheets. In the first six months of 1999, the Company incurred impairment cost of $60,000. In 1998, the Company recorded impairment cost of $1,858,000. Factors causing the impairment of oil and gas properties were the decline in oil prices worldwide and the re-assessment of reserve values on certain producing properties in 1998, and re-assessment of reserve values on a drilling venture in 1999. Gains and losses are generally recognized upon the sale of interests in proved oil and gas properties based on the portion of the property sold. For sales of partial interests in unproved properties, the Company treats the proceeds as a recovery of costs with no gain recognized until all costs have been recovered. Energy Marketing Arrangements--In 1998, BFC entered into an agreement to manage certain natural gas contracts of an unrelated entity. For contracts under which BFC takes title to the gas which services these contracts, BFC consolidates by item, all revenue, expense, receivables and payables associated with the contracts. In contracts where title is not taken, BFC records only the margin associated with the transaction. This agreement was terminated at the end of April 1999. Other Property and Equipment--Depreciation of other property and equipment is calculated using the straight-line method over the estimated useful lives (ranging from 3 to 25 years) of the respective assets. The cost of normal maintenance and repairs is charged to operating expenses as incurred. Material expenditures which increase the life of an asset are capitalized and depreciated over the estimated remaining useful life of the asset. The cost of properties sold, or otherwise disposed of, and the related accumulated depreciation or amortization is removed from the accounts, and any gains or losses are reflected in current operations. Deferred Loan Costs--Costs associated with the Company's note payable have been deferred and are being amortized using the effective interest method over the original term of the note. Gas Balancing--The Company uses the sales method of accounting for amounts received from natural gas sales resulting from production credited to the Company in excess of its revenue interest share. Under this method, all proceeds from production credited to the Company are recorded as revenue until such time as the Company has produced its share of related estimated remaining reserves. Thereafter, additional amounts received are recorded as a liability. Income Taxes--The Company accounts for income taxes under the liability method which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. BPC includes the Company's operations in its consolidated tax return. Income taxes are allocated by BPC as if the Company were a separate taxpayer. Accounting for Hedged Transactions--The Company periodically enters into futures, forwards, and swap contracts as hedges of commodity prices associated with the production of oil and gas and with the purchase and sale of natural gas in order to mitigate the risk of market price fluctuations. Changes in the market value of futures, forwards, and swap contracts are not recognized until the related production occurs or until the related F-23 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) gas purchase or sale takes place. Realized losses from any positions which were closed early are deferred and recorded as an asset or liability in the accompanying balance sheet, until the related production, purchase or sale takes place. Gains and losses incurred on these contracts are included in oil and gas revenue or in gas marketing costs in the accompanying statements of operations. Reclassifications--Certain reclassifications have been made to conform the 1999 financial statements to the presentation in 1998. These reclassifications had no effect on net income. 2. Parent Company Bankruptcy and Related Transactions: In 1991, BPC filed a petition for re-organization under Chapter 11 of the U.S. Bankruptcy Code and in June 1992, a Trustee was appointed for the case. As a result of BPC's bankruptcy, the Company established, prior to 1994, an allowance for doubtful accounts from BPC equal to the receivable. In 1995, claims filed against the estate of BPC were amended to total $1,788,000 to reflect additional amounts due related to pre-petition transactions. As a condition of granting a loan in 1991, the lender required that BPC convert intercompany debt of $3,600,000 to equity. In Board meetings at both the Company and BPC, the officers of each company were authorized and directed to complete this financing. In their respective internal financial statements, both the Company and BPC treated the intercompany debt as converted to equity. In 1993, it was discovered that the BPC Board resolution to ratify the conversion had not been duly executed. The Company, therefore, continued to disclose the intercompany debt as a liability. On December 20, 1996, the Bankruptcy Court authorized the Trustee to offset the mutual debts of the Company and BPC. After the offset, the Company was to convert any remaining intercompany debt to equity. The Company had established, prior to 1994, an allowance for doubtful accounts from BPC equal to the receivable. The amount of the offset equal to the allowance was recorded as an extraordinary gain on extinguishment of debt, with the remainder being recorded as a contribution of capital. In 1998, BPC approved the conversion of $1,663,000 in taxes payable to equity. Also in 1998, BPC emerged from bankruptcy. 3. Long-Term Debt: The Company has an asset-based line-of-credit with a bank which provides for borrowing up to the borrowing base (as defined). The borrowing base was $16,900,000 at June 30, 1999. Outstanding borrowings amounted to $8,400,000, with interest at a variable rate that approximated 6.70% at June 30, 1999. The Company has issued letters of credit totaling $2,500,000 which further reduce the amount available for borrowing under the base. This facility is collateralized by certain oil and gas properties of the Company and is scheduled to convert to a term note on July 1, 2001. This term loan is scheduled to have a maturity of either the economic half life of the Company's remaining reserves on the date of conversion, or July 1, 2006, whichever is earlier. The borrowing base is based upon the lender's evaluation of BFC's proved oil and gas reserves, generally determined semi-annually. The future minimum principal payments under the term note will be dependent upon the bank's evaluation of the Company's reserves at that time. The Company also has an accounts receivable-based credit facility which includes a revolving line-of-credit with the bank which provides for borrowings up to $1,500,000. Outstanding borrowings under this facility at June 30, 1999 amounted to $300,000. This facility bears interest at prime (7.75% at June 30, 1999). This facility is collateralized by certain trade receivables of BFC and has a maturity date of July 1, 2001. F-24 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The credit agreement contains various covenants which prohibit or limit the Company's ability to pay dividends, purchase treasury shares, incur indebtedness, repay debt to the Parent, sell properties or merge with another entity. Additionally, the Company is required to maintain certain financial ratios. 4. Commitments: Office Lease--The Company leases office space under a noncancellable operating lease. Total rental expense was approximately $73,000 and $57,000 for the periods ended June 30, 1999 and 1998, respectively. Beginning in 1998, the Company has a new lease agreement which provides for total minimum rental commitments of: 1999 (balance of year).......................................... $ 73,000 2000............................................................ 153,000 2001............................................................ 159,000 2002............................................................ 166,000 -------- $551,000 ========
5. Income Taxes: The components of the net deferred tax asset are as follows:
December 31, 1998 ----------- Excess of tax basis over book basis of oil and gas properties................................................ $ 1,873,000 ----------- Deferred tax asset......................................... 1,873,000 Less valuation allowance................................... (1,873,000) ----------- Net deferred tax asset..................................... $ -0- ===========
The Company has not accrued an income tax liability for the six months ending June 30, 1999 due to the availability of intangible drilling cost which will essentially eliminate taxable net income. The effective tax rate of the Company differed from the Federal statutory rate primarily due to changes in the valuation allowance on the deferred tax asset. 6. Concentrations of Credit Risk and Price Risk Management: Concentrations of Credit Risk--Substantially all of the Company's accounts receivable at June 30, 1999 result from crude oil and natural gas sales and/or joint interest billings to companies in the oil and gas industry. This concentration of customers and joint interest owners may impact the Company's overall credit risk, either positively or negatively, since these entities may be similarly affected by changes in economic or other conditions. In determining whether or not to require collateral from a customer or joint interest owner, the Company analyzes the entity's net worth, cash flows, earnings, and credit ratings. Receivables are generally not collateralized. Historical credit losses incurred on trade receivables by the Company have been insignificant. The Company's revenues are predominantly derived from the sale of natural gas. Management estimates that over 85% of the value of the Company's properties is derived from natural gas reserves. Energy Financial Instruments--BFC uses energy financial instruments and long-term user contracts to minimize its risk of price changes in the spot and fixed price natural gas and crude oil markets. Energy risk management products used include commodity futures and options contracts, fixed-price swaps, and basis swaps. Pursuant to company guidelines BFC is to engage in these activities only as a hedging mechanism against price volatility associated with pre-existing or anticipated gas or crude oil sales in order to protect profit margins. As of June 30, 1999, BFC has financial and physical contracts which hedge 5.1 bcf (billion cubic feet) of production through December 2001. F-25 BONNEVILLE FUELS CORPORATION AND SUBSIDIARIES (A Wholly-Owned Subsidiary of Bonneville Pacific Corporation) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The difference between the current market value of the hedging contracts and the original market value of the hedging contracts was an unfavorable $894,000 and an unfavorable $209,000 as of June 30, 1999 and 1998, respectively. These amounts are not reflected in the accompanying financial statements. In the event energy financial instruments do not qualify for hedge accounting, the difference between the current market value and the original contract value would be currently recognized in the statement of operations. In the event that the energy financial instruments are terminated prior to the delivery of the item being hedged, the gains and losses at the time of the termination are deferred until the period of physical delivery. Such deferrals were immaterial in all periods presented. 7. Financial Instruments: SFAS Nos. 107 and 127 requires certain entities to disclose the fair value of certain financial instruments in their financial statements. Accordingly, management's best estimate is that the carrying amount of cash, receivables, notes payable, accounts payable, undistributed revenue, and accrued expenses approximates fair value of these instruments. See Note 6 for a discussion regarding the fair value of energy financial instruments. 8. Management Retention Bonuses and Employment Contracts: The Company has accrued bonuses as of June 30, 1999 of $164,000 in accordance with a management retention program approved by the bankruptcy court. The Company has also entered into certain employment contracts with key employees that provide for certain benefits to the employees upon termination without cause. 9. Subsequent Event: During the first quarter, BPC engaged a financial advisor to pursue various strategic opportunities. BPC is considering several options including the continued operation of all its subsidiaries or the sale of the entire company or any part thereof. BFC management has had discussions with various interested parties during the second quarter, but no agreements have been reached. No adjustment to the financial statements has been made to reflect this uncertainty. F-26 AUDITORS' REPORT To the Stockholders of CEC Resources Ltd. We have audited the balance sheets of CEC Resources Ltd. as at November 30, 1998 and 1997, and the statements of income, stockholders' equity and cash flows for each of the three years in the period ended November 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these financial statements present fairly, in all material respects, the financial position of CEC Resources Ltd. as at November 30, 1998 and 1997 and the results of its operations and the statements of cash flows for each of the three years in the period ended November 30, 1998, in accordance with accounting principles generally accepted in Canada. PricewaterhouseCoopers LLP Chartered Accountants Calgary, Canada February 16, 1999 F-27 CEC RESOURCES LTD. BALANCE SHEETS
November 30, ----------------------- 1998 1997 ------- -------------- ASSETS (Reclassified, ------ Note 3) (in Canadian dollars) (in thousands) Current assets: Cash and cash equivalents............................ $ 1,666 $ 1,073 Accounts receivable: Oil and gas sales.................................. 466 404 Crown royalty refund and other..................... 333 266 Joint interest partners............................ 8 3 Income tax receivable (Note 6)....................... -- 53 ------- ------- Total current assets............................. 2,473 1,799 ------- ------- Property and equipment: Oil and gas assets, full cost method (Note 5)........ 16,192 16,047 Liquid extraction plant.............................. 1,477 1,473 Other property and equipment......................... 108 49 ------- ------- 17,777 17,569 Less: Accumulated depreciation, depletion and amortization (Notes 2 and 5)........................ (9,015) (7,990) ------- ------- Net property and equipment....................... 8,762 9,579 ------- ------- $11,235 $11,378 ======= =======
(continued) F-28 CEC RESOURCES LTD. BALANCE SHEETS--(continued)
November 30, ---------------------- 1998 1997 ------- -------------- LIABILITIES AND STOCKHOLDERS' EQUITY (Reclassified, ------------------------------------ Note 3) (in Canadian dollars) (in thousands) Current liabilities: Accounts payable...................................... $ 220 $ 483 Due to former Parent (Note 7)......................... 17 35 Income tax payable (Note 6)........................... 3 -- Undistributed oil and gas production receipts......... 113 132 ------- ------- Total current liabilities........................... 353 650 ------- ------- Future site restoration costs........................... 165 103 Deferred income taxes (Note 6).......................... 1,995 1,934 Commitments and contingent liabilities (Note 10) Stockholders' equity (Note 3): Preferred stock, authorized unlimited number of shares, no par value; none issued Share capital, common stock, authorized unlimited number of shares, without nominal or par value; 1,544,400 shares issued in 1998 and 1,589,000 in 1997 (Note 8)............................................. 1,534 1,106 Retained earnings..................................... 7,188 7,683 ------- ------- 8,722 8,789 ------- ------- Less: 15,000 shares held for cancellation............. -- (98) ------- ------- Total stockholders' equity.......................... 8,722 8,691 ------- ------- $11,235 $11,378 ======= =======
The accompanying notes are an integral part of these financial statements. F-29 CEC RESOURCES LTD. STATEMENTS OF INCOME
Year ended November 30, ---------------------- 1998 1997 1996 ------ ------ ------ (in Canadian dollars) (in thousands, except per share data) Revenues: Oil and gas sales..................................... $3,235 $3,451 $3,093 Royalties............................................. (586) (722) (462) Alberta royalty tax credit............................ 309 335 239 Field services........................................ 246 217 324 Other................................................. 49 28 18 ------ ------ ------ Total revenues...................................... 3,253 3,309 3,212 ------ ------ ------ Costs and expenses: Lease operating expenses.............................. 710 582 620 Field services........................................ 148 185 244 General and administrative............................ 984 751 747 Depreciation, depletion and amortization.............. 1,087 882 746 ------ ------ ------ Total costs and expenses............................ 2,929 2,400 2,357 ------ ------ ------ Operating income...................................... 324 909 855 ------ ------ ------ Other expense........................................... 4 1 5 ------ ------ ------ Earnings before income taxes.......................... 320 908 850 Provision for income taxes (Note 6)..................... 80 303 324 ------ ------ ------ Net earnings.......................................... $ 240 $ 605 $ 526 ====== ====== ====== Earnings per share: Basic................................................. $ .16 $ .38 $ .35 ====== ====== ====== Fully diluted......................................... $ .16 $ .38 $ .35 ====== ====== ====== Average number of common shares outstanding: Basic................................................. 1,545 1,580 1,505 ====== ====== ====== Fully diluted......................................... 1,549 1,584 1,511 ====== ====== ======
The accompanying notes are an integral part of these financial statements. F-30 CEC RESOURCES LTD. STATEMENTS OF STOCKHOLDERS' EQUITY For The Three Years Ended November 30, 1998 (in Canadian dollars) (in thousands, except shares)
Shares Held for Share Capital Cancellation ----------------- Retained --------------- Shares Amount Earnings Shares Amount --------- ------ -------- ------- ------ (Reclassified, Note 3) Balances, December 1, 1995......... 1,500,000 $ 502 $6,552 -- $-- Exercise of employee stock options (Note 8).......................... 10,000 32 -- -- -- --------- ------ ------ ------- Issuance of common stock (Note 8).. 79,000 572 -- -- -- Net earnings....................... -- -- 526 -- -- --------- ------ ------ ------- ---- Balances, November 30, 1996........ 1,589,000 1,106 7,078 -- -- Purchase of shares................. -- -- -- 15,000 (98) Net earnings....................... -- -- 605 -- -- --------- ------ ------ ------- ---- Balances, November 30, 1997........ 1,589,000 1,106 7,683 15,000 (98) Cancellation of 15,000 shares...... (15,000) (11) (87) (15,000) 98 Purchase and cancellation of shares............................ (99,600) (74) (648) -- -- Shares issued (Note 8)............. 70,000 513 -- -- -- Net earnings....................... -- -- 240 -- -- --------- ------ ------ ------- ---- Balances, November 30, 1998........ 1,544,400 $1,534 $7,188 -- $-- ========= ====== ====== ======= ====
The accompanying notes are an integral part of these financial statements. F-31 CEC RESOURCES LTD. STATEMENTS OF CASH FLOWS (Note 4)
Year Ended November 30, ------------------------ 1998 1997 1996 ------ ------- ------- (in Canadian dollars) (in thousands) Net earnings........................................ $ 240 $ 605 $ 526 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation, depletion and amortization.......... 1,087 882 746 Future income taxes............................... 61 299 299 Other............................................. -- -- 9 Changes in operating assets and liabilities: Accounts receivable and other..................... (134) (221) (17) Due to (receivable from) former Parent............ (18) (6) 10 Accounts payable.................................. 93 12 159 Income taxes payable (receivable)................. 56 39 (78) Other current liabilities......................... (19) 114 2 ------ ------- ------- Net cash provided by operating activities......... 1,366 1,724 1,656 ------ ------- ------- Cash flows from investing activities: Proceeds from sale of oil and gas properties...... 53 -- 20 Additions to oil and gas properties............... (566) (1,190) (2,324) Additions to liquid extraction plant and other.... (51) (75) (29) ------ ------- ------- Net cash used in investing activities............. (564) (1,265) (2,333) ------ ------- ------- Cash flows from financing activities: Proceeds from issuance of common stock............ 513 -- 572 Proceeds from exercise of stock options........... -- -- 32 Purchase of common stock.......................... (722) (98) -- ------ ------- ------- Net cash provided by (used in) financing activities....................................... (209) (98) 604 ------ ------- ------- Net increase (decrease) in cash and cash equivalents........................................ 593 361 (73) Cash and cash equivalents at beginning of year...... 1,073 712 785 ------ ------- ------- Cash and cash equivalents at end of year............ $1,666 $ 1,073 $ 712 ====== ======= ======= Supplemental disclosure of cash flow information: Cash paid (received) during the period for: Income taxes, net of refunds.................... $ (36) $ 3 $ 103 ====== ======= =======
The accompanying notes are an integral part of these financial statements. F-32 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS (1) Formation and Operations of the Company CEC Resources Ltd. ("Resources" or "the Company") was incorporated as an Alberta, Canada corporation on May 31, 1955 and, since its acquisition in 1969 as a wholly-owned Canadian subsidiary by its former parent, Consolidated Oil & Gas, Inc., has been engaged in exploration, development and production of oil and gas reserves in Canada and oil and gas field services. Resources was a wholly-owned subsidiary of Columbus Energy Corp. ("Parent" or "Columbus") from 1984 until February 24, 1995 when 100% of the Resources shares were sold by its Parent to its shareholders or the public in a rights offering. (2) Accounting Policies The financial statements of the Company are prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and require the use of management's estimates. The following is a summary of the significant accounting policies followed by the Company. Currency The amounts in these financial statements and notes thereto are in Canadian dollars, unless otherwise stated. Cash Equivalents For purposes of the statements of cash flows, the Company considers all temporary investments to be cash equivalents. Results of hedging activities, when employed, are included in cash flow from operations in the statements of cash flows. Oil and Gas Properties The Company follows the full cost method of accounting whereby all costs associated with the acquisition of, exploration for and the development of oil and gas reserves are capitalized. Such costs include land acquisition costs, geological and geophysical expenditures, drilling productive and non- productive wells and tangible production equipment. General and administrative expenses are capitalized to the extent such costs are directly associated with acquisition, exploration and development of oil and gas properties. Proceeds from the sale of petroleum and natural gas properties reduce capitalized costs without recognition of a gain or loss unless such a sale would significantly alter the rate of depletion and depreciation. Capitalized costs, including tangible production equipment, are depleted using the unit of production method based on proved reserves of oil and gas, before royalties, as estimated by independent engineers. For purposes of the calculation, oil and gas reserves are converted to a common unit of measure on the basis of six thousand cubic feet of gas to one barrel of oil. Depreciation of the liquid extraction plant and other assets are calculated using the straight line method over their estimated useful lives. In applying the full cost method, the Company performs a ceiling test which restricts the net capitalized costs from exceeding an amount equal to the estimated undiscounted value of future net revenues from proven oil and gas reserves, based on current prices and costs, after deducting estimated future operating costs, development costs, general and administrative expense and income tax expense. Estimated future site abandonment and restoration costs are provided using the unit of production method over the life of proven reserves with the current year provision included in depreciation, depletion and amortization expense. Site abandonment and restoration expenditures incurred are recorded as a reduction of the accumulated accrual. F-33 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) Income Taxes The liability method is used in measuring income taxes based on temporary differences including both timing differences and other differences between the tax basis of an asset or liability and its carrying amount in the financial statements. This method uses the tax rate and tax law expected to apply to taxable income in the periods in which the future income tax asset or liability is expected to be realized. The Company is subject to tax under applicable Canadian tax law. Field Services The Company recognizes revenue for field services provided to third parties from its one-third ownership in the Carbon area liquids extraction plant as well as from facilities in other fields. The Company's share of the cost of providing such third party services is expensed and shown as "field services" cost. Earnings Per Share Basic earnings per share is calculated using the weighted average number of shares of common stock outstanding during the year. Fully diluted earnings per share is calculated assuming the exercise of outstanding options. (3) Reclassification Effective for the 1998 fiscal year, Resources has classified its stockholders' equity to conform to Canadian laws in Alberta to combine stated capital and additional paid-in capital as share capital as well as to net the purchase of shares against those accounts when they are cancelled. Accordingly, year end stockholder equity balances for 1995 through 1997 have been reclassified as follows:
November 30, -------------------------- Additional Share Common Paid-in Capital Stock Capital ------- ------ ---------- 1995As previously reported..................... $ -- $ 300 $ 202 Reclassification............................ 502 (300) (202) ------ ----- ----- As reclassified............................. $ 502 $ -- $ -- ====== ===== ===== 1996As previously reported..................... $ -- $ 318 $ 788 Reclassification............................ 1,106 (318) (788) ------ ----- ----- As reclassified............................. $1,106 $ -- $ -- ====== ===== ===== 1997As previously reported..................... $ -- $ 318 $ 788 Reclassification............................ 1,106 (318) (788) ------ ----- ----- As reclassified............................. $1,106 $ -- $ -- ====== ===== =====
(4) Statements of Cash Flows The Company elected to adopt Canadian Institute of Chartered Accountants (CICA) 1540, Cash Flow Statements for fiscal 1998. This statement requires a business enterprise to provide a statement of cash flows in place of a statement of changes in financial position. Application of this statement is required for fiscal years F-34 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) beginning on or after August 1, 1998, and earlier application is encouraged. Cash flow information for earlier years that is presented with corresponding information for the initial year of application is restated to conform to the requirements of CICA 1540 as follows:
Year Ended November 30, Net Cash Provided by Net Cash Provided by 1997 Operating Activities (Used In) Investing Activities ----------------------- -------------------- ------------------------------ As previously reported.. $2,108 $(1,649) Restatement............. (384) 384 ------ ------- As Restated............. $1,724 $(1,265) ====== =======
There are no restatements for the year ended November 30, 1996. The adjustments for 1997 were due to capital expense accruals that are excluded in calculating cash flows from investing activities. (5) Oil and Gas Producing Activities The following tables set forth the capitalized costs related to oil and gas producing activities, costs incurred in oil and gas property acquisition, exploration and development activities, and results of operations for producing activities: CAPITALIZED COSTS RELATING TO OIL AND GAS PRODUCING ACTIVITIES (in thousands)
November 30, ---------------- 1998 1997 ------- ------- Costs being amortized (a) (b).......................... $15,527 $15,383 Less accumulated depreciation, depletion, amortization and valuation allowance............................... (8,003) (7,117) ------- ------- Total net properties................................. $ 7,524 $ 8,266 ======= =======
- -------- (a) Excludes well facilities cost of $664,000 in 1998 and 1997 that are amortized on a straight-line basis. (b) In 1998 and 1997 no costs are excluded from amortization. COSTS INCURRED IN OIL AND GAS PROPERTY ACQUISITION, EXPLORATION AND DEVELOPMENT ACTIVITIES (in thousands)
Year Ended November 30, ------------------ 1998 1997 1996 ---- ------ ------ Property acquisition costs: Proved.............................................. $ 10 $ -- $ -- Unproved............................................ -- 54 65 Exploration costs..................................... 54 230 181 Development costs..................................... 134 1,159 1,889 ---- ------ ------ Total costs incurred.............................. $198 $1,443 $2,135 ==== ====== ======
During the three years ended November 30, 1998, no general and administrative expenses have been capitalized. F-35 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) RESULTS OF OPERATIONS FOR PRODUCING ACTIVITIES (in thousands)
Year Ended November 30, -------------------- 1998 1997 1996 ------ ------ ------ Sales............................................... $3,235 $3,451 $3,093 Royalties, net of credits........................... 277 387 223 Production (lifting) costs (a)...................... 710 582 620 Depletion and amortization (b)...................... 949 746 614 ------ ------ ------ 1,299 1,736 1,636 Imputed income tax.................................. 325 579 624 ------ ------ ------ Results of operations from producing activities (excluding overhead and interest costs)............ $ 974 $1,157 $1,012 ====== ====== ======
- -------- (a) Production costs only include lease operating expenses. (b) Depletion and amortization expense per equivalent barrel of production: 1998--$4.02, 1997--$3.01, 1996 --$2.15 MAJOR CUSTOMERS
Year Ended November 30, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Customer 1 Amount sold......................... $2,315,000 $2,190,000 $1,997,000 Percent of revenue.................. 72% 64% 65% Customer 2 Amount sold......................... $ 425,000 $ 651,000 $ 636,000 Percent of revenue.................. 13% 16% 21%
The Company sells its own natural gas production in the Carbon and East Carbon areas directly to gas marketing companies. The operator of the gas processing plant pays Resources for liquids sold at the plant tailgate and those amounts are included in Customer 2. During the fourth quarter of 1998, the Company made a change in accounting estimate in proved reserves due to a significant decrease in proved developed non-producing and proved undeveloped reserves. The majority of this decrease is attributable to the unsuccessful completion of a well in the East Carbon area and additional offset well information. The effect of this change on current year operations was an increase in depletion expense of $190,000. F-36 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) (6) Income Taxes The provision for income taxes consists of the following (in thousands):
Year Ended November 30, -------------- 1998 1997 1996 ---- ---- ---- Current: Federal................................................. $19 $-- $ 23 Alberta................................................. -- 4 2 --- ---- ---- 19 4 25 --- ---- ---- Future: Federal................................................. 58 209 215 Alberta................................................. 3 90 84 --- ---- ---- 61 299 299 --- ---- ---- Total income tax expense.............................. $80 $303 $324 === ==== ====
The total tax provision has resulted in effective tax rates which differ from the statutory Federal income tax rates. The reasons for these differences are illustrated by the following table:
Year Ended November 30, ---------------- 1998 1997 1996 ---- ---- ---- Percent of Pretax Earnings Federal Canadian and provincial statutory rates......... 45% 45% 45% Resource allowance...................................... (46) (19) (13) Crown royalties, net of credits......................... 26 14 6 Statutory rate change................................... -- -- 1 Adjustments of prior year amounts and other............. -- (7) (1) --- --- --- Effective rate.......................................... 25% 33% 38% === === ===
The tax effect of significant temporary differences representing Canadian deferred tax assets and liabilities and charges were as follows (in thousands):
Dec. 1, Current Nov. 30, 1997 Activity 1998 ------- -------- -------- Deferred income tax liabilities: Temporary differences, principally oil and gas properties.............................. $1,934 $61 $1,995 ====== === ======
For Canadian income tax purposes, Resources has the following tax attributes available at November 30, 1998 to reduce future taxable income which have been included in calculating the temporary differences above: Accumulated property exploration and development costs of $1,696,000, earned depletion base of $1,167,000 and undepreciated capital cost of $1,152,000. The tax attributes of carryforward pools are included to determine the temporary differences shown as deferred tax liabilities. These attributes generally do not expire. F-37 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) The earnings before income taxes for financial statements differed from taxable income as follows (in thousands):
Year Ended November 30, ------------------------ 1998 1997 1996 ------ ------- ------- Earnings before income taxes per financial statements................................... $ 320 $ 908 $ 850 Differences between income before taxes for financial statement purposes and taxable income: Book depletion, depreciation and amortization............................... 1,087 882 746 Non-deductible crown royalties, net......... 190 286 126 Capital cost allowance...................... (354) (409) (429) Resource allowance.......................... (329) (379) (241) Tax pools utilized.......................... (818) (1,283) (1,082) Earned depletion allowance.................. (22) -- -- Other....................................... (7) (5) 30 ------ ------- ------- Canadian taxable income....................... $ 67 $ -- $ -- ====== ======= =======
(7) Related Party Transactions The Company incurs certain direct and indirect general and administrative costs for management services provided by its former Parent in lieu of expanding the number of its own full-time employees. These costs are primarily for labor, related benefits and other overhead costs. The following table sets forth these costs, in thousands, for each period: Year Ended November 30, 1998........................................ $334 Year Ended November 30, 1997........................................ 394 Year Ended November 30, 1996........................................ 445
(8) Capital Stock During November 1996, the Company issued 79,000 shares of common stock at U.S. $5.25 per share by private placement using an investment letter under a Regulation D exemption of which 38,000 shares were purchased by Resources' then President and Chairman of the Board. During June 1998, McDonald Energy, LLC ("McDonald"), a Colorado limited liability company solely owned by Patrick R. McDonald, currently a director, President and Chief Executive Officer of Resources acquired 70,000 shares of common stock by direct purchase from Resources for U.S. $5.50 per share. On October 27, 1994 the Company's Board of Directors authorized an unlimited number of shares of preferred stock, no par value, none of which is currently issued. On October 27, 1994 the Company adopted an Employee Incentive Share Option Plan (the "Plan"). The Plan is administered by a committee appointed by the Board of Directors of the Company. The Plan authorizes the committee to grant options for up to 300,000 shares of the Company's common stock. The shares are to be issued out of the Company's authorized and unissued shares and will be issued as fully paid and non-assessable. Also, the number of Resources shares so reserved for issuance or subject to an option under the Plan to any one person may not exceed 5% of the number of Resources shares which are outstanding at the time of the granting of the option. F-38 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) Options may be granted to officers, directors and regular full and part- time employees of the Company and majority-owned subsidiaries. Options may be exercised starting one year after grant. The option term cannot be less than one year or more than five years from the date the option is granted. The option price may not be less than 100% of the fair market value of the last trading price on the date the option is granted. During 1996, the Board of Directors granted stock options for 30,000 shares at the exercise price of U.S. $5.50 per share and an option for 10,000 shares was exercised at the price of U.S. $3.25 per share. At November 30, 1996, there were 80,000 shares under option at prices ranging from U.S. $3.25 to U.S. $6.00 per share, of which 50,000 shares were exercisable. No options were granted in fiscal year 1997. At November 30, 1997, there were 80,000 shares under option at prices ranging from U.S. $3.25 to U.S. $6.00 per share, all of which were exercisable. During 1998, the Board of Directors granted stock options for 152,000 shares at exercise prices ranging from U.S. $4.625 to U.S. $5.50 per share and a stock option grant of 10,000 shares at U.S. $6.00 per share expired. At November 30, 1998 there were 222,000 shares under option at prices ranging from U.S. $3.25 to U.S. $6.00 per share, of which 70,000 shares are exercisable. On June 30, 1998, Resources entered into a Stock Purchase Agreement (the "Agreement") with McDonald. In connection with the Agreement, McDonald was granted a one-year option to purchase 250,000 shares of common stock at U.S. $6.00 per share, all of which are exercisable and were granted in addition to options granted to Mr. McDonald as a director and officer. (9) Financial Instruments The nature of the Company's operations exposes the Company to fluctuations in commodity prices. The Company attempts to manage these risks by minimizing its commodity price exposure through the use of derivative contracts. Gain and losses on these contracts are deferred and recognized in income as an adjustment to oil and gas sales revenues during the period in which the physical product to which the contracts relate is actually sold. During the fourth quarter of 1998, the Company entered into three AECO C/N.I.T. based forward price hedge transactions. The terms of these transactions are as follows:
Daily Quantity Contract Quantity Period GigaJoules GigaJoule Price/GigaJoule ------ -------------- ----------------- --------------- Nov 98-Mar 99........... 1,055 159,000 $2.82 Apr 99-Oct 99........... 1,055 226,000 $2.39 Dec 98-Oct 01........... 1,055 1,125,000 $2.57
The unrecognized gain on these contracts totaled $148,000 based on November 30, 1998 market values. (10) Commitments and Contingent Liabilities The Company leases office space in Calgary, Alberta and Denver, Colorado. These leases are month-to-month with no related future minimum lease payments. Total rent expense for 1998, 1997 and 1996 was $64,000, $34,000 and $33,000, respectively. The Company adopted a separation pay policy effective February 24, 1995 which covers all regular terminations and, in addition, certain "special" terminations of officers in the case of certain contractions and restrictions of the Company, or in the event of a change of control of the Company. At the discretion of the F-39 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) Board of Directors, officers and non-officer employees may receive upon their retirement the same benefits they would have received upon a friendly change of control of the Company. As of November 30, 1998 no benefits are payable. Resources sells its natural gas production in the Carbon and East Carbon areas directly to certain gas marketing companies. At November 30, 1998 the Company had entered into three forward price hedge transactions, as described in Note 9. The majority of the Company's remaining gas is contracted to a gas marketing company on a deliverability basis and sold at published index prices less applicable transportation and marketing charges. The Company has assigned its firm transportation agreements through October 1999 but has reserved the right to obtain firm transportation service in its own name. The Company estimates that future costs of site abandonment and restoration of well sites, gas processing plant and other facilities will be $310,000 as of November 30, 1998 in addition to $165,000 already accrued as a liability. The estimated costs are being recognized on the unit of production basis over the life of the properties. (11) Industry Segments The Company's business is primarily participating in (1) oil and gas exploration and development, and (2) field services. Summarized financial information concerning the business segments is as follows:
Year Ended November 30, ------------------------- 1998 1997 1996 ------- ------- ------- (in thousands) Operating revenues from unaffiliated services (a): Oil and gas............................... $ 3,007 $ 3,092 $ 2,888 Services.................................. 640 633 809 ------- ------- ------- Total................................... $ 3,647 $ 3,725 $ 3,697 ======= ======= ======= Depreciation, depletion and amortization: Oil and gas............................... $ 952 $ 749 $ 617 Services.................................. 135 133 129 ------- ------- ------- Total................................... $ 1,087 $ 882 $ 746 ======= ======= ======= Operating income: Oil and gas............................... $ 951 $ 1,344 $ 1,166 Services.................................. 357 316 436 General corporate expenses................ (984) (751) (747) ------- ------- ------- Total operating income.................. $ 324 $ 909 $ 855 Other expense............................... 4 1 5 ------- ------- ------- Earnings before income taxes................ $ 320 $ 908 $ 850 ======= ======= ======= Identifiable assets: Oil and gas............................... $10,063 $10,076 $ 8,804 Services.................................. 1,172 1,302 1,362 ------- ------- ------- Total................................... $11,235 $11,378 $10,166 ======= ======= ======= Additions to property and equipment: Oil and gas............................... $ 258 $ 1,444 $ 2,135 Services.................................. 4 73 26 ------- ------- ------- Total................................... $ 262 $ 1,517 $ 2,161 ======= ======= =======
- -------- (a) Inter-segment revenues of $394,000, $416,000 and $485,000 for 1998, 1997 and 1996, respectively, are included in services revenues and are offset by the same amounts in oil and gas operating expenses. F-40 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) (12) Concentrations of Credit Risk and Financial Instruments The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable approximate fair value because of the short maturity of these instruments. Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents and accounts receivable. The Company maintains demand deposit accounts with separate banks in Calgary, Alberta and Denver, Colorado. The Company also invests cash in the highest rated commercial paper of large Canadian companies, with maturities not over 30 days, which have minimal risk of loss. At November 30, 1998 the Company had $1,598,000 invested in such commercial paper. Most jointly owned oil and gas properties are operated by other companies who sell oil and liquids production to relatively large Canadian oil and gas purchasers (see Note 5) and who pay vendors of oil and gas services on the wells. The Company sells its own natural gas production in the Carbon and East Carbon Areas directly to certain gas marketing companies. The risk of non- payment by the purchasers or by those operators is monitored and is considered minimal. The Company does not obtain collateral from these purchasers to assure payment for sales to them. Joint interest receivables are subject to collection under the terms of operating agreements which provide lien rights to the operator. In management's judgment, termination by any purchaser under which its present sales are made would not have a material impact upon its ability to sell its production to another purchaser at similar prices. Also, because the Company has a high percentage of natural gas reserves, results of operations are particularly sensitive to current pricing. The sensitivity to current prices has been partially mitigated by the Company's use of financial instruments that provide a fixed sales price for a percentage of the Company's production. (13) Generally Accepted Accounting Principles in Canada and the United States The financial statements have been prepared in accordance with Canadian GAAP which differ in certain respects from those principles that the Company would have followed had its financial statements been prepared in accordance with U.S. GAAP. Differences in disclosures which affect these financial statements are: (a) Under U.S. GAAP, cash (and cash equivalents) includes bank deposits, money market instruments, and commercial paper with original maturities of three months or less. Canadian GAAP permits the inclusion of temporary investments with maturities greater than 90 days in cash. The differences in measurement had no impact on classification in the balance sheets. (b) Basic earnings per share using U.S. GAAP is the same as basic earnings per share using Canadian GAAP. Diluted earnings per share using U.S. GAAP uses the "treasury stock method". Fully diluted earnings per share using Canadian GAAP assumes cash proceeds from the deemed exercise of stock options are invested in such a way as to earn a reasonable return but the number of shares remains the same. (c) Using the full cost accounting method under U.S. GAAP, the ceiling test is applied to capitalized costs using a 10% discount factor. There would be no impairment of the U.S. full cost pool under this method. Stock Based Compensation Plans Using U.S. GAAP, the Company would have adopted in 1996, Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). The Company would have elected to continue to measure compensation costs for these plans using the current method of accounting under F-41 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) Accounting Principles Board ("APB") Opinion No. 25 and related interpretations in accounting for its stock option plan. Accordingly, no compensation expense is recognized for stock options granted with an exercise price equal to the market value of Resources stock on the date of grant. Had compensation cost for the Company's stock option plan been determined using the fair-value method in SFAS No. 123, the Company's net income and earnings per share would have been as follows:
Year Ended November 30, ----------------- 1998 1997 1996 ----- ----- ----- (Thousand except per share amounts) Net income As reported.......................................... $ 240 $ 605 $ 526 Pro forma............................................ $ 90 $ 581 $ 526 Earnings per share (basic) As reported.......................................... $0.16 $0.38 $0.35 Pro forma............................................ $0.06 $0.37 $0.35
Options are granted at 100% of fair market value on the date of grant. The following table is a summary of stock option transactions (reported in U.S. dollars) for the three years ended November 30, 1998:
1998 1997 1996 ---------- --------- ---------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Price Price Price Shares Shares Shares ---------- --------- ---------- (options in thousands) Shares under option at beginning of year....... 80 $5.44 80 $5.44 60 $5.04 Granted........................................ 152 5.26 -- -- 30 5.50 Exercised...................................... -- -- -- -- (10) 3.25 Expired........................................ (10) 6.00 -- -- -- -- --- --- --- Shares under option at end of year............. 222 5.29 80 5.44 80 5.44 === === === Options exercisable at Nov. 30................. 70 5.36 80 5.44 50 5.39 Shares available for future grant at end of year.......................................... 68 210 210 Weighted-average fair value of options granted during the year............................... $0.83 N/A $1.28
The following table summarizes information about the Company's stock options (reported in U.S. dollars) outstanding at November 30, 1998:
Options Outstanding (in Options Exercisable thousands) (in thousands) -------------------------------- -------------------- Weighted Average Remaining Weighted Weighted Options Contractual Average Options Average Outstanding Life Exercise Exercisable Exercise Range of Exercise Prices At Year End (Years) Price at Year End Price - ------------------------ ----------- ----------- -------- ----------- -------- $3.25--$4.75............. 50 4.2 $4.40 10 $3.25 $5.375--$5.50............ 142 3.4 5.47 30 5.50 $5.75-- $6.00............ 30 1.5 5.92 30 5.92 --- --- ----- --- ----- $3.25--$6.00............. 222 3.3 $5.29 70 $5.36 === === ===== === =====
F-42 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:
1998 1996 ----- ----- Expected option life--years................................ 1.70 3.00 Risk-free interest rate.................................... 5.31% 6.29% Dividend yield............................................. 0% 0% Volatility................................................. 28.35% 20.70%
No options were granted during 1997. (14) SUBSEQUENT EVENTS In December 1998, the Company acquired working interests in 16 producing natural gas wells and associated leaseholds in the Wayne-Rosedale Field, located in Alberta, Canada, effective September 1, 1998 for $2.3 million. The assets, liabilities, revenues and expenses for the period September through November 1998 have not been recorded as of November 30, 1998 because the closing did not take place until after year end. In December 1998, the Company secured a financing commitment. The initial commitment is a $2.5 million revolving production loan. The revolving phase of the loan will expire on April 30, 1999 and may be renewed by the bank. The interest rate on outstanding borrowings is the CIBC Prime Rate plus 3/4 of 1%. F-43 CEC RESOURCES LTD. BALANCE SHEETS
August 31, November ASSETS 1999 30, 1998 ------ ----------- -------- (unaudited) (in Canadian dollars) (in thousands) Current assets: Cash and cash equivalents............................... $ -- $ 1,666 Accounts receivable: Oil and gas sales..................................... 421 466 Crown royalty refund and other........................ 470 333 Joint interest partners............................... 24 8 Income tax receivable................................... 58 0 -------- ------- Total current assets................................ 973 2,473 -------- ------- Property and equipment: Oil and gas assets, full cost method.................... 22,023 16,192 Liquid extraction plant................................. 1,477 1,477 Other property and equipment............................ 200 108 -------- ------- 23,700 17,777 Less: Accumulated depreciation, depletion and amortization........................................... (10,556) (9,015) -------- ------- Net property and equipment.............................. 13,144 8,762 -------- ------- Other assets............................................ 1,864 -- -------- ------- $ 15,981 $11,235 ======== ======= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable........................................ $ 282 $ 237 Income tax payable...................................... 2 3 Undistributed oil and gas production receipts........... 507 113 -------- ------- Total current liabilities............................. 791 353 -------- ------- Future site restoration costs (Note 5).................... 221 165 Deferred income taxes (Note 3)............................ 1,739 1,995 Long-term debt (Note 7)................................... 4,850 -- Stockholders' equity Preferred stock, authorized unlimited number of shares, no par value; none issued.............................. Share capital, common stock, authorized unlimited number of shares, without nominal or par value; 1,521,400 shares issued in 1999 and 1,544,400 in 1998............ 1,512 1,534 Retained earnings....................................... 6,868 7,188 -------- ------- Total stockholders' equity............................ 8,380 8,722 -------- ------- $ 15,981 $11,235 ======== =======
The accompanying notes are an integral part of these financial statements. F-44 CEC RESOURCES LTD. STATEMENTS OF INCOME (Unaudited)
Nine Months Ended August 31, -------------- 1999 1998 ------ ------ (in Canadian dollars) (in thousands, except per share data) Oil and gas sales............................................... $3,684 $2,380 Royalties....................................................... (732) (460) Alberta royalty tax credit...................................... 434 242 Field services.................................................. 75 175 Other........................................................... 2 27 ------ ------ Total revenues................................................ 3,463 2,364 ------ ------ Lease operating expenses........................................ 585 563 Field services.................................................. 65 111 General and administrative...................................... 1,522 615 Depreciation, depletion and amortization........................ 1,597 686 ------ ------ Total costs and expenses...................................... 3,769 1,975 ------ ------ Operating income................................................ (306) 389 ------ ------ Interest expense and other...................................... 136 (23) ------ ------ Earnings before income taxes.................................... (442) 412 Provisions for income taxes (Note 3)............................ (254) 144 ------ ------ Net earnings.................................................... $ (188) $ 268 ====== ====== Earnings per share.............................................. $(0.12) $ 0.17 ====== ====== Basic........................................................... $(0.12) $ 0.17 ====== ====== Average number of common shares outstanding Basic........................................................... 1,529 1,542 ====== ====== Fully diluted................................................... 1,529 1,546 ====== ======
The accompanying notes are an integral part of these financial statements. F-45 CEC RESOURCES LTD. STATEMENT OF STOCKHOLDERS' EQUITY For the Nine Months Ended August 31, 1999 (Unaudited)
Earnings Shares Amount Retained --------- ------ -------- (in Canadian dollars) (in thousands, except share data) Balances, November 30, 1998......................... 1,544,400 $1,534 $7,188 Purchase and cancellation of shares................. (23,000) (22) (132) Net earnings........................................ -- -- (224) --------- ------ ------ Balances August 31, 1999............................ 1,521,400 $1,512 $6,832 ========= ====== ======
The accompanying notes are an integral part of these financial statements. F-46 CEC RESOURCES LTD. STATEMENTS OF CASH FLOW (Note 2) (Unaudited)
Nine Months Ended August 31, --------------- 1999 1998 ------- ------ (in Canadian dollars) (in thousands) Net earnings.................................................. $ (188) $ 268 Adjustments to reconcile net earnings to net cash provided by operating activities:........................................ -- -- Depreciation, depletion and amortization.................... 1,597 686 Future income taxes......................................... (256) 120 Other....................................................... (55) -- Net change in operating assets and liabilities................ 291 144 ------- ------ Net cash provided by operating activities................... 1,389 1,218 ------- ------ Cash flows from investing activities: Additions to oil and gas properties......................... (5,851) (489) Additions to other assets................................... (1,900) -- ------- ------ Net cash used in investing activities....................... (7,751) (489) Cash flows from financing activities: Proceeds from long-term debt................................ 4,850 0 Proceeds from issuance of common stock...................... 513 Purchase of common stock.................................... (154) (592) ------- ------ Net cash provided by (used in) financing activities......... 4,696 (79) Net increase (decrease) in cash and cash equivalents.......... (1,666) 650 Cash and cash equivalents at beginning of period.............. 1,666 1,073 ------- ------ Cash and cash equivalents at end of period.................... $ 0 $1,723 ======= ====== Supplemental disclosure of cash flow information: Cash paid (received) during the period for: Income taxes, net of refunds.............................. $ 40 $ (50) ------- ------
The accompanying notes are an integral part of these financial statements. F-47 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS (Unaudited) (1) Basis of Presentation The accompanying financial statements are for CEC Resources Ltd. ("Resources" or "Company"). Resources is an independent oil and gas company and was incorporated on May 31, 1955 under the Business Corporations Act (Alberta ) in Canada and was acquired by the former parent of Columbus Energy Corporation ("Columbus") in 1969 and by Columbus on July 31, 1984. It remained a wholly owned subsidiary of Columbus until spun-off from Columbus by a rights offering in February 1995. These financial statements are prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and require the use of management's estimates. These statements contain all adjustments (consisting only of normal recurring accruals) which, in the opinion of management, are necessary to present fairly the financial position of the Company as of August 31, 1999 and November 30, 1998, and the results of its operations and of its cash flows for the periods presented. The results of operations for interim periods are not necessarily indicative of results to be expected for the full year. Currency The amounts in these financial statements and notes thereto are in Canadian dollars, unless otherwise stated. Cash Equivalents For purposes of the statements of cash flow, the Company considers all temporary investments to be cash equivalents. Results of hedging activities, when employed, are included in cash flow from operations in the statements of cash flow. Oil and Gas Properties The Company follows the full cost method of accounting whereby all costs associated with the acquisition of, exploration for, and the development of oil and gas reserves are capitalized. Such costs include land acquisition costs, geological and geophysical expenditures, drilling costs of productive and non-productive wells and tangible production equipment. General and administrative expenses are capitalized to the extent such costs are directly associated with acquisition, exploration and development of oil and gas properties. Proceeds from the sale of petroleum and natural gas properties reduce capitalized costs without recognition of a gain or loss unless such a sale would significantly alter the rate of depletion and depreciation. Capitalized costs, including tangible production equipment, are depleted using the unit of production method based on proved reserves of oil and gas, before royalties, as estimated by independent engineers. For purposes of the calculation, oil and gas reserves are converted to a common unit of measure on the basis of six thousand cubic feet of gas to one barrel of oil. Depreciation of the natural gas liquids processing plant and other property and equipment are calculated using the straight line method over their estimated useful lives. In applying the full cost method, the Company performs a ceiling test which restricts the net capitalized costs from exceeding an amount equal to the estimated undiscounted value of future net revenues from proven oil and gas reserves, based on current prices and costs, after deducting estimated future operating costs, development costs, general and administrative expenses and income tax expense. Estimated future site abandonment and restoration costs are provided using the unit of production method over the life of proven reserves with the current year provision included in depreciation, depletion and amortization expense. Site abandonment and restoration expenditures incurred are recorded as a reduction of the accumulated accrual. F-48 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) (Unaudited) Field Services Business Segment The Company receives field service revenue generated by its share of natural gas processing fees at the Carbon gas plant. The portion of the plant processing fee revenue attributable to Resources own gas volumes processed by the plant is not reported as field service revenue, but instead offsets an identical amount otherwise chargeable to lease operating expenses. The Carbon plant also processes natural gas belonging to unrelated plant non-owners which represents the majority of Resources field services revenues. Resources also derives less significant revenues and net cash flow from other gathering and compression facilities in which it has ownership. Amounts applicable to Resources' own gas production volumes have likewise been eliminated from both revenues and expenses from these operations. Income Taxes The liability method is used in measuring income taxes based on temporary differences including timing differences and other differences between the tax basis of an asset or liability and its carrying amount in the financial statements. The method uses the tax rate and the tax law expected to apply to taxable income in the periods in which the future income tax asset or liability is expected to be realized. The Company is subject to tax under applicable Canadian tax law. Earnings Per Share Basic earnings per share are calculated using the weighted average number of shares of common stock outstanding during the period. Fully diluted earnings per share are calculated assuming the exercise of outstanding dilutive options. (2) Statements of Cash Flow The Company elected for 1998 to adopt Canadian Institute of Chartered Accountants (CICA) 1540, Cash Flow Statements, which require a business enterprise to provide a statement of cash flow in place of a statement of changes in financial position. Application of CICA 1540 is required for fiscal years beginning on or after August 1, 1998. Cash flow information for prior years is restated to conform to the requirements of CICA 1540 as follows:
Net Cash Provided by Net Cash Provided by Operating (Used In) Investing Activities Activities ----------- -------------------- (In Canadian Dollars) (in thousands) Nine Months Ended August 31, 1998 As previously reported................... $ 835 $(106) Restatement.............................. 383 (383) ------ ----- As Restated.............................. $1,218 $(489) ====== =====
F-49 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) (Unaudited) (3) Income Taxes The provision for income taxes consists of the following (in thousands):
Nine Months Ended August 31, ----------- 1999 1998 ----- ---- Current: Federal..................................................... $ 2 $ 24 Alberta..................................................... -- -- ----- ---- 2 24 ----- ---- Future: Federal..................................................... (160) 68 Alberta..................................................... (96) 52 ----- ---- (256) 120 ----- ---- Total income tax expense...................................... $(254) $144 ===== ====
Total tax provision has resulted in effective tax rates which differ from statutory Federal income tax rates. The reasons for these differences are illustrated by the following table:
Percent of Pretax Earnings Nine Months Ended August 31, ---------- 1999 1998 ---- ---- Federal Canadian and provincial statutory rates............... 45% 45% Resource allowance............................................ 28 (27) Crown royalties, net of credits............................... (19) 16 Adjustments of prior year amounts and other................... 3 1 --- --- Effective Rate................................................ 57% 35% === ===
The tax effect of significant temporary differences representing deferred tax assets and liabilities and charges were as follows (in thousands):
Current Dec. 1, Year August 31, 1998 Activity 1999 ------- -------- ---------- Deferred tax liabilities: Temporary differences, principally oil and gas properties............................ $1,995 $(256) $1,739 ====== ===== ======
For Canadian income tax purposes Resources has tax pools available at August 31, 1999 to reduce future taxable income. These pools include oil and gas property expenses of $4,235,000, development and exploration expenses of $1,042,000, earned depletion base of $1,170,000 and undepreciated capital costs of $2,465,000. The tax attributes of carryforward pools are included to determine the temporary differences shown as deferred tax liabilities. These attributes generally do not expire. F-50 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) (Unaudited) (4) Related Party Transactions Resources incurred certain direct and indirect general and administrative costs for services provided by its former Parent in lieu of expanding the number of its own full-time employees. These costs were primarily for labor, related benefits and other overhead costs as provided by an agreement between the parties. These costs were $54,000 and $271,000 for the nine months of 1999 and 1998, respectively. Effective March 31, 1999, this management agreement was terminated. (5) Commitments The majority of the Company's natural gas is contracted to gas marketing companies on a deliverability basis and sold at published index prices less applicable transportation and marketing charges. The Company has temporarily assigned its firm transportation agreements through October, 1999 and has retained the option to obtain additional firm transportation service. At August 31, 1999, the Company had seven forward priced hedge contracts. These contracts allow the Company to receive fixed prices for a percentage of its production. The terms of these transactions are as follows:
Daily Contract Quantity Quantity Fixed Period GigaJoules GigaJoules Price/GigaJoule ------ ---------- ---------- --------------- Apr 99-Oct 99....................... 1,055 226,000 $2.390 Dec 98-Oct 01....................... 1,055 1,125,000 $2.570 Apr 99-Oct 99....................... 1,000 214,000 $2.310 Apr 99-Oct 99....................... 500 107,000 $2.220 Nov 99-Oct 00....................... 1,000 366,000 $2.730 Nov 99-Mar 00....................... 750 113,250 $3.620 Apr 00-Oct 00....................... 750 160,500 $2.925
The unrecognized loss on these contracts totaled $806,000 based on August 31, 1999 market values. The Company estimates that future costs of site abandonment and restoration of well sites, gas processing plants and other facilities will be $434,362 as of August 31, 1999 in addition to $221,000 already accrued as a liability. The estimated costs are being recognized on a unit-of-production basis over the life of the properties. (6) Acquisition of Oil and Gas Properties Between December 1998 and April 1999, Resources purchased producing oil and gas properties and natural gas gathering and compression facilities in Alberta, Canada. These acquisitions were accounted for as a purchase and considered "material" by management for purposes of pro forma disclosure. The following pro forma statement presents incremental results of operations for the current year and for the corresponding period of the preceding year as though the acquisitions had occurred at the beginning of the periods being reported on. Revenues and expenses subsequent to the purchase dates have been included in 1999 operating results and are not included in the incremental results. The incremental pro forma results below are not indicative of the results that would have occurred if the acquisitions had been in effect for the entire periods presented. The pro forma results are not intended to be a F-51 CEC RESOURCES LTD. NOTES TO THE FINANCIAL STATEMENTS--(Continued) (Unaudited) projection of future results. Financial information showing the incremental pro forma results of the acquisition is presented below:
Nine Months Ended August 31, ------------- 1999 1998 ----- ------ (in Canadian dollars) (in thousands, except per share data) Revenues................................................... $ 168 $1,080 Direct Operating Expenses.................................. 64 510 Depreciation & Depletion................................... 109 682 Interest Expense........................................... 40 237 Income Tax Expense (a)..................................... (15) (122) Net Income................................................. (30) (227) Earnings per share......................................... (0.02) (0.15)
- -------- (a) Income taxes at Company's effective rate for the applicable period. (7) Long-Term Debt The Company has a revolving loan from a bank used to finance acquisitions of oil and gas reserves and for normal operating requirements. The loan is secured by the Company's oil and gas assets and had a borrowing base of $5.0 million at August 31, 1999. The interest rate on the outstanding borrowings is the bank's prime rate, plus 3/4% which has averaged 7.25% for the nine months ended August 31, 1999. The revolving phase of the loan will expire on April 30, 2000 and may be renewed by the bank. If the revolving commitment is not renewed by the bank the loan will be converted into a term loan and will be permanently reduced by way of conseutive monthly principal payments over a period not to exceed 36 months. Outstanding borrowings amounted to $4.5 million at August 31, 1999. (8) Generally Accepted Accounting Principles in Canada and the United States The financial statements have been prepared in accordance with Canadian GAAP and differ in certain respects from financial statements which the Company would have made had its financial statements been prepared in accordance with United States GAAP. Differences between the two methods which affect these financial statements are: (a) Under U.S. GAAP, cash (and cash equivalents) includes bank deposits, money market instruments, and commercial paper with original maturities of three months or less. Canadian GAAP permits the inclusion in cash of temporary investments with maturities greater than 90 days. The differences in measurement had no impact on classification in the balance sheets. (b) Basic earnings per share using U.S. GAAP is the same as basic earnings per share using Canadian GAAP. Under U.S. GAAP, fully diluted earnings per share are reported using the "treasury stock method". Under Canadian GAAP, fully diluted earnings per share assumes that cash proceeds from the deemed exercise of stock options are invested by the Company in such a way as to earn a reasonable return. The number of shares used in the calculation is the same for both methods. (c) Under U.S. GAAP, the full cost accounting method requires that capitalized costs less related accumulated depletion and deferred income taxes may not exceed the sum of (1) the present value (discounted at 10%) of future net revenues from estimated production of proved oil and gas reserves; plus (2) the cost of properties not being amortized, if any, plus (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized if any, less (4) income tax effects related to differences in the book and tax basis of oil and gas properties. Using U.S. GAAP, there would not have been an impairment to the full cost pool. F-52 PART II INFORMATION NOT REQUIRED IN THE PROSPECTUS Item 20. Indemnification Of Directors And Officers Under the Colorado Business Corporation Act, we have broad powers to indemnify our directors and officers against liabilities they may incur in such capacities, including liabilities under the Securities Act. Colorado law provides that a director, officer or any other employee, fiduciary or agent, may be entitled to indemnification if: (1) the person conducted himself or herself in good faith; (2) the person reasonably believed, (a) in the case of conduct in an official capacity with the corporation, that his or her conduct was in the corporation's best interests, and (b) in all other cases, that his or her conduct was at least not opposed to the corporation's best interests; and (3) in the case of any criminal proceeding, the person had no reasonable cause to believe his or her conduct was unlawful. A corporation may not indemnify a director in connection with a proceeding by or in the right of the corporation in which the director was adjudged liable to the corporation or in connection with any other proceeding charging that the director derived an improper personal benefit, whether or not involving action in an official capacity, in which the director was adjudged liable on the basis that he or she derived an improper personal benefit. Our Bylaws provide that we will indemnify our directors and executive officers and may indemnify our other officers, employees and other agents to the full extent permitted under Colorado law. We have also entered into indemnification agreements with each of our executive officers and directors. The terms of these indemnification agreements are described in "Management-- Indemnification and Limitation of Liability." Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling Carbon pursuant to the foregoing provisions, we have been informed that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is therefore unenforceable. II-1 Item 21. Exhibits and Financial Statement Schedules (a) Exhibits
Exhibit Number Description of Exhibit ------- ---------------------- 2 Articles of Incorporation of Carbon Energy Corporation. 3 Bylaws of Carbon Energy Corporation. 4 Specimen stock certificate representing shares of common stock of Carbon Energy Corporation.* 5 Opinion of Holland & Hart LLP regarding the legality of the securities being registered.* 8.1 Tax Opinion of Holland & Hart LLP, dated October 20, 1999. 8.2 Tax Opinion of Bennett Jones, dated October 20, 1999. 10.1 1999 Stock Option Plan. 10.2 1999 Restricted Stock Plan. 10.3 Exchange and Financing Agreement dated October 14, 1999 among Carbon Energy Corporation, CEC Resources Ltd and Yorktown Energy Partners III, L.P. 10.4 Stock Purchase Agreement dated August 11, 1999 between Bonneville Pacific Corporation and CEC Resources Ltd. 10.5 Form of Indemnification Agreement between Carbon Energy Corporation and its officers and directors. 10.6 Form of Employment Agreement, dated as of October 29, 1999, between Carbon Energy Corporation and Patrick R. McDonald. 10.7 Form of Employment Agreement, dated as of October 29, 1999, between Carbon Energy Corporation and Kevin D. Struzeski. 23.1 Consent of Holland & Hart LLP (included in Exhibits 5 and 8.1). 23.2 Consent of Arthur Andersen LLP. 23.3 Consent of Hein + Associates LLP. 23.4 Consent of PricewaterhouseCoopers LLP. 23.5 Consent to Being Director of Harry A. Trueblood, Jr. 23.6 Consent of Reed W. Ferrill & Associates, Inc. 23.7 Consent of Sproule Associates Limited 23.8 Ryder Scott Company, L.P. 24 Power of Attorney. 27 Financial Data Schedule
- -------- *to be filed by amendment Item 22. Undertakings Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the small business issuer has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the small business issuer of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question of whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. II-2 SIGNATURES In accordance with the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements of the filing on Form S-4 and authorized this registration statement to be signed on its behalf by the undersigned in the City of Denver, State of Colorado, on October 22, 1999. Carbon Energy Corporation /s/ Patrick R. McDonald By: _________________________________ Patrick R. McDonald President In accordance with the requirements of the Securities Act of 1933, this registration statement was signed below by the following persons in the capacities and on the dates stated.
Signature Title Date --------- ----- ---- /s/ Patrick R. McDonald President (Principal October 26, 1999 ____________________________________ Executive Officer) Patrick R. McDonald /s/ David H. Kennedy* Director October 26, 1999 ____________________________________ David H. Kennedy /s/ Lambros J. Lambros* Director October 26, 1999 ____________________________________ Lambros J. Lambros /s/ Bryan H. Lawrence* Director October 26, 1999 ____________________________________ Bryan H. Lawrence /s/ Peter A. Leidel* Director October 26, 1999 ____________________________________ Peter A. Leidel /s/ Kevin D. Struzeski* Treasurer (Principal October 26, 1999 ____________________________________ Financial Officer and Kevin D. Struzeski Principal Accounting Officer)
/s/ Patrick R. McDonald *By: __________________________ Attorney-in-Fact II-3 INDEX TO EXHIBITS
Exhibit Number Description of Exhibit ------- ---------------------- 2 Articles of Incorporation of Carbon Energy Corporation. 3 Bylaws of Carbon Energy Corporation. 4 Specimen stock certificate representing shares of common stock of Carbon Energy Corporation.* 5 Opinion of Holland & Hart LLP regarding the legality of the securities being registered.* 8.1 Tax Opinion of Holland & Hart LLP, dated October 20, 1999. 8.2 Tax Opinion of Bennett Jones, dated October 20, 1999. 10.1 1999 Stock Option Plan. 10.2 1999 Restricted Stock Plan. 10.3 Exchange and Financing Agreement dated October 14, 1999 among Carbon Energy Corporation, CEC Resources Ltd and Yorktown Energy Partners III, L.P. 10.4 Stock Purchase Agreement dated August 11, 1999 between Bonneville Pacific Corporation and CEC Resources Ltd. 10.5 Form of Indemnification Agreement between Carbon Energy Corporation and its officers and directors. 10.6 Form of Employment Agreement, dated as of October 29, 1999, between Carbon Energy Corporation and Patrick R. McDonald. 10.7 Form of Employment Agreement, dated as of October 29, 1999, between Carbon Energy Corporation and Kevin D. Struzeski. 23.1 Consent of Holland & Hart LLP (included in Exhibits 5 and 8.1). 23.2 Consent of Arthur Andersen LLP. 23.3 Consent of Hein + Associates LLP. 23.4 Consent of PricewaterhouseCoopers LLP. 23.5 Consent to Being Director of Harry A. Trueblood, Jr. 23.6 Consent of Reed W. Ferrill & Associates, Inc. 23.7 Consent of Sproule Associates Limited 23.8 Consent of Ryder Scott Company, L.P. 24 Power of Attorney. 27.1 Financial Data Schedule 27.2 Financial Data Schedule 27.3 Financial Data Schedule
- -------- *To be filed by Amendment EX-2 2 ARTICLES OF INCORPORATION OF CARBON ENERGY EXHIBIT 2 ARTICLES OF INCORPORATION OF CARBON ENERGY CORPORATION The undersigned, acting as the incorporator of a corporation to be incorporated under the laws of the State of Colorado, adopts these Articles of Incorporation. ARTICLE I. Name The name of the Corporation is Carbon Energy Corporation. ARTICLE II. Authorized Capital A. Authorized Shares. The aggregate number of shares which the Corporation shall have the authority to issue is 20,000,000 shares of common stock, without par value (the "Common Stock") and 10,000,000 shares of preferred stock, without par value (the "Preferred Stock"). The Preferred Stock may be issued in series. Except as otherwise expressly provided by law, and subject to the voting rights, if any, provided to the holders of Preferred Stock by these Articles of Incorporation, the Common Stock has exclusive voting rights on all matters requiring a vote of shareholders. Except for and subject to those rights expressly granted to the holders of the Preferred Stock, or except as may be provided by law, the holders of Common Stock shall have exclusively all other rights of shareholders. B. Preferred Stock. The Corporation's board of directors shall have the authority, without shareholder action, to determine the preferences, limitations and relative rights of any Preferred Stock (whether in a series or as a class), including without limitation the following: (i) the designation of any series of Preferred Stock; (ii) unlimited, special, conditional, or limited voting rights, or no right to vote; except that no condition, limitation, or prohibition on voting shall eliminate any right to vote provided by the Colorado Business Corporation Act; (iii) redemption rights; (iv) conversion rights; (v) distribution or dividend rights, including the determination of whether such rights are cumulative, noncumulative or partially cumulative; and (vi) preference rights over any other class or series of shares with respect to distributions, including dividends and distributions upon the dissolution of the Corporation. ARTICLE III. Agent -- Offices A. Initial Registered Agent. The street address of the initial registered office of the Corporation is 1700 Broadway, Suite 1150, Denver, CO 80290-1101, and the name of the Corporation's initial registered agent at that address is Kevin D. Struzeski. The written consent of the Corporation's initial registered agent to the appointment as such is stated below. B. Initial Principal Office. The address of the Corporation's initial principal office is 1700 Broadway, Suite 1150, Denver, CO 80290-1101. ARTICLE IV. Incorporator The name and address of the incorporator is Rondi J. Boroos, 555 17/th/ Street, Suite 3200, Denver, Colorado 80202. -1- ARTICLE V. Purpose -- Powers A. Purpose. The purpose for which the Corporation is organized is to engage in any lawful business or businesses. B. Powers. The Corporation shall have and may exercise all powers and rights granted or otherwise provided by the Colorado Business Corporation Act as in effect from time to time and any successor law (the "Act"). ARTICLE VI. Preemptive Rights No shareholder of the Corporation shall be entitled as of right to acquire unissued shares of the Corporation or securities convertible into such shares or carrying a right to subscribe for or to acquire such shares. ARTICLE VII. Board of Directors The corporate powers shall be exercised by or under the authority of, and the business and affairs of the Corporation shall be managed under the direction of, a board of directors which shall consist of one or more members, with the number specified or fixed in accordance with the bylaws. The directors shall be elected at each annual meeting of the shareholders. Each director shall continue to serve until such director's successor is elected and qualifies. The names and addresses of the members of the initial board of directors are as follows: Name Address ---- ------- David H. Kennedy 18 Pasture Lane Carien, CT 06820 Lambros J. Lambros 131 Goshen Road Norfolk, CT 06058 Bryan H. Lawrence 410 Park Avenue New York, NY 10022 Peter A. Leidel 410 Park Avenue New York, NY 10022 Patrick R. McDonald 1700 Broadway, Suite 1150 Denver, CO 80290-1101 ARTICLE VIII. Cumulative Voting Cumulative voting shall not be permitted in the election of directors. -2- ARTICLE IX. Limitation on Director Liability There shall be no personal liability, either direct or indirect, of any director of the Corporation to the Corporation or to its shareholders for monetary damages for any breach or breaches of fiduciary duty as a director; except that this provision shall not eliminate the liability of a director to the Corporation or to its shareholders for monetary damages for any breach, act, omission or transaction as to which the Act prohibits expressly the elimination of liability. This provision shall not limit the rights of directors of the Corporation for indemnification or other assistance from the Corporation. Any repeal or modification of this Article IX shall not adversely affect any right or protection of a director of the Corporation under this Article IX, as in effect immediately prior to such repeal or modification, with respect to any act or omission of such director occurring prior to such repeal or modification. ARTICLE X. Quorum and Voting Requirements for Shareholders' Meetings A. Quorum. A majority of the votes entitled to be cast on a matter by a voting group shall constitute a quorum of that voting group for action on that matter at any meeting of shareholders. (When used in these Articles of Incorporation, the term "voting group" or "voting groups" shall have the meaning assigned by the Act.) B. Voting. Except as is otherwise required by the Act, action by a voting group on a matter other than the election of directors is approved if a quorum exists and if the votes cast within the voting group favoring the action exceed the votes cast within the voting group opposing the action. C. Change in Quorum or Voting Requirements. Any amendment to these Articles of Incorporation adding, changing, or deleting a greater quorum or voting requirement for shareholders shall meet the same quorum requirement and be adopted by the same vote and voting groups required to take action under the quorum and voting requirements then in effect or proposed to be adopted, whichever are greater. The undersigned incorporator who is a natural person over the age of eighteen years has executed these Articles of Incorporation on September 14, 1999. Name: /s/ Rondi J. Boroos --------------------------- Rondi J. Boroos -3- Registered Agent's Consent Option CONSENT OF REGISTERED AGENT The undersigned initial registered agent of Carbon Energy Corporation does hereby confirm the address for such agent and consent to the undersigned's appointment as such registered agent, all as set forth in Article III, above, as provided in Section 7-102-102(1)(f) of the Colorado Business Corporation Act. Executed this 13 day of September, 1999. Name: /s/ Kevin D. Struzeski ------------------------------- Kevin D. Struzeski -4- EX-3 3 BYLAWS OF CARBON ENERGY CORPORATION EXHIBIT 3 BYLAWS OF CARBON ENERGY CORPORATION (A Colorado Corporation) Effective as of September 15, 1999 BYLAWS OF CARBON ENERGY CORPORATION TABLE OF CONTENTS
Page ARTICLE I. Offices.............................................................. 1 1. Business Offices........................................................ 1 2. Principal Office........................................................ 1 3. Registered Office....................................................... 1 ARTICLE II. Shareholders' Meetings.............................................. 1 1. Annual Meetings......................................................... 1 2. Special Meetings........................................................ 2 3. Place of Special Meetings............................................... 2 4. Notice of Meetings...................................................... 3 5. Shareholders' List...................................................... 3 6. Organization............................................................ 4 7. Agenda and Procedure.................................................... 5 8. Quorum.................................................................. 5 9. Adjournment............................................................. 5 10. Voting................................................................. 6 11. Inspectors............................................................. 7 12. Meeting by Telecommunication........................................... 7 ARTICLE III. Board of Directors................................................. 8 1. Authority, Election and Tenure.......................................... 8 2. Number and Qualification................................................ 9 3. Regular Meetings........................................................ 9 4. Special Meetings........................................................ 9 5. Place of Meetings....................................................... 9 6. Notice of Meetings...................................................... 9 7. Quorum and Voting....................................................... 10 8. Organization, Agenda and Procedure...................................... 10 9. Resignation............................................................. 11 10. Removal................................................................ 11 11. Vacancies.............................................................. 11 12. Executive and Other Committees......................................... 12 13. Compensation of Directors.............................................. 13 14. Meeting by Telecommunication........................................... 13 ARTICLE IV. Waiver of Notice by Shareholders and Directors and Action of Shareholders and Directors by Consent...................................... 14 1. Waiver of Notice........................................................ 14 2. Action Without a Meeting................................................ 15 ARTICLE V. Officers............................................................. 16 1. Election and Tenure..................................................... 16
2. Resignation, Removal and Vacancies........................................ 16 3. Chairman of the Board..................................................... 17 4. President................................................................. 17 5. Vice Presidents........................................................... 17 6. Secretary................................................................. 18 7. Treasurer................................................................. 18 8. Assistant Secretaries and Assistant Treasurers............................ 19 9. Bond of Officers.......................................................... 19 10. Compensation............................................................. 19 ARTICLE VI. Indemnification....................................................... 20 1. Indemnification........................................................... 20 2. Provisions Not Exclusive.................................................. 20 3. Effect of Modification of Act............................................. 21 4. Definitions............................................................... 21 5. Insurance................................................................. 22 6. Expenses as a Witness..................................................... 23 7. Notice to Shareholders.................................................... 23 ARTICLE VII. Execution of Instruments; Loans; Checks and Endorsements; Deposits; Proxies............................................................ 23 1. Execution of Instruments.................................................. 23 2. Borrowing................................................................. 24 3. Loans to Directors, Officers and Employees................................ 24 4. Checks and Endorsements................................................... 25 5. Deposits.................................................................. 25 6. Proxies................................................................... 25 ARTICLE VIII. Shares of Stock..................................................... 26 1. Certificates of Stock..................................................... 26 2. Shares Without Certificates............................................... 26 3. Record.................................................................... 27 4. Transfer of Stock......................................................... 27 5. Transfer Agents and Registrars; Regulations............................... 27 6. Lost, Destroyed or Mutilated Certificates................................. 28 ARTICLE IX. Corporate Seal........................................................ 28 ARTICLE X. Fiscal Year............................................................ 28 ARTICLE XI. Corporate Records..................................................... 28 1. Corporate Records......................................................... 28 2. Addresses of Shareholders................................................. 29 3. Fixing Record Date........................................................ 29 4. Inspection of Corporate Records........................................... 30 5. Distribution of Financial Statements...................................... 30 6. Audits of Books and Accounts.............................................. 30 ARTICLE XII. Emergency Bylaws and Actions......................................... 30 ARTICLE XIII. Amendments.......................................................... 30
-ii- BYLAWS OF Carbon Energy Corporation (a Colorado Corporation) ARTICLE I. Offices 1. Business Offices. The Corporation may have one or more offices at such place or places within or without the State of Colorado as the Board of Directors may from time to time determine or as the business of the Corporation may require. 2. Principal Office. The initial principal office of the Corporation shall be as set forth in the Articles of Incorporation. The Board of Directors, from time to time, may change the principal office of the Corporation. 3. Registered Office. The registered office of the Corporation shall be as set forth in the Articles of Incorporation, unless changed as provided by the provisions of the Colorado Business Corporation Act, as it may be amended from time to time, or any successor law (the "Act"). ARTICLE II. Shareholders' Meetings 1. Annual Meetings. The annual meetings of shareholders for the election of directors to succeed those directors whose terms expire and for the transaction of such other business as may come before the meeting shall be held each year at such date, time and place, either within or without the State of Colorado, as may be designated by resolution of the Board of Directors from time to time; provided, however, that an annual meeting shareholders shall be held each year on a date that is within the earlier of six months after the close of the last fiscal year or fifteen months after the last annual meeting. If the day so fixed for such annual meeting shall be a legal holiday at the place of the meeting, then such meeting shall be held on the next succeeding business day at the same hour. 2. Special Meetings. Special meetings of shareholders for any purpose or purposes, unless otherwise prescribed by statute or by the Articles of Incorporation, may be called at any time by the President or by the Board of Directors and shall be called by the President or the Secretary upon one or more written demands (which shall state the purpose or purposes therefor) signed and dated by the holders of shares representing not less than ten percent of all votes entitled to be cast on any issue proposed to be considered at the meeting. The record date for determining the shareholders entitled to demand a special meeting is the date of the earliest of any of the demands pursuant to which the meeting is called, or the date that is 60 days before the date on which the first of such demands is received, whichever is later. Business transacted at any special meeting of shareholders shall be limited to the purpose or purposes stated in the notice of such meeting. 3. Place of Special Meetings. Special meetings of shareholders shall be held at such place or places, within or without the State of Colorado, as may be determined by the Board of Directors and designated in the notice of the meeting, or, if no place is so determined and designated in the notice, special meetings of shareholders shall be held at the principal office of the Corporation. -2- 4. Notice of Meetings. Not less than 10 nor more than 60 days prior to each annual or special meeting of shareholders, written notice of the date, time and place of each annual and special shareholders' meeting shall be given to each shareholder entitled to vote at such meeting; provided, however, that if the authorized shares of the Corporation are proposed to be increased, at least 30 days' notice in like manner shall be given; and provided, further, that if the Act prescribes notice requirements for particular circumstances (as in the case of the sale, lease or exchange of the Corporation's assets other than in the usual and regular course of business, or the merger or dissolution of the Corporation), the provisions of the Act shall govern. Notice may be given in person; by telephone, telegraph, teletype, electronically transmitted facsimile, or other form of wire or wireless communication; and, if so given, shall be effective when received by the shareholder. Notice may also be given by deposit in the United States mail, postage prepaid, if addressed to the shareholder at the address of such shareholder shown in the Corporation's current record of shareholders, and, of so given, shall be effective when mailed. If three successive notices mailed to any shareholder in accordance with the provisions of this Section 4 are returned as undeliverable, no further notices to such shareholder shall be necessary until another address for such shareholder is made known to the Corporation. The notice of a special meeting shall, in addition, state the meeting's purposes. 5. Shareholders' List. A complete record of the shareholders entitled to notice of any shareholders' meeting (or an adjourned meeting described in Section 9 of this Article II) shall be prepared by the Secretary of the Corporation. Such shareholders' list shall be arranged by voting groups and, within each voting group by class or series of -3- shares, shall be alphabetical within each class or series and shall show the address of, and the number of shares of each such class and series that are held by, each shareholder. (When used in these Bylaws, the term "voting group" or "voting groups" shall have the meaning assigned by the Act.) The shareholders' list shall be available for inspection by any shareholder beginning on the earlier of ten days before the meeting for which the list was prepared or two business days after notice is given and continuing through the meeting and any adjournment thereof at the Corporation's principal office or at a place identified in the notice of the meeting in the city where the meeting will be held. A shareholder or his agent or attorney is entitled on written demand to inspect and, subject to the requirements of the Act, to copy the list during regular business hours and during the period it is available for inspection. 6. Organization. The Chairman of the Board, if any, or, if there is no Chairman of the Board or in the Chairman of the Board's absence, the President, or in the President's absence, any Vice President shall call meetings of shareholders to order and act as chairperson of such meetings. In the absence of said officers, any shareholder entitled to vote at the meeting, or any proxy of any such shareholder, may call the meeting to order and a chairperson shall be elected by a majority of the votes present and entitled to be cast at the meeting. The Secretary or any Assistant Secretary of the Corporation or any person appointed by the chairperson may act as secretary of such meetings. 7. Agenda and Procedure. The Board of Directors shall have the responsibility of establishing an agenda for each meeting of shareholders, subject to the rights of shareholders to raise matters, if any, which may properly be brought before the -4- meeting although not included within the agenda. The chairperson shall be charged with the orderly conduct of all meetings of shareholders. 8. Quorum. Shares entitled to vote as a separate voting group may take action on a matter at a meeting only if a quorum of those shares exists with respect to that matter. Unless otherwise provided in the Act or in the Corporation's Articles of Incorporation a majority of the votes entitled to be cast on a matter by a voting group constitutes a quorum of that voting group for action on that matter. In the absence of a quorum at any shareholders' meeting, a majority of the votes present in person or represented by proxy and entitled to vote on any matter at the meeting may adjourn the meeting from time to time for a period not to exceed 120 days from the original date of the meeting without further notice (except as provided in Section 9 of this Article II) until a quorum shall be present or represented. 9. Adjournment. When a meeting is for any reason adjourned to another date, time or place, notice need not be given of the adjourned meeting if the date, time and place thereof are announced at the meeting at which the adjournment is taken. At the adjourned meeting, any business may be transacted which might have been transacted at the original meeting. If the adjournment is for more than 120 days from the date of the original meeting, or if, after the adjournment, a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each shareholder as of the new record date. 10. Voting. (a) Except as provided by law or in the Articles of Incorporation, at every meeting of shareholders, or with respect to corporate action which may be taken -5- without a meeting, each outstanding share having voting power is entitled to one vote, and each fractional share, if any is outstanding, is entitled to a corresponding fractional vote, on each matter voted on at a shareholders' meeting. (b) A shareholder may vote the shareholder's shares in person or by proxy. A shareholder may appoint a proxy by signing an appointment form, either personally or by the shareholder's attorney-in-fact. A shareholder may appoint a proxy by transmitting or authorizing the transmission of a telegram, teletype or other electronic transmission providing a written statement of the appointment to the proxy, to a proxy solicitor, proxy support service organization, or other person duly authorized by the proxy to receive appointments as agent for the proxy, or to the Corporation; except that the transmitted appointment shall set forth or be transmitted with written evidence from which it can be determined that the shareholder transmitted or authorized the transmission of the appointment. An appointment of a proxy is not effective against the Corporation until the appointment is received by the Corporation. The appointment is effective for eleven months unless a different period is expressly provided in the appointment form. An appointment of a proxy shall be revocable by the shareholder except as may be permitted or provided by law. (c) When a quorum is present at any meeting of shareholders, action on a matter, other than the election of directors, by a voting group is approved if the votes cast within the voting group favoring the action exceed the votes cast within the voting group opposing the action, unless the matter is one upon which a different vote is required by express provision of a statute, or the Articles of Incorporation, or these -6- Bylaws, in which case such express provision shall govern and control the decision on such matter. 11. Inspectors. The chairperson of the meeting may at any time appoint two or more inspectors to serve at a meeting of the shareholders. Such inspectors shall decide upon the qualifications of voters, including the validity of proxies, accept and count the votes for and against the matters presented, report the results of such votes, and subscribe and deliver to the secretary of the meeting a certificate stating the number of shares of stock within each voting group that is issued and outstanding and entitled to vote thereon and the number of shares within each voting group that voted for and against the matters presented. The voting inspectors need not be shareholders of the Corporation, and any director or officer of the Corporation may be an inspector on any matter other than a vote for or against such director's or officer's election to any position with the Corporation or on any other matter in which such officer or director may be directly interested. 12. Meeting by Telecommunication. If and only if permitted by the Board of Directors, any or all of the shareholders may participate in an annual or special shareholders' meeting by, or the meeting may be conducted through the use of, any means of communication by which all persons participating in the meeting may hear each other during the meeting. If the Board of Directors determines to allow shareholders to participate in a shareholders' meeting by telecommunication, the Board shall establish the terms and conditions under which shareholders may participate by such means and shall cause the notice of the meeting to contain such terms and conditions. Only shareholders who comply with the terms and conditions indicated in such notice shall be entitled to so -7- participate by telecommunication in the shareholders' meeting. A shareholder participating in a meeting by telecommunication in compliance with the terms and conditions established by the Board of Directors is deemed to be present in person at the meeting. ARTICLE III. Board of Directors 1. Authority, Election and Tenure. All corporate power shall be exercised by or under the authority of, and the business and affairs of the Corporation shall be managed by, a Board of Directors. The Board of Directors shall be elected at each annual meeting of shareholders. In an election of directors, that number of candidates equaling the number of directors to be elected having the highest number of votes cast in favor of their election shall be elected to the Board of Directors. The terms of the initial directors of the Corporation shall expire at the first shareholders' meeting at which directors are elected. The term of each director who is not an initial director of the Corporation shall expire at the next annual meeting of shareholders; provided, however, that a director shall continue to serve, despite the expiration of his or her term, until such director's successor shall be elected and shall qualify, or until such director's earlier death, resignation or removal. 2. Number and Qualification. The number of directors shall be fixed from time to time by resolution of the Board of Directors and may be increased or decreased from time to time by resolution of the Board of Directors, but no decrease in the number of directors shall have the effect of shortening the term of any incumbent director. -8- Directors must be natural persons at least eighteen years of age but need not be shareholders or residents of the State of Colorado. 3. Regular Meetings. Regular meetings of the Board of Directors shall be held at such dates, times and places as may be determined by the Board of Directors. Regular meetings of the Board of Directors may be held without notice of the date, time, place or purpose of the meeting. 4. Special Meetings. Special meetings of the Board of Directors may be called by the President at any time and shall be called by the President or the Secretary on the written request of any two directors. 5. Place of Meetings. Any meeting of the Board of Directors may be held at such place or places either within or without the State of Colorado as shall from time to time be determined by the Board of Directors and as shall be designated in the resolution of the Board of Directors fixing the date, time and place of the regular meetings of the Board of Directors or in the notice of special meeting. 6. Notice of Meetings. Notice of the date, time and place of each special meeting of directors shall be given to each director at least two days prior to such meeting. The notice of a special meeting of the Board of Directors need not state the purposes of the meeting. Notice to each director of any special meeting may be given in person; by telephone, telegraph, teletype, electronically transmitted facsimile, or other form of wire or wireless communication; or by mail or private carrier. Oral notice to a director of any special meeting is effective when communicated. Written notice to a director of any special meeting, including without limitation notice sent by electronic mail, is effective at the earliest of: (a) the date received; (b) five days after it is deposited -9- in the United States mail, properly addressed to the last address for the director shown on the records of the Corporation, first class postage prepaid; (c) the date shown on the return receipt if mailed by registered or certified mail, return receipt requested, postage prepaid, in the United States mail and if the return receipt is signed by or on behalf of the director to whom the notice is addressed. 7. Quorum and Voting. A majority of the number of directors fixed by or in accordance with Section 2 of this Article III shall constitute a quorum at all meetings of the Board of Directors. The vote of a majority of the directors present at a meeting at which a quorum is present shall be the act of the Board of Directors, except as otherwise required by the Act. 8. Organization, Agenda and Procedure. The of the Board, if any, or, if there is no Chairman of the Board or in the absence of the Chairman of the Board, the President, or in the President's absence, any director chosen by a majority of the directors present, shall act as chairperson of the meetings of the Board of Directors. The Secretary, any Assistant Secretary, or any other person appointed by the chairperson shall act as secretary of each meeting of the Board of Directors. The agenda of and procedure for such meetings shall be as determined by the Board of Directors. 9. Resignation. Any director of the Corporation may resign at any time by giving written resignation notice to the Corporation or the Secretary of the Corporation at the Corporation's principal office. Such resignation shall take effect at the date of receipt of such notice or at any later time specified therein and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it -10- effective, unless it so provides. A director who resigns may deliver to the Secretary of State for filing a statement to that effect. 10. Removal. Any director may be removed, either with or without cause, at any time, at a special meeting of the shareholders called and held for such purpose if the number of votes cast in favor of removal exceeds the number of votes cast against removal; provided, however, that if a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove that director. A vacancy in the Board of Directors caused by any such removal may be filled by the Corporation's shareholders at such meeting or, if the shareholders at such meeting shall fail to fill such vacancy, by the Board of Directors as provided in Section 11 of this Article III. 11. Vacancies. If a vacancy occurs on the Board of Directors, including a vacancy resulting from an increase in the number of directors: (a) the shareholders may fill the vacancy at the next annual meeting or at a special meeting called for that purpose; or (b) the Board of Directors may fill the vacancy; or (c) if the directors remaining in office constitute fewer than a quorum of the Board of Directors, they may fill the vacancy by the affirmative vote of a majority of all the directors remaining in office. The term of a director elected to fill a vacancy pursuant to subparagraph (b) or (c) of the foregoing sentence expires at the next annual shareholders' meeting. The term of a director elected to fill a vacancy pursuant to subparagraph (a) of this Section 11 shall be the unexpired term of such director's predecessor in office; except that, if the director's predecessor had been elected to fill a vacancy pursuant to Subparagraph (b) or (c) of this Section 11, the term of a director elected pursuant to Section (a) of this Section 11 shall -11- be the unexpired term of the last predecessor elected by the shareholders. If the vacant directorship was held by a director elected by a voting group of shareholders and one or more of the remaining directors were elected by the same voting group, only such directors are entitled to vote to fill the vacancy if it is filled by directors, and they may do so by the affirmative vote of a majority of such directors remaining in office; and only the holders of shares of that voting group are entitled to vote to fill such vacancy if it is filled by the shareholders. 12. Executive and Other Committees. Except as otherwise required by the Act, the Board of Directors, by resolution adopted by the greater of a majority of the number of directors fixed by or in accordance with Section 2 of this Article III or the number of directors required to take action pursuant to Section 7 of this Article III, may designate from among its members an executive committee and one or more other committees each of which, to the extent provided in the resolution and except as otherwise prescribed by the Act, shall have and may exercise all of the authority of the Board of Directors in the management of the Corporation, except that no committee shall: (a) authorize distributions; (b) approve or propose to shareholders action that the Act requires to be approved by shareholders; (c) fill vacancies on the Board of Directors or on any of its committees; (d) amend the Articles of Incorporation; (e) adopt, amend, or repeal these Bylaws; (f) approve a plan of merger not requiring shareholder approval; (g) authorize or approve reacquisition of shares, except according to a formula or method prescribed by the Board of Directors; or (h) authorize or approve the issuance or sale of shares, or a contract for the sale of shares, or determine the designation and relative rights, preferences, and limitations of a class or series of shares, except that with -12- respect to this clause (h) the Board of Directors may authorize a committee to do so within limits specifically prescribed by the Board of Directors. The provision of these Bylaws governing meetings, action without meeting, notice, waiver of notice, and quorum and voting requirements of the Board of Directors shall apply to committees and the members thereof. 13. Compensation of Directors. Each director may be paid such compensation as fixed from time to time by resolution of the Board of Directors, together with reimbursement for the reasonable and necessary expenses incurred by such director in connection with the performance of such director's duties. Nothing herein contained shall be construed to preclude any director from serving the Corporation in any other capacity or any of its subsidiaries in any other capacity and receiving proper compensation therefor. 14. Meeting by Telecommunication. One or more members of the Board of Directors or any committee designated by the Board of Directors may hold or participate in a meeting of the Board of Directors or such committee through the use of any means of communication by which all persons participating can hear each other at the same time. ARTICLE IV. Waiver of Notice by Shareholders and Directors and Action of Shareholders and Directors by Consent 1. Waiver of Notice. A shareholder may waive any notice required by the Act or by the Articles of Incorporation or these Bylaws, and a director may waive any notice of a directors' meeting, whether before or after the date or time stated in the notice as the date or time when any action will occur or has occurred. The waiver shall be in -13- writing, be signed by the shareholder or director entitled to the notice, and be delivered to the Corporation for inclusion in the minutes or filing with the corporate records, but such delivery and filing shall not be conditions of the effectiveness of the waiver. Attendance of a shareholder at a meeting waives objection to lack of notice or defective notice of the meeting, unless the shareholder at the beginning of the meeting objects to holding the meeting or transacting business at the meeting because of lack of notice or defective notice, and waives objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice unless the shareholder objects to considering the matter when it is presented. A director's attendance at or participation in a meeting waives any required notice to him or her of the meeting unless the director, at the beginning of the meeting or promptly upon his or her later arrival, objects to holding the meeting or transacting business at the meeting because of lack of notice or defective notice and does not thereafter vote for or assent to action taken at the meeting, or if special notice was required of a particular purpose pursuant to the Act, the director objects to transacting business with respect to the purpose for which such special notice was required and does not thereafter vote for or assent to action taken at the meeting with respect to such purpose. 2. Action Without a Meeting. Any action required or permitted to be taken at a meeting of the shareholders, directors or members of an executive or other committee, as applicable, may be taken without a meeting if all shareholders entitled to vote with respect to such action, or all directors or all members of an executive or other committee, as the case may be, give written consent to such action in writing. The record date for determining shareholders entitled to take action without a meeting is the -14- date a writing upon which the action is taken, pursuant to this Section 2 of Article IV, is first received by the Corporation. Any shareholder who has signed a writing describing and consenting to action taken pursuant to this Section 2 of this Article IV may revoke such consent by a writing signed by such shareholder describing the action and stating that the shareholder's prior consent thereto is revoked, if such writing is received by the Corporation before the effectiveness of the action. Action taken without a meeting shall be effective: in the case of an action of shareholders, as of the date the last writing necessary to effect the action is received by the Corporation unless all of the writings necessary to effect the action specify another date, which may be before or after the date the writings are received by the Corporation; and in the case of directors' action, action is taken when the last director signs a writing describing the action taken unless before such time the Secretary has received a written revocation of the consent of any other director, and any action so taken shall be effective at the time taken unless the directors specify a different effective date. ARTICLE V. Officers 1. Election and Tenure. The officers of the Corporation shall consist of a Chairman of the Board if the Board of Directors determines that there shall be such a position, a President, a Secretary and Treasurer, each of whom shall be appointed annually by the Board of Directors. The Board of Directors may also designate and appoint such other officers and assistant officers as may be deemed necessary. The Board of Directors may delegate to any such officer the power to appoint or remove subordinate officers, agents or employees. Any two or more offices may be held by the -15- same person. Each officer so appointed shall continue in office until a successor shall be appointed and shall qualify, or until the officer's earlier death, resignation or removal. Each officer shall be a natural person who is eighteen years of age or older. 2. Resignation, Removal and Vacancies. Any officer may resign at any time by giving written notice of resignation to the Board of Directors or the President. Such resignation shall take effect when the notice is received by the Corporation unless the notice specifies a later effective date, and acceptance of the resignation shall not be necessary to render such resignation effective. Any officer may at any time be removed by the Board of Directors. If any office becomes vacant for any reason, the vacancy may be filled by the Board of Directors. An officer appointed to fill a vacancy shall be appointed for the unexpired term of such officer's predecessor in office and shall continue in office until a successor shall be elected or appointed and shall qualify, or until such officer's earlier death, resignation or removal. The appointment of an officer shall not itself create contract rights in favor of the officer, and the removal of an officer does not affect the officer's contract rights, if any, with the Corporation and the resignation of an officer does not affect the Corporation's contract rights, if any, with the officer. 3. Chairman of the Board. If there shall be a Chairman of the Board, the Chairman of the Board shall preside at meetings of the Board of Directors and of the shareholders at which he or she is present, and shall give counsel and advice to the Board of Directors and the officers of the Corporation on all subjects concerning the welfare of the Corporation and the conduct of its business. The Chairman of the Board of Directors shall perform such other duties as the Board may from time to time determine. -16- 4. President. The President shall be the chief executive officer of the Corporation. If there is no Chairman of the Board, or if there is a Chairman of the Board in the absence of the Chairman of the Board, or if authorized by the Chairman of the Board, the President shall preside at meetings of the shareholders. The President shall have general and active management of the business of the Corporation; shall see that all orders and resolutions of the Board of Directors are carried into effect; and shall perform all duties as may from time to time be assigned by the Board of Directors. 5. Vice Presidents. The Vice Presidents, if any, shall perform such duties and possess such powers as from time to time may be assigned to them by the Board of Directors or the President. In the absence of the President or in the event of the inability or refusal of the President to act, the Vice President (or in the event there be more than one Vice President, the Vice Presidents in the order designated by the Board of Directors, or in the absence of any designation, then in the order of the election or appointment of the Vice Presidents) shall perform the duties of the President and when so performing shall have all the powers of and be subject to all the restrictions upon the President. 6. Secretary. The Secretary shall perform such duties and shall have such powers as may from time to time be assigned by the Board of Directors or the President. In addition, the Secretary shall perform such duties and have such powers as are incident to the office of Secretary including, without limitation, the duty and power to give notice of all meetings of shareholders and the Board of Directors, the preparation and maintenance of minutes of the directors' and shareholders' meetings and other records and information required to be kept by the Corporation under Article XI and for -17- authenticating records of the Corporation, and to be custodian of the corporate seal and to affix and attest to the same on documents, the execution of which on behalf of the Corporation is authorized by these Bylaws or by the action of the Board of Directors. 7. Treasurer. The Treasurer shall perform such duties and shall have such powers as may from time to time be assigned by the Board of Directors or the President. In addition, the Treasurer shall perform such duties and have such powers as are incident to the office of Treasurer including, without limitation, the duty and power to keep and be responsible for all funds and securities of the Corporation, to deposit funds of the Corporation in depositories selected in accordance with these Bylaws, to disburse such funds as ordered by the Board of Directors, making proper accounts thereof, and to render as required by the Board of Directors statements of all these transactions taken as Treasurer and of the financial condition of the Corporation. 8. Assistant Secretaries and Assistant Treasurers. The Assistant Secretaries and Assistant Treasurers, if any, shall perform such duties as shall be assigned to them by the Secretary or the Treasurer, respectively, or by the President or the Board of Directors. In the absence, inability or refusal to act of the Secretary or the Treasurer, the Assistant Secretaries or Assistant Treasurers, respectively, in the order designated by the Board of Directors, or in the absence of any designation, then in the order of their election or appointment, shall perform the duties and exercise the powers of the Secretary or Treasurer, as the case may be. 9. Bond of Officers. The Board of Directors may require any officer to give the Corporation a bond in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for such terms and conditions as the Board of -18- Directors may specify, including without limitation for the faithful performance of such officer's duties and for the restoration to the Corporation of any property belonging to the Corporation in such officer's possession or under the control of such officer. 10. Compensation. Officers of the Corporation shall be entitled to such salaries, emoluments, compensation or reimbursement as shall be fixed or authorized from time to time by the Board of Directors. ARTICLE VI. Indemnification 1. Indemnification. To the extent permitted or required by the Act and any other applicable law, if any director or officer of the Corporation is made a party to or is involved in any proceeding because such person is or was a director or officer of the Corporation, the Corporation shall (a) indemnify such person from and against any liability, including but not limited to expenses of investigation and preparation, expenses in connection with appearance as a witness, and fees and disbursements of counsel, accountants or other experts, incurred by such person in such proceeding, and (b) advance to such person expenses incurred in such proceeding. The Corporation may in its discretion, but is not obligated in any way to, indemnify and advance expenses to an employee or agent of the Corporation to the same extent as to a director or officer, and the Corporation may indemnify an employee, fiduciary, or agent of the Corporation to a greater extent than expressly permitted herein for officers and directors if not inconsistent with public policy. 2. Provisions Not Exclusive. The foregoing provisions for indemnification and advancement of expenses are not exclusive, and the Corporation may at its discretion -19- provide for indemnification or advancement of expenses in a resolution of its shareholders or directors, in a contract or in its Articles of Incorporation. 3. Effect of Modification of Act. Any repeal or modification of the foregoing provisions of this Article for indemnification or advancement of expenses shall not affect adversely any right or protection stated in such provisions with respect to any act or omission occurring prior to the time of such repeal or modification. If any provision of this Article or any part thereof shall be held to be prohibited by or invalid under applicable law, such provision or part thereof shall be deemed amended to accomplish the objectives of the provision or part thereof as originally written to the fullest extent permitted by law, and all other provisions or parts shall remain in full force and effect. 4. Definitions. As used in this Article, the following terms have the following meanings: (a) Act. When used with reference to an act or omission occurring prior to the effectiveness of any amendment to the Act which occurs after the effectiveness of the adoption of this Article, the term "Act" shall include such amendment only to the extent that the amendment permits a corporation to provide broader indemnification rights than the Act permitted prior to the amendment. (b) Corporation. The term "Corporation" includes any domestic or foreign entity that is a predecessor of the Corporation by reason of a merger or other transaction in which the predecessor's existence ceased upon consummation of the transaction. (c) Director or Officer. A "director" or "officer" is an individual who is or was a director or officer of the Corporation or an individual who, while a director -20- or officer of the Corporation, is or was serving at the Corporation's request as a director, officer, partner, trustee, employee, fiduciary, or agent of another domestic or foreign corporation or other person or entity or of an employee benefit plan. A director or officer is considered to be serving an employee benefit plan at the Corporation's request if his or her duties to the Corporation also impose duties on, or otherwise involve services by, the director or officer to the plan or to participants in or beneficiaries of the plan. The terms "director" and "officer" include, unless the context requires otherwise, the estate or personal representative of a director, or officer. (d) Liability. The term "liability" means the obligation incurred with respect to a proceeding to pay a judgment, settlement, penalty, fine (including any excise tax assessed with respect to an employee benefit plan), or reasonable expenses. (e) Proceeding. The term "proceeding" means any threatened, pending or completed action, suit, or proceeding whether civil, criminal, administrative or investigative, and whether formal or informal. 5. Insurance. The Corporation may purchase and maintain insurance on behalf of a person who is or was a director, officer, employee, fiduciary, or agent of the Corporation, or who, while a director, officer, employee, fiduciary, or agent of the Corporation, is or was serving at the request of the Corporation as a director, officer, partner, trustee, employee, fiduciary, or agent of another domestic or foreign corporation or other person or entity or of an employee benefit plan, against liability asserted against or incurred by the person in that capacity or arising from his or her status as a director, officer, employee, fiduciary, or agent, whether or not the Corporation would have power to indemnify the person against the same liability under the Act. Any such insurance may -21- be procured from any insurance company designated by the Board of Directors, whether such insurance company is formed under the laws of this state or any other jurisdiction of the United States or elsewhere, including any insurance company in which the Corporation has an equity or any other interest through stock ownership or otherwise. 6. Expenses as a Witness. The Corporation may pay or reimburse expenses incurred by a director, officer, employee, fiduciary, or agent in connection with an appearance as a witness in a proceeding at a time when he or she has not been made a named defendant or respondent in the proceeding. 7. Notice to Shareholders. If the Corporation indemnifies or advances expenses to a director under this Article in connection with a proceeding by or in the right of the Corporation, the Corporation shall give written notice of the indemnification or advance to the shareholders with or before the notice of the next shareholders' meeting. If the next shareholder action is taken without a meeting at the instigation of the Board of Directors, such notice shall be given to the shareholders at or before the time the first shareholder signs a writing consenting to such action. ARTICLE VII. Execution of Instruments; Loans; Checks and Endorsements; Deposits; Proxies 1. Execution of Instruments. The President or any Vice President shall have the power to execute and deliver on behalf of and in the name of the Corporation any instrument requiring the signature of an officer of the Corporation, except as otherwise provided in these Bylaws or when the execution and delivery of the instrument shall be expressly delegated by the Board of Directors to some other officer or agent of the Corporation. Unless authorized to do so by these Bylaws or by the Board of Directors, -22- no officer, agent or employee shall have any power or authority to bind the Corporation in any way, to pledge its credit or to render it liable pecuniarily for any purpose or in any amount. 2. Borrowing. No loan shall be contracted on behalf of the Corporation, and no evidence of indebtedness shall be issued, endorsed or accepted in its name, unless authorized by the Board of Directors or a committee designated by the Board of Directors so to act. Such authority may be general or confined to specific instances. When so authorized, an officer may (a) effect loans at any time for the Corporation from any bank or other entity and for such loans may execute and deliver promissory notes or other evidences of indebtedness of the Corporation; and (b) mortgage, pledge or otherwise encumber any real or personal property, or any interest therein, owned or held by the Corporation as security for the payment of any loans or obligation of the Corporation, and to that end may execute and deliver for the Corporation such instruments as may be necessary or proper in connection with such transaction. 3. Loans to Directors, Officers and Employees. The Corporation may lend money to, guarantee the obligations of and otherwise assist directors, officers and employees of the Corporation, or directors of another corporation of which the Corporation owns a majority of the voting stock, only upon compliance with the requirements of the Act. 4. Checks and Endorsements. All checks, drafts or other orders for the payment of money, obligations, notes or other evidences of indebtedness, bills of lading, warehouse receipts, trade acceptances and other such instruments shall be signed or endorsed for the Corporation by such officers or agents of the Corporation as shall from -23- time to time be determined by resolution of the Board of Directors, which resolution may provide for the use of facsimile signatures. 5. Deposits. All funds of the Corporation not otherwise employed shall be deposited from time to time to the Corporation's credit in such banks or other depositories as shall from time to time be determined by resolution of the Board of Directors, which resolution may specify the officers or agents of the Corporation who shall have the power, and the manner in which such power shall be exercised, to make such deposits and to endorse, assign and deliver for collection and deposit checks, drafts and other orders for the payment of money payable to the Corporation or its order. 6. Proxies. Unless otherwise provided by resolution adopted by the Board of Directors, the President or any Vice President: (a) may from time to time appoint one or more agents of the Corporation, in the name and on behalf of the Corporation, (i) to cast the votes which the Corporation may be entitled to cast as the holder of stock or other securities in any other corporation, association or other entity whose stock or other securities may be held by the Corporation, at meetings of the holders of the stock or other securities of such other corporation, association or other entity, or (ii) to consent in writing to any action by such other corporation, association or other entity; (b) may instruct the person so appointed as to the manner of casting such votes or giving such consent; and (c) may execute or cause to be executed in the name and on behalf of the Corporation and under its corporate seal, or otherwise, all such written proxies or other instruments as may be deemed necessary or proper. -24- ARTICLE VIII. Shares of Stock 1. Certificates of Stock. The shares of the Corporation may but need not be represented by certificates. Unless the Act or another law expressly provides otherwise, the fact that the shares are not represented by certificates shall have no effect on the rights and obligations of shareholders. If the shares are represented by certificates, such certificates shall be signed either manually or in facsimile by the President and the Secretary or such other representatives of the Corporation as are designated by the Board of Directors. If the person who signed, either manually or in facsimile, a share certificate, no longer holds office when the certificate is issued, the certificate is nevertheless valid. Every certificate representing shares issued by the Corporation shall state the number and class of shares and the designation of the series, if any, the certificate represents, and shall otherwise be in such form as is required by law and as the Board of Directors shall prescribe. 2. Shares Without Certificates. The Board of Directors may authorize the issuance of any class or series of shares of the Corporation without certificates. Such authorization shall not affect shares already represented by certificates until they are surrendered to the Corporation. Within a reasonable time following the issue or transfer of shares without certificates, the Corporation shall send the shareholder a complete written statement of the information required on certificates by the Act. 3. Record. A record shall be kept of the names and addresses of the Corporation's shareholders, in a form that permits preparation of a list of shareholders that is arranged by voting group and within each voting group by class or series of -25- shares, that is alphabetical within each class or series, and that shows the addresses of, and the number of shares of each class and series and the date of issuance of the shares (and in case of cancellation, the date of cancellation) held by, each shareholder. The person or other entity in whose name shares of stock stand on the books of the Corporation shall be deemed the owner thereof, and thus a holder of record of such shares of stock, for all purposes as regards the Corporation. 4. Transfer of Stock. Transfers of shares of the stock of the Corporation shall be made only on the books of the Corporation by the registered holder thereof, or by such registered holder's attorney thereunto authorized, and on the surrender of the certificate or certificates for such shares properly endorsed. 5. Transfer Agents and Registrars; Regulations. The Board of Directors may appoint one or more transfer agents or registrars with respect to shares of the stock of the Corporation. The Board of Directors may make such rules and regulations as it may deem expedient and as are not inconsistent with these Bylaws, concerning the issue, transfer and registration of certificates for shares of the stock of the Corporation. 6. Lost, Destroyed or Mutilated Certificates. In case of the alleged loss, destruction or mutilation of a certificate representing stock of the Corporation, a new certificate may be issued in place thereof, in such manner and upon such terms and conditions as the Board of Directors may prescribe, and shall be issued in such situations as required by the Act. -26- ARTICLE IX. Corporate Seal The corporate seal shall be in the form approved by resolution of the Board of Directors. Said seal may be used by causing it or a facsimile thereof to be impressed or affixed or in any other manner reproduced. The impression of the seal may be made and attested by either the Secretary or any Assistant Secretary for the authentication of contracts or other papers requiring the seal. ARTICLE X. Fiscal Year The fiscal year of the Corporation shall be the year established by the Board of Directors. ARTICLE XI. Corporate Records 1. Corporate Records. The Corporation shall comply with the provisions of the Act regarding maintenance of records and shall keep such records at such place as the Act may designate or, if the Act does not designate the place for such records, then at such place or places as may be from time to time designated by the Board of Directors. 2. Addresses of Shareholders. Each shareholder shall furnish to the Secretary of the Corporation or the Corporation's transfer agent an address to which notices from the Corporation, including notices of meetings, may be directed and if any shareholder shall fail so to designate such an address, it shall be sufficient for any such -27- notice to be directed to such shareholder at such shareholder's address last known to the Secretary or transfer agent. 3. Fixing Record Date. The Board of Directors may fix in advance a date as a record date for the determination of the shareholders entitled to a notice of or to vote at any meeting of shareholders or entitled to receive payment of any dividend or other distribution or allotment of rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action. Such record date shall not be more than 70 days before the meeting or action requiring a determination of shareholders; except that the record date for determining shareholders entitled to take action without a meeting or entitled to be given notice of action so taken is the date upon which a writing upon which such action is taken is first received by the Corporation. Only such shareholders as shall be shareholders of record on the date so fixed shall be so entitled with respect to the matter to which the same relates. If the Board of Directors shall not fix a record date as above provided, then the record date shall be determined in accordance with the Act. 4. Inspection of Corporate Records. Shareholders shall have those rights to inspect and copy the Corporation's records as provided in the Act. 5. Distribution of Financial Statements. Upon the written request of any shareholder of the Corporation, the Corporation shall mail to such shareholder its last annual and most recently published financial statement, if any. 6. Audits of Books and Accounts. The Corporation's books and accounts may be audited at such times and by such auditors as shall be specified and designated by resolution of the Board of Directors. -28- ARTICLE XII. Emergency Bylaws and Actions Subject to repeal or change by action of the shareholders, the Board of Directors may adopt emergency bylaws and exercise other powers in accordance with and pursuant to the provisions of the Act. ARTICLE XIII. Amendments Unless the Act, the Articles of Incorporation or a particular Bylaw reserves the right to amend the Bylaws exclusively to the shareholders, the Board of Directors may amend or repeal these Bylaws or adopt new bylaws. The shareholders may also amend or repeal these Bylaws or adopt new bylaws. -29- EX-8.1 4 TAX OPINION OF HOLLAND & HART LLP EXHIBIT 8.1 [Letterhead of Holland & Hart LLP] October 20, 1999 Board of Directors Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, CO 80290 Re: Carbon Energy Corporation's Acquisition of Common Stock of CEC Resources Ltd. in Exchange for Carbon Energy Corporation Voting Stock Gentlemen: This letter is in response to your request for our opinion concerning the U.S. federal income tax consequences of Carbon Energy Corporation's ("Carbon") acquisition of common stock of CEC Resources Ltd. ("CEC") in exchange for Carbon voting stock. As described below, Carbon will effectuate such exchange by offering to exchange one share of Carbon common stock for each share of CEC stock. This exchange offer will be open to all holders of CEC common stock. The factual context of the Exchange Offer is generally described below and in more detail in the draft Form S-4 Registration Statement to be filed by Carbon with the Securities and Exchange Commission ("SEC") on or about October 22, 1999 (the "Registration Statement") and representation letters from CEC and Carbon to us dated October 20, 1999 (the "Representation Letters"). General Factual Context ----------------------- CEC is a publicly traded Canadian corporation organized under the laws of Alberta. Yorktown Energy Partners III, L.P. ("Yorktown") is a limited partnership organized under the laws of Delaware. Carbon is a U.S. corporation organized under the laws of Colorado. Yorktown formed Carbon for the purposes of facilitating the following transactions. On August 11, 1999, CEC entered into a Stock Purchase Agreement with Bonneville Pacific Corporation, under which CEC agreed to purchase all outstanding shares of Bonneville Fuels Corporation ("BFC") for $23,857,951 in Carbon Energy Corporation Board of Directors October 20, 1999 Page 2 cash, subject to certain adjustments, with debt, less working capital, of approximately $6,500,000 remaining at BFC. The Stock Purchase Agreement provided for the assignment of CEC's rights and obligations thereunder to Carbon as an affiliate of Yorktown. On October 14, 1999, Carbon, CEC and Yorktown entered into an Exchange and Financing Agreement. Under the Exchange and Financing Agreement, each of Carbon, CEC and Yorktown agreed that, as part of an overall plan to contribute cash, securities and other property to Carbon by CEC, Yorktown and CEC shareholders: (1) CEC would assign its rights under the BFC Stock Purchase Agreement to Carbon; (2) Yorktown would purchase 4,500,000 shares of Carbon common stock for $24,750,000 (in order, in large part, to provide equity financing for the total purchase price of the BFC shares under the Stock Purchase Agreement); and (3) Carbon would make an offer to all shareholders of CEC to exchange one share of Carbon common stock for each outstanding share of CEC common stock (hereinafter referred to as the "Exchange Offer"). You have requested our opinion as to whether the Exchange Offer described above is a taxable transaction for U.S. federal income tax purposes. Assumptions, Qualifications and Conditions ------------------------------------------ Our opinion as set forth below is based upon a number of assumptions, qualifications and conditions. If any of these assumptions, qualifications or conditions is not accurate or satisfied, the opinion set forth below could change or be withdrawn. These assumptions, qualifications and conditions are as follows: 1. The Exchange Offer will be effectuated in accordance with the executed Exchange and Financing Agreement, as amended, between Carbon, CEC and Yorktown dated October 14, 1999 pertaining to the Exchange Offer, and all other documents entered into in connection with the Exchange and Financing Agreement (the "Transaction Documents"); 2. All Transaction Documents have been or will be properly executed and are valid, binding and enforceable in accordance with their terms, and all copies of such documents provided to us are accurate reproductions of the originals; Carbon Energy Corporation Board of Directors October 20, 1999 Page 3 3. The Exchange Offer and related transactions will take place as described in the Transaction Documents and in the Registration Statement, and the facts described in those documents are accurate, complete and will not materially change, and the conduct of the parties is and will be materially consistent with those facts; and 4. The representations made to us in the Representation Letters, which we have not independently verified, and the factual matters described in the Registration Statement, which have not been independently verified, are true, complete and accurate in all material respects. Our opinion is based on the existing Sections of the Code,/1/ applicable Treasury Regulations issued thereunder, the official published interpretations of those provisions by the Internal Revenue Service and the courts, and other administrative pronouncements of the Internal Revenue Service, all of which are subject to change, which changes could be applied retroactively. If the applicable law changes, our opinion may be different. Moreover, the IRS or a court may disagree with the conclusions expressed herein. Opinion Not a Guarantee of Favorable Results -------------------------------------------- Any tax planning of consequence involves inherent risk. Our opinion set forth below merely constitutes our best legal judgment based upon the facts, the assumptions, and qualifications and the conditions set forth above. Our opinion is not binding on the Service or the courts, and our opinion does not constitute "insurance" or a guarantee that our conclusion is correct. Rather, the Service may challenge the positions set forth below and the courts may uphold that position. Opinion ------- Subject to the assumptions, conditions and qualifications described above, and based on existing federal income tax law, it is our opinion that, for U.S. federal income tax purposes, assuming that Carbon acquires 80% of the outstanding CEC stock pursuant to the Exchange Offer, the Exchange Offer should be treated as a tax-free reorganization under Section 368(a)(1)(B) of the ____________________ /1/ All Section references are to the Internal Revenue Code of 1986, as amended, unless otherwise specified. Carbon Energy Corporation Board of Directors October 20, 1999 Page 4 Code. Furthermore, the Exchange Offer likely constitutes a tax-free transfer of property to Carbon by the holders of CEC common stock governed by Section 351 of the Code. The undersigned hereby consents to: (i) filing this opinion as Exhibit 8.1 to the Registration Statement; and (ii) using its name in the Registration Statement under the caption "LEGAL MATTERS." Very truly yours, Holland & Hart LLP EX-8.2 5 TAX OPINION OF BENNETT JONES EXHIBIT 8.2 [Letterhead of Bennett Jones] October 20, 1999 Board of Directors Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, CO 80290-1101 Ladies and Gentlemen: Re: Exchange of CEC Resources Ltd. ("CEC") Shares for Carbon Energy Corporation ("Carbon") Shares We have been asked to give an opinion on the material Canadian income tax consequences for the exchange (the "Exchange") of common stock of CEC for common stock in Carbon. The Exchange will occur pursuant to the terms of the exchange offer (the "Exchange Offer") contained in the draft Form S-4 Registration Statement to be filed by Carbon with the United States Securities and Exchange Commission ("SEC") on or about October 22, 1999 (the "Registration Statement"). Opinion Based upon and subject to the foregoing, the discussions (which are reproduced below) contained in the Registration Statement under the caption "Canadian Federal Income Tax Consequences" express our opinion as to the material Canadian income tax consequences of the Exchange to be effected in accordance with the terms of the Exchange Offer. Due to the fact that this opinion is being delivered prior to the Exchange being effectuated, it must be considered prospective and dependent on future events. There can be no assurance that changes in the law will not take place which could affect the Canadian income tax consequences of the Exchange or that contrary positions may not be taken by Revenue Canada and the applicable Canadian provincial taxing authorities. In addition, our opinion is subject to the limitations and qualifications expressed in the following opinion. October 20, 1999 Page Two CANADIAN FEDERAL INCOME TAX CONSEQUENCES Subject to the qualifications and assumptions contained herein, in the opinion of Bennett Jones, Canadian counsel to CEC, the following is a general summary of the material Canadian federal income tax consequences generally applicable to holders of CEC common stock who dispose of CEC common stock pursuant to the exchange offer. This summary: (i) is based on the current provisions of the Income Tax Act (Canada) (the "Canadian Tax Act"), the regulations thereunder (the "Regulations") and counsel's understanding of the current administrative practices of Revenue Canada, Customs, Excise and Taxation. This summary also takes into account the amendments to the Canadian Tax Act and Regulations publicly announced by the Canadian Minister of Finance prior to the date hereof (the "Proposed Amendments") and assumes that all such Proposed Amendments will be enacted in their present form. However, no assurances can be given that the Proposed Amendments will be enacted in the form proposed, or at all. Except for the foregoing, this summary does not take into account or anticipate any changes in law, whether by legislative, administrative or judicial decision or action, nor does it take into account provincial, territorial or foreign income tax legislation or considerations, which may differ from the Canadian federal income tax consequences described herein; and (ii) applies only to persons who, within the meaning of the Canadian Tax Act, acquire, hold and dispose of CEC common stock and Carbon common stock as capital property, deal at arm's length with CEC and Carbon and are not "financial institutions" for the purposes of the mark-to- market rules. CEC common stock and Carbon common stock will generally be considered to be capital property to a holder thereof provided that the holder does not hold any such shares in the course of carrying on a business of buying and selling shares and has not acquired such shares in a transaction considered to be an adventure in the nature of trade. Certain holders who are resident in Canada and who might not otherwise be considered to hold CEC common stock as capital property may be entitled to have such shares treated as capital property by making the election provided by subsection 39(4) of the Canadian Tax Act. The tax consequences of the exchange will in all likelihood differ from one holder to the next. Therefore, we urge you to consult your tax advisor regarding the tax consequences unique to your situation. October 20, 1999 Page Three Holders Resident in Canada The following portion of the summary is applicable only to holders of CEC common stock who are resident or deemed to be resident in Canada for the purposes of the Canadian Tax Act (a "Canadian Holder"). Disposition of CEC Common Stock On the exchange of CEC common stock for Carbon common stock, a Canadian Holder will be considered to have disposed of the CEC common stock for proceeds of disposition equal to the fair market value at the time of the exchange of the Carbon common stock received by the holder. A Canadian Holder will realize a capital gain or capital loss, as appropriate, equal to the amount by which such proceeds of disposition, net of any reasonable costs associated with the disposition, exceed or are less than, as appropriate, the holder's adjusted cost base of the CEC common stock. The cost to the Canadian Holder of the Carbon common stock received by such holder will be equal to the fair market value of such shares at the time of the exchange. The computation of the adjusted cost base of Carbon common stock is discussed below in this section under the heading "Disposition of Carbon Common Stock." The general tax treatment of capital gains and losses is discussed in this section under the heading "Capital Gains and Losses." Disposition of Carbon Common Stock A disposition or deemed disposition by a Canadian Holder of Carbon common stock will generally give rise to a capital gain or capital loss, as appropriate, equal to the amount by which the proceeds of disposition of the Carbon common stock, net of any reasonable costs associated with the disposition, exceed or are less than, as appropriate, the holder's adjusted cost base of the Carbon common stock. In that regard, the cost to the holder of the Carbon common stock acquired on the exchange will be averaged with the adjusted cost base of any other Carbon common stock then owned by such holder as capital property for the purposes of determining the adjusted cost base of such Carbon common stock. The general tax treatment of capital gains and losses is discussed below in this section under the heading "Capital Gains and Losses". Capital Gains and Losses A Canadian Holder's taxable capital gain or allowable capital loss from the disposition of CEC common stock or Carbon common stock will be equal to three-quarters of the amount of the holder's capital gain or capital loss, as appropriate, in respect of such disposition. A Canadian Holder must include any such taxable capital gain in income for the taxation year of disposition, and may, subject to the detailed provisions of the October 20, 1999 Page Four Canadian Tax Act, deduct any such allowable capital loss from taxable capital gains in the year in which such allowable capital loss is realized. Subject to the detailed rules contained in the Canadian Tax Act, any remaining allowable capital loss may generally be applied to reduce net taxable gains realized by the holder in the three preceding and in all subsequent taxation years. If a Canadian Holder is a corporation, the amount of any capital loss arising from a disposition or deemed disposition of CEC common stock or Carbon common stock may be reduced by the amount of dividends received or deemed to have been received by it on such shares to the extent and under circumstances prescribed by the Canadian Tax Act. Similar rules may apply where a corporation is a member of a partnership or a beneficiary of a trust that owns CEC common stock or Carbon common stock. Capital gains realized by a Canadian Holder who is an individual may be subject to alternative minimum tax under the Canadian Tax Act, depending on the individual's circumstances. A Canadian Holder that is a "Canadian-controlled private corporation," as defined in the Canadian Tax Act, may be liable to pay an additional refundable tax of 6-2/3 percent on certain investment income, including amounts in respect of taxable capital gains. Eligibility for Investment The Carbon common stock issued pursuant to the offer, when listed on a prescribed stock exchange, which includes the American Stock Exchange, will be qualified investments under the Canadian Tax Act for trusts governed by registered retirement savings plans, registered retirement income funds and deferred profit sharing plans. However, such shares will constitute "foreign property," as defined in the Canadian Tax Act, for the purposes of such plans. Subsequent Transactions As described in "The Exchange Offer - Second Step Merger", Carbon may, in certain circumstances, merge CEC with a wholly-owned Canadian subsidiary of Carbon (the "Second Step Merger"). The consequences under the Canadian Tax Act to a holder whose CEC common stock is not exchanged under the exchange offer and is disposed of in connection with the Second Step Merger will depend upon the circumstances of the merger including, without limitation, the consideration received by the holder and the person from whom such consideration is received. If a holder receives Carbon common stock or cash in consideration for the disposition of CEC common stock to Carbon, the holder will realize a capital gain (or a capital loss) to the extent that the proceeds received for such common stock, net of any October 20, 1999 Page Five reasonable costs associated with the disposition, exceed (or are less than) the adjusted cost base of the CEC common stock disposed of. If in the course of the Second Step Merger, CEC common stock is acquired by CEC from an individual holder (including upon the exercise by an individual holder of certain dissent rights), the individual holder will be deemed to have received a taxable dividend in the amount by which the amount received (other than in respect of interest awarded by a Court) exceeds the paid-up capital of such CEC common stock. This amount will be excluded from the former individual holder's proceeds of disposition for the purposes of computing any taxable gain on the disposition. If the former individual holder is a resident of Canada, the deemed dividend will be treated in the same manner as a regular taxable dividend received from CEC. Corporations or trusts or partnerships which have corporations as beneficiaries or partners should consult their own tax advisors with respect to the income tax consequences where CEC common stock is acquired by CEC. Upon the merger of CEC and a wholly-owned Canadian affiliate of Carbon, the Canadian Tax Act deems the CEC common stock to be disposed of and the shares of the amalgamated corporation to be acquired for an amount equal to the adjusted cost base to the former holders of the CEC common stock. Consequently, no capital gain or capital loss would be realized by the former holders upon such amalgamation. A subsequent disposition of the shares of the amalgamated corporation acquired on the amalgamation may give rise to a capital gain, a capital loss, or if such shares are repurchased by the amalgamated corporation, a deemed dividend. If on such amalgamation the former holder receives property other than shares of the amalgamated corporation (such as Carbon shares or cash) or exercises a dissent right pursuant to the Alberta Business Corporations Act and receives cash in consideration for his CEC common stock, such former holder will have a capital gain (or a capital loss) to the extent that the proceeds received for such CEC common stock (other than in respect of interest awarded by a Court), net of any reasonable costs associated with the disposition, exceed (or are less than) the adjusted cost base of the CEC common stock disposed of by the former holder. Holders Not Resident in Canada The following portion of the summary is applicable only to holders of CEC common stock who are not and will not be resident nor deemed to be resident in Canada for the purposes of the Canadian Tax Act and any applicable tax treaty at any time they hold such shares, who do not use or hold and are not deemed to use or hold their CEC common stock in carrying on a business in Canada, and in the case of a holder who carries on an insurance business in Canada and elsewhere, whose shares are not "designated insurance property" and are not effectively connected with an insurance business carried on in Canada at any time (a "Non-Resident Holder"). October 20, 1999 Page Six A Non-Resident Holder will not be subject to tax in respect of capital gains realized on the disposition of CEC common stock provided that the CEC common stock is not "taxable Canadian property" of the Non-Resident Holder immediately before the exchange. The CEC common stock will not constitute "taxable Canadian property" of a Non-Resident Holder provided that such shares are listed on a prescribed stock exchange (which currently includes the American Stock Exchange), and the holder, persons with whom such holder does not deal at arm's length, or the holder together with all such persons, has not owned (or had under option) 25 percent or more of the issued shares of any class or series of the capital stock of CEC at any time within five years preceding the date of the exchange, and the shares were not acquired in a transaction which deemed them to be "taxable Canadian property." The Canadian federal income tax consequences to a Non-Resident Holder who does not tender to the offer of the transactions described in this summary under "Subsequent Transaction" may be substantially different than those described above and may include, without limitation, the recognition of a gain which is subject to tax in Canada and/or the receipt of deemed dividends and/or interest which would be subject to Canadian withholding tax. If CEC common stock ceases at any time to be listed on a prescribed exchange, the stock will at that time be considered "taxable Canadian property" to the Non-Resident Holder. Non-Resident Holders who are considering not tendering to the exchange offer are urged to consult their tax advisors as to the potential consequences to them of such transactions. This opinion is effective as at the date hereof and is based upon laws in effect and facts in existence as of such date. We undertake no duty to modify this opinion to reflect subsequent facts or developments in the law occurring after the date hereof. The opinion has been delivered to you for the purposes of being included in documents to be filed with the SEC. We hereby consent to the filing of this opinion as such an exhibit. We also consent to the reference to our firm name wherever appearing in the Registration Statement with respect to the discussion of the material Canadian income tax consequences in connection with the Exchange Offer. In giving this consent, we do not thereby admit that we are in the category of persons whose consent is required under Section 7 of the Securities Act of 1933, as amended, or the rules and regulations of the SEC thereunder, nor do we thereby admit that we are experts with respect to any part of such Registration Statement within the meaning of the term "experts" as used in the Securities Act of 1933, as amended, or the rules and regulations of the SEC thereunder. Yours truly, /s/ BENNETT JONES EX-10.1 6 1999 STOCK OPTION PLAN 10/13/99 EXHIBIT 10.1 CARBON ENERGY CORPORATION 1999 STOCK OPTION PLAN SECTION 1: PURPOSE ------------------ The purpose of the Carbon Energy Corporation 1999 Stock Option Plan (the "Plan") is to further the growth and development of Carbon Energy Corporation, a Colorado corporation (the "Company"), by affording an opportunity for stock ownership to selected employees, directors and consultants of the Company and its Subsidiaries who are responsible for the conduct and management of its business or who are involved in endeavors significant to its success. SECTION 2: DEFINITIONS ---------------------- Unless otherwise indicated, the following words when used herein shall have the following meanings: (a) "Affiliate" shall mean, with respect to any person or entity, a person or entity that directly or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such person or entity. (b) "Board of Directors" shall mean the Board of Directors of the Company. (c) "Cause" shall mean a termination on account of (1) repeated refusal to obey written directions of the Board of Directors or a superior officer (so long as such directions do not involve illegal or immoral acts), (2) repeated acts of substance abuse which are materially injurious to the Company or any of its Subsidiaries, (3) fraud or dishonesty that is materially injurious to the Company or any of its Subsidiaries, (4) breach of any material obligation of nondisclosure or confidentiality owed to the Company or any of its Subsidiaries, (5) commission of a criminal offense involving money or other property of the Company (excluding any traffic violations or similar violations), or (6) commission of a criminal offense that constitutes a felony in the jurisdiction in which the offense is committed. (d) "Change in Control" shall be deemed to have occurred: (1) At such time as a third person, including a "group" as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, becomes the beneficial owner of shares of the Company having 50% or more of the total number of votes that may be cast for the election of Directors of the Company; or (2) On the date on which the stockholders of the Company approve: (A) any agreement for a merger or consolidation of the Company with another entity, provided that there shall be no Change in Control if the persons and entities who were the stockholders of the Company immediately before such merger or consolidation continue to own directly more than two-thirds of the outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the voting securities of the Company outstanding immediately before such merger or consolidation; or (B) any sale, exchange or other disposition of all or substantially all of the Company's assets; or (3) On the effective date of any sale, exchange or other disposition of greater than 50% in fair market value of the Company's assets, other than in the ordinary course of business, whether in a single transaction or a series of related transactions; or (4) At such time that there is a change in more than a majority of the Company's Board of Directors as a result of a proxy contest, except this clause (4) will not apply to any Options of an Optionee who, or an Affiliate of whom, has waged the proxy contest or has endorsed the change in the Board of Directors. In determining whether clause (1) of the preceding sentence has been satisfied, the third person owning shares must be someone other than Yorktown Energy Partners III, L.P., Yorktown Partners LLC, or entities controlled by Yorktown Partners LLC. For this purpose, the term "controlled" means possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether (1) through the ownership of more than 50% of the outstanding voting securities of the person, (2) by contract or (3) by a position such as a general partner or manager. The Plan Administrator's reasonable determination as to whether such an event has occurred shall be final and conclusive. (e) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time. (f) "Common Stock" shall mean the Company's common stock (no par value) and any share or shares of the Company's capital stock hereafter issued or issuable in substitution for such shares. (g) "Director" shall mean a member of the Board of Directors. (h) "Early Exercise Stock Purchase Agreement" shall mean an agreement for the repurchase by the Company of shares acquired upon exercise of any portion of an Option prior to its vesting. (i) "Incentive Stock Option" shall mean any Option granted to an eligible employee under the Plan, which the Company intends at the time the Option is granted to be an Incentive Stock Option within the meaning of Section 422 of the Code. (j) "Non-Employee Director" shall mean a Director who is a Non- Employee Director within the meaning of Rule 16b-3 as promulgated by the Securities and Exchange Commission under the Securities Act of 1933, as amended from time to time. 2 (k) "Nonqualified Stock Option" shall mean any Option granted to an eligible employee, director or consultant under the Plan which is not an Incentive Stock Option. (l) "Option" shall mean and refer collectively to Incentive Stock Options and Nonqualified Stock Options. (m) "Option Agreement" means the agreement specified in Section 7.2. (n) "Optionee" shall mean any employee, director or consultant who is granted an Option under the Plan. "Optionee" shall also mean the personal representative of an Optionee and any other person who acquires the right to exercise an Option by bequest or inheritance. (o) "Parent" shall mean a parent corporation of the Company as defined in Section 424(e) of the Code. (p) "Plan Administrator" shall mean the body which is responsible for the administration of the Plan, as determined pursuant to Section 4.1. (q) "Subsidiary" shall mean a subsidiary corporation of the Company as defined in Section 424(f) of the Code. SECTION 3: EFFECTIVE DATE ------------------------- The effective date of the Plan is October 14, 1999; provided, however, that the adoption of the Plan by the Board of Directors is subject to approval and ratification by the stockholders of the Company within 12 months of the effective date. Options granted under the Plan prior to approval of the Plan by the stockholders of the Company shall be subject to approval of the Plan by the stockholders of the Company. SECTION 4: ADMINISTRATION ------------------------- 4.1 Plan Administrator. The Plan shall be administered by the Board of ------------------ Directors, unless and until such time as the Board of Directors delegates the administration of the Plan to a committee. Any such committee shall be appointed by and shall serve at the pleasure of the Board of Directors and shall consist of two or more Non-Employee Directors and the President of the Company; provided that no member of such committee shall participate in the deliberations and actions of the committee with respect to the granting of an Option to that member. The Board of Directors may from time to time remove members from or add members to any such committee, and vacancies on the committee, howsoever caused, shall be filled by the Board of Directors. 4.2 Meetings and Actions. The Plan Administrator shall hold meetings at -------------------- such times and places as it may determine. A majority of the members of the Plan Administrator shall constitute a quorum, and the acts of the majority of the members present at a meeting or a consent in writing signed by all members of the Plan Administrator shall be the acts of the Plan Administrator and shall be final, binding and conclusive upon all persons, including the Company, 3 its Subsidiaries, its stockholders, and all persons having any interest in Options which may be or have been granted pursuant to the Plan. 4.3 Powers of Plan Administrator. The Plan Administrator shall have the ---------------------------- full and exclusive right to grant and determine terms and conditions of all Options granted under the Plan and to prescribe, amend and rescind rules and regulations for administration of the Plan. In granting Options, the Plan Administrator shall take into consideration the contribution the Optionee has made or may make to the success of the Company or its Subsidiaries and such other factors as the Plan Administrator shall determine. 4.4 Interpretation of Plan. The determination of the Plan Administrator as ---------------------- to any disputed question arising under the Plan, including questions of construction and interpretation, shall be final, binding and conclusive upon all persons, including the Company, its Subsidiaries, its stockholders, and all persons having any interest in Options which may be or have been granted pursuant to the Plan. 4.5 Indemnification. Each person who is or shall have been a member of the --------------- Plan Administrator or of the Board of Directors shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense that may be imposed upon or reasonably incurred in connection with or resulting from any claim, action, suit or proceeding to which such person may be a party or in which such person may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid in settlement thereof, provided that the Company approved such settlement, or paid in satisfaction of a judgment in any such action, suit or proceeding, provided such person shall give the Company an opportunity, at its own expense, to handle and defend the same before undertaking to handle and defend it on such person's own behalf. The foregoing right of indemnification shall not be exclusive of, and is in addition to, any other rights of indemnification to which any person may be entitled under the Company's Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless. SECTION 5: STOCK SUBJECT TO THE PLAN ------------------------------------ 5.1 Number. The aggregate number of shares of Common Stock which may be ------ issued under Options granted pursuant to the Plan shall not exceed seven hundred thousand (700,000) shares. Shares which may be issued under Options may consist, in whole or in part, of authorized but unissued stock or treasury stock of the Company not reserved for any other purpose. 5.2 Unused Stock. If any outstanding Option under the Plan expires or for ------------ any other reason ceases to be exercisable, in whole or in part, other than upon exercise of the Option, the shares which were subject to such Option and as to which the Option had not been exercised shall continue to be available for issuance under the Plan. 5.3 Adjustment for Change in Outstanding Shares. If there is any change, ------------------------------------------- increase or decrease, in the outstanding shares of Common Stock which is effected without receipt of additional consideration by the Company, by reason of a stock dividend, recapitalization, merger, consolidation, stock split, combination or exchange of stock, or other similar circumstances, then 4 in each such event, the Plan Administrator shall make an appropriate adjustment in the aggregate number of shares of stock available under the Plan, the number of shares of stock subject to each outstanding Option and the Option prices in order to prevent the dilution or enlargement of any Optionee's rights. The Plan Administrator's determinations in making adjustments shall be final and conclusive. 5.4 Reorganization or Sale of Assets. In the event of (i) a dissolution, -------------------------------- liquidation or sale of all or substantially all of the Company's assets; (ii) a merger or consolidation of the Company with another entity; or (iii) any other capital reorganization in which the persons and entities who were the stockholders of the Company immediately before such capital reorganization own, directly or indirectly, less than two-thirds of the outstanding voting securities of the Company following such capital reorganization (each of such events being referred to hereinafter as a "Reorganization Event"), the Plan Administrator shall, as to outstanding Options, either (1) make appropriate provision for the protection of any such outstanding Options by the substitution on an equitable basis of appropriate stock of the Company, or of the merged, consolidated or otherwise reorganized corporation, which will be issuable in respect of the Common Stock, provided that no additional benefits shall be conferred upon Optionees as a result of such substitution, and provided further that the excess of the aggregate fair market value of the shares subject to the Options immediately after such substitution over the purchase price thereof is not more than the excess of the aggregate fair market value of the shares subject to such Options immediately before such substitution over the purchase price thereof, or (2) upon written notice to all Optionees, which notice shall be given not less than 20 days prior to the effective date of the Reorganization Event, provide that all unexercised Options must be exercised within a specified number of days (which shall not be less than 30) of the date of such notice or such Options will terminate. In response to a notice provided pursuant to clause (2) of the preceding sentence, an Optionee may make an irrevocable election to exercise the Optionee's Option contingent upon and effective as of the effective date of the Reorganization Event. Options which are not exercised within the specified period following the receipt of such a notice shall terminate and cease to be outstanding. If the Reorganization Event results in a Change of Control, then the provisions of Section 9 shall be applied before the provisions of this Section 5.4 become effective. SECTION 6: ELIGIBILITY ---------------------- All salaried employees of the Company and its Subsidiaries who are responsible for the conduct and management of its business or who are involved in endeavors significant to its success shall be eligible to receive both Incentive Stock Options and Nonqualified Stock Options under the Plan. Directors and consultants who are not employees of the Company or its Subsidiaries but who are involved in endeavors significant to its success shall be eligible to receive Nonqualified Stock Options, but not Incentive Stock Options, under the Plan. SECTION 7: GRANT OF OPTIONS --------------------------- 7.1 Grant of Options. The Plan Administrator may from time to time in its ---------------- discretion determine which of the eligible employees, directors and consultants of the Company or its Subsidiaries should receive Options, the type of Options to be granted (whether Incentive Stock Options or Nonqualified Stock Options), the number of shares subject to such Options, and the 5 dates on which such Options are to be granted. No employee may be granted Incentive Stock Options to the extent that the aggregate fair market value (determined as of the time each Option is granted) of the Common Stock with respect to which any such Options are exercisable for the first time during a calendar year (under all incentive stock option plans of the Company and its Parent and Subsidiaries) would exceed $100,000. To the extent that the limitation set forth in the preceding sentence has been exceeded, the Options which exceed the annual limitation shall be deemed to be Nonqualified Stock Options rather than Incentive Stock Options. 7.2 Option Agreement. Each Option granted under the Plan shall be ---------------- evidenced by a written Option Agreement setting forth the terms upon which the Option is granted. Each Option Agreement shall designate the type of Options being granted (whether Incentive Stock Options or Nonqualified Stock Options), and shall state the number of shares of Common Stock, as designated by the Plan Administrator, to which that Option pertains. More than one Option may be granted to an eligible person. 7.3 Option Price. The option price per share of Common Stock under each ------------ Option shall be determined by the Plan Administrator and stated in the Option Agreement. The option price for Incentive Stock Options granted under the Plan shall not be less than 100% of the fair market value (determined as of the day the Option is granted) of the shares subject to the Option. The option price for Nonqualified Stock Options granted under the Plan shall not be less than 85% of the fair market value (determined as of the day the Option is granted) of the shares subject to the Option. 7.4 Determination of Fair Market Value. If the Common Stock is listed upon ---------------------------------- an established stock exchange or exchanges, then the fair market value per share shall be deemed to be the average of the quoted closing prices of the Common Stock on such stock exchange or exchanges for the five business days immediately preceding the day for which the determination is made. If the Common Stock is not listed upon an established stock exchange but is traded in the NASDAQ National Market System, the fair market value per share shall be deemed to be the average of the closing price of the Common Stock in the National Market System for the five business days immediately preceding the day for which the determination is made. If the Common Stock is not listed upon an established stock exchange and is not traded in the National Market System, the fair market value per share shall be deemed to be the average of the mean between the dealer "bid" and "ask" closing prices of the Common Stock on the NASDAQ System for each of the five business days immediately preceding the day for which the determination is made, or if there shall have been no trading of the Common Stock during those days, on the next preceding five business days during which there was such trading. If none of these conditions apply, the fair market value per share shall be deemed to be an amount as determined in good faith by the Plan Administrator by applying any reasonable valuation method. 7.5 Duration of Options. Each Option shall be of a duration as specified ------------------- in the Option Agreement; provided, however, that the term of each Option shall be no more than ten years from the date on which the Option is granted and shall be subject to early termination as provided herein. 6 7.6 Additional Limitations on Grant. No Incentive Stock Option shall be ------------------------------- granted to an employee who, at the time the Incentive Stock Option is granted, owns stock (as determined in accordance with Section 424(d) of the Code) representing more than 10% of the total combined voting power of all classes of stock of the Company or of any Parent or Subsidiary, unless the option price of such Incentive Stock Option is at least 110% of the fair market value (determined as of the day the Incentive Stock Option is granted) of the stock subject to the Incentive Stock Option and the Incentive Stock Option by its terms is not exercisable more than five years from the date it is granted. 7.7 Early Exercise. The Option Agreement may, but need not, provide that -------------- the Optionee may elect to exercise all or any portion of the Option prior to its vesting. Any shares purchased upon exercise of an unvested portion of the Option shall be subject to a right of repurchase in favor of the Company in accordance with the terms of an Early Exercise Stock Purchase Agreement which shall be set forth as an attachment to the Stock Option Agreement. 7.8 Other Terms and Conditions. The Option Agreement may contain such -------------------------- other provisions, which shall not be inconsistent with the Plan, as the Plan Administrator shall deem appropriate, including, without limitation, provisions that relate the Optionee's ability to exercise an Option to the passage of time or the achievement of specific goals or the occurrence of certain events, as specified by the Plan Administrator. 7.9 Substitution of Options for Existing Options Under the CEC Resources -------------------------------------------------------------------- Ltd. Employee Incentive Share Option Plan. The Plan Administrator shall grant - ----------------------------------------- under the Plan substitute Options for each option outstanding as of October 14, 1999, under the CEC Resources Ltd. Employee Incentive Share Option Plan (the "Prior Plan"). Any Option granted under this Plan in substitution for an option granted under the Prior Plan shall expressly provide that it is being granted in full satisfaction of, and in substitution for, any and all options previously granted under the Prior Plan. The following terms and conditions of the substitute Options granted pursuant to this Plan shall be the same as the terms and conditions relating to the specific options granted pursuant to an optionee's Stock Option Agreement executed under the terms of the Prior Plan: (1) the grant and exercise prices of the Option; (2) the character of the Option as an Incentive Stock Option or a Nonqualified Stock Option; (3) the vesting provisions applicable to the Option (except to the extent previously modified in executed employment agreements between the Optionee and CEC Resources Ltd.); (4) the change in control provisions applicable to the Option (except to the extent previously modified in executed employment agreements between the Optionee and CEC Resources, Ltd.); (5) the provisions addressing the consequences of the Optionee's termination of employment for any reason; (6) the limitations on assignability of the Option; (7) the expiration date of the Option; and (8) the payment method for the purchase of the shares subject to the Option. To the maximum extent possible, such substitution shall be accomplished in a manner that meets the requirements of Section 424(a) of the Code. SECTION 8: EXERCISE OF OPTIONS ------------------------------ 8.1 Manner of Exercise. Subject to the limitations and conditions of the ------------------ Plan or the Option Agreement, an Option shall be exercisable, in whole or in part, from time to time, by giving written notice of exercise to the Secretary of the Company, which notice shall specify the 7 number of shares of Common Stock to be purchased and shall be accompanied by (1) payment in full to the Company of the purchase price of the shares to be purchased, plus (2) payment in full of such amount as the Company shall determine to be sufficient to satisfy any liability it may have for any withholding of federal, state or local income or other taxes incurred by reason of the exercise of the Option, and (3) representations meeting the requirements of Sections 12.3 if requested by the Company. 8.2 Payment of Purchase Price. Payment for shares and withholding taxes ------------------------- shall be in the form of either (1) cash, (2) a certified or bank cashier's check to the order of the Company, or (3) shares of the Common Stock, properly endorsed to the Company, in an amount the fair market value of which on the date of receipt by the Company (as determined in accordance with Section 7.4) equals or exceeds the aggregate option price of the shares with respect to which the Option is being exercised, (4) any other form of legal consideration that may be acceptable to the Plan Administrator, or (5) in any combination thereof; provided, however, that no payment may be made in shares of Common Stock unless the Plan Administrator has approved of payment in such form by such Optionee with respect to the Option exercise in question. Should the Common Stock be registered under Section 12(g) of the Securities Exchange Act of 1934, as amended, at the time an Option is exercised, and to the extent the Option is exercised for vested shares, then payment may also be made through a special sale and remittance procedure pursuant to which the Optionee shall concurrently provide irrevocable written instructions (A) to a brokerage firm designated by the Company to effect the immediate sale of the purchased shares and remit to the Company, out of the sale proceeds available on the settlement date, sufficient funds to cover the aggregate exercise price payable for the purchased shares plus all applicable withholding taxes, and (B) to the Company to deliver the certificates for the purchased shares directly to such brokerage firm in order to complete the sale. Upon the exercise of any Option, the Company, in its sole discretion, may permit the deferred payment of the purchase price on such terms and conditions as the Company shall specify. SECTION 9: CHANGE IN CONTROL ---------------------------- Notwithstanding any vesting requirements contained in any Option Agreement, all outstanding Options shall become immediately exercisable in full upon the occurrence of a Change in Control. However, if the Change in Control occurs because of the change in the Board of Directors described in clause (4) of the definition of Change in Control, this Section 9 shall not apply to any Options of an Optionee who, or an Affiliate of whom, has waged a proxy contest resulting in the change in more than a majority of the Board of Directors or has endorsed the change in the Board of Directors, and the exercisability of the Options of that Optionee shall not be affected by this Section 9. If any employment agreement between an Optionee and the Company provides that Options granted under this Plan will become vested upon the occurrence of other events (such as, but not limited to, an event that constitutes a change in control as defined in that employment agreement but that is not a Change in Control as defined in Section 2(d) of this Plan), then Options granted under this Plan shall become vested upon the occurrence of such other events in accordance with the terms of such employment agreement, in addition to becoming vested in accordance with the terms of this Plan and the Option Agreement issued to the Optionee under this Plan. 8 SECTION 10: EFFECT OF TERMINATION OF EMPLOYMENT ----------------------------------------------- 10.1 Termination of Employment Other Than Upon Death or Disability. ------------------------------------------------------------- Subject to any limitations set forth in the Option Agreement, and provided that the notice of exercise is provided prior to the expiration of the Option, the Optionee shall be entitled to exercise the Option (i) during the Optionee's employment by the Company or a Subsidiary and (ii) for a period of three months after the date of a termination of employment other than for Cause. Any vesting of the Option shall cease upon termination of employment, and the Option shall be exercisable only to the extent that it was exercisable on the date of such termination. Any Options not exercisable as of the date of termination, and any Options or portions of Options not exercised within the period specified herein, shall terminate. 10.2 Termination By Death of Optionee. Notwithstanding Section 10.1, if an -------------------------------- Optionee should die while in the employ of the Company or a Subsidiary or within a period of three months after termination of employment with the Company or a Subsidiary under circumstances in which Section 10.1 would permit the exercise of the Option following termination, the personal representatives of the Optionee's estate or the person or persons who shall have acquired the Option from the Optionee by bequest or inheritance may exercise the Option at any time within the year after the date of death, but not later than the expiration date of the Option. Any vesting of the Option shall cease upon termination of employment, and the Option shall be exercisable only to the extent that it was exercisable on the date of such termination. Any Options not exercisable as of the date of termination, and any Options or portions of Options not exercised within the period specified herein, shall terminate. 10.3 Termination By Disability of Optionee. Notwithstanding Section 10.1, ------------------------------------- if an Optionee should terminate employment with the Company or a Subsidiary by reason of the Optionee's disability (within the meaning of Section 22(e)(3) of the Code), the Optionee may exercise the Option at any time within one year after the date of termination but not later than the expiration date of the Option. Any vesting of the Option shall cease upon termination of employment, and the Option shall be exercisable only to the extent that it was exercisable on the date of such termination. Any Options not exercisable as of the date of termination, and any Options or portions of Options not exercised within the period specified herein, shall terminate. 10.4 Termination of Directors and Consultants. For purposes of this ---------------------------------------- Section 10, a termination of employment shall be deemed to include the termination of a director's service as a member of the board of directors and the termination of a consulting arrangement in the case of consultants, provided that immediately following such termination the director or consultant is not employed by the Company or a Subsidiary. 10.5 Breach of Covenant Not to Compete. Notwithstanding anything herein to --------------------------------- the contrary, Options granted to the Optionee shall terminate immediately if the Optionee breaches any obligation under a covenant not to compete with the Company or any of its Subsidiaries. 10.6 Extension of Option Termination Date. The Plan Administrator, in its ------------------------------------ sole discretion, may extend the termination date of an Option granted under the Plan without regard to the preceding provisions of this Section 10. In such event, the termination date shall be a date 9 selected by the Plan Administrator in its sole discretion, but not later than the latest expiration date of the Option permitted pursuant to Section 7.5. Such extension may be made in the Option Agreement as originally executed or by amendment to the Option Agreement, either prior to or following termination of an Optionee's employment. The Plan Administrator shall have no power to extend the termination date of an Incentive Stock Option beyond the periods provided in Sections 10.1, 10.2 and 10.3 prior to the termination of the Optionee's employment or without the approval of the Optionee, which may be granted or withheld in the Optionee's sole discretion. Any extension of the termination date of an Incentive Stock Option shall be deemed to be the grant of a new Option for purposes of the Code. Any extension of the termination date of an Incentive Stock Option beyond the termination dates set forth in Sections 10.1, 10.2 and 10.3 may result in the disqualification of the Option as an Incentive Stock Option. SECTION 11: NON-TRANSFERABILITY OF OPTION ------------------------------------------ Options granted pursuant to the Plan are not transferable by the Optionee other than by Will or the laws of descent and distribution and shall be exercisable during the Optionee's lifetime only by the Optionee. Upon any attempt to transfer, assign, pledge, hypothecate or otherwise dispose of the Option contrary to the provisions hereof, or upon the levy of any attachment or similar process upon the Option, the Option shall immediately become null and void. Notwithstanding the foregoing, an Option may be transferred by an Optionee solely to (i) members of the Optionee's immediate family (children, grandchildren, or spouse); (ii) trusts for the benefit of such family members; or (iii) partnerships where the only partners are such family members. SECTION 12: ISSUANCE OF SHARES ------------------------------ 12.1 Transfer of Shares to Optionee. As soon as practicable after the ------------------------------ Optionee has given the Company written notice of exercise of an Option and has otherwise met the requirements of Section 8.1, the Company shall issue or transfer to the Optionee the number of shares of Common Stock as to which the Option has been exercised and shall deliver to the Optionee a certificate or certificates therefor, registered in the Optionee's name. If the Optionee has made an early exercise in accordance with the Option Agreement, the Company may retain the non-vested shares of Common Stock until they have vested pursuant to the Early Exercise Stock Purchase Agreement. In no event shall the Company be required to transfer fractional shares to the Optionee, and in lieu thereof, the Company may pay an amount in cash equal to the fair market value (as determined in accordance with Section 7.4) of such fractional shares on the date of exercise. 12.2 Compliance with Laws. If the issuance or transfer of shares by the -------------------- Company would for any reason, in the opinion of counsel for the Company, violate any applicable federal or state laws or regulations, the Company may delay issuance or transfer of such shares to the Optionee until compliance with such laws can reasonably be obtained. In no event shall the Company be obligated to effect or obtain any listing, registration, qualification, consent or approval under any applicable federal or state laws or regulations or any contract or agreement to which the Company is a party with respect to the issuance of any such shares. If, after reasonable efforts, the Company is unable to obtain the authority which counsel for the Company deems 10 necessary for the lawful issuance and sale of shares upon exercise of Options under the Plan, the Company shall be relieved from any liability for failure to issue and sell shares upon exercise of such Options unless and until such authority is obtained. 12.3 Investment Representation. The Company may require any Optionee, as a ------------------------- condition precedent to exercising any Option, to provide a written representation providing assurances satisfactory to the Company (i) as to the Optionee's knowledge and experience in financial and business matters and/or that the Optionee has engaged a purchaser representative reasonably satisfactory to the Company who is knowledgeable and experienced in financial and business matters, (ii) that the Optionee is capable of evaluating, alone or together with the purchaser representative, the merits and risks of exercising the Option; and (iii) that the Optionee is acquiring the stock subject to the Option for such person's own account and not with any present intention of selling or otherwise distributing the stock. Such a representation shall not be required if (A) the issuance of the shares upon the exercise of the Option has been registered under a then currently effective registration statement under the Securities Act of 1933, as amended (the "Securities Act"), or (B) as to any particular requirement, a determination is made by counsel for the Company that such representation is not required. Certificates representing Common Stock acquired upon exercise of Options may contain such legends and transfer restrictions as the Company shall deem reasonably necessary or desirable, including, without limitation, legends restricting transfer of the Common Stock until there has been compliance with federal and state securities laws and until the Optionee or any other holder of the Common Stock has paid the Company such amounts as may be necessary in order to satisfy any withholding tax liability of the Company. SECTION 13: AMENDMENTS ---------------------- The Board of Directors may at any time and from time to time alter, amend, suspend or terminate the Plan or any part thereof as it may deem proper, except that no such action shall diminish or impair the rights under an Option previously granted. Unless the stockholders of the Company shall have given their approval, the total number of shares for which Options may be issued under the Plan shall not be increased, except as provided in Section 5.3, and no amendment shall be made which reduces the price at which the Common Stock may be offered under the Plan below the minimum required by Section 7.3, except as provided in Section 5.3, or which materially modifies the requirements as to eligibility for participation in the Plan. Subject to the terms and conditions of the Plan, the Board of Directors may modify, extend or renew outstanding Options granted under the Plan, or accept the surrender of outstanding Options to the extent not theretofore exercised and authorize the granting of new Options in substitution therefor, except that no such action shall diminish or impair the rights under an Option previously granted without the consent of the Optionee. SECTION 14: TERM OF PLAN ------------------------ This Plan shall terminate on September 1, 2009; provided, however, that the Board of Directors may at any time prior thereto suspend or terminate the Plan. No such suspension or termination shall diminish or impair the rights under an Option previously granted without the consent of the Optionee. 11 SECTION 15: RIGHTS AS STOCKHOLDER ---------------------------------- An Optionee shall have no rights as a stockholder of the Company with respect to any shares of Common Stock covered by an Option until the date of the issuance of the stock certificate for such shares. SECTION 16: NO EMPLOYMENT RIGHTS --------------------------------- Nothing contained in this Plan or in any Option granted under the Plan shall confer upon any Optionee any right with respect to the continuation of such Optionee's employment by the Company or any Subsidiary or interfere in any way with the right of the Company or any Subsidiary, subject to the terms of any separate employment agreement to the contrary, at any time to terminate such employment or to increase or decrease the compensation of the Optionee from the rate in existence at the time of the grant of the Option. SECTION 17: GOVERNING LAW -------------------------- This Plan, and all Options granted under this Plan, shall be construed and shall take effect in accordance with the laws of the State of Colorado, without regard to the conflicts of laws rules of such State. SECTION 18: USE OF PROCEEDS ---------------------------- Any cash proceeds received by the Company from the sale of shares of Common Stock under the Plan shall be used for general corporate purposes. Adopted effective the 14th day of October, 1999. CARBON ENERGY CORPORATION By:______________________________ Title:___________________________ 12 EX-10.2 7 1999 RESTRICTED STOCK PLAN 10/13/99 EXHIBIT 10.2 CARBON ENERGY CORPORATION 1999 RESTRICTED STOCK PLAN SECTION 1: Purpose ------------------- The purpose of the Carbon Energy Corporation 1999 Restricted Stock Plan (the "Plan") is to further the growth and development of Carbon Energy Corporation, a Colorado corporation (the "Company"), by affording an opportunity for stock ownership to selected employees, directors and consultants of the Company and its Subsidiaries who are responsible for the conduct and management of its business or who are involved in endeavors significant to its success. SECTION 2: Definitions ----------------------- Unless otherwise indicated, the following words when used herein shall have the following meanings: (a) "Affiliate" shall mean, with respect to any person or entity, a person or entity that directly or indirectly through one or more intermediaries, controls, or is controlled by, or is under common control with, such person or entity. (b) "Board of Directors" shall mean the Board of Directors of the Company. (c) "Change in Control" shall be deemed to have occurred: (1) At such time as a third person, including a "group" as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, becomes the beneficial owner of shares of the Company having 50% or more of the total number of votes that may be cast for the election of Directors of the Company; or (2) On the date on which the stockholders of the Company approve: (A) any agreement for a merger or consolidation of the Company with another entity, provided that there shall be no Change in Control if the persons and entities who were the stockholders of the Company immediately before such merger or consolidation continue to own directly more than two-thirds of the outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the voting securities of the Company outstanding immediately before such merger or consolidation; or (B) any sale, exchange or other disposition of all or substantially all of the Company's assets; or (3) On the effective date of any sale, exchange or other disposition of greater than 50% in fair market value of the Company's assets, other than in the ordinary course of business, whether in a single transaction or a series of related transactions; or (4) At such time that there is a change in more than a majority of the Company's Board of Directors as a result of a proxy contest, except this clause (4) will not apply to any Common Stock of a Grantee who, or an Affiliate of whom, has waged the proxy contest or has endorsed the change in the Board of Directors. In determining whether clause (1) of the preceding sentence has been satisfied, the third person owning shares must be someone other than Yorktown Energy Partners III, L.P., Yorktown Partners LLC, or entities controlled by Yorktown Partners LLC. For this purpose, the term "controlled" means possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether (1) through the ownership of more than 50% of the outstanding voting securities of the person, (2) by contract or (3) by a position such as a general partner or manager. The Plan Administrator's reasonable determination as to whether such an event has occurred shall be final and conclusive. (d) "Common Stock" shall mean the Company's common stock (no par value) and any share or shares of the Company's capital stock hereafter issued or issuable in substitution for such shares. (e) "Director" shall mean a member of the Board of Directors. (f) "Plan Administrator" shall mean the body which is responsible for the administration of the Plan, as determined pursuant to Section 4.1. (g) "Recipient" shall mean the employee, director, or consultant of the Company or its Subsidiaries who has been granted Restricted Stock under this Plan. (h) "Restricted Stock" shall mean shares of Common Stock granted to an employee, director, or consultant of the Company or its Subsidiaries, which are subject to restrictions set forth in a Stock Restriction Agreement in such form as the Plan Administrator in its sole discretion shall specify at the time that the shares are granted. (i) "Stock Restriction Agreement" shall mean the agreement between the Company and a Recipient pursuant to which Restricted Stock is granted to the Recipient and which sets forth the restrictions on such Restricted Stock. (j) "Subsidiary" shall mean a subsidiary corporation of the Company as defined in Section 424(f) of the Internal Revenue Code of 1986, as amended. SECTION 3: EFFECTIVE DATE -------------------------- The effective date of the Plan is October 14, 1999. SECTION 4: ADMINISTRATION -------------------------- 4.1 Plan Administrator. The Plan shall be administered by the Board of ------------------ Directors, unless and until such time as the Board of Directors delegates the administration of the Plan to a 2 committee. Any such committee shall be appointed by and shall serve at the pleasure of the Board of Directors and shall consist of two or more non-employee Directors and the President of the Company; provided that no member of such committee shall participate in the deliberations and actions of the committee with respect to the granting of Restricted Stock to that member. The Board of Directors may from time to time remove members from or add members to any such committee, and vacancies on the committee, howsoever caused, shall be filled by the Board of Directors. 4.2 Meetings and Actions. The Plan Administrator shall hold meetings at -------------------- such times and places as it may determine. A majority of the members of the Plan Administrator shall constitute a quorum, and the acts of the majority of the members present at a meeting or a consent in writing signed by all members of the Plan Administrator shall be the acts of the Plan Administrator and shall be final, binding and conclusive upon all persons, including the Company, its Subsidiaries, its stockholders, and all persons having any interest in Restricted Stock which may be or has been granted pursuant to the Plan. 4.3 Powers of Plan Administrator. The Plan Administrator shall have the ---------------------------- full and exclusive right to grant and determine terms and conditions of all Stock Restriction Agreements under the Plan and to prescribe, amend and rescind rules and regulations for administration of the Plan. In granting Restricted Stock, the Plan Administrator shall take into consideration the contribution the Recipient has made or may make to the success of the Company or its Subsidiaries and such other factors as the Plan Administrator shall determine. 4.4 Interpretation of Plan. The determination of the Plan Administrator as ---------------------- to any disputed question arising under the Plan, including questions of construction and interpretation, shall be final, binding and conclusive upon all persons, including the Company, its Subsidiaries, its stockholders, and all persons having any interest in Restricted Stock which may be or has been granted pursuant to the Plan. 4.5 Indemnification. Each person who is or shall have been a member of the --------------- Plan Administrator or of the Board of Directors shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense that may be imposed upon or reasonably incurred in connection with or resulting from any claim, action, suit or proceeding to which such person may be a party or in which such person may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid in settlement thereof, provided that the Company approved such settlement, or paid in satisfaction of a judgment in any such action, suit or proceeding, provided such person shall give the Company an opportunity, at its own expense, to handle and defend the same before undertaking to handle and defend it on such person's own behalf. The foregoing right of indemnification shall not be exclusive of, and is in addition to, any other rights of indemnification to which any person may be entitled under the Company's Certificate of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless. 3 SECTION 5: STOCK SUBJECT TO THE PLAN ------------------------------------- 5.1 Number. The aggregate number of shares of Common Stock which may be ------ granted under the Plan shall not exceed three hundred thousand (300,000) shares. Shares which may be issued as Restricted Stock may consist, in whole or in part, of authorized but unissued stock or treasury stock of the Company not reserved for any other purpose. 5.2 Unused Stock. If any Restricted Stock granted under the Plan is ------------ forfeited, in whole or in part, such shares shall once again be available for issuance under the Plan. 5.3 Adjustment for Change in Outstanding Shares. If there is any change, ------------------------------------------- increase or decrease, in the outstanding shares of Common Stock which is effected without receipt of additional consideration by the Company, by reason of a stock dividend, recapitalization, merger, consolidation, stock split, combination or exchange of stock, or other similar circumstances, then in each such event, the Plan Administrator shall make an appropriate adjustment in the aggregate number of shares of Common Stock available under the Plan. The Plan Administrator's determinations in making adjustments shall be final and conclusive. SECTION 6: ELIGIBILITY ----------------------- All salaried employees, all directors, and all consultants of the Company and its Subsidiaries who are responsible for the conduct and management of its business or who are involved in endeavors significant to its success shall be eligible to receive grants of Restricted Stock under the Plan. SECTION 7: GRANT OF RESTRICTED STOCK ------------------------------------- The Plan Administrator may from time to time in its sole discretion determine which of the eligible employees, directors, or contractors of the Company should receive grants of Restricted Stock, the number of shares of Restricted Stock to be granted to each such eligible employee, director, and contractor, the dates on which such shares of Restricted Stock are to be granted, and the restrictions applicable to each grant of shares of Restricted Stock. The restrictions applicable to each grant of shares of Restricted Stock shall be set forth in a Stock Restriction Agreement in such form as the Plan Administrator, in its sole discretion, shall determine to be appropriate. The terms of any Stock Restriction Agreement need not be identical to the terms of other Stock Restriction Agreements applicable to other grants of Restricted Stock under the Plan to the same or other Recipients. No shares of Restricted Stock shall be issued under the Plan until the Recipient of such shares provides the Company with a signed Stock Restriction Agreement in the form specified by the Plan Administrator with respect to the grant of Restricted Stock to that recipient. SECTION 8: CHANGE IN CONTROL ----------------------------- Notwithstanding any vesting requirements contained in any Stock Restriction Agreement, all Restricted Stock issued under the Plan shall become immediately vested in full upon the occurrence of a Change in Control. However, if the Change in Control occurs because of the change in the Board of Directors described in clause (4) of the definition of Change in Control, 4 this Section 8 shall not apply to any Restricted Stock of a Recipient who, or an Affiliate of whom, has waged a proxy contest resulting in the change in more than a majority of the Board of Directors or has endorsed the change in the Board of Directors, and the Restricted Stock of that Recipient shall not be affected by this Section 8. If any employment agreement between a Recipient and the Company provides that Restricted Stock granted under this Plan will become vested upon the occurrence of other events (such as, but not limited to, an event that constitutes a change in control as defined in that employment agreement but that is not a Change in Control as defined in Section 2(c) of this Plan), then Restricted Stock granted under this Plan shall become vested upon the occurrence of such other events in accordance with the terms of such employment agreement, in addition to becoming vested in accordance with the terms of this Plan and the Stock Restriction Agreement issued to the Recipient under this Plan. SECTION 9: ISSUANCE OF SHARES ------------------------------ 9.1 Compliance with Laws. If the issuance or transfer of shares by the -------------------- Company would for any reason, in the opinion of counsel for the Company, violate any applicable federal or state laws or regulations, the Company may delay issuance or transfer of such shares to the Recipient until compliance with such laws can reasonably be obtained. In no event shall the Company be obligated to effect or obtain any listing, registration, qualification, consent or approval under any applicable federal or state laws or regulations or any contract or agreement to which the Company is a party with respect to the issuance of any such shares. If, after reasonable efforts, the Company is unable to obtain the authority which counsel for the Company deems necessary for the lawful issuance of shares under the Plan, the Company shall be relieved from any liability for failure to issue shares unless and until such authority is obtained. 9.2 Investment Representation. The Company may require any Recipient to ------------------------- provide a written representation providing assurances satisfactory to the Company (i) as to the Recipient's knowledge and experience in financial and business matters and/or that the Recipient has engaged a representative reasonably satisfactory to the Company who is knowledgeable and experienced in financial and business matters, (ii) that the Recipient is capable of evaluating, alone or together with the representative, the merits and risks of owning the Restricted Stock; and (iii) that the Recipient is acquiring the Restricted Stock for such person's own account and not with any present intention of selling or otherwise distributing the stock. Certificates representing Restricted Stock may contain such legends and transfer restrictions as the Company shall deem reasonably necessary or desirable, including, without limitation, legends restricting transfer of the Restricted Stock until there has been compliance with federal and state securities laws. SECTION 10: AMENDMENTS ----------------------- The Board of Directors may at any time and from time to time alter, amend, suspend or terminate the Plan or any part thereof as it may deem proper, except that no such action shall diminish or impair the rights under a previous grant of Restricted Stock. Subject to the terms and conditions of the Plan, the Board of Directors may modify, extend or renew outstanding Stock Restriction Agreements granted under the Plan, except that no such action shall diminish or impair the rights under a Stock Restriction Agreement previously granted without the consent of the Recipient. 5 SECTION 11: TERM OF PLAN ------------------------- This Plan shall terminate on September 1, 2009; provided, however, that the Board of Directors may at any time prior thereto suspend or terminate the Plan. No such suspension or termination shall diminish or impair the rights under a grant of Restricted Stock previously made without the consent of the Recipient. SECTION 12: NO EMPLOYMENT RIGHTS --------------------------------- Nothing contained in this Plan shall confer upon any person any right with respect to the continuation of such person's employment by the Company or any Subsidiary or interfere in any way with the right of the Company or any Subsidiary, subject to the terms of any separate employment agreement to the contrary, at any time to terminate such employment or to increase or decrease the compensation of the person from the rate in existence at the time of the grant of the Restricted Stock. SECTION 13: GOVERNING LAW -------------------------- This Plan, and all Stock Restriction Agreements granted under this Plan, shall be construed and shall take effect in accordance with the laws of the State of Colorado, without regard to the conflicts of laws rules of such State. Adopted effective the 14th day of October, 1999. CARBON ENERGY CORPORATION By:_________________________________________ Title:______________________________________ 6 EX-10.3 8 EXCHANGE AND FINANCING AGREEMENT Exhibit 10.3 EXCHANGE AND FINANCING AGREEMENT AMONG CARBON ENERGY CORPORATION CEC RESOURCES LTD. AND YORKTOWN ENERGY PARTNERS III, L.P. DATED OCTOBER 14, 1999 TABLE OF CONTENTS PAGE Article 1 Articles and Bylaws of Carbon........................................2 Article 2 Authorization and Sale of Carbon Common Stock........................2 2.1 Authorization and Sale of Shares .....................................2 2.2 Closing for Shares ...................................................2 2.3 Use of Proceeds ......................................................2 Article 3 Assignment of Stock Purchase Agreement...............................3 3.1 Assignment ...........................................................3 3.2 Assumption; Reimbursement of Deposit .................................3 3.3 Amendments ...........................................................3 Article 4 Exchange Offer.......................................................3 4.1 The Offer ............................................................3 4.2 Compliance With Applicable Law .......................................4 4.3 CEC Canada Approval ..................................................4 4.4 Shareholder Information ..............................................5 Article 5 Stock Options........................................................5 5.1 Stock Option Plan ....................................................5 5.2 Replacement of Stock Options .........................................5 5.3 Employment Agreements ................................................6 5.4 Related Actions ......................................................6 5.5 [Other Employee Plans] ...............................................6 Article 6 Board of Directors of Carbon.........................................6 6.1 Definitions ..........................................................6 i 6.2 Board of Directors After BFC Closing .................................7 6.3 Yorktown Designations ................................................7 6.4 McDonald as a Director ...............................................7 6.5 Nominating Committee .................................................7 6.6 Nomination of Directors ..............................................8 6.7 Vacancies ............................................................8 6.8 Voting of Shares .....................................................8 6.9 Super Majority .......................................................9 6.10 Termination of this Article .........................................9 Article 7 Representations and Warranties of Carbon.............................9 7.1 Organization and Authority ...........................................9 7.2 No Subsidiaries ......................................................9 7.3 Capitalization ......................................................10 7.4 Authorization; No Conflict ..........................................10 7.5 No Operations .......................................................11 7.6 Brokers and Finders .................................................11 Article 8 Representations and Warranties of CEC Canada........................11 8.1 Organization and Authority ..........................................11 8.2 No Subsidiaries .....................................................11 8.3 Capitalization ......................................................11 8.4 Authorization; No Conflict ..........................................12 8.5 Brokers and Finders .................................................13 8.6 SEC Reports .........................................................13 Article 9 Representations and Warranties of Yorktown..........................13 ii 9.1 Organization and Authority ..........................................13 9.2 Authorization .......................................................14 9.3 Brokers and Finders .................................................14 9.4 Investment Matters ..................................................15 Article 10 Covenants..........................................................15 10.1 Covenants of Carbon ................................................15 10.2 Covenants of CEC Canada ............................................18 10.3 Covenants of Yorktown ..............................................20 Article 11 Conditions.........................................................21 11.1 Conditions Precedent to Obligation of Carbon and CEC Canada ........21 11.2 Condition Precedent to Obligation of Yorktown ......................21 Article 12 Termination and Miscellaneous......................................22 12.1 Obligation to Make Exchange Offer ..................................22 12.2 Termination of Agreement ...........................................22 12.3 HSR Act Filing .....................................................23 12.4 Expenses ...........................................................23 12.5 Successors and Assigns .............................................23 12.6 Third Party Beneficiaries ..........................................23 12.7 Notices ............................................................24 12.8 Complete Agreement .................................................25 12.9 Captions ...........................................................25 12.10 Waiver and Other Action ...........................................25 12.11 Amendment .........................................................25 12.12 Governing Law .....................................................25 iii 12.13 Non-Survival of Representations and Warranties ....................25 12.14 Attorneys' Fees ...................................................25 12.15 Counterparts ......................................................25 iv EXCHANGE AND FINANCING AGREEMENT This Agreement is made as of October 14, 1999 among Carbon Energy Corporation ("Carbon"), a Colorado corporation, CEC Resources Ltd. ("CEC Canada"), an Alberta corporation, and Yorktown Energy Partners III, L.P. ("Yorktown"). Recitals A. CEC Canada has entered into a Stock Purchase Agreement dated August 11, 1999 (as it may be amended from time to time, called the "Stock Purchase Agreement") with Bonneville Pacific Corporation ("Bonneville Pacific"). The Stock Purchase Agreement provides for the purchase by CEC Canada from Bonneville Pacific of all outstanding shares of Bonneville Fuels Corporation ("BFC") for $24,000,000 in cash, subject to certain adjustments. After this transaction, BFC will continue to have outstanding certain indebtedness. B. The parties desire that the purchase of BFC stock under the Stock Purchase Agreement be completed by Carbon which is a corporation organized under the laws of a state in the United States and which has its principal executive offices in the United States. The Stock Purchase Agreement permits the assignment of rights and obligations of CEC Canada under the Stock Purchase Agreement to Carbon as an affiliate of Yorktown. C. Yorktown has committed to purchase equity of Carbon for $24,750,000 in order to provide equity financing for the total purchase price of the BFC shares under the Stock Purchase Agreement. D. All parties to this Agreement require that, in connection with the assignment of the Stock Purchase Agreement to Carbon and as part of an overall plan to contribute cash, securities and other property by CEC Canada, Yorktown and shareholders of CEC Canada to Carbon, Carbon shall make an offer to all shareholders of CEC Canada to exchange one share of Carbon for each outstanding share of CEC Canada. E. The Boards of Directors of CEC Canada and Carbon have unanimously approved of the making of the exchange offer described in paragraph D above and later in this Agreement. The Board of Directors of CEC Canada has also resolved to recommend that the holders of shares of CEC Canada tender their shares pursuant to that exchange offer. 1 Agreement In consideration of the mutual promises and covenants contained in this Agreement, the parties, intending to be legally bound, agree as follows: Article 1 Articles and Bylaws of Carbon The parties concur and approve of the Articles of Incorporation of Carbon and Bylaws of Carbon as currently in effect, subject to any changes to be made in the future. Article 2 Authorization and Sale of Carbon Common Stock 2.1 Authorization and Sale of Shares. -------------------------------- Carbon shall authorize the sale and issuance of 4,500,000 shares of its common stock to Yorktown. Subject to the terms and conditions of this Agreement, Carbon shall issue and sell to Yorktown, and Yorktown shall purchase from Carbon, 4,500,000 shares of Carbon common stock at a total purchase price of $24,750,000 in cash, which is $5.50 per share. 2.2 Closing for Shares. ------------------ The closing of the purchase and sale of the Carbon common stock to Yorktown as provided in Section 2.1 shall be held at a date, time and place mutually agreeable to all parties to this Agreement but in any event no later than the closing of the purchase of BFC stock under the Stock Purchase Agreement (the "BFC Closing"). At the closing for the sale of Carbon shares as provided in Section 2.1, Carbon shall deliver to Yorktown a certificate or certificates, registered in Yorktown's name, representing 4,500,000 shares, free and clear of any liens, security interests or encumbrances (other than any transfer restrictions imposed by securities laws); and at that closing Yorktown shall pay to Carbon the purchase price of $24,750,000 in immediately available funds by wire transfer per instructions of Carbon. 2.3 Use of Proceeds. --------------- The proceeds of the sale of shares to Yorktown as provided in this Agreement shall be used for the purchase of BFC shares under the Stock Purchase Agreement, and any remaining proceeds after that purchase shall be added to and be part of the working capital of Carbon. 2 Article 3 Assignment of Stock Purchase Agreement 3.1 Assignment. ---------- On a date mutually agreed upon by all parties to this Agreement but in any event immediately prior to the BFC Closing, CEC Canada shall assign all rights and obligations of CEC Canada under the Stock Purchase Agreement to Carbon, including the right to purchase all outstanding BFC shares. CEC Canada shall cause prior notice of this assignment to be given to Bonneville Pacific under the terms of the Stock Purchase Agreement. It is further understood that, in accordance with the terms of the Stock Purchase Agreement, CEC Canada shall remain fully liable for all of its obligations under the Stock Purchase Agreement. 3.2 Assumption; Reimbursement of Deposit. ------------------------------------ Carbon, upon receipt of that assignment of the Stock Purchase Agreement, shall perform and comply with all obligations and terms applicable to CEC Canada under the Stock Purchase Agreement, as if Carbon were named as the Buyer in the Stock Purchase Agreement instead of CEC Canada. Also, upon receipt of that assignment of the Stock Purchase Agreement, Carbon shall pay $1,200,000 to CEC Canada as reimbursement of the deposit made by CEC Canada on the purchase price under the Stock Purchase Agreement. 3.3 Amendments. ---------- Neither CEC Canada nor Carbon will make any amendment to the Stock Purchase Agreement or grant any waiver under the Stock Purchase Agreement without the permission and consent of the other parties to this Agreement, including Yorktown. Article 4 Exchange Offer 4.1 The Offer. --------- Carbon shall, and Yorktown and CEC Canada shall cause Carbon to, make an offer to all holders of shares of CEC Canada to exchange one share of common stock of Carbon for each outstanding share of CEC Canada (the "Exchange Offer") as promptly as reasonably practicable after the BFC Closing. The obligation of Carbon to make the Exchange Offer is subject only to the assignment of the Stock Purchase Agreement by CEC Canada to Carbon as provided above and the consummation of the BFC Closing. In order for any specific term to be included in the Exchange Offer, the term must be approved by Yorktown, CEC Canada and Carbon, whose approval shall not be unreasonably withheld. Promptly after the expiration of any 3 withdrawal rights for tendered shares in the Exchange Offer or the expiration of the Exchange Offer, as the case may be, Carbon shall exchange its shares for all shares of CEC Canada validly tendered in the Exchange Offer and not withdrawn. 4.2 Compliance With Applicable Law. ------------------------------ Carbon shall take, and CEC Canada and Yorktown shall cause Carbon to take, all necessary steps to comply with applicable law in making the Exchange Offer, including without limitation (a) filing with the Securities and Exchange Commission ("SEC") a registration statement on Form S-4 (together with any amendments and supplements, called the "Registration Statement") under the Securities Act of 1933 (the "Securities Act"), (b) filing with the SEC a tender offer statement on Schedule 14D-1 (together with all amendments and supplements, called the "Schedule 14D-1") with respect to the Exchange Offer, and (c) filing all documents required to obtain any permits and approvals, if any, required to carry out the transactions contemplated by this Agreement under any applicable Canadian laws or state securities laws and will use its best efforts to obtain such permits and approvals. The Registration Statement and Schedule 14D-1 shall include summary advertisements, letters of transmittal and such other documents as necessary to make the Exchange Offer (the Registration Statement, Schedule 14D-1 and other documents, together with all supplements and amendments, are called collectively the "Offer Documents"). 4.3 CEC Canada Approval. ------------------- CEC Canada hereby approves of the Exchange Offer and represents that the Board has unanimously determined that this Agreement and the transactions contemplated by this Agreement, including the Exchange Offer, are fair to and in the best interests of the shareholders of CEC Canada. The Board of Directors of CEC Canada shall recommend that the shareholders of CEC Canada accept the Exchange Offer, and CEC Canada consents to the inclusion in the Registration Statement and other Offer Documents of the recommendation of the Board of Directors as described above. Also CEC Canada represents that it has been advised by each of its directors and executive officers that each of them intends either to tender or cause to be tendered all shares of CEC Canada beneficially owned by them in the Exchange Offer. As soon as reasonably practical and no later than the date of commencement of the Exchange Offer, CEC Canada shall file with the SEC a Solicitation/ Recommendation Statement on Schedule 14D-9 (which, together with all amendments and supplements, is called the "Schedule 14D-9") containing the recommendation of the Board described in this Section and shall disseminate the Schedule 14D-9 to the extent required by rules of the SEC under the Securities Exchange Act of 1934 (the "Exchange Act") and any other applicable federal securities laws. CEC Canada agrees to correct promptly any information provided by it for use in the Schedule 14D-9 which shall have become false or misleading and to take all steps necessary to cause the Schedule 14D-9 as so corrected to be filed with 4 the SEC and disseminated to holders of shares of CEC Canada to the extent required by applicable federal securities laws. 4.4 Shareholder Information. ----------------------- CEC Canada shall promptly furnish to Carbon mailing labels containing the name and addresses of all record holders of shares of CEC Canada and with security position listings of all shares held in stock depositories, each as of a recent date, together with all other available listings and computer files containing names, addresses and security position listings of record holders and beneficial owners of shares of CEC Canada. CEC Canada shall furnish Carbon with such additional information, including without limitation, updated listings and computer files of shareholders, mailing labels and security position listings and such other assistance as Carbon may reasonably request for the Exchange Offer. Carbon shall, subject to the requirements of applicable law and except as necessary to disseminate the Exchange Offer and any Offer Documents, hold in confidence the information contained in those labels, listings and files and shall use such information only in connection with the Exchange Offer. Article 5 Stock Options 5.1 Stock Option Plan. ----------------- Each of the parties shall approve the 1999 Stock Option Plan of Carbon (the "Carbon Stock Option Plan") and the 1999 Restricted Stock Plan, both attached as Exhibit 1, and shall cause these Plans to be in effect prior to the BFC --------- Closing. 5.2 Substitution of Stock Options. ----------------------------- Carbon shall grant under the Carbon Stock Option Plan substitute options for each option outstanding under the CEC Resources Ltd. Stock Option Plan (the "CEC Canada Stock Option Plan"). Any option granted by Carbon in substitution for an option granted under the CEC Stock Option Plan shall expressly provide that it is being granted in full satisfaction of, and in substitution for, any and all options for CEC Resources, Ltd. Stock previously granted under the CEC Stock Option Plan. The following terms and conditions of the substitute options granted pursuant to the Carbon Stock Option Plan shall be the same as the terms and conditions relating to the specific options granted pursuant to an optionee's Stock Option Agreement executed under the terms of CEC Stock Option Plan: (1) the grant and exercise prices of the option; (2) the character of the option as an "incentive stock option" or a "nonqualified stock option" (as defined in the Code); (3) the vesting provisions applicable to the option (except to the extent previously modified in executed employment agreements between the optionee and CEC Canada); (4) the change in 5 control provisions applicable to the option (except to the extent previously modified in executed employment agreements between the optionee and CEC Canada); (5) the provisions addressing the consequences of the optionee's termination of employment for any reason; (6) the limitations on assignability of the option; (7) the expiration date of the option; and (8) the payment method for the purchase of the shares subject to the option. 5.3 Employment Agreements. --------------------- The parties approve of the Employment Agreements with Patrick R. McDonald ("McDonald") and Kevin Struzeski ("Struzeski") in the forms attached as Exhibit ------- 2 to this Agreement and will cause Carbon to enter into these Employment - - Agreements on or prior to the BFC Closing. 5.4 Related Actions. --------------- Concurrently with acquiring shares of Carbon as provided below, Yorktown shall, as a shareholder of Carbon, approve of the Carbon Stock Option Plan, Carbon's 1999 Restricted Stock Plan and the above-described Employment Agreements. Carbon and Yorktown shall cause the Board of Directors of Carbon to approve and adopt the Carbon Stock Option Plan, Carbon's 1999 Restricted Stock Plan and the Employment Agreements. 5.5 Other Employee Plans. -------------------- CEC Canada may, in its discretion, transfer the sponsorship of all employee benefit plans formerly sponsored by CEC Canada, including but not limited to the CEC Resources Ltd. 401(k) Profit Sharing Plan, to Carbon as soon as practicable following the completion of the Exchange Offer. Article 6 Board of Directors of Carbon 6.1 Definitions. ----------- For purposes of this Article 6, the following terms have the following meanings: "Beneficial ownership" or "owned beneficially" with respect to any voting stock means stock of which a person or entity is a beneficial owner as defined at the date hereof in Rule 13d-3 of the SEC under the Exchange Act. "Independent director" means a person who is not an officer or employee of Carbon, is not related to an officer of Carbon and does not represent Yorktown or any other beneficial owner of 10% or more of the outstanding voting stock of Carbon. 6 "Super majority vote of the Board" means approval by a majority of the entire Board of Directors of Carbon, which majority includes a majority of all Yorktown directors and at least one independent director. "Voting stock" means securities having the right to vote generally in any election of directors of Carbon. 6.2 Board of Directors After BFC Closing. ------------------------------------ After consummation of the BFC Closing, the Board of Directors of Carbon shall consist of five directors, and these five directors shall be: David H. Kennedy; Lambros J. Lambros; Bryan H. Lawrence; Peter A. Leidel; and McDonald. Upon completion of the Exchange Offer, and if Harry A. Trueblood accepts the Exchange Offer for all CEC shares owned beneficially by him, the Board of Directors of Carbon shall consist of six directors, and these six directors shall be the above-named five persons and Harry A. Trueblood. 6.3 Yorktown Designations. --------------------- Bryan H. Lawrence and Peter A. Leidel named above are persons designated by Yorktown. So long as Yorktown is the beneficial owner of voting shares with 50% or more of the outstanding votes in the election of directors of Carbon, Yorktown shall have the right to designate for nomination two directors of Carbon ("Yorktown Directors"). If Yorktown owns beneficially voting stock with 25% or more but less than 50% of the outstanding votes in the election of directors of Carbon, then Yorktown shall have the right to designate for nomination one director of Carbon. Yorktown will not have the right, as a contractual matter under this Agreement, to designate any persons for nomination as directors if Yorktown owns beneficially voting stock with less than 25% of the outstanding votes in the election of directors of Carbon. 6.4 McDonald as a Director. ---------------------- So long as McDonald is an officer of Carbon, McDonald shall be designated for nomination as a director of Carbon. 6.5 Nominating Committee. -------------------- The Board of Directors of Carbon shall establish, empower and maintain a nominating committee. The nominating committee shall be responsible for determining, on behalf of the Carbon Board of Directors, nominees for the position of director of Carbon or persons to be elected by the Board of Directors or shareholders to fill any vacancy in the Board of Directors. The nominating committee shall be comprised of one Yorktown director, McDonald so long as he is a director of Carbon and two independent directors. The Yorktown director to serve on the nominating 7 committee shall be selected by a majority vote of the Yorktown directors. A majority of the independent directors shall designate the independent directors to serve on the nominating committee. Any Yorktown or independent director may select himself or herself to serve on the nominating committee. A quorum of the nominating committee, which shall be required for any action of the nominating committee, shall be all members of the nominating committee. The nominating committee shall act by a majority vote of the entire nominating committee. 6.6 Nomination of Directors. ----------------------- The directors of Carbon shall be nominated at all times from and after the consummation of the BFC Closing as follows (a nomination includes any nomination of an incumbent director to be reelected to the Board): (a) The nominating committee shall nominate for director each Yorktown director which Yorktown has the right to designate and has so designated; (b) The nominating committee shall nominate McDonald if he is entitled to be so nominated as provided in Section 6.4 above; and (c) The nominating committee shall nominate the remaining directors and at least two of the persons so nominated shall be independent directors unless the size of the Board has been changed by a super majority vote of the Board and there are not sufficient positions for the election of two independent directors after taking into account Yorktown directors and the nomination of McDonald. 6.7 Vacancies. --------- Upon the death, resignation, retirement, disqualification or removal from office, with or without cause, of any independent director or Yorktown director, the nominating committee (in the case of an independent director) and the remaining Yorktown director (in the case of the vacancy relating to a Yorktown director) shall have the right to designate any replacement to fill the vacancy. Any vacancy on the Board of Directors caused by the death, resignation, retirement, disqualification or removal of McDonald, shall be designated by the nominating committee. The Board of Directors shall take any action necessary to duly appoint or elect as a director each person so designated to fill a vacancy on the Board. 6.8 Voting of Shares. ---------------- Each party shall take such actions as a shareholder of Carbon, or as is otherwise reasonably in the party's control, to effectuate the election of directors and the filling of vacancies as provided in this Article 6. In addition, Carbon shall use all reasonable efforts to solicit from shareholders of Carbon eligible to vote in the election of directors proxies in favor of the nominees selected in accordance with this 8 Article 6. In any election of directors or any meeting of shareholders for the removal of directors, Yorktown and McDonald shall be present for purposes of establishing a quorum and shall vote all of their voting stock in favor of any nominee for director selected in accordance with this Article 6 and against the removal of any director selected in accordance with this Article 6, except that Yorktown and McDonald may vote for the removal of any Yorktown director for which Yorktown has indicated approval of the removal and Yorktown and McDonald may vote for the removal of any independent director as to which the nominating committee has recommended removal. 6.9 Super Majority. -------------- No action by Carbon shall be taken with respect to the following without approval of the Board of Directors of Carbon which approval shall be by a super majority vote of the Board: Any change in the size or composition of the Board of Directors of Carbon or the nominating committee. 6.10 Termination of this Article. --------------------------- This Article shall cease to be effective and shall not apply to any Carbon matters (a) 10 years after the consummation of the BFC Closing or, if earlier, (b) when and if Yorktown owns beneficially voting shares with less than 25% of the outstanding votes in the election of directors and McDonald is no longer an officer of Carbon. Article 7 Representations and Warranties of Carbon Carbon represents and warrants at the date hereof to Yorktown and CEC Canada as follows: 7.1 Organization and Authority. -------------------------- Carbon is a corporation duly organized, validly existing and in good standing under the laws of the State of Colorado, is duly qualified to do business and is in good standing in all jurisdictions where its ownership or leasing of property or the conduct of its business requires it to be so qualified and failure to be so qualified would have a material adverse effect on the business, financial condition or results of operations (a "Material Adverse Effect") of Carbon and has corporate power and authority to own its properties and assets and to carry on its business as it is now being conducted. Carbon has furnished Yorktown and CEC Canada true and correct copies of its articles of incorporation and bylaws, as amended. 7.2 No Subsidiaries. --------------- 9 Prior to the BFC Closing, Carbon has no subsidiaries. 7.3 Capitalization. -------------- The authorized capital stock of Carbon consists of 10,000,000 shares of preferred stock, no par value, of which no shares are outstanding, and 20,000,000 shares of common stock, no par value, of which as of the date of this Agreement 100 shares issued to Yorktown were outstanding. Except for the options required by Article 5 above, there are no outstanding subscriptions, contracts, conversion privileges, options, warrants, calls, preemptive rights or other rights obligating Carbon to issue, sell or otherwise dispose of, or to purchase, redeem or otherwise acquire, any shares of capital stock of Carbon. 7.4 Authorization; No Conflict. -------------------------- Carbon has the corporate power and authority to enter into this Agreement and to carry out its obligations under this Agreement. The execution, delivery and performance of this Agreement by Carbon and the consummation of the transactions contemplated hereby have been duly authorized by the Board of Directors of Carbon This Agreement is a valid and binding obligation of Carbon enforceable against Carbon in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the rights of creditors and contracting parties generally and except as enforceability may be subject to general principles of equity. Neither the execution, delivery and performance by Carbon of this Agreement, nor the consummation of the transactions contemplated hereby, nor compliance by Carbon with any of the provisions hereof, will (a) violate, conflict with, or result in a breach of any provision of, or constitute a default (or an event of which, with notice or lapse of time or both, would constitute a default) under, or result in the termination of, or accelerate the performance required by, or result in a right of termination or acceleration of, or result in the creation of, any lien, security interest, charge or encumbrance upon any of the properties or assets of Carbon under any of the terms, conditions or provisions of (i) its articles of incorporation or bylaws or (ii) any note, bond, mortgage, indenture, deed of trust, license, lease, agreement or other instrument or obligation to which Carbon is a party or by which it may be bound, or to which Carbon or any of the properties or assets of Carbon may be subject, or (b) subject to compliance with the statutes and regulations referred to in the next paragraph, to the knowledge of Carbon, violate any judgment, ruling, order, writ, injunction, decree, statute, rule or regulation applicable to Carbon or any of its properties or assets. Other than in connection or in compliance with the provisions of the Securities Act and the rules and 10 regulations thereunder, the securities or blue sky laws of the various states or Canadian provinces, no notice to, filing with, exemption or review by, or authorization, consent or approval of, any public body or authority is necessary for the consummation by Carbon of the transactions contemplated by this Agreement. 7.5 No Operations. ------------- Carbon was incorporated in September, 1999 and has not conducted any active business between its date of incorporation and the date of this Agreement, except any actions to enter into this Agreement, complete the purchase of BFC Stock under the Stock Purchase Agreement and make the Exchange Offer. 7.6 Brokers and Finders. ------------------- Neither Carbon nor any of its officers, directors or employees has employed any broker or finder or incurred any liability for any financial advisory fees, brokerage fees, commissions or finder's fees, and no broker or finder has acted directly or indirectly for Carbon in connection with this Agreement or the transactions contemplated hereby. ARTICLE 8 REPRESENTATIONS AND WARRANTIES OF CEC CANADA CEC Canada represents and warrants at the date hereof to Yorktown and Carbon as follows: 8.1 Organization and Authority. -------------------------- CEC Canada is a corporation duly organized, validly existing and in good standing under the laws of the Province of Alberta, is duly qualified to do business and is in good standing in all jurisdictions where its ownership or leasing of property or the conduct of its business requires it to be so qualified and failure to be so qualified would have a Material Adverse Effect on CEC Canada and has corporate power and authority to own its properties and assets and to carry on its business as it is now being conducted. CEC Canada has furnished the other two parties true and correct copies of its articles of incorporation and bylaws, as amended. 8.2 No Subsidiaries. --------------- CEC Canada has no subsidiaries. 8.3 Capitalization. -------------- The authorized capital stock of CEC Canada consists of an unlimited number of shares of preferred stock, no par value, of which no shares are outstanding, and an 11 unlimited number of shares of common stock, no par value, of which as of the close of business on August 31, 1999, 1,521,400, shares were outstanding. The maximum number of shares of CEC Canada common stock (assuming for this purpose that phantom shares and other share-equivalents constitute CEC Canada common stock) that would be outstanding as of August 31, 1999, if all options, warrants, conversion rights and other rights with respect thereto were exercised is 1,785,900. All of the outstanding shares of capital stock of CEC Canada have been duly and validly authorized and issued and are fully paid and nonassessable. Except as set forth in Exhibit 3, there are no outstanding --------- subscriptions, contracts, conversion privileges, options, warrants, calls, preemptive rights or other rights obligating CEC Canada to issue, sell or otherwise dispose of, or to purchase, redeem or otherwise acquire, any shares of capital stock of CEC Canada. Since May 31, 1999, no shares of CEC Canada common stock have been purchased, redeemed or otherwise acquired, directly or indirectly, by CEC Canada, and no dividends or other distributions have been declared, set aside, made or paid to the shareholders of CEC Canada. 8.4 Authorization; No Conflict. -------------------------- CEC Canada has the corporate power and authority to enter into this Agreement and to carry out its obligations hereunder. The execution, delivery and performance of this Agreement by CEC Canada and the consummation of this Agreement by CEC Canada have been duly authorized by the Board of Directors of CEC Canada. This Agreement is a valid and binding obligation of CEC Canada enforceable against CEC Canada in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the rights of creditors and contracting parties generally and except as enforceability may be subject to general principles of equity. Except as set forth on Exhibit 4 attached hereto, neither the execution, --------- delivery and performance of CEC Canada of this Agreement, nor the consummation of the transactions contemplated hereby, nor compliance by CEC Canada with any of the provisions hereof, will (a) violate, conflict with, or result in a breach of any provision of, or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or result in the termination of, or accelerate the performance required by, or result in a right of termination or acceleration of, or result in the creation of, any lien, security interest, charge or encumbrance upon any of the properties or assets of CEC Canada under any of the terms, conditions or provisions of (i) its articles of incorporation or bylaws or (ii) any material note, bond, mortgage, indenture, deed of trust, license, lease, agreement or other instrument or obligation to which CEC Canada is a party or by which it may be bound, or to which CEC Canada or any of the properties or assets of CEC Canada may be subject, or (b) subject to compliance with the statutes and regulations referred to in the next paragraph, to the knowledge of CEC Canada, violate any judgment, ruling, order, 12 writ, injunction, decree, statute, rule or regulation applicable to CEC Canada or any of its material properties or assets. Other than in connection or in compliance with the provisions of the Securities Act and the rules and regulations thereunder, the Exchange Act and the rules and regulations thereunder, the securities or blue sky laws of the various states or Canadian provinces, no notice to, filing with, exemption or review by, or authorization, consent or approval of, any public body or authority is necessary for the consummation by CEC Canada of the transactions contemplated by this Agreement. 8.5 Brokers and Finders. ------------------- Neither CEC Canada nor any of its officers, directors or employees has employed any broker or finder or incurred any liability for any financial advisory fees, brokerage fees, commissions or finder's fees, and no broker or finder has acted directly or indirectly for CEC Canada in connection with this Agreement or the transactions contemplated hereby. 8.6 SEC Reports. ----------- Since December 1, 1998, CEC Canada has filed all reports, registrations and statements, together with any required amendments thereto, that it was required to file with the SEC, including, but not limited to, Forms 10-K, Forms 10-Q and proxy statements. All such reports and statements filed with the SEC are collectively referred to herein as the "CEC Canada Reports." As of their respective dates the CEC Canada Reports complied in all material respects with all the rules and regulations promulgated by the SEC, and as of their respective dates, the CEC Canada Reports filed with the SEC did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading. Copies of all the CEC Canada Reports have been made available to Yorktown and Carbon by CEC Canada. Article 9 Representations and Warranties of Yorktown Yorktown represents and warrants at the date hereof to Carbon and CEC Canada. 9.1 Organization and Authority. -------------------------- Yorktown is a limited partnership duly organized, validly existing and in good standing under the laws of the State of Delaware, is duly qualified to do business and is in good standing in all jurisdictions where its ownership or leasing of property or the conduct of its business requires it to be so qualified and failure to be so qualified 13 would have a Material Adverse Effect on Yorktown and has full power and authority to own its properties and assets and to carry on its business as it is now being conducted. 9.2 Authorization. ------------- Yorktown has the full power and authority to enter into this Agreement and to carry out its obligations hereunder. The execution, delivery and performance of this Agreement by Yorktown and the consummation of the transactions contemplated hereby have been duly authorized by the governing board of Yorktown. No approval or consent by the members of Yorktown is necessary for the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby. This Agreement is a valid and binding obligation of Yorktown enforceable against Yorktown in accordance with its terms, except as enforceability may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting the rights of creditors and contracting parties generally and except as enforceability may be subject to general principles of equity. Neither the execution, delivery and performance by Yorktown of this Agreement nor the consummation of the transactions contemplated hereby, nor compliance by Yorktown with any of the provisions hereof; will (a) violate, conflict with, or result in a breach of any provision of, or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or result in the termination of, or accelerate the performance required by, or result in a right of termination or acceleration of, or result in the creation of, any lien, security interest, charge or encumbrance upon any of the properties or assets of Yorktown under any of the terms, conditions or provisions of (i) its organizational documents or operating agreements or (ii) any material note, bond, mortgage, indenture, deed of trust, license, lease, agreement or other instrument or obligation to which Yorktown is a party or by which it may be bound, or to which Yorktown or any of the properties or assets of Yorktown may be subject, or (b) subject to compliance with the statutes and regulations referred to in the next paragraph, to the knowledge of Yorktown, violate any judgment, ruling, order, writ, injunction, decree, statute, rule or regulation applicable to Yorktown or any of its properties or assets. Other than in connection with or in compliance with the provisions of the Securities Act and the rules and regulations thereunder, the Exchange Act and the rules and regulations thereunder, the securities or blue sky laws of the various states or Canadian provinces, no notice to, filing with, exemption or review by, or authorization, consent or approval of, any public body or authority is necessary for the consummation by Yorktown of the transactions contemplated by this Agreement. 9.3 Brokers and Finders. ------------------- 14 Neither Yorktown nor any of its respective managers, officers, directors, partners, members or employees has employed any broker or finder or incurred any liability for any financial advisory fees, brokerage fees, commissions or finder's fees, and no broker or finder has acted directly or indirectly for Yorktown in connection with this Agreement or the transactions contemplated hereby. 9.4 Investment Matters. ------------------ Yorktown has substantial experience in evaluating and investing in private placement transactions of securities in companies similar to Carbon so that it is capable of evaluating the merits and risks of its investment in Carbon and has the capacity to protect its own interests. It is acquiring Carbon shares as provided in Article 2 for investment for its own account, not as a nominee or agent, and not with the view to, or for resale in connection with, any distribution thereof. It understands that Carbon shares have not been, and will not be registered, under the Securities Act by reason of a specific exemption from the registration provisions of the Securities Act, the availability of which depends upon, among other things, the bona fide nature of the investment intent and the accuracy of Yorktown's representations as expressed in this Section. Yorktown has had an opportunity to discuss Carbon's business, management and financial affairs with Carbon's management and has had the opportunity to review Carbon's existing and proposed properties and operations. It has also had an opportunity to ask questions of officers of Carbon, which questions were answered to its satisfaction. Article 10 Covenants 10.1 Covenants of Carbon. ------------------- Carbon covenants and agrees with CEC Canada and Yorktown as follows: (a) From the date hereof until completion of the Exchange Offer, Carbon will maintain its corporate existence in good standing; after acquisition of the stock of BFC pursuant to the Stock Purchase Agreement, maintain the general character of BFC's business and conduct BFC's business in its ordinary and usual manner; maintain all books and records of Carbon and, after the purchase of BFC's stock, of BFC, including all financial statements, in accordance with the accounting principles and practices consistent with those used for CEC Canada financial statements, except for changes in such principles and practices required under generally accepted accounting principles or as to which Yorktown and CEC Canada concur. 15 (b) As promptly as practicable after the execution of this Agreement, Carbon will file with the SEC the Registration Statement under the Securities Act, the Schedule 14D-1 and any other applicable documents, relating to the Exchange Offer and the shares of Carbon common stock to be delivered to the stockholders of CEC Canada pursuant to this Agreement and the Exchange Offer, and will use its best efforts to cause the Registration Statement to become effective as soon as practicable. At the time the Registration Statement becomes effective, the Registration Statement will comply in all material respects with the provisions of the Securities Act and the published rules and regulations thereunder, and will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not false or misleading, and at the times of making and completing the Exchange Offer the prospectus included as part of the Registration Statement, as amended or supplemented by any amendment or supplement filed by Carbon (called the "Prospectus"), will not contain any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein not false or misleading; provided, however, that -------- ------- none of the provisions of this paragraph shall apply to statements in or omissions from the Registration Statement or the Prospectus made in reliance upon and in conformity with information furnished by Yorktown or CEC Canada for use in the Registration Statement or the Prospectus. The Schedule 14D-1 shall comply in all material respects with provisions of applicable law. (c) Carbon will file all documents required to be filed to list Carbon common stock to be issued pursuant to this Agreement and the Exchange Offer on the American Stock Exchange and use its best efforts to effect said listing at or prior to completion of the Exchange Offer. (d) The shares of Carbon common stock to be issued by Carbon to the shareholders of CEC Canada pursuant to this Agreement and the shares of Carbon to be issued by Carbon to Yorktown will, upon such issuance and delivery to said shareholders and Yorktown pursuant to this Agreement, be duly authorized, validly issued, fully paid and nonassessable. The shares of Carbon common stock to be delivered to the shareholders of CEC Canada and to Yorktown pursuant to this Agreement are and will be free of any preemptive rights of any shareholders of Carbon and free and clear of any liens, security interests or encumbrances (other than transfer restrictions imposed by securities laws). (e) Carbon will file all documents required to obtain, prior to commencing the Exchange Offer, all necessary Blue Sky and Canadian Province permits and approvals, if any, required to carry out the transactions contemplated by this Agreement, will pay all expenses incident thereto and will use its best efforts to obtain such permits and approvals. 16 (f) Carbon will hold in confidence all documents and information concerning CEC Canada and Yorktown furnished to it and its representatives in connection with the transactions contemplated by this Agreement and will not release or disclose such information to any other person, except as required by law or in connection with the Exchange Offer or the Registration Statement and except to its outside professional advisers in connection with this Agreement, with the same undertaking from such professional advisers. If the transactions contemplated by this Agreement shall not be consummated, such confidence shall be maintained and, upon request, all such documents, copies thereof or extracts therefrom shall immediately thereafter be returned to CEC Canada or Yorktown, as the case may be. (g) Carbon shall consult with CEC Canada and Yorktown as to the form and substance of any proposed press release or other proposed public disclosure by Carbon of matters related to this Agreement or any of the transactions contemplated hereby, except Carbon may make any press release or statement believed in good faith by Carbon to be required by law or under the rules and regulations of any stock exchange on which its shares are listed. (h) With respect to the indemnification of officers and directors and officers' and directors' insurance, Carbon agrees as follows: (i) Carbon shall ensure that all rights to indemnification and all limitations of liability existing in favor of any person who is now, or has been at any time prior to the date hereof, or who becomes prior to the completion of the Exchange Offer, a director or officer of CEC Canada (an "Indemnified Party" and, collectively, the "Indemnified Parties"), in CEC Canada's Articles of Incorporation or Bylaws or similar governing documents shall, with respect to claims arising from (A) facts or events that occurred before the completion of the Exchange Offer, or (B) this Agreement or any of the transactions contemplated by this Agreement, whether in any case asserted or arising before or after the completion of the Exchange Offer, survive the Exchange Offer and shall continue in full force and effect. Nothing contained in this paragraph 10.1(h)(i) shall be deemed to preclude the liquidation, consolidation or merger of CEC Canada, in which case all of such rights to indemnification and limitations on liability shall be deemed to survive and continue as contractual rights notwithstanding any such liquidation or consolidation or merger; provided, however, that in the event -------- ------- of liquidation or sale of substantially all of the assets of CEC Canada, Carbon shall guarantee, to the extent of the net asset value of Carbon as of the completion of the Exchange Offer, the indemnification obligations of CEC Canada to the extent of indemnification obligations of Carbon described above. (ii) any Indemnified Party wishing to claim indemnification under paragraph 10.1(h)(i), upon learning of any such claim, action, suit, proceeding 17 or investigation, shall promptly notify Carbon thereof, but the failure to so notify shall not relieve Carbon of any liability it may have to such Indemnified Party. In the event of any such claim, action, suit, proceeding or investigation (whether arising before or after completion of the Exchange Offer), (A) Carbon shall have the right to assume the defense thereof and Carbon shall not be liable to any Indemnified Party for any legal expenses of other counsel or any other expenses subsequently incurred by such Indemnified Party in connection with the defense thereof, except that if Carbon elects not to assume such defense or counsel for the Indemnified Party advises that there are issues which raise conflicts of interest between Carbon and the Indemnified Party, the Indemnified Party may retain counsel satisfactory to them, and Carbon shall pay the reasonable fees and expenses of such counsel for the Indemnified Party promptly as statements therefor are received; provided, however, that Carbon shall be obligated -------- ------- pursuant to this subparagraph (ii) to pay for only one firm of counsel for all Indemnified Parties in any jurisdiction unless the use of one counsel for such Indemnified Parties would present such counsel with a conflict of interest and (B) such Indemnified Party shall cooperate in the defense of any such matter. In any event, Carbon shall not be liable for the settlement of any claim, action, suit, proceeding or investigation unless Carbon consents to the settlement, which consent shall not be unreasonably withheld. (iii) if Carbon or any of its successors or assigns (A) shall consolidate with or merge into any other corporation or entity and shall not be the continuing or surviving corporation or entity of such consolidation or merger or (B) shall transfer all or substantially all of its properties and assets to any individual, corporation or other entity, then and in each such case, proper provision shall be made so that the successors and assigns of Carbon shall assume the obligations set forth in this paragraph 10.1(h). (iv) the provisions of this paragraph 10.1(h) are intended to be for the benefit of, and shall be enforceable by, each Indemnified Party and his or her heirs and representatives. 10.2 Covenants of CEC Canada. ----------------------- CEC Canada covenants and agrees with Carbon and Yorktown as follows: (a) Except as otherwise permitted or required by this Agreement, from the date hereof until completion of the Exchange Offer, CEC Canada will: maintain its corporate existence in good standing; maintain the general character of its business and conduct its business in its ordinary and usual manner; maintain proper business and accounting records in accordance with generally accepted principles; maintain in all material respects presently existing insurance coverage; use its reasonable efforts to preserve its business organization intact, to keep the services of its present 18 principal employees and to preserve its good will and the good will of its suppliers, customers and others having business relationships with it; use its reasonable efforts to obtain any approvals or consents required to maintain existing leases and other contracts in effect following the Exchange Offer; and furnish monthly financial reports, in the form submitted by CEC Canada to its management, to Carbon and Yorktown. (b) Except as otherwise contemplated or required by this Agreement, from the date hereof until completion of the Exchange Offer, CEC Canada will not (without the prior written consent of Carbon and Yorktown): amend or otherwise change its articles of incorporation or association or Bylaws; issue or sell or authorize for issuance or sale, or grant any options or make other agreements with respect to the issuance or sale or conversion of, any shares of its capital stock, phantom shares or other share-equivalents or any other of its securities, except that CEC Canada may issue shares of CEC Canada common stock upon the exercise of any outstanding options; authorize or incur any long-term debt (other than borrowings under a revolving line of credit in the ordinary course of business or borrowings to replace any existing borrowings or borrowings as to which Yorktown and Carbon approve); mortgage, pledge or subject to lien or other encumbrance any of its properties, except in the ordinary course of business or in connection with borrowings permitted by this paragraph; amend or terminate any employee plan except as required by law; make any contributions to any employee plan except as required by the terms of such plan in effect as of the date hereof except discretionary contributions made in the ordinary course of business in accordance with past practices; declare, set aside, make or pay any dividend or other distribution with respect to its capital stock; redeem, purchase or otherwise acquire, directly or indirectly, any of the capital stock of CEC Canada; increase the compensation of any officers, directors or executive employees, except pursuant to existing compensation plans and practices; or sell or otherwise dispose of any of its assets or properties other than in the ordinary course of business. (c) CEC Canada will furnish or cause to be furnished to Carbon all the information concerning CEC Canada required for inclusion in the Registration Statement or other Offer Documents. Any financial statement for any fiscal year provided under this paragraph must include the audit opinion and the consent of the relevant auditor to use such opinion in such Registration Statement. The information regarding CEC Canada furnished by CEC Canada will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, not false or misleading, at the time of any filing of the Registration Statement or other Offer Documents with the SEC or any other regulatory authority, at the time of making the Exchange Offer and throughout the making of the Exchange Offer. CEC Canada shall correct promptly any information provided by CEC Canada for use in the Registration Statement or other Offer Documents which is or shall become false or misleading. All documents 19 which CEC Canada is responsible for filing with the SEC in connection with the Exchange Offer will comply as to form in all material respects with the provisions of applicable law. (d) CEC Canada will cooperate in obtaining and file any documents which may be required to obtain all necessary Blue Sky and Canadian Province permits and approvals, if any, required to carry out the transactions contemplated by this Agreement. (e) CEC Canada shall consult with Carbon and Yorktown as to the form and substance of any proposed press release or other proposed public disclosure, by CEC Canada or any of its representatives of matters related to this Agreement or any of the transactions contemplated hereby, except that CEC Canada may make any press release or statement believed in good faith by CEC Canada to be required by law or under the rules and regulations of any stock exchange on which its shares are listed. (f) CEC Canada will take all action necessary or required to terminate or amend, if requested by Carbon, all qualified pension and welfare benefit plans to facilitate the merger of such plans with Carbon plans without gaps in coverage for participants in the plans and without duplication of costs caused by the continuation of such plans after coverage is available under Carbon plans, [and all non-qualified benefit plans and compensation arrangements as of the completion of the Exchange Offer]. 10.3 Covenants of Yorktown. --------------------- Yorktown covenants and agrees with Carbon and CEC Canada as follows: (a) From the date hereof until completion of the Exchange Offer, Yorktown will maintain its existence in good standing. (b) Yorktown will furnish to Carbon all the information concerning Yorktown required for inclusion in the Registration Statement or other Offer Documents. Such information will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not false or misleading, at the time of filing the Registration Statement or other Offer Document with the SEC or any other regulatory authority, the making of the Exchange Offer and throughout the making of the Exchange Offer. Yorktown shall correct promptly any information provided by Yorktown for use in the Registration Statement or other Offer Documents which is or shall become false or misleading. (c) Yorktown will cooperate in obtaining and file any documents which may be required to obtain all necessary Blue Sky and Canadian Province permits and 20 approvals, if any, required to carry out the transactions contemplated by this Agreement. (d) Yorktown will hold in confidence all documents and information concerning Carbon and CEC Canada furnished to it and its representatives in connection with the transactions contemplated by this Agreement and will not release or disclose such information to any other person, except as required by law and except to its outside professional advisers or its limited partners in connection with this Agreement, with the same undertaking from such professional advisers or limited partners, as the case may be. If the transactions contemplated by this Agreement shall not be consummated, such confidence shall be maintained (except to the extent that such information can be shown to be previously known to Yorktown, in the public domain, or later acquired by Yorktown from other legitimate sources) and, upon request, all such documents, copies thereof or extracts therefrom shall immediately thereafter be returned by Carbon or CEC Canada, as the case may be. (e) Yorktown shall consult with Carbon and CEC Canada as to the form and substance of any proposed press release or other proposed public disclosure of matters related to this Agreement or any of the transactions contemplated hereby except that Yorktown may make a press release or statement believed in good faith to be required by law. Article 11 Conditions 11.1 Conditions Precedent to Obligation of Carbon and CEC Canada. ----------------------------------------------------------- The obligation of Carbon to make and complete the Exchange Offer and CEC Canada to recommend favorably the Exchange Offer to its shareholders shall be subject to the satisfaction of the following (a) No court or governmental authority of competent jurisdiction shall have issued an order restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated by this Agreement. (b) The Registration Statement (as amended or supplemented) shall have become effective under the Securities Act and shall not be subject to any stop order. Carbon shall have received all state securities law or blue sky and Canadian Province authorizations necessary in any material respect to carry out the transactions contemplated by this Agreement. 11.2 Condition Precedent to Obligation of Yorktown. --------------------------------------------- The obligation of Yorktown to effect the purchase of Carbon common stock as required by Article 2 shall be subject to the satisfaction at or before the 21 consummation of the BFC Closing of the following condition, which may be waived in writing by Yorktown: No court or governmental authority of competent jurisdiction shall have issued an order restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated by this Agreement. Article 12 Termination and Miscellaneous 12.1 Obligation to Make Exchange Offer. --------------------------------- On and after the BFC Closing has been consummated, the parties shall cause the Exchange Offer to be made subject only to the conditions stated expressly in Article 11, whether or not there has been a breach of any provision of this Agreement by any party. The obligations of the parties regarding the Exchange Offer are independent of any other provisions of this Agreement, and the remedy of any party for breach of any covenant or other provisions of this Agreement shall be limited to damages or specific performance and shall not include any right under this Agreement or applicable law to terminate this Agreement. 12.2 Termination of Agreement. ------------------------ (a) This Agreement may be terminated at any time prior to the consummation of the BFC Closing: (i) by mutual written consent of the parties hereto; (ii) by any of the parties hereto upon written notice to the other parties if the BFC Closing shall not have been consummated by April 1, 2000 unless such failure of consummation shall be due to the failure of the party seeking to terminate to perform or observe in all material respects the covenants and agreements hereof to be performed or observed by such party; or (iii) by a party upon written notice to the other parties if any court or governmental authority of competent jurisdiction shall have issued a final order restraining, enjoining or otherwise prohibiting the consummation of the transactions contemplated by this Agreement. (b) Termination of this Agreement under this Section 12.1 shall not release, or be construed as so releasing, any party hereto from any liability or damage to the other parties hereto arising out of the breaching party's willful and material breach of the warranties and representations made by it, or willful and material failure in performance of any of its covenants, agreements, duties or obligations arising hereunder, and the obligations under paragraphs 10.1(f), 10.1(g), 10.2(d), 10.3(e) and 10.3(f) and Article 12 shall survive such termination. 22 12.3 HSR Act Filing -------------- Carbon and Yorktown shall, as promptly as possible, make or cause to be made any required filings under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and the rules and regulations thereunder (the "HSR Act") with respect to the purchase of BFC shares and the Exchange Offer and shall cooperate with each other regarding these matters. Each party shall promptly inform the other parties of any material communication between the party and the Federal Trade Commission, the Department of Justice or any other governmental authority regarding any of the transactions contemplated by this Agreement. If any party receives a request for additional information or documents from any such governmental authority with respect to the transactions contemplated by this Agreement, then the parties shall use its reasonable efforts, as soon as reasonably practicable, and after consultation with the other parties, an appropriate response in substantial compliance with the request. Each party shall take all reasonable actions necessary to cause the expiration of the waiting periods under the HSR Act as promptly as possible. 12.4 Expenses. -------- All expenses in connection with this Agreement and the transactions contemplated hereby, including without limitation legal and accounting fees, incurred by a party shall be borne by the party, except that Carbon shall reimburse CEC Canada for any and all expenses in connection with this Agreement, the transactions contemplated hereby and the Stock Purchase Agreement upon consummation of the BFC Closing and for those expenses incurred by CEC Canada after consummation of the BFC Closing and except Carbon shall reimburse Yorktown for all its reasonable out-of-pocket legal expenses (including, without limitation, reasonable, attorneys fees), and any out-of-pocket expenses of Yorktown relating to any filings under the HSR Act, in connection with this Agreement and the transactions contemplated hereby. 12.5 Successors and Assigns. ---------------------- This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, but shall not be assignable by either party hereto without the prior written consent of the other parties hereto. Notwithstanding the foregoing, Yorktown may assign this Agreement to any party controlled by, under common control with or controlling Yorktown with prior notice to Carbon and CEC Canada, and in that event Yorktown shall nevertheless remain fully liable for all obligations of Yorktown contained in this Agreement. 12.6 Third Party Beneficiaries. ---- ------------------------- 23 Each party hereto intends that except as otherwise expressly provided herein, this Agreement shall not benefit or create any right or cause of action in or on behalf of any person other than the parties hereto. 12.7 Notices. ---- ------- Any notice or other communication provided for herein or given hereunder to a party hereto shall be in writing and shall be delivered in person or shall be mailed by first class registered or certified mail, postage prepaid, addressed as follows or may be delivered by fax or other electronic transmission to the appropriate address: If to Carbon: Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, CO 80290-1101 Attention: President Telephone Number: (303) 860-1575 Fax Number: (303) 860-9128 Email Address: pmcdonald@cecresources.com If to CEC Canada: CEC Resources Ltd. 1700 Broadway, Suite 1150 Denver, CO 80290-1101 Attention: President Telephone Number: (303) 860-1575 Fax Number: (303) 860-9128 Email Address: pmcdonald@cecresources.com If to Yorktown: Yorktown Energy Partners III, L.P. Attention: Peter A. Leidel 410 Park Avenue, Suite 1900 New York, NY 10025 Telephone Number: (212) 515-2113 Fax Number: (212) 515-2105 Email Address: pleidel@yorktownenergy.com or to such other address with respect to a party as such party shall notify the other in writing as above provided. 24 12.8 Complete Agreement. ---- ------------------ This Agreement contains the complete agreement between the parties hereto with respect to the Exchange Offer and other transactions contemplated hereby and supersede all prior agreements and understandings between the parties hereto with respect thereto. 12.9 Captions. ---- -------- The captions contained this Agreement are for convenience of reference only and do not form a part of this Agreement. 12.10 Waiver and Other Action. ----- ----------------------- Either party hereto may, by a signed writing, given any consent or waiver. The waiver by any party of a breach of any term or provision of this Agreement shall not construed as a waiver of any subsequent breach. 12.11 Amendment. ----- --------- The parties hereto, by action taken by all of their respective Boards of Directors or governing authorities or pursuant to authority delegated by all of their respective Boards of Directors or governing authorities, may amend this Agreement. Any amendment of this Agreement must be in writing signed by the party against which enforcement of the amendment is sought. 12.12 Governing Law. ----- ------------- This Agreement shall be construed and enforced in accordance with the laws of the State of Colorado. 12.13 Non-Survival of Representations and Warranties. ----- ---------------------------------------------- No representation or warranty contained in this Agreement shall survive the consummation of the BFC Closing. 12.14 Attorneys' Fees. ----- --------------- A prevailing party in any legal proceeding brought under or to enforce this Agreement shall be entitled to recover court costs, reasonable costs of the legal proceeding and reasonable attorneys' fees from the non-prevailing parties. 12.15 Counterparts. ----- ------------ This Agreement may be executed in two or more counterparts, each of which shall be deemed an original but all of which shall constitute but one instrument. 25 The parties hereto have executed this Agreement as of the day and year first above written. CARBON ENERGY CORPORATION CEC RESOURCES LTD. By: /s/ Patrick R. McDonald By: /s/ Patrick R. McDonald ------------------------ ------------------------ Name: Name: ------------------------ ------------------------ Title: President Title: President ----------------------- ----------------------- YORKTOWN ENERGY PARTNERS III, L.P. By: /s/ Peter Leidel ------------------------------- General Partner By: --------------------- Name: ------------------- Title: ------------------ DENVER:0938621.08 26 EX-10.4 9 STOCK PURCHASE AGREEMENT EXHIBIT 10.4 BY AND BETWEEN BONNEVILLE PACIFIC CORPORATION, AS SELLER, AND CEC RESOURCES LTD. AS BUYER STOCK PURCHASE AGREEMENT THIS STOCK PURCHASE AGREEMENT (this "Agreement"), dated as of August 11, 1999, is by and between Bonneville Pacific Corporation, a Delaware corporation ("Seller"), and CEC Resources Ltd., a company organized under the laws of the Province of Alberta, Canada ("Buyer"). WHEREAS, Seller desires to sell to Buyer, and Buyer desires to purchase from Seller, all of the issued and outstanding capital stock of Bonneville Fuels Corporation, a Colorado corporation (the "Company"), a wholly owned subsidiary of Seller, upon the terms and subject to the conditions set forth in this Agreement; NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth in this Agreement, the parties hereto agree as follows: ARTICLE 1 CERTAIN DEFINITIONS ------------------- Section 1.1 Certain Defined Terms. Unless the context otherwise requires, --------------------- the respective terms defined in Appendix A attached hereto and incorporated herein shall, when used herein, have the respective meanings therein specified, with each such definition to be equally applicable both to the singular and the plural forms of the term so defined. Section 1.2 References, Gender, Number. All references in this Agreement -------------------------- to an "Article," "Section," or "subsection' shall be to an Article, Section, or subsection of this Agreement, unless the context requires otherwise. Unless the context otherwise requires, the words "this Agreement," "hereof," "hereunder," "herein," "hereby," or words of similar import shall refer to this Agreement as a whole and not to a particular Article, Section, subsection, clause or other subdivision hereof. Whenever the context requires, the words used herein shall include the masculine, feminine and neuter gender, and the singular and the plural. ARTICLE 2 SALE AND PURCHASE OF STOCK -------------------------- Section 2.1 Sale and Purchase. On and subject to the terms and conditions ----------------- of this Agreement, Seller agrees to sell and convey to Buyer, and Buyer agrees to purchase from Seller, all of the issued and outstanding Company Shares. ARTICLE 3 PURCHASE PRICE AND PAYMENT -------------------------- Section 3.1 Purchase Price. The purchase price for the sale and -------------- conveyance of the Company Shares to Buyer is Twenty-Three Million Eight Hundred Fifty-Seven Thousand Nine Hundred Fifty-One Dollars and no/100 ($23,857,951.00) (the "Purchase Price"), subject to adjustment in accordance with the terms of this Agreement. The "Adjusted Purchase Price" shall be the Purchase Price (i) as adjusted downward for any Environmental Defect pursuant to Section 5.5, (ii) as adjusted downward for Title Defects, if any, in accordance with Section 6.2, (iii) as adjusted for undisclosed gas imbalances, if any, pursuant to Section 3.3, (iv) as adjusted downward by the amount of the Deposit, and (v) as adjusted downward for the amount of any loss of deduction pursuant to Section 8.15. Section 3.2 Payment. Contemporaneously with the execution of this ------- Agreement, Buyer shall deposit with Seller an amount equal to five percent (5%) of the Purchase Price ($1,200,000) as a deposit hereunder (the "Deposit"). The "Closing Payment" shall be an amount equal to the Adjusted Purchase Price. At the Closing, Buyer shall wire transfer the Closing Payment in immediately available funds to the account specified by Seller to Buyer. Seller shall be entitled to all interest and other amounts earned on the Deposit and such amounts shall not be applied to the Adjusted Purchase Price. Section 3.3 Gas Imbalance Adjustments. The Purchase Price shall be: ------------------------- (a) reduced by the product obtained by multiplying the aggregate amount of Unscheduled (Negative) Imbalances by $2.00 per MMBtu; and (b) increased by the product obtained by multiplying the aggregate amount of Unscheduled (Positive) Imbalances by $2.00 per MMBtu; provided, however, that there shall be no adjustment for Unscheduled (Negative) Imbalances or for Unscheduled (Positive) Balances if the aggregate amount of net adjustments under clauses (a) and (b) above is less than $50,000. ARTICLE 4 REPRESENTATIONS AND WARRANTIES ------------------------------ Section 4.1 Representations and Warranties of Seller. As of the date of ---------------------------------------- this Agreement, Seller represents and warrants to Buyer as follows: (a) Organization and Qualification of Seller. Seller is a corporation ---------------------------------------- duly organized, validly existing and in good standing under the laws of the State of Delaware. -2- (b) Organization and Qualification of the Company. The Company is a --------------------------------------------- corporation duly organized, validly existing and in good standing under the laws of the State of Colorado and has the requisite corporate power to carry on its business as it is now being conducted. The Company is duly qualified to do business, and is in good standing, in each jurisdiction in which the Assets owned or leased by it makes such qualification necessary, except where the failure to so qualify and be in good standing will not have a Material Adverse Effect. (c) Authority. Seller has all requisite corporate power and authority to --------- execute and deliver this Agreement and to perform its obligations hereunder. The execution, delivery and performance of this Agreement and the transactions contemplated hereby have been duly and validly authorized by all requisite corporate action on the part of Seller, except as provided in Section 9.1(g). (d) Enforceability. This Agreement constitutes a valid and binding -------------- agreement of Seller enforceable against Seller in accordance with its terms, subject to (i) applicable bankruptcy, insolvency, reorganization, moratorium and other similar laws of general application with respect to creditors, (ii) general principles of equity and (iii) the power of a court to deny enforcement of remedies generally based upon public policy. (e) Company Shares. The Seller holds of record and owns beneficially all -------------- outstanding Company Shares free and clear of any security interests, liens, options, warrants, purchase rights, or other encumbrances (except as created by this Agreement and restrictions on sales of stock under applicable securities laws). Upon the purchase of the Company Shares as contemplated by this Agreement, the Buyer will obtain good and valid title to the Company Shares free and clear of all security interests, liens, options, warrants, purchase rights, or other encumbrances (other than those created by, through or under Buyer and restrictions on sales of stock under applicable securities laws). The Seller is not a party to any option, warrant, purchase right, or other contract or commitment (other than this Agreement) that could require the Seller to sell, transfer, or otherwise dispose of any Company Shares. Except as created by this Agreement, the Seller is not a party to any voting trust, proxy, or other agreement or understanding with respect to the voting, holding or disposition of any Company Shares. (f) Company Capitalization. The entire authorized capital stock of the ---------------------- Company consists of 1,000 shares of common stock, of which only the 1,000 Company Shares held beneficially and of record by the Seller are issued and outstanding. All of the issued and outstanding Company Shares have been duly authorized and are validly issued, fully paid and nonassessable and were not issued in violation of the preemptive rights of any person. Except for the Company Shares, there are outstanding (i) no shares of capital stock or other voting securities of the Company; (ii) no securities of the Company convertible into or exchangeable for shares of capital stock or other voting securities of the Company; and (iii) no options, warrants, calls, rights (including preemptive rights), commitments or agreements to which the Company or Seller or any Affiliate of Seller is a party or by which any of them is bound in any case obligating the Company or Seller or any Affiliate of Seller to issue, deliver, sell, purchase, redeem or acquire, -3- or cause to be issued, delivered, sold, purchased, redeemed or acquired, additional shares of capital stock or other voting securities of the Company, or obligating the Company, the Seller or any Affiliate of Seller to grant, extend or enter into any such option, warrant, call, right, commitment or agreement. (g) Company Financial Statements. Attached hereto as Schedule 4.1(g) are ---------------------------- the following financial statements (collectively the "Financial Statements"): (i) audited Consolidated Financial Statements for the Company and Subsidiaries, including Consolidated Balance Sheets - December 31, 1998 and 1997; Consolidated Statements of Operations - For the Years Ended December 31, 1998, 1997 and 1996; Consolidated Statement of Stockholders Equity - For the Period From January 1, 1996 Through December 31, 1998; and Consolidated Statements of Cash Flows - For the Years Ended December 31, 1998, 1997 and 1996; and (ii) unaudited Consolidated Financial Statements for the Company and Subsidiaries, including Consolidated Balance Sheet as of March 31, 1999 and 1998; Consolidated Statement of Operations For the three months ended March 31, 1999; Consolidated Statement of Stockholders Equity For the three months ended March 31, 1999, and the year ended December 31, 1998; and Consolidated Statements of Cash Flows For the three months ended March 31, 1999 and 1998 (the "Most Recent Financial Statements"). The Financial Statements present fairly, in all material respects and in accordance with GAAP applied on a consistent basis throughout the periods covered, the financial condition of the Company as of such dates and the results of operations and cash flows of the Company for such periods; provided, however, that (1) the Most Recent Financial Statements are subject to normal year-end adjustments and lack footnotes and other presentation items and (2) no representation or warranty is made under this subsection with respect to the title of the Company to any Subject Interests, any matters addressed in any Reserve Report or in Section 3.3, any pending or threatened Actions, any Plugging and Abandonment Obligations, or the existence, non-existence or effect of any Environmental Condition, Environmental Claims, Offsite Environmental Matters, Environmental Liabilities, Environmental Defects or Environmental Matters. With respect to Plugging and Abandonment Obligations, Seller does represent and warrant that its estimates of the Company's share of the costs to plug and abandon existing wells included in the Wells or Units are in accordance with GAAP and reflect all notices received from any Governmental Authority or any operator with respect to the plugging and abandonment of any such wells. (h) No Conflict or Violation. Except for any exceptions set forth in ------------------------ Section 4.1(i) (or Schedule 4.l(i)) , neither the execution and delivery of this Agreement nor the consummation of the transactions and performance of the terms and conditions contemplated hereby by Seller will (i) conflict with or result in a violation or breach of or default under any provision of the certificate of incorporation, by-laws or other similar governing documents of Seller or the Company, (ii) conflict with or result in a violation or breach of or default under any agreement, indenture or other instrument under which Seller or the Company is bound, other than such conflicts, breaches, violations or defaults as will not have a Material Adverse Effect, or (iii) violate or conflict with any Law applicable to Seller or the Company or the properties or assets of Seller or the Company. -4- (i) Consents. Except for the consents, filings, notices or preferential -------- or preemptive rights expressly described and set forth in Schedule 4.1(i) (the "Unobtained Consents") or the failure of which to obtain or with which to comply will not have a Material Adverse Effect, no consent, approval, authorization or permit of, or filing with or notification to, or waiver or non-exercise of any preferential or preemptive rights by any Person (including, without limitation, any consent under the Public Utility Holding Company Act of 1935, as amended) is required for or in connection with the execution and delivery of this Agreement by Seller or for or in connection with the consummation of the transactions and performance of the terms and conditions contemplated hereby by Seller or the Company. (j) Actions. Except as set forth on Schedule 4.1(j), there is no Action ------- pending against the Company or, to the knowledge of Seller, pending against the Assets or threatened against the Company or the Assets, other than Actions which are not reasonably likely to have a Material Adverse Effect. (k) Compliance With Laws. To the knowledge of Seller and except as set -------------------- forth on Schedule 4.l(k), the Company is not in violation of any Law, other than violations of Law which are not reasonably likely to have a Material Adverse Effect; provided that, Seller makes no representation or warranty, express or implied with respect to any Environmental Law, any Tax Law or any employee benefit plans or arrangements except as respectively set forth in Sections 4.1(p), 4.1(q) and 4.1(r). (l) Advisors' and Brokers' Fees. Seller has engaged CIBC World Markets as --------------------------- its financial advisor in connection with the transactions contemplated by this Agreement. Neither Seller nor any Affiliate of Seller has retained any other advisor or broker in respect of the transactions contemplated by this Agreement for which Buyer or the Company are liable or shall incur any liability. (m) Bankruptcy. There are no bankruptcy, reorganization or arrangement ---------- proceedings pending against, being contemplated by, or, to the knowledge of Seller, threatened against Seller or the Company. (n) Material Contracts. To the knowledge of Seller, Schedule 4.1(n) sets ------------------ forth a complete list of the following contracts, agreements or commitments to which the Company is a party or by which the Company or its Assets are bound: (1) any written or oral contract or agreement with Seller or any Affiliate of Seller relating to the provision of goods or services which will survive the Closing; (2) any contract, agreement or commitment that commits the Company to aggregate expenditures with respect to the Company's interest of more than $100,000 in any calendar year, excluding (i) the Subject Interests and any contracts or agreements creating interests in the Subject Interests or in any Wells or Units, (ii) joint operating -5- agreements, (iii) unitization or pooling agreements, and (iv) any contracts, agreements or commitments listed pursuant to other clauses of this Section 4.1(n); (3) any lease, sublease, installment purchase or similar arrangement for the use or occupancy of any land, building or other real property, excluding (i) interests in the Subject Interests or in any Wells or Units, (ii) surface leases not material to the operation of the Subject Interests, and (iii) leases of real property which involve aggregate expenditures or receipts by the Company of $100,000 or less in any calendar year; (4) any indenture, trust agreement, loan agreement or note under which the Company has outstanding indebtedness for borrowed money or with respect to which the Company has guaranteed the obligations of any other Person for borrowed money; (5) any agreement of surety, guarantee or indemnification by the Company outside of the ordinary course of the Company's business; and (6) any covenant not to compete or area of mutual interest agreement (collectively the "Material Contracts"). (o) Events Subsequent to Report Date. Except in each case as set forth in -------------------------------- Schedule 4.1(o), Schedule 4.1(r) and Section 7.2(b), or as otherwise disclosed in the Financial Statements, since the Report Date the Company has engaged in business in a manner consistent with its past practices, and to the knowledge of Seller there has not been any: (1) destruction, damage to, or loss of any Assets of the Company that (after giving effect to any insurance coverage with regard thereto) is reasonably likely to have a Material Adverse Effect; (2) change in accounting policies or practices (including, without limitation, any change in depreciation or amortization policies) by the Company, except as required under GAAP; (3) sale or other disposition of any properties or assets of the Company except (i) in the ordinary course of business having a value of less than $50,000,. or (ii) any item of personal property or equipment having a value of less than $25,000; (4) employment agreement (not terminable at will) entered into by the Company or any material increases in the compensation payable to any officers or employees of the Company (other than increases for employees who are not officers of the Company made in the ordinary course of business and consistent with past practice); -6- (5) (i) dividend or other distribution in respect of the Company Shares or (ii) other transactions between the Company and the Seller or any Affiliate of Seller; (6) change in any Plan or Benefit Arrangement, except as required by Law; (7) labor dispute, strike or similar work stoppages or, to the knowledge of Seller, threats thereof by or with respect to persons employed by the Company; or (8) settlement entered into or consent made to any order, decree or judgment relating to or arising out of any Action relating to the Company which is reasonably likely to have a Material Adverse Effect. (9) notice from any Governmental Authority or any operator with respect to the plugging and abandonment of any Well. (10) material adverse change in the business or financial condition of the Company. For purposes hereof a material adverse change means an unfavorable or adverse change or occurrence, or the result thereof, which causes the business, operations, financial condition, prospects or properties of the Company and its Subsidiaries as a whole to be materially impaired or reduced. (p) Environmental Matters. Except as set forth in Schedule 4.1(p)), --------------------- Seller has no knowledge of any Environmental Claim or Offsite Environmental Matter, other than Environmental Claims and Offsite Environmental Matters which, either individually or in the aggregate, are not reasonably likely to have a Material Adverse Effect. (q) Tax Matters. With respect to the Company, except as set forth in ----------- Schedule 4.1(q), (i) all reports, returns, statements (including, without limitation, estimated reports, returns, or statements), and other similar filings required to be filed on or before the Closing Date by the Company (or the common parent of the affiliated, consolidated, combined and/or unitary group of which the Company is a member) (the "Tax Returns") with respect to any Taxes have been or will be timely filed with the appropriate governmental agencies in all jurisdictions in which such Tax Returns are required to be filed; (ii) the Tax Returns are or will be true and correct in all material respects, and all Taxes reported on such returns, and all other material Taxes of the Company that are due on or prior to the Closing Date (except those Taxes that are being disputed in good faith and for which adequate provision has been made in the Company's Financial Statements to the extent required by GAAP), have been or will be paid; (iii) the Company (or the common parent of the affiliated, consolidated, combined and/or unitary group of which the Company is a member) has not extended or waived the application of any statute of limitations of any jurisdiction regarding the assessment or collection of any Tax; (iv) there are no audits, claims, proposed or final deficiency notices, assessments, levies, administrative proceedings, or lawsuits pending or, to the knowledge of Seller, threatened against the Company by any taxing -7- authority; (v) there are no liens for Taxes upon any of the Assets except liens for Taxes not yet delinquent; (vi) the Company does not have any liability for the Taxes of any Person other than the Company under Treasury Regulation Section 1.1502-6 (or any similar provision of state, local or foreign tax law); (vii) no agreements relating to the allocation or sharing of, or liability or indemnification for, Taxes exist among the Company and any other Person; (viii) all Taxes required by law to be withheld or collected by the Company (including, but not limited to, Taxes required to be withheld with respect to amounts paid or owing to any officer, employee, creditor, stockholder, independent contractor or other person) have been timely withheld or collected and, to the extent required by Law, have been timely paid, remitted or deposited to or with the relevant taxing authority in all material respects; (ix) no closing agreement or agreement pursuant to Section 7121 of the Code or any similar provision of any state, local or foreign law has been entered into by or with respect to the Company, and the Company has not agreed to make any adjustment pursuant to Section 481(a) of the Code (or any predecessor provision) by reason of any change in any accounting method of the Company, which requires the Company to include any item of income in, or exclude any item of deduction from, any Tax Return; (x) the Company has not filed a consent under Section 341(f) of the Code concerning collapsible corporations; (xi) the Company has not made any material payments nor is it obligated to make material payments, nor is it a party to any agreement that under certain circumstances could obligate it to make any material payments that will not be deductible under Section 280G of the Code; (xii) except for Taxes resulting from any Section 338(h)(10) Election, the unpaid income Taxes of the Company do not as of the Most Recent Financial Statements for the Company, exceed the reserve for Tax liability (rather than any reserve for deferred taxes established to reflect timing differences between book and tax income) set forth on the face of the Most Recent Financial Statements for the Company (rather than in any notes thereto) and will not exceed that reserve as adjusted for operations and transactions through the Closing Date in accordance with past custom and practice in the filing of the Company's Tax returns; (xiii) the Company has not been a member of an affiliated group of corporations filing a consolidated federal income Tax Return other than a group the common parent of which is Seller; and (xiv) all material income Taxes owed by any affiliated group with which Company has filed a consolidated return have been or will be paid for each taxable period during which Company was a member of such group. (r) Employee Benefit Plans. ---------------------- (1) List of Plans. Except to the extent of obligations provided for ------------- under Section 7.2(b), Schedule 4.1(r) includes a complete and accurate list of all material employee benefit plans as defined in section 3(3) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA") ("Plans"), and material benefit arrangements that are not Plans ("Benefit Arrangements"), including, but not limited to any (A) incentive bonus or deferred bonus arrangements, (B) arrangements providing termination allowance, severance or similar benefits, (C) equity compensation plans, (D)deferred compensation plans, (E) employee assistance programs, (F) vacation policies, and (G) stock option plans that are currently in effect or were maintained within three years of the Closing Date, or have been approved before the Closing Date but are not yet -8- effective, for the benefit of directors, officers, employees or former employees (or their beneficiaries) of the Company or with respect to which the Company would have any liability. (2) Compliance. Except as otherwise disclosed in Schedule 4.1(r), ---------- with respect to each Plan listed on Schedule 4.1(r), (i) the plan is in material compliance with ERISA in all respects, including but not limited to the reporting and disclosure requirements of Part 1 of Subtitle B of Title I of ERISA; (ii) there has been no transaction described in section 406 or 407 of ERISA or section 4975 of the Code relating to the plan unless exempt under section 408 of ERISA or section 4975 of the Code, as applicable; (iii) the bonding requirements of section 412 of ERISA have been satisfied; and (iv) there is no litigation, action, proceeding, investigation or claim asserted or, to the Seller's knowledge, threatened (other than the payment of benefits in the normal course). All group health plans maintained by the Company have been operated in material compliance with section 4980B of the Code. (3) Severance Pay and Medical Coverage. Except as provided under ---------------------------------- Section 7.2(b) or as disclosed on Schedule 4.1(r), no plan, arrangement or agreement with any one or more employees will cause, and the execution, delivery and performance of this Agreement by Seller will not cause, the Company to have liability for severance pay as a result of the consummation of the transactions described in this Agreement. The Company's liability for severance pay will be funded exclusively through the Employee Benefits Trust described in Section 7.2(b). Except as provided under Section 7.2(b) or as disclosed on Schedule 4.1(r), the Company does not provide employee post-retirement medical coverage or contribute to or maintain any plan or arrangement that provides for medical coverage following termination of employment except as is required by section 4980B(f) of the Code, nor has it made any representations, agreements, covenants or commitments to provide that coverage. (4) Certain Pension Plans. The terms of all pension plans listed in --------------------- Schedule 4.1(r) to this Agreement that are intended to qualify under section 401(a) of the Code (i) have been determined by the IRS to be qualified under section 401(a) of the Code or (ii) the applicable remedial amendment periods will not have ended before the Closing Date. Except as disclosed on Schedule 4.1(r), neither Seller nor the Company has any knowledge of any event or circumstance that would jeopardize the tax qualified status of the Plans listed in Schedule 4.1(r). (5) No Multiemployer Pension Plans. Neither the Company nor any ------------------------------ entity (whether or not incorporated) that was at any time during the six years before the Closing Date treated as a single employer together with the Company under section 414 of the Code has ever maintained, had any obligation to contribute to or incurred any liability with respect to a pension plan that is or was subject to the provisions of Title IV of ERISA or section 412 of the Code. -9- (s) Subsidiaries. Except as set forth in Schedule 4.1(s), the Company ------------ does not have any Subsidiaries. Each such Subsidiary is a corporation duly organized, validly existing and in good standing under the laws of the state of its incorporation and is duly qualified to do business, and is in good standing, in each jurisdiction in which the properties owned or leased by it make such qualification necessary, except where the failure to so qualify and be in good standing will not have a Material Adverse Effect. The Company holds of record and owns beneficially all outstanding shares issued and outstanding of such Subsidiaries, free and clear of any security interests, liens, options, warrants, purchase rights, or other encumbrances (except restrictions on sales of stock under applicable securities laws), and there is no option, warrant, purchase right, or other contract or commitment that could require the Company to sell, transfer, or otherwise dispose of any of the shares of such Subsidiaries, nor is the Company a party to any voting trust, proxy, or other agreement or understanding with respect to the voting, holding or disposition of such shares. (t) No Default. To the knowledge of Seller, the Company is not in default ---------- under any term or provision of any of the Material Contracts in any material respect. (u) Royalties. Except (i) for matters which, individually or in the --------- aggregate, are not reasonably likely to have a Material Adverse Effect, and (ii) for matters which would not result in the cancellation or loss of title in a Subject Interest, all royalties, overriding royalties and other similar payments due and payable on production with respect to a Subject Interest have been timely and fully paid, except amounts that are being held in suspense for title and other reasons which are customary in the industry and which suspense will not result in grounds for cancellation of the Company's rights in such Subject Interest. (v) Employees. The Company is not a party to or subject to any collective --------- bargaining agreement. To the knowledge of Seller, no collective bargaining agent has been certified as a representative of any of the employees or former employees of the Company. To the knowledge of Seller, no union organizational campaign is currently pending with respect to any of the employees or former employees of the Company. (w) Information Regarding Subject Interests. --------------------------------------- (1) Except as set forth in Schedule 4.1(w), there is no contract, commitment or agreement binding on the Subject Interests which provides for the approval of specific capital expenditures by the Company or Seller and under which the Company or Seller has approved future capital expenditures in excess of $100,000. (2) Except as set forth in Schedule 4.1(w), this Agreement and any document executed in connection herewith, there are no agreements or arrangements relating to the Subject Interests with Seller or any Affiliate of Seller that will be binding on Buyer, the Company or the Subject Interests after the Closing. -10- (3) Except as set forth in Schedule 4.1(w), there are no contracts, commitments or agreements for the sale or other disposition of oil, natural gas or natural gas liquids attributable to the Subject Interests having a term in excess of one year that are not terminable without penalty on 90 days' notice or less. (x) Wells and Units. Without representing or warranting the Company's --------------- title therein, the Property Schedule sets forth in all material respects a complete listing of all Wells and Units in which the Company owns an interest, together with the locations thereof and the Company's Net Revenue Interests and Working Interests therein. (y) Permits. Except for those with respect to Environmental Laws, which ------- are addressed exclusively in Sections 4.1(p) and 5.3, the Company has, and, to the knowledge of Seller, each other Person who operates a Well or Unit has, obtained all material permits, licenses, franchises, authorities, consents and approvals necessary for owning and operating the Wells and Units as presently operated, and all such permits, licenses, franchises, authorities, consents and approvals are in full force and effect, except such failures as would not, individually or in the aggregate, have a Material Adverse Effect. (z) Personal Property. Subject to the repairs, maintenance and ----------------- replacements contemplated by the capital expenditures referenced in Schedule 4.1(n), all equipment and all vehicles owned or leased by the Company and currently used by the Company in connection with the operation of the Wells and Units have been maintained in an operable state of repair adequate to maintain normal operations in a manner consistent with the Company's past practices, except such failures to maintain as would not, individually or in the aggregate, have a Material Adverse Effect. (aa) Public Utility Holding Company Act. Except as set forth in Schedule ---------------------------------- 4.1(aa), neither the Company nor Seller nor any of the Subsidiaries is a "holding company" or a "subsidiary company" of a "holding company" or an "affiliate" of either a "holding company" or a "subsidiary company" of a "holding company," in each case within the meaning of the Public Utility Holding Company Act of 1935, as amended. Further, neither the Company nor any of the Subsidiaries is a "public utility company" or an "electric utility company" or a "gas utility company, " in each case within the meaning of the Public Utility Holding Company Act of 1935, as amended. (bb) Investment Company Act. The Company is not an "investment company" ---------------------- within the meaning of the Investment Company Act of 1940, as amended, and the Seller is not required to register under the Investment Company Act of 1940, as amended. (cc) Seller's Knowledge. Seller has no knowledge of any fact which results ------------------ in any representation or warranty of Buyer in Section 4.2 being breached. If after the date of this Agreement, Seller obtains knowledge of any fact which results in any representation or warranty of Buyer in Section 4.2 being breached, Seller will immediately furnish Buyer written notice -11- thereof. This Section 4.1(cc) shall not apply to Buyer's representation and warranty in Section 4.2(i). (dd) Representations and Warranties re Company. To the extent that the ----------------------------------------- foregoing representations of Seller relate to the Company, such representations and warranties are for the purpose of establishing whether Buyer's closing conditions have been satisfied under Section 9.2 and shall not form the basis for any claim, action, suit or proceeding based on a breach thereof. (ee) Y2K Representation and Warranty. The Company has made inquiries of ------------------------------- the suppliers and manufacturers of its computer systems, including equipment supplied by third parties, and has been advised that such systems are Y2K Compliant except in the case of the Company's property management software which is currently under review regarding Y2K compliance. Except for costs associated with the items set forth on Schedule 4.1(ee), the cost to the Company of the reasonably foreseeable consequences of the failure of the Company's computer systems to be Y2K Compliant cannot be reasonably expected to have a Material Adverse Effect. For purposes hereof, "Y2K Compliant" means that the Company's computer systems, including equipment supplied by third parties, will record, process, calculate and present calendar dates falling on and after January 1, 2000 and calculate information dependent on or relating to such dates in the same manner and with the same functionality, data integrity and performance as such systems record, process, calculate and present calendar dates on or before December 31, 1999 or calculate any information dependent on or relating to such dates. Section 4.2 Representations and Warranties of Buyer. Buyer represents --------------------------------------- and warrants to Seller as follows: (a) Organization and Qualification. Buyer is a corporation duly organized, ------------------------------ validly existing and in good standing under the laws of the Province of Alberta, Canada, and has the requisite corporate power to carry on its business as it is now being conducted. (b) Authority. Buyer has all requisite corporate power and authority to --------- execute and deliver this Agreement and to perform its obligations under this Agreement. The execution, delivery and performance of this Agreement and the transactions contemplated hereby have been duly and validly authorized by all requisite corporate action on the part of Buyer. (c) Enforceability. This Agreement constitutes a valid and binding -------------- agreement of Buyer enforceable against Buyer in accordance with its terms, subject to (i) applicable bankruptcy, insolvency, reorganization, moratorium and other similar laws of general application with respect to creditors, (ii) general principles of equity and (iii) the power of a court to deny enforcement of remedies generally based upon public policy. (d) No Conflict or Violation. Neither the execution and delivery of this ------------------------ Agreement nor the consummation of the transactions and performance of the terms and conditions contemplated hereby by Buyer will (i) conflict with or result in a violation or breach of any provision of the certificate of incorporation, bylaws or other similar governing documents of -12- Buyer or any material agreement, indenture or other instrument under which Buyer is bound or (ii) violate or conflict with any Law applicable to Buyer or the properties or assets of Buyer. (e) Consents. No consent, approval, authorization or permit of, or filing -------- with or notification to, any Person (including, without limitation, any consent under the Public Utility Holding Company Act of 1935, as amended) is required for or in connection with the execution and delivery of this Agreement by Buyer or for or in connection with the consummation of the transactions and performance of the terms and conditions contemplated hereby by Buyer, except for such consents, approvals, authorizations, permits, filings and notifications the failure of which to obtain or make are not reasonably likely to have a material adverse effect on the ability of Buyer to consummate and perform the transactions contemplated by this Agreement. (f) Actions. There is no Action pending against Buyer or, to the knowledge ------- of Buyer, threatened against Buyer, other than Actions which are not reasonably likely to have a material adverse effect on the ability of Buyer to consummate and perform the transactions contemplated by this Agreement. (g) Advisors' and Brokers' Fees. Neither Buyer nor any Affiliate of Buyer --------------------------- has retained any advisor or broker in respect of the transactions contemplated by this Agreement for which Seller or the Company are liable or shall incur any liability. (h) Qualified Owner. The consummation of the transactions contemplated --------------- hereby will not cause Buyer or the Company to be disqualified as an owner of any federal or state oil, gas and mineral lease or to exceed any acreage limitation imposed by any statute, rule, regulation or order of governmental authority. (i) Funds. Buyer has, and at all times prior to Closing will have, ----- sufficient funds available to enable Buyer to consummate the transactions contemplated hereby and to pay the Closing Payment and all related fees and expenses of Buyer. (j) Buyer's Knowledge. Buyer has no knowledge of any fact which results ----------------- in any representation or warranty of Seller in Section 4.1 being breached. If after the date of this Agreement, Buyer obtains knowledge of any fact which results in any representation or warranty of Seller in Section 4.1 being breached, Buyer will immediately furnish Seller written notice thereof. (k) No Distribution. Buyer is an experienced and knowledgeable investor in --------------- the oil and gas business. Prior to entering into this Agreement, Buyer was advised by its counsel and such other persons it has deemed appropriate concerning this Agreement and has relied solely on an independent investigation and evaluation of, and appraisal and judgment with respect to, the geologic and geophysical characteristics of the Subject Interests, the estimated reserves recoverable therefrom, and the price and expense assumptions applicable thereto. Buyer is an "accredited investor," as such term is defined in Regulation D of the Securities Act of 1933, as -13- amended, and will acquire the Company Shares for its own account and not with a view to a sale or distribution thereof in violation of the Securities Act of 1933, as amended, and the rules and regulations thereunder, any applicable state blue sky laws or any other applicable securities laws. (1) Bankruptcy. There are no bankruptcy, reorganization or arrangement ---------- proceedings pending against, being contemplated by, or to the knowledge of Buyer, threatened against Buyer. ARTICLE 5 ACCESS TO INFORMATION; ENVIRONMENTAL MATTERS; ETC. -------------------------------------------------- Section 5.1 General Access. Subject to Section 5.4 (which shall govern -------------- all environmental reviews, inspections and audits), promptly following the execution of this Agreement and until the Closing Date (or earlier termination of this Agreement), Seller shall cause the Company (i) to permit Buyer and its representatives to have reasonable access at reasonable times in the Company's offices, and in a manner so as not to interfere unduly with the business operations of the Company, to the Company's books, records, contracts, abstracts of title, title opinions, title files, ownership maps, lease files, assignments, division orders, Reserve Reports and documents relating to the Assets or the Company insofar as the same are in the Company's or Seller's possession and insofar as the Company and Seller may do so without (a) violating legal constraints or any legal obligation or (b) waiving any attorney/client, work product or like privilege and (ii), subject to any required consent of any third Person (other than an Affiliate of Seller), to permit Buyer and its representatives at reasonable times and at Buyer's sole risk, cost and expense, to conduct, in the presence of Company representatives, reasonable inspections of the Assets; provided, however, Buyer shall repair any damage to the Assets resulting from such inspections and Buyer does hereby indemnify and hold harmless, release and agree to defend the Seller Indemnified Parties and the Company from and against any and all losses, costs, damages, obligations, claims, liabilities, expenses and causes of action to the extent arising from Buyer's inspection of the Assets, including, without limitation, claims for personal injuries, property damage and reasonable attorney's fees and expenses, regardless of the form of claim whether at common law, strict liability negligence under any statute or regulation. However, except to the extent such inspections materially contribute to, materially aggravate or materially adversely affect an Environmental Defect, such indemnification shall not extend to any Environmental Defect discovered in the course of such inspections, shall expire upon the Closing and shall not in any way affect or limit Seller's liabilities or responsibilities with respect to any Environmental Defect. Nothing in this Article V shall be construed to permit Buyer or its representatives to have access to any files, records, contracts or documents of Seller relating to this transaction, including, without limitation, any bids or offers received by Seller or the Company for the sale of the Company or any of the Company's assets in competition with the Buyer's bid or offer, it being agreed that any such competing bids or offers shall be the sole property of the Seller. -14- Section 5.2 Confidential Information. Unless and until the Closing ------------------------ occurs, Buyer agrees to maintain all information made available to it pursuant to this Agreement confidential and to cause its officers, employees, representatives, consultants and advisors to maintain all information made available to them pursuant to this Agreement confidential, all as provided in that certain confidentiality agreement dated May 10, 1999 (the "Confidentiality Agreement"), by and between Seller and Buyer, the terms of which are incorporated herein by reference and made a part of this Agreement. Section 5.3 No Warranty or Representation. Except for Seller's warranty ----------------------------- and representation in Section 4.1(p), Seller makes no warranty or representation, express or implied, statutory or otherwise, with respect to any Environmental Matters (including, without limitation, any Environmental Condition, Environmental Claim or Offsite Environmental Matter) and Buyer hereby acknowledges and agrees that Buyer's sole remedy for any Environmental Matter (including, without limitation any Environmental Defect, Environmental Condition, Environmental Claim or Offsite Environmental Matter) with respect to any of the Assets or the Company shall be pursuant to the Seller's limited warranty and representation in Section 4.1(p)) (which shall not survive the Closing) and the procedures set forth in Sections 5.4 and 5.5. Furthermore, without limiting the provisions of the Confidentiality Agreement (which shall continue in full force and effect) and except for the express representations and warranties contained in Section 4.1, Seller makes no warranty or representation, express, implied, statutory or otherwise, with respect to the accuracy or completeness of the information, records and data now, heretofore or hereafter made available to Buyer in connection with this Agreement, including, without limitation, any description of the Assets, pricing assumptions, potential for production of oil, gas or other hydrocarbons from the Subject Interests, projected development costs, projected plugging and abandonment costs or any other matters contained in or related to the Reserve Reports, any environmental information, or any other material furnished to Buyer by Seller, the Company or any other source, including any of their respective directors, officers, employees, counsel, agents or advisors. Section 5.4 Environmental Review and Audit. ------------------------------ (a) Environmental Access. For a period of forty-five (45) days following -------------------- the execution of this Agreement (the "Environmental Examination Period") and subject to the restrictions contained in this Agreement and any required consent or waiver of any third Person (other than an Affiliate of Seller), Seller shall cause the Company (i) to permit Buyer and its representatives to have reasonable access at reasonable times in the Company's offices, and in a manner so as not to interfere unduly with the business operations of the Company, to Seller's and the Company's environmental files and records in the Seller's or the Company's possession relating to the Assets or any property formerly owned or operated by the Company insofar as Seller and the Company may do so without waiving any attorney/client, work product or like privilege and (ii) to permit Buyer and the Environmental Consultant to have reasonable access to the Assets for the purpose of allowing Buyer and the Environmental Consultant to inspect and/or -15- audit the Assets for any Environmental Defects (collectively, "Buyer's Environmental Review"), all at Buyer's sole risk, cost and expense. (b) Conduct of Review. Prior to conducting Buyer's Environmental Review, ----------------- Buyer shall furnish Seller with a proposed scope of Buyer's Environmental Review, including a description of the activities to be conducted and the locations of such activities. No third Person, other than the Environmental Consultant and Buyer's employees and attorneys, may conduct Buyer's Environmental Review. Buyer shall not commence any activity proposed to be included in Buyer's Environmental Review unless and until such activity (including the location thereof) has been approved in writing by Seller, which approval shall not be unreasonably withheld and shall be given or denied within two Business Days after Buyer furnishes Seller with reasonably sufficient information with respect to such activity. Seller or its representative shall have the right to be present during any inspection (including Buyer's Environmental Review) of the Assets and shall have the right, at its option and expense, to split samples with Buyer. (c) Buyer Responsibility for Review. In connection with Buyer's ------------------------------- Environmental Review, Buyer agrees that Buyer, the Environmental Consultant and Buyer's employees, agents and contractors shall comply with all Laws and shall exercise due care with respect to the Assets and their condition, taking into consideration the characteristics of any wastes or substances found thereon, and in light of all relevant facts and circumstances. Specifically, but without limitation, when handling solid waste or hazardous substances, if any, discovered during the inspection of the Assets, Buyer, the Environmental Consultant and Buyer's employees, agents and contractors shall handle such waste or substances in accordance with all Laws. Any soil or water samples taken by Buyer from the Assets shall be managed by Buyer consistent with the applicable rules and regulations of the U.S. Environmental Protection Agency and applicable state agencies with regulatory authority, provided, the Company shall be identified as the generator of such samples. Promptly after completing Buyer's Environmental Review, Buyer shall, at its sole cost and expense, restore the Assets to substantially the same condition the Assets were in at the time of Buyer's entry thereon, in accordance with good engineering practice, if changed due to Buyer's Environmental Review. Failure by Buyer to comply with the requirements of this subsection within a reasonable time period will entitle (but shall not obligate) Seller or the Company to take any action deemed necessary or appropriate by Seller or the Company to correct such failure after written notice to Buyer, all at Buyer's expense. Buyer shall maintain and shall cause its officers, employees, agents, representatives, contractors, consultants (including the Environmental Consultant) and advisors to maintain all information obtained by Buyer and the Environmental Consultant pursuant to the Buyer's Environmental Review as strictly confidential and shall not disclose same to any third Person without the prior written consent of Seller, except to the extent required by Law. Buyer shall provide Seller's counsel with copies of any final written reports prepared and analytical test results received by Buyer or the Environmental Consultant promptly following Buyer's or the Environmental Consultant's preparation or receipt of same. Buyer does hereby indemnify and hold harmless, release and agree to defend the Seller Indemnified Parties and the Company from and against any and all losses, costs, damages, obligations, claims, liabilities, expenses and causes of action, -16- including all Environmental Liabilities, to the extent arising out of any violation by Buyer or Buyer's officers, employees, agents, representatives, contractors, consultants (including the Environmental Consultant) and advisors of the provisions of this subsection or from the inspection or testing of the Assets conducted by or on behalf of Buyer, including, without limitation, claims for personal injuries, property damage and reasonable attorney's fees and expenses, regardless of the form of claim whether at common law, strict liability, negligence or under any statute or regulation. However, except to the extent such inspections or testings materially contribute to, materially aggravate or materially adversely affect an Environmental Defect, such indemnification shall not extend to any Environmental Defect discovered in the course of such inspections and testings, shall expire upon the Closing and shall not in any way affect or limit Seller's liabilities or responsibilities with respect to any Environmental Defect. Section 5.5 Environmental Defects. --------------------- (a) Buyer's Assertions of Environmental Defects. Prior to the expiration ------------------------------------------- of the Environmental Examination Period, Buyer may notify Seller in writing of any matters which, in Buyer's reasonable opinion, constitute Environmental Defects. Buyer's written notice must include (i) a specific description of each Asset (or portion thereof) that is affected by the alleged Environmental Defect, (ii) a description of the alleged Environmental Defect and the facts and circumstances giving rise thereto, including all evidence compiled by Buyer which supports the existence of such alleged Environmental Defect, and (iii) a calculation of the Remediation Amount (itemized in reasonable detail) that Buyer asserts is attributable to such Environmental Defect. Buyer's calculation of the Remediation Amount must describe the Remediation proposed for the Environmental Condition that gives rise to the asserted Environmental Defect and identify all material assumptions used by the Buyer in calculating the Remediation Amount, including the standards the Buyer asserts must be met to comply with Environmental Laws. (b) Seller's Rights and Elections. If Buyer timely notifies Seller in ----------------------------- writing of any Environmental Defect as required by Section 5.5(a), Seller shall have the right to then or thereafter dispute the existence of such Environmental Defect and/or the alleged Environmental Defect Amount asserted with respect thereto in accordance with the provisions of Section 6.5 of this Agreement. In addition, Seller, at its option, shall elect, at or prior to the Closing, one of the following options with respect to the Assets affected by the alleged Environmental Defect and, at Seller's option, any other Assets which form part of any field or other economic operating unit which includes such affected Assets (collectively, the "Environmental Defect Property"): (i) leave such Environmental Defect Property in the Assets and assume responsibility for the Remediation of such Environmental Defect; provided that, all costs for Remediation shall first be borne by Buyer to the extent Seller elects to apply any of the Environmental Defect Deductible to such costs; or (ii) leave such Environmental Defect Property in the Assets and reduce the Purchase Price by the Environmental Defect Amount with respect to such Environmental -17- Defect (taking into account any application of the Environmental Defect Deductible which Seller elects to make with respect thereto). If Seller elects the option set forth in clause (ii) above, Buyer shall be deemed to have assumed responsibility for Remediation of such Environmental Defect and such Environmental Defect shall be deemed to constitute a Company Liability. If Seller elects the option set forth in clause (i) above, Seller shall use commercially reasonable efforts to implement such Remediation in a manner which is consistent with the requirements of Environmental Laws and the provisions of any applicable lease, and Seller shall have access to the Environmental Defect Property after the Closing Date to implement and complete such Remediation in accordance with this section and an Access Agreement in substantially the form attached hereto as Exhibit 5.5(b) (the "Access Agreement"). Seller will be deemed to have adequately completed the Remediation required in the immediately preceding sentence (a) (i) upon receipt of a certificate or approval from the applicable state or federal authority that the Remediation has been implemented to the extent necessary to comply with existing regulatory requirements or (ii) upon receipt of a certificate from a licensed professional engineer if the approval or certification specified in (i) cannot be obtained because provision for such approval or certification is not provided under federal or state law and (b) to the extent express approval from the lessor is required under any applicable lease, upon receipt of such approval. (c) Environmental Defect Amount. If Seller elects the option set forth in --------------------------- Section 5.5(b)(ii) with respect to one or more Environmental Defects, then as Buyer's sole and exclusive remedy with respect to such Environmental Defects, Buyer shall be entitled to reduce the Purchase Price by the amount (the "Environmental Defect Amount"), if any, by which the Remediation Amount with respect to the Environmental Conditions giving rise to such Environmental Defects exceeds that part, if any, of $500,000 (the "Environmental Defect Deductible") which Seller elects to apply as an offset or deduction against such Remediation Amount. Seller may also apply any part of the Environmental Defect Deductible to the cost of any Remediation undertaken by Seller pursuant to the option set forth in Section 5.5(b)(i). Any Remediation costs to which Seller elects to apply the Environmental Defect Deductible shall be borne by the Buyer. Seller shall have the right from time to time upon written notice to Buyer to reallocate and change its application of the Environmental Defect Deductible, except to the extent of Remediation costs already incurred or contracted for by Buyer based on Seller's previous application thereof. It is expressly understood and agreed that the Environmental Defect Deductible represents an aggregate deductible for Environmental Defects which may be apportioned as provided in this Section 5.5(c) rather than as a separate deductible for each individual Environmental Claim. (d) Waiver by Buyer. If, prior to the expiration of the Environmental --------------- Examination Period, the Buyer has knowledge of an Environmental Defect and does not notify Seller in writing of the existence thereof on or before the expiration of the Environmental Examination Period (including, without limitation, any Environmental Defect noted or described in any oral or written report prepared by the Environmental Consultant), the Buyer shall be deemed to have -18- waived such Environmental Defect and such Environmental Defect shall be deemed to constitute a Company Liability. In addition, all conditions and matters of which Buyer has knowledge prior to the expiration of the Environmental Examination Period and which would have constituted Environmental Defects but for the $50,000 threshold limitation set forth in the definition of Environmental Defect shall be deemed to constitute Company Liabilities. ARTICLE 6 TITLE ADJUSTMENTS ----------------- Section 6.1 No Title Warranty or Representation. Without limiting ----------------------------------- Buyer's right to adjust the Purchase Price by operation of Section 6.2, Seller makes no warranty or representation, express, implied, statutory or otherwise, with respect to the Company's title to any of the Assets and Buyer hereby acknowledges and agrees that Buyer's sole remedy for any defect of title, including any Title Defect, with respect to any of the Assets shall be pursuant to the procedures set forth in this Article VI, which remedies shall cease, and be deemed to be finally and conclusively satisfied, in all respects, upon the Closing. Section 6.2 Buyer's Title Review. -------------------- (a) Buyer's Assertion of Title Defects. For a period of forty-five (45) ---------------------------------- days following the execution of this Agreement (the "Title Examination Period"), Buyer shall have the right to furnish Seller written notice meeting the requirements of this Section 6.2(a) (the "Title Defect Notice") setting forth any matters which, in Buyer's reasonable opinion, constitute Title Defects and which Buyer asserts as a Title Defect with respect to any Well or Unit pursuant to this Article VI. For all purposes of this Agreement, Buyer shall be deemed to have waived any Title Defect which Buyer fails to assert as a Title Defect by a Title Defect Notice given to Seller on or before the expiration of the Title Examination Period. To be effective, Buyer's Title Defect Notice of a Title Defect must include (i) a brief description of the matter constituting the asserted Title Defect, (ii) the claimed Title Defect Amount attributable thereto, and (iii) supporting documents reasonably necessary for Seller (as well as any title attorney or examiner hired by Seller) to verify the existence of such asserted Title Defect. To give Seller an opportunity to commence reviewing and curing Title Defects, on or before the end of each calendar week during the Title Examination Period, Buyer agrees to give Seller written notice of all Title Defects discovered by Buyer during such calendar week, which may be preliminary in nature and supplemented prior to the end of the Title Examination Period. At the same time, Buyer shall also furnish Seller with written notice of any Seller Title Credit which is discovered during such calendar week by any of Buyer's employees or representatives while conducting Buyer's title review, due diligence or investigation with respect to any Well or Unit. (b) Purchase Price Allocations. A portion of the Purchase Price has been -------------------------- allocated to the various Wells and Units in the manner and in accordance with the respective values set forth in the Property Schedule. If any adjustment is made to the Purchase Price pursuant to this -19- Section 6.2, a corresponding adjustment shall be made to the portion of the Purchase Price allocated to the affected Well or Unit in the Property Schedule. (c) Seller's Rights and Opportunity to Cure. If Buyer timely gives Seller --------------------------------------- Title Defect Notice(s) of one or more Title Defects, Seller shall have the right to then or thereafter dispute the existence of such Title Defect and/or the alleged Title Defect Amount asserted with respect thereto in accordance with the provisions of Section 6.5 of this Agreement. In addition, the following terms and conditions shall apply with respect to any Title Defect asserted by Buyer in a timely Title Defect Notice: (i) Seller shall have until two (2) days prior to the Closing Date, at its cost and expense, if it so elects but without obligation, to cure all or a portion of such asserted Title Defects. Any asserted Title Defects which are waived by Buyer within such time shall be deemed "Permitted Encumbrances" hereunder. Subject to Sections 6.2(c)(ii) and 6.2(c)(iii) and Seller's continuing right to dispute the existence of a Title Defect and/or the Title Defect Amount asserted with respect thereto under Section 6.5, if Seller within such time fails to cure any Title Defect of which Buyer has given timely written notice as required above, and Buyer has not and does not waive same on or before the day immediately preceding the Closing Date, the Well or Unit affected by such uncured and unwaived Title Defect shall be a "Title Defect Property." (ii) If Buyer furnishes to Seller timely Title Defect Notice(s) of one or more Title Defects and the same are not waived or cured as provided in Section 6.2(c)(i), Seller may elect to delay the Closing for a period of up to thirty (30) calendar days to afford Seller the opportunity, if it so elects, to attempt to cure any of the properly asserted Title Defects prior to the Closing. Subject to Section 6.2(c)(iii) and Seller's continuing right to dispute the existence of a Title Defect and/or the Title Defect Amount asserted with respect thereto under Section 6.5, if Seller within such time period fails or refuses to cure any Title Defect of which Buyer has given a timely Title Defect Notice and Buyer has not waived and does not waive the same before the delayed Closing, the Well or Unit affected by such uncured and unwaived Title Defect shall be a "Title Defect Property." (iii) If Buyer furnishes to Seller timely Title Defect Notice(s) of one or more Title Defects and the same are not waived or cured as provided in Section 6.2(c)(i) or Section 6.2(c)(ii), as applicable, Seller may elect to close the transactions contemplated hereby and retain the right to cure any of such Title Defects after Closing (whether or not Seller elects to delay Closing pursuant to Section 6.2(c)(ii) above). In such event, but subject to Seller's continuing right to dispute the existence of a Title Defect and/or the Title Defect Amount asserted with respect thereto under Section 6.5, the Purchase Price shall be subject to reduction pursuant to Section 6.2(d) taking into account all Title Defect Amounts attributable to the Title Defect Properties affected by the Title Defects which Seller may elect to cure after Closing. Seller shall have one hundred twenty (120) calendar days after the Closing Date (as may be delayed pursuant to Section 6.2(c)(iii) -20- above) in which to attempt to cure any such Title Defects and to increase or restore any Seller Title Credits. If Seller cures any such Title Defect, then Buyer shall promptly pay Seller the Title Defect Amount with respect to the Title Defect that is so cured, but not exceeding the aggregate amount of the reductions in the Purchase Price which Buyer received as a result of any Title Defects, together with interest on the amount due Seller from the Closing Date through and including the date of payment at the Agreed Rate. Furthermore, the Title Defect Deductible shall be restored to the extent any portion of the Title Defect Deductible was applied as a credit against the Title Defect Amount attributable to such cured Title Defect. If a positive balance exists in the Available Deductible Amount after any restorations or increases thereof pursuant to the foregoing, and Seller has suffered a reduction in the Purchase Price as a result of any one or more uncured Title Defects, Buyer shall pay to Seller an amount (together with interest thereon from the Closing Date through and including the date of payment at the Agreed Rate) equal to the lesser of (i) the amount by which the Purchase Price was reduced as a result of such uncured Title Defects and (ii) the then existing balance of the Available Deductible Amount. (d) Buyer's Title Adjustments. As Buyer's sole and exclusive remedy with ------------------------- respect to Title Defects, Buyer shall be entitled to reduce the Purchase Price by the amount, if any, by which the aggregate amount of Title Defect Amounts with respect to all Title Defect Properties exceeds the sum (the "Available Deductible Amount") of $500,000 (the "Title Defect Deductible") plus the aggregate amount of Seller Title Credits with respect to all Wells or Units. "Title Defect Amount" shall mean, with respect to a Title Defect Property, the amount by which the value of such Title Defect Property is impaired as a result of the existence of one or more uncured and unwaived Title Defects, which amount shall be determined as follows and subject to the following conditions: (1) If the Title Defect results from the Company having a lesser Net Revenue Interest in such Title Defect Property than the Net Revenue Interest specified therefor in the Property Schedule, the Title Defect Amount shall be equal to the product obtained by multiplying the portion of the Purchase Price allocated to such Title Defect Property in the Property Schedule by a fraction, the numerator of which is the reduction in the Net Revenue Interest and the denominator of which is the Net Revenue Interest specified for such Title Defect Property in the Property Schedule. (2) If the Title Defect results from the Company having a greater Working Interest in a Title Defect Property than the Working Interest specified therefor in the Property Schedule, the Title Defect Amount shall be equal to the product obtained by multiplying the portion of the Purchase Price allocated to such Title Defect Property in the Property Schedule by a fraction, the numerator of which is the increase in the Working Interest and the denominator of which is the Working Interest specified for such Title Defect Property in the Property Schedule. -21- (3) If the Title Defect results from the existence of a lien, the Title Defect Amount shall be an amount sufficient to discharge such lien. (4) If the Title Defect results from any matter not described in paragraphs (1), (2) or (3) above, the Title Defect Amount shall be an amount equal to the difference between the value of the Title Defect Property affected by such Title Defect with such Title Defect and the value of such Title Defect Property without such Title Defect (taking into. account the portion of the Purchase Price allocated in the Property Schedule to such Title Defect Property); provided, that if such Title Defect is reasonably susceptible of being cured, the Title Defect Amount shall be the reasonable cost and expense of curing such Title Defect, if less. (5) If a Title Defect is not effective or does not affect a Title Defect Property throughout the entire productive life of such Title Defect Property, such fact shall be taken into account in determining the Title Defect Amount. (6) The Title Defect Amount with respect to a Title Defect Property shall be determined without duplication of any costs or losses included in another Title Defect Amount hereunder. (7) The Title Defect Amount attributable to a Title Defect Property shall not exceed the portion of the Purchase Price allocated to such Title Defect Property in Section 6.2(b). (8) No Title Defect Amount shall be allowed on account of and to the extent that an increase in the Company's Working Interest in a Well or Unit has the effect of proportionately increasing the Company's Net Revenue Interest in such Well or Unit. (9) With respect to any Well or Unit in which Buyer or an Affiliate of Buyer likewise owned an undivided interest at the Effective Time, no Title Defect Amount shall be allowed on account of a Title Defect affecting such Subject Interest that also affected Buyer's or such Affiliate's interest in such Well or Unit in the same manner at the Effective Time. (10) Notwithstanding the foregoing, if the Title Defect Amount determined pursuant to the foregoing with respect to a Title Defect Property is $50,000 or less, after taking into account any curative work performed by or on behalf of Seller, then the Title Defect Amount with respect to such Title Defect Property shall be deemed zero. Section 6.3 Determination of Title Defects. A Well or Unit shall not be ------------------------------ deemed to have a "Title Defect" if the following statements are true in all material respects with respect to such Well or Unit as of the Closing Date: -22- (a) The Company has Defensible Title thereto. (b) All rentals, Pugh clause payments, shut-in gas payments and other similar payments (other than royalties, overriding royalties and other similar payments on production) due with respect to such Well or Unit have been properly and timely paid. (c) Seller is not in default under the material terms of any leases, farmout agreements or other contracts or agreements respecting such Well or Unit which could (1) prevent the Company from receiving the proceeds of production attributable to the Company's interest therein, or (2) result in cancellation of the Company's interest therein. Notwithstanding any other provision in this Agreement to the contrary, the following matters shall not be asserted as, and shall not constitute Title Defects: (i) defects in the chain of title such as minor name discrepancies, the mere failure to recite marital status in a document, or omissions of successions of heirship proceedings, unless Buyer provides affirmative evidence that such failure or omission results in another Person's superior claim of title to the relevant Subject Interest or portion thereof, (ii) defects arising out of lack of survey, (iii) defects arising out of lack of corporate authorization, unless Buyer provides affirmative evidence that such lack of authorization results in another Person's superior claim of title to the relevant Subject Interest or portion thereof, (iv) the failure to obtain or absence of any federal patent or conveyance with respect to any lands over which any state has claimed ownership and which have been covered by a state lease for more than ten years, (v) defects that have been cured by possession under the applicable statutes of limitations or statutes for prescription and (vi) other defects of a type expected to be encountered in the area involved and customarily acceptable to prudent operators and interest owners. Furthermore, in determining the existence of a Title Defect, due consideration shall be given to the length of time hydrocarbons have been produced from the affected property in an undisputed "pay status" without any adverse claim even though such period may be less than the period of possession or use required under applicable limitations or prescription statutes. (As used herein, "pay status" shall mean payment is being made by a third party for production from the affected Well or Unit without indemnity from the Company except such indemnities as are customarily included in division orders, transfer orders, product purchase agreements and similar documents commonly used in connection with the payment of proceeds from production.) Section 6.4 Seller Title Credit. A "Seller Title Credit" shall mean, ------------------- with respect to a Well or Unit, the amount by which the value of such Well or Unit is enhanced by virtue of (a) the Company having a greater Net Revenue Interest in such Well or Unit than the Net Revenue specified therefor in the Property Schedule, (b) the Company having a lesser Working Interest in such Well or Unit than the Working Interest specified therefor in the Property Schedule, or (c) such Well or Unit being subject to a lien indebtedness which is less than that used for the Purchase Price allocation in the Property Schedule, which amount shall be determined as follows: -23- (1) If the Seller Title Credit results from the Company having a greater Net Revenue Interest in such Well or Unit than the Net Revenue Interest specified therefor in the Property Schedule, the Seller Title Credit shall be equal to the product obtained by multiplying the portion of the Purchase Price allocated to such Well or Unit in the Property Schedule by a fraction, the numerator of which is the increase in the Net Revenue Interest and the denominator of which is the Net Revenue Interest specified for such Well or Unit in the Property Schedule. (2) If the Seller Title Credit results from the Company having a lesser Working Interest in a Well or Unit than the Working Interest specified therefor in the Property Schedule, the Seller Title Credit shall be equal to the product obtained by multiplying the portion of the Purchase Price allocated to such Well or Unit in the Property Schedule by a fraction, the numerator of which is the decrease in the Working Interest and the denominator of which is the Working Interest specified for such Well or Unit in the Property Schedule. (3) If the Seller Title Credit results from a Well or Unit being subject to lesser lien indebtedness, the Seller Title Credit shall be equal to the amount of the Company's proportionate share of the reduction in such lien indebtedness; provided that, if lien indebtedness affects more than one Well or Unit, the Seller Title Credits with respect to such Wells or Units shall be determined without duplication (e.g., credit shall not be given twice to the same reduction in indebtedness);and provided further, no Seller Title Credit shall be allowed to the extent such lien indebtedness is paid by the Company after the Report Date and is not reimbursed by Seller. (4) In determining the amount of Seller Title Credits, the principles and methodology set forth in paragraphs (5), (6) and (7) of Section 6.2(d) shall be applied, mutatis mutandis. ---------------- (5) No Seller Title Credit shall be allowed on account of and to the extent that a decrease in the Company's Working Interest in a Well or Unit has the effect of proportionately decreasing the Company's Net Revenue Interest in such Well or Unit. (6) Notwithstanding the foregoing, if the Seller Title Credit determined pursuant to the foregoing with respect to any Well or Unit is $50,000 or less, then the Seller Title Credit with respect thereto shall be deemed zero. The Title Defect Deductible shall be increased dollar for dollar by the aggregate amount of all Seller Title Credits. In addition, the Title Defect Deductible shall be restored to the extent that any portion thereof is applied as a credit against a Title Defect Amount attributable to a Title Defect which is subsequently cured by Seller or determined not to constitute a Title Defect. -24- Section 6.5 Deferred Claims and Disputes. In the event that Buyer and ---------------------------- Seller have not agreed upon (i) the existence of one or more Title Defects or Seller Title Credits or one or more adjustments, credits or offsets claimed by Buyer or Seller pursuant to and in accordance with the requirements of this Article VI, or (ii) the existence of one or more Environmental Defects, any Remediation, Remediation Amount or plan therefor, or one or more adjustments, credits or offsets claimed by Buyer or Seller pursuant to Section 5.5, any such dispute or claim (a "Deferred Adjustment Claim") shall be settled pursuant to this Section 6.5 and, except as provided in Sections 9.1(f), 9.2(f) and 9.4, shall not prevent or delay Closing. In no event shall any Title Defect Amount, Environmental Defect Amount or Remediation Amount asserted by Buyer, or any Seller Title Credit asserted by Seller, as a Deferred Adjustment Claim exceed the amount asserted by Buyer or Seller therefor prior to the end of the Title Examination Period in accordance with Section 6.2 or the Environmental Examination Period in accordance with Section 5.5, as applicable. With respect to each potential Deferred Adjustment Claim, Buyer and Seller shall deliver to the other a written notice describing each such potential Deferred Adjustment Claim, the amount in dispute and a statement setting forth the facts and circumstances that support such party's position with respect to such Deferred Adjustment Claim. At Closing, the Purchase Price shall not be adjusted on account of, and, except as provided in Sections 9.1(f) and 9.2(f), no effect shall be given to, the Deferred Adjustment Claim. On or prior to the thirtieth (30th) consecutive calendar day following the Closing Date or, if earlier, the date which was the "Closing Date" before Closing was delayed under Section 9.4 (the "Deferred Matters Date"), the Seller and Buyer shall attempt in good faith to reach agreement on the Deferred Adjustment Claims and, ultimately, to resolve by written agreement all disputes regarding the Deferred Adjustment Claims. Any Deferred Adjustment Claims which are not so resolved on or before the Deferred Matters Date may be submitted by either party to final and binding arbitration in accordance with the Arbitration Procedures; provided, however, that the Seller may elect at any time to resolve all disputes relating to the Deferred Adjustment Claims by the payment to Buyer of the amount by which the Purchase Price would have been reduced at Closing on account of the Title Defects or Environmental Defects which constitute Deferred Adjustment Claims if same did not constitute Deferred Adjustment Claims, together with interest thereon from the Closing Date to the date of such payment at the Agreed Rate. Notwithstanding anything herein provided to the contrary, including Section 6.2(c), but without limiting Seller's rights under Sections 6.2(c)(ii) and 6.2(c)(iii), Seller shall be entitled to cure any Title Defect which constitutes a Deferred Adjustment Claim at any time prior to the point in time when a final and binding written decision of the board of arbitrators is made with respect thereto in accordance with the Arbitration Procedures. The amount of any reduction in the Purchase Price to which Buyer becomes entitled under the final and binding written decision of the board of arbitrators shall be promptly refunded by Seller to Buyer, together with interest thereon from the Closing Date to the date of payment at the Agreed Rate. Section 6.6 No Duplication. Notwithstanding anything herein provided to -------------- the contrary, if a Title Defect results from any matter which could also result in the breach of any representation or warranty of Seller set forth in Section 4.1, then Buyer shall only be entitled to -25- assert such matter as a Title Defect pursuant to this Article VI and shall be precluded from also asserting such matter as the basis of the breach of any such representation or warranty. ARTICLE 7 TAXES AND EMPLOYEE BENEFITS --------------------------- Section 7.1 Tax Agreements. -------------- (a) Tax Return Filings and Tax Payments for 1999. Seller shall include the -------------------------------------------- Company in its consolidated federal income Tax Return, and in those state, local and foreign income Tax Returns that are filed on a consolidated, combined, unitary or nonunitary basis, for its tax period that includes the Closing Date, and Seller shall be responsible for the payment of, and shall indemnify and hold harmless the Buyer against, all Taxes required to be paid with respect to such consolidated, combined, unitary or nonunitary Tax Returns. Such Tax Returns shall include (a) the income and gains resulting from the purchase and sale of the Company Shares, including, without limitation, any gain or loss recognized pursuant to any Section 338(h)(10) Election made pursuant to Section 7.1(d) below, (b) any deferred income and gain taken into income by reason of Treasury Regulation Section 1.1502-13 or any similar provision of state, local or foreign law, and (c) all other items of income, gain, loss, deduction and credit of the Company for the period up to and including the Closing Date, as determined by closing the books of the Company as of the end of the Closing Date; provided, however, such Tax Return shall not include any income, gain, loss, deduction or credit of the Company arising as a result of action of Buyer or the Company taken after the Closing, and all such Tax Returns shall be prepared in a manner consistent with past practice (including any Tax elections and methods of accounting), unless a contrary treatment is required by a change in Law (or the judicial or administrative interpretations thereof). (b) Termination of Existing Income Tax Sharing Agreements. The Seller ----------------------------------------------------- shall cause any existing income tax sharing agreements or arrangements disclosed on Schedule 4.1(q) to be terminated as of the Closing Date. The Company shall not be obligated to pay the Seller (or Seller's successor in interest) for any tax benefit it receives from the utilization of net operating losses in Seller's consolidated return filing for any period to and including the Closing Date. The Company shall have no liability to Seller or Seller's Affiliates for any income taxes with respect to any periods ending on or prior to the Closing Date. (c) State and Local Taxes/Refunds. Buyer shall prepare or cause to be ----------------------------- prepared with respect to Taxes other than income Taxes and file or cause to be filed any Tax Returns of the Company for Tax periods which begin before the Closing Date and end after the Closing Date. With respect to Taxes (other than Taxes to be included by Seller in its Tax Returns as required in Section 7.1(a) above) that are imposed on a periodic basis and are payable for a taxable period that includes (but does not end on) the Closing Date, the Company has accrued as of March 31, 1999, and is continuing to accrue reserves for Taxes through the Closing Date. The parties agree -26- that such accruals will be a final settlement as between the parties for all liabilities relating to such taxes and that no adjustments or refunds will be made with respect thereto. (d) Section 338(h)(10) Election. At Buyer's option, Seller (or Seller's --------------------------- successor in interest) (or if applicable, its ultimate parent corporation) will join with Buyer in making an election under Section 338(h)(10) of the Code (and any corresponding elections under state, local, or foreign tax law) (collectively, a "Section 338(h)(10) Election") with respect to the purchase and sale of the stock of the Company hereunder. Seller (or Seller's successor in interest) will pay any Tax attributable to the making of the Section 338(h)(10) Election and will indemnify the Buyer and the Company against any liability arising out of any failure to pay such Tax. Seller will also pay any state, local or foreign Tax (and indemnify Buyer and Company against any liability arising out of any failure to pay such Tax) attributable to an election under state, local, or foreign law similar to the election available under Section 338(g) of the Code (or which results from the making of an election under 338(g) of the Code) with respect to the purchase and sale of stock of the Company hereunder. (e) Allocation of Purchase Price. The parties agree to negotiate in good ---------------------------- faith to agree upon an allocation of the Purchase Price for Tax purposes among the Company's Assets as promptly as possible after Closing; and the parties further agree that for all income and franchise tax purposes (and, where applicable, financial accounting purposes), including but not limited to section 338 of the Code, they and their Affiliates will report consistently with such allocation; provided if no such allocation is agreed upon within one (1) year following Closing, the parties will not be required to report on a consistent basis. Section 7.2 Employee Matters. ---------------- (a) Maintenance of Health Benefit Program. From and after Closing, and ------------------------------------- until a date not earlier than the expiration of the Trust provided for under Section 7.2(b), Buyer agrees to cause the Company to (a) maintain equal or greater medical benefit coverage under the same or better terms and conditions as is provided under the Company's existing plans which plans are in effect immediately prior to the Closing Date and which provide benefits to current and former Company employees covered under such plans as of the date of this Agreement and their covered dependents, and (b) fulfill the medical benefit commitments described on Schedule 4.1(r). (b) Employee Benefits Trust. Prior to Closing, the Company shall establish ----------------------- a trust, pursuant to an Employee Benefits Trust Agreement substantially in the form attached hereto as Exhibit "C," for the purpose of providing salary continuation and benefits under the Company's insurance plans for the periods provided and in accordance with the terms set forth in Exhibit "C." Prior to Closing, the Company shall fund the Employee Benefits Trust with not more than $1,730,000 to cover the obligations to such employees of the Company under the terms of the Employee Benefits Trust Agreement, the letters describing severance benefits dated March 30, 1999 and April 11, 1999, and each and every employment agreement with an employee of the Company, and such funding shall not cause any adjustment in the Purchase Price. Unutilized -27- funds in the trust shall be the property of the Company as set forth in the Employee Benefits Trust Agreement. Prior to the Closing, no change in the Employee Benefits Trust Agreement from the form attached hereto as Exhibit "C" shall be made without the prior written consent of Buyer, which consent shall not be unreasonably withheld. Any payment made pursuant to the terms of the Employee Benefits Trust shall comply with ERISA regulation '2510.3.2(b). (c) Company Employee Benefits. With respect to those employees of the ------------------------- Company who continue their employment with the Company after the Closing Date or are hired by the Buyer or an Affiliate of Buyer within the six (6) month period following the Closing Date, Buyer shall, or shall cause the Company or the Buyer's Affiliates to, take all action necessary to cause all such employees to be covered under the employee benefit plans and fringe benefit arrangements of the Company, Buyer or Buyer's Affiliates, as the case may be, on the same basis as those provided to employees of Buyer or its Affiliates who hold comparable positions, as determined by Buyer in its discretion; and further provided that Buyer's or its Affiliates' health plans shall not impose any preexisting condition or waiting period requirement on any such employee's participation in such health plan with respect to conditions currently permitted to be covered thereunder if such employee enrolls within thirty (30) days of beginning employment with Buyer or Buyer's Affiliate. Buyer or Buyer's Affiliate shall grant all such employees credit for purposes of eligibility and vesting under Buyer's or its Affiliate's employee benefit plans (including vacation and severance) for their service with the Company prior to the Closing Date. If Buyer or its Affiliates give credit under their employee vacation plans for oil and gas industry experience, such employees shall be given credit for their years of industry experience prior to the Closing Date for vacation plan purposes rather than for their years of service with the Company prior to the Closing Date. (d) Severance of Employment Relationship With Certain Employees. As of or ----------------------------------------------------------- prior to the Closing Date, Seller shall cause the Company to sever its employment relationship with any person who is designated by Buyer in accordance with the provisions of this Section 7.2(d). No later than ten (10) Business Days prior to Closing, Buyer shall provide Seller with irrevocable written notice of which employees of Company will not continue to be employed by the Company following the Closing Date. Buyer agrees to make its determination and selection of such employees in compliance with applicable federal and state laws. Within five (5) Business Days after Seller receives such written notice regarding an employee, Seller will cause the Company to provide such employee with written notice of the date of such employee's severance of employment with the Company, which notice shall comply with the requirements of any employment agreement, as applicable, and with the notice requirements of ERISA ''606 and 701. ARTICLE 8 COVENANTS OF SELLER AND BUYER ----------------------------- -28- Section 8.1 Conduct of Business Pending Closing. Subject to Section 8.2 ----------------------------------- and the constraints of applicable operating agreements and other existing agreements with third Persons (other than any Affiliate of Seller) from the date hereof through the Closing, except as disclosed in Schedule 8.1. or as otherwise consented to or approved by Buyer (which consent or approval shall not be unreasonably withheld or delayed), Seller covenants and agrees that: (a) Changes in Business. The Company shall not: ------------------- (1) make any material change in the conduct of its business or operations; (2) except in the ordinary course of business and consistent with past practices, enter into, assign, terminate or amend, in any material respect, any contract or agreement required to be disclosed pursuant to Section 4.1(n); (3) declare or pay any dividends, or make any distributions, in respect of, or issue any of, its equity securities or securities convertible into its equity securities, or repurchase, redeem or otherwise acquire any such securities or make or propose to make any other change in its capitalization; (4) merge into or with or consolidate with any other corporation or acquire all or substantially all of the business or assets of any corporation or other Person; (5) make any change in its articles of incorporation or by-laws; (6) purchase any securities of or equity interests in any corporation or other Person, except for investments in marketable securities made in the ordinary course of business and consistent with prior practices; (7) other than pursuant to the requirements of existing contracts or commitments, sell, lease or otherwise dispose of any of the Assets, except (i) Assets sold, leased or otherwise disposed of in the ordinary course of business having a value of less than $50,000 and (ii) any item of personal property or equipment having a value of less than $25,000; (8) take any action or enter into any commitment with respect to or in contemplation of any liquidation, dissolution, recapitalization, reorganization or other winding up of its business or operations; (9) enter into any settlement of any pending or threatened Action, unless the settlement involves the payment of money damages of not more than $50,000 individually or $500,000 in the aggregate (other than on account of any insurance deductible of $50,000 or less) and does not impose an injunction or similar equitable -29- relief upon the Company or materially impair the Company's defense of any other Action then pending or threatened against the Company of which the Company has knowledge; (10) change its accounting policies or practices (including without limitation, any change in depreciation or amortization policies), except as required under GAAP; (11) enter into any employment agreement not terminable at will or grant any increases in the compensation of its officers and employees, except increases to employees who are not officers made in the ordinary course of business and consistent with past practices; (12) create or change any Plan or any Benefit Arrangement except as contemplated in Section 7.2(b); (13) incur any indebtedness for borrowed money or guarantee the indebtedness or obligations of any other Person for borrowed money except for advances and payments in the ordinary course of business under the Company's existing credit facility with U.S. Bank National Association, et. al. (See Schedule 4.1(n)); (14) enter into any transactions, agreement or contract with Seller or any Affiliate of Seller other than in the ordinary course of business and consistent with prior practices pursuant to agreements disclosed in Schedule 4.1(n); (15) except in the ordinary course of business and consistent with prior practices, enter into any material lease (whether such lease is an operating or capital lease); (16) make or rescind any material express or deemed election relating to Taxes unless it is reasonably expected that such action will not materially and adversely affect the Company or Buyer, settle or compromise any material claim, action, suit, litigation, proceeding, arbitration, investigation, audit or controversy relating to Taxes or change in any material respect any of its methods of reporting income or deductions for federal income tax purposes from those employed in the preparation of its federal income tax returns for the taxable year ending December 31, 1998, except as may be required by Law or except for such changes as are not reasonably expected to materially and adversely affect the Company or Buyer; or (17) agree in writing to do any of the foregoing matters which are prohibited by this Section 8.1(a). (18) adopt, amend, modify or alter any Plan or Benefit Arrangement listed in Schedule 4.1(r) or describe in Section 7.2 to increase the cost or obligation of the Company thereunder. -30- (b) Liens. The Company shall not create any express lien or security ----- interest on any Assets, except to the extent (i) required or permitted incident to the exploration, operation or development of the Assets and the business of the Company pursuant to this Section 8.1 or (ii) required or evidenced by any contract or agreement required to be disclosed pursuant to Section 4.1(n). (c) Operation of Assets. The Company shall: ------------------- (1) cause the Assets to be maintained and operated in the ordinary course of business in accordance with the Company's past practices (including the repair or replacement of damaged, destroyed, obsolete, depreciated, non-working or non-economical items of equipment or other personal property without regard to the limitation of Section 8.1(c)(3) below), maintain insurance now in force with respect to the Assets, and pay or cause to be paid all costs and expenses in connection therewith promptly when due; (2) cause, or in the event the Company is not operator, use reasonable efforts to cause, the Assets to be maintained and operated in material compliance with all Laws; (3) (a) not commit to participate in the drilling of any new well or other new capital expenditure on the Assets the projected cost of which (net to the Company's interest and without consideration of any cost overruns) is in excess of $500,000 in any single instance, or (b) elect to become a nonconsenting party with respect to any operation or capital expenditure proposed by a third Person if the projected cost of such operation or capital expenditure (net to the Company's interest and without consideration of any cost overruns) is in excess of $500,000 in any single instance, or if the Company's election not to participate in such operation or capital expenditure would cause a permanent forfeiture of any Well or Unit valued in excess of $500,000 in the Property Schedule, in both cases without the advance written consent of Buyer, which consent shall not be unreasonably withheld and which consent or non-consent must be given by Buyer within the lesser of (x) ten (10) days of Buyer's receipt of the notice from Seller or the Company or (y) one-half (2) of the applicable notice period within which the Company is contractually obligated to respond to third parties to avoid a deemed election by the Company regarding such operation or capital expenditure (provided Seller or the Company promptly gives such notice to Buyer after Seller or the Company receives it), as specified in Seller's or the Company's notice to Buyer requesting such consent which notice shall set forth the Company's recommendation as to whether the Company should participate in such operation or capital expenditure; provided that, failure by Buyer to respond within the aforesaid applicable period shall constitute Buyer's approval of the recommendation of the Company set forth in such notice with respect to such operation or capital expenditure; -31- (4) maintain and keep the Assets in full force and effect, except where such failure is due to (i) the failure to pay a delay rental, royalty, shut in royalty or other payment by mistake or oversight (including the Company's negligence) unless caused by the Company's gross negligence or willful misconduct, or (ii) the failure to participate in an operation due to the express or deemed nonconsent of Buyer; and (5) use reasonable diligence to maintain its relationships with suppliers, customers and others having material business relations with the Company with respect to the Assets so that they will be preserved for Buyer on and after the Closing Date. (d) Contracts and Agreements. The Company shall not: ------------------------ (1) grant or create any Preference Right or Transfer Requirement with respect to the Assets except (i) in connection with the performance by the Company of an obligation or agreement existing on the date hereof or pursuant to this Agreement or (ii) in connection with the acquisition of Assets after the Effective Time if granting or creating such Preference Right or Transfer Requirement is a condition of such acquisition; (2) enter into any oil, gas or other hydrocarbon sales, exchange, processing or transportation contract with respect to the Assets having a term in excess of one year which is not terminable without penalty on notice of ninety (90) days or less; or (3) voluntarily relinquish the Company's position as operator with respect to any of the Assets. Section 8.2 Qualifications on Conduct. ------------------------- (a) Emergencies; Legal Requirements. Seller or the Company may take (or ------------------------------- not take, as the case may be) any of the actions mentioned in Section 8.1 above if reasonably necessary under emergency circumstances (or if required or prohibited (as the case may be) pursuant to Law) and provided, Buyer is notified as soon thereafter as practicable. (b) Non-Operated Properties. If the Company is not the operator of a ----------------------- particular portion of the Assets, the obligations of the Company in Section 8.1 above with respect to such portion of the Assets which have reference to operations or activities that pursuant to existing contracts are carried out or performed by the operator, shall be construed to require only that the Company use reasonable diligence (without being obligated to incur any expense or institute any cause of action) to cause the operator of such portion of the Assets to take such actions or render such performance within the constraints of the applicable operating agreements and other applicable agreements. -32- (c) Certain Operations. ------------------ (1) Should the Company not wish to pay any lease rental or other payment or participate in any reworking, deepening, drilling, completion, equipping or other operation on or with respect to any well or other Well or Unit which may otherwise be required by Section 8.1 above, the Company shall give Buyer written notice thereof at least fifteen (15) days prior to the date such rental or other payment is due or, in the case of an operation, promptly after the Company receives notice of such proposed operation from the operator of such property (or if the Company is the operator, at the same time the Company gives or is required to give notice of such proposed operation to the non-operators of such property). The Company shall not be obligated to make any such payment or to elect to participate in any such operation which the Company does not wish to make or participate in unless the Company receives from Buyer, within a reasonable time prior to the date when such payment or election is required to be made by the Company, (a) the written election and agreement of Buyer (i) to require the Company to take such action and (ii) to pay all costs and expenses of the Company with respect to such lease rental or other payment or such operation and (b) the funds necessary for such payment or operation as contained in the applicable AFE therefor or estimated by the Company. Notwithstanding the foregoing, the Company shall not be obligated to pay any lease rental or other payment or to elect to participate in any operation if the operator of the property involved recommends that such action not be taken. (2) If a notice delivered to Buyer pursuant to Section 8.1(c)(3) sets forth a recommendation that the Company participate in an operation or capital expenditure the failure in which to participate will cause the forfeiture of all or any portion of a Subject Interest (or any interest in production attributable thereto) and the Buyer timely notifies Seller that it does not desire the Company to participate in same, then the resulting forfeiture shall not be a Title Defect nor shall the Subject Interest affected be a Title Defect Property for purposes of this Agreement. Section 8.3 Public Announcements. Prior to the Closing Date, no party -------------------- hereto will issue, or permit any agent or Affiliate of it to issue, any press releases or otherwise make, or cause any agent or Affiliate of it to make, any public statements with respect to this Agreement and the transactions contemplated hereby without first providing a copy to the other party and allowing them the opportunity to comment on such press release or statement, except where such release or statement is deemed in good faith by the releasing party to be required by Law or under the rules and regulations of any stock exchange on which the shares of such party or any of its Affiliates are listed. In each case to which such exception applies, the releasing party will use reasonable diligence to provide a copy of such release or statement to the other party prior to releasing or making the same. Section 8.4 Actions by Parties. Each of the parties agrees to use ------------------ reasonable diligence to satisfy the conditions to Closing set forth in Article IX and to refrain from taking any action within its control which would cause a breach by such party of a representation or warranty set -33- forth herein; provided, however, that neither Seller nor any Affiliate of Seller (other than the Company) shall be required to expend any funds or incur any costs to prevent or cure a breach of the representations and warranties set forth in Section 4.1 with respect to the Company. Section 8.5 Further Assurances. Seller and Buyer each agrees that from ------------------ time to time after the Closing Date, each of them will execute and deliver or cause their respective Affiliates (including the Company) to execute and deliver such further instruments, and take (or cause their respective Affiliates, including the Company, to take) such other action, as may be necessary to carry out the purposes and intents of this Agreement. Section 8.6 Records and Record Keeping System. Buyer agrees to maintain --------------------------------- (or cause the Company to maintain) the Company Records until the fifth anniversary of the Closing Date (or for such longer period of time as Seller shall advise Buyer (or the Company) is necessary in order to have Company Records available with respect to open years for tax audit purposes), or, if any of the Company Records pertain to any claim or dispute pending on the fifth anniversary of the Closing Date, Buyer shall maintain any of the Company Records designated by Seller until such claim or dispute is finally resolved and the time for all appeals has been exhausted. In addition, Buyer agrees to maintain (or cause the Company to maintain) the financial record keeping system (including the computer system) relating to the Company and Assets which exists on the Closing Date (the "Record Keeping System") for a period of six months from the Closing Date. Buyer shall provide (or cause the Company to provide) Seller and its representatives reasonable access at reasonable times to and the right to copy all or any portion of the Company Records and the Record Keeping System (at Seller's sole expense) for the purposes of (i) preparing and delivering any accounting provided for under this Agreement and adjusting, prorating and settling the charges and credits provided for in this Agreement, (ii) complying with any Law affecting Seller's interest in the Company Shares or the Company's interest in the Assets prior to the Closing Date, (iii) preparing any audit of the books and records of any third party relating to Seller's interest in the Company Shares or the Company's interest in the Assets prior to the Closing Date, or responding to any audit prepared by such third parties, (iv) preparing Tax Returns, (v) responding to or disputing any Tax audit or (vi) asserting, defending or otherwise dealing with any claim or dispute under this Agreement or with respect to the Company or the Assets. Section 8.7 Maintenance of Indemnification Provisions. In addition to ----------------------------------------- and without limiting the Company's and Buyer's respective obligations under Articles XII and XIII, from and after the Closing Date, Buyer shall indemnify (or shall cause Company and its successors and assigns to indemnify) and hold harmless each present and former director and officer of the Company as to all claims, actions, suits, proceedings, or investigations arising out of or pertaining to matters existing or occurring at or prior to the Closing Date to the extent provided in the Company's certificate of incorporation and bylaws (or similar governing documents) as in effect on the date hereof (to the extent consistent with Law), which provisions shall survive the Closing Date and shall continue in full force and effect for a period of not less than five years from the Closing Date with respect only to the officers and directors of the Company as of and -34- prior to the Closing; Buyer shall not amend (or shall cause Company and its successors and assigns not to amend) those provisions for such period to the extent such amendment would affect the Company's indemnity obligations under this Section 8.7 with respect to the period at or prior to the Closing Date; and Buyer shall advance (or shall cause Company and its successors and assigns) to advance expenses to each person indemnified hereunder to the fullest extent permitted by Law and required by such certificate of incorporation and bylaws (or similar governing documents). If any claim or claims are asserted or made as to matters subject to the foregoing indemnity provisions within such five year period, all rights to indemnification in respect of any such claim or claims shall continue until the disposition thereof. Buyer shall take all steps necessary to assure the Company's compliance with the foregoing covenants. This Section 8.7 shall not prevent the dissolution, merger or reorganization of the Company provided the indemnification obligations in this Section 8.7 are carried forward to the Company's successor by merger or reorganization or are adequately provided for in the event of a dissolution. Section 8.8 Minimum Net Worth. In addition to and without limiting the ----------------- Company's and Buyer's respective obligations under Section 8.7 and Articles XII and XIII, from and after the Closing Date, Buyer agrees to cause Company and its successors and assigns to maintain a minimum net worth of not less than 50% of the net worth of the Company as of the Effective Time during the term of the Employee Benefits Trust Agreement provided for under Section 7.2(b). Section 8.9 Company Obligations. From and after Closing, Buyer agrees to ------------------- cause the Company to perform and comply with each of the actions and obligations required or stipulated in this Agreement to be performed or complied with by the Company and not to take any action which would prevent such performance and compliance by the Company; provided that, without limiting the representations, warranties, covenants and agreements of the Buyer which are set forth in other Sections of this Agreement or releasing the Buyer or any Affiliate of Buyer from any duty, obligation or requirement under the Uniform Fraudulent Transfer Act or any other Law, neither Buyer nor any Affiliate of Buyer (other than the Company) shall be required to contribute any capital to the Company by virtue of Buyer's obligations under this Section. Section 8.10 Unobtained Consents. Seller agrees to provide all Unobtained ------------------- Consents to Buyer on the Closing Date. Section 8.11 Financial Statements and Reports. From time to time -------------------------------- following the execution of this Agreement, Buyer shall provide Seller with written notice identifying any financial and other information specifically related to the Company that are in Seller's possession or under its control and that Buyer reasonably believes it will need before or after the Closing. Seller will use its reasonable best efforts to provide Buyer, at Buyer's expense, with copies of the material requested at or prior to Closing, and will cooperate with Buyer, at Buyer's expense, in connection with furnishing any additional financial and other information that are in Seller's possession or under its control specifically concerning the Company that Buyer may reasonably -35- request from Seller within one year following Closing that Buyer reasonably needs to prepare its financial statements, tax returns, or reports or registrations required by federal or state securities laws. In addition, Seller will provide Buyer at the Closing with written authorization for Seller's accountants to release to Buyer, at Buyer's expense, any such information concerning the Company needed to prepare Buyer's financial statements, tax returns or reports or registrations required by federal or state securities laws. Seller shall also obtain and provide to Buyer at Closing a covenant of any successor to Seller or substantially all assets of Seller that the successor will comply in full with this Section 8.11, as if the successor were the Seller, for a period of one year from the date of the Closing. Section 8.12 Salary Continuation and Other Employee Benefits. On or ----------------------------------------------- before the Closing Date, Seller shall provide Buyer with copies of documentation reasonably satisfactory to Buyer that any payments provided under the Employee Benefits Trust Agreement to any employee of the Company by reason of the termination of his or her employment during the term of the Employee Benefits Trust Agreement include, and are not in addition to, severance pay and insurance benefits payable under any employment agreement with such employee or under the two letters referred to in Section 7.2(b). Nothing in this Section 8.12 or elsewhere in this Agreement, including without limitation the Employee Benefits Trust Agreement, shall limit or otherwise affect the Company's obligations under the terms of any employment agreement disclosed in Schedule 4.1(r) with respect to matters other than the payment of such severance pay and insurance benefits. Section 8.13 Targeted Incentive Plan. The Seller shall provide the ----------------------- Company with funds to make all payments to employees of the Company required under Seller's Targeted Incentive Plan. The Company shall make all such payments prior to Closing. In addition, prior to or at the Closing, Seller shall provide evidence reasonably satisfactory to Buyer (i) that Seller has provided the Company with all funds necessary to make all payments to employees of the Company required under Seller's Targeted Incentive Plan and (ii) that the Company has made all such payments. Section 8.14. Approval by Buyer's Shareholders. If Buyer determines that -------------------------------- approval of its shareholders is required in connection with the transactions contemplated by this Agreement, Buyer may extend the Closing Date for up to 30 days after October 31, 1999, provided that (i) the approval by Buyer's shareholders shall not be a condition to closing; and (ii) in no event shall the Closing Date be extended by reason of this Section 8.14 beyond the date agreed to by Seller in an agreement to be entered into concerning a sale or merger of Seller as the target date for closing such sale or merger. Section 8.15 Excess Parachute Payments. The Seller shall be responsible ------------------------- for and shall make all payments to employees of the Company that are "Excess Parachute Payments" within the meaning of Code Section 280G and that are attributable to the vesting of options of the -36- Seller, and shall be entitled to claim the deduction therefor. The Purchase Price shall be adjusted downward at the Closing by an amount equal to the amount of any loss of deduction for "Excess Parachute Payments" made to any employees of the Company, calculated for each employee of the Company and totaled for all employees, and borne by the Company calculated as follows at the Closing: (Company Obligations under the Employee Benefits Trust and Employment Agreements (Related to Payments in Lieu of Notice) x "Excess Parachute Payment" -------------------------------------------------------------- Total Parachute Payment)
Multiplied by an assumed combined federal and state income Tax rate of 40%. An example of this calculation for an individual employee using estimated figures available on the date hereof is attached hereto as Schedule 8.15. ARTICLE 9 CLOSING CONDITIONS ------------------ Section 9.1 Seller's Closing Conditions. The obligation of Seller to --------------------------- proceed with the Closing contemplated hereby is subject, at the option of Seller, to the satisfaction on or prior to the Closing Date of all of the following conditions: (a) Representations, Warranties and Covenants. The (1) representations and ----------------------------------------- warranties of Buyer contained in this Agreement shall be true and correct in all material respects on and as of the Closing Date, and (2) covenants and agreements of Buyer to be performed on or before the Closing Date in accordance with this Agreement shall have been duly performed in all material respects; provided however, for purposes of this Section 9.1(a), in determining whether this condition has been satisfied, any such representation, warranty, covenant or agreement of Buyer contained in this Agreement which is qualified by materiality shall be read and interpreted as if such qualification was not included therein (it being the intent of the parties not to apply a double materiality threshold in determining the satisfaction of this condition). (b) Officer's Certificate. Seller shall have received a certificate dated --------------------- as of the Closing Date, executed by a duly authorized officer of Buyer, to the effect that to such officer's knowledge the conditions set forth in subsection (a) of this Section 9.1 have been satisfied. (c) Closing Documents. On or prior to the Closing Date, Buyer shall have ----------------- delivered, or be standing ready to deliver at Closing, all agreements, instruments and other documents required to be delivered by Buyer pursuant to Section 10.3. (d) No Action. On the Closing Date, no suit, action or other proceeding --------- (excluding any such matter initiated by Seller or any of its Affiliates) shall be pending or threatened before -37- any court or governmental agency or body of competent jurisdiction seeking to enjoin or restrain the consummation of the Closing or recover damages from Seller or any Affiliate of Seller resulting therefrom. (e) Opinion of Counsel. Buyer shall have delivered to Seller the written ------------------ opinion of counsel to Buyer, dated as of the Closing Date, which counsel shall be reasonably acceptable to Seller, substantially in the form attached hereto as Exhibit 9.1(e). (f) Adjustments. The sum of (i) the reductions in the Purchase Price on ----------- account of the aggregate (net) amount of all Environmental Defect Amounts and Title Defect Amounts, and (ii) the aggregate amount of Environmental Defect Amounts and Title Defect Amounts claimed by Buyer with respect to unresolved Deferred Adjustment Claims shall not exceed $3,000,000. (g) Seller Shareholder Approval. The transactions provided for under this --------------------------- Agreement shall have been approved by Seller's shareholders, provided that Seller may waive this condition based on Seller having obtained an opinion of Delaware counsel to the effect that such approval is not required under the General Corporation Law of Delaware, which opinion shall be from a firm and in a form and substance reasonably satisfactory to Buyer and Buyer's counsel. Section 9.2 Buyer's Closing Conditions. The obligation of Buyer to -------------------------- proceed with the Closing contemplated hereby is subject, at the option of Buyer, to the satisfaction on or prior to the Closing Date of all of the following conditions: (a) Representations, Warranties and Covenants. (1) The representations and ----------------------------------------- warranties of Seller contained in this Agreement (i) which contain a Material Adverse Effect qualifier shall be true and correct on and as of the Closing Date as though made as of the Closing Date and (ii) which do not contain a Material Adverse Effect qualifier shall be true and correct in all material respects on and as of the Closing Date as though made as of the Closing Date, and (2) the covenants and agreements of Seller to be performed on or before the Closing Date in accordance with this Agreement shall have been duly performed in all material respects. If the Seller breaches any of the representations and warranties of the Seller contained herein, which breaches individually would not have a Material Adverse Effect, but that in the aggregate would exceed $1,000,000 (an "Aggregate Material Adverse Effect"), on or before the Closing Date, the Buyer may notify the Seller of such Aggregate Material Adverse Effect, and Seller shall have right to (x) extend the Closing Date by no more than ten days and cure the breaches underlying the Aggregate Material Adverse Effect to the satisfaction of the Buyer within such ten-day period or (y) reduce the Purchase Price by the estimated amount of such Aggregate Material Adverse Effect, it being understood by the parties that if the Seller (x) cures such breaches to the satisfaction of the Buyer within such ten-day period or (y) adjusts the Purchase Price accordingly, the Buyer shall not have the right to terminate this Agreement under this Section 9.2(a). Notwithstanding the foregoing, for purposes of determining whether breaches of Seller's representations and warranties have an "Aggregate Material Adverse Effect," any -38- breaches of any single representation and warranty which have an adverse effect on the value of the Company of $200,000 or less will be treated as having a value of zero. In addition, Buyer agrees to use diligent efforts to notify Seller of any asserted breach of Seller's representations and warranties as soon as reasonably possible so that Seller, at its option, can attempt to cure such asserted breaches. (b) Officer's Certificate. Buyer shall have received a certificate dated --------------------- as of the Closing Date, executed by a duly authorized officer of the Seller and the Company, to the effect that to such officers' knowledge the conditions set forth in subsection (a) of this Section 9.2 have been satisfied. (c) Closing Documents. On or prior to the Closing Date, Seller shall have ----------------- delivered, or be standing ready to deliver at the Closing, all agreements, instruments and documents required to be delivered by Seller pursuant to Section 10.2. (d) No Action. On the Closing Date, no suit, action or other proceeding --------- (excluding any such matter initiated by Buyer or any of its Affiliates) shall be pending or threatened before any court or governmental agency or body of competent jurisdiction seeking to enjoin or restrain the consummation of the Closing or recover damages from Buyer or any Affiliate of Buyer resulting therefrom. (e) Opinion of Counsel. Seller shall have delivered to Buyer the written ------------------ opinion of counsel to Seller, dated as of the Closing Date, which counsel shall be reasonably acceptable to Buyer, substantially in the form attached hereto as Exhibit 9.2(e). (f) Adjustments. The sum of (i) the reductions in the Purchase Price on ----------- account of the aggregate (net) amount of all Environmental Defect Amounts and Title Defect Amounts, and (ii) the aggregate amount of Environmental Defect Amounts and Title Defect Amounts claimed by Buyer with respect to unresolved Deferred Adjustment Claims shall not exceed $3,000,000. Section 9.3 Regulatory Approvals. If Buyer or Seller determines that -------------------- approval of a Governmental Authority is required to permit the Company or Buyer to continue to use any governmental permits with respect to the Assets or the Company after Closing, Buyer and Seller shall, as promptly as practicable after the date of this Agreement, cooperate in filing the required applications and notices with the appropriate Governmental Authorities seeking authorization to confirm the Company's continued right to use such permits or to transfer or assign such permits to Buyer (the "Regulatory Approvals") as necessary. To the extent assignable and assignment to Buyer is necessary in the foregoing context, Seller will cause the Company to assign such permits to Buyer at the Closing. Each party agrees to use reasonable diligence to obtain the Regulatory Approvals and the parties agree to cooperate fully with each other and with all Governmental Authorities to obtain the Regulatory Approvals at the earliest practicable date. -39- Section 9.4 Deferred Adjustment Claims Extension. Notwithstanding ------------------------------------ Section 9.2(f), if Buyer elects not to proceed with the Closing as a result of the non-satisfaction of the condition set forth in Section 9.2(f) and such condition would have been satisfied but for the amount of Environmental Defect Amounts and Title Defect Amounts claimed by Buyer with respect to unresolved Deferred Adjustment Claims, Seller may elect to delay the Closing until the tenth Business Day following the date when a sufficient amount of such Deferred Adjustment Claims have been resolved pursuant to Section 6.5 to determine that the condition set forth in Section 6.5 has been satisfied or has not been satisfied. A Deferred Adjustment Claim will be deemed resolved pursuant to Section 6.5 when a final and binding written decision of the board of arbitrators is made with respect thereto in accordance with the Arbitration Procedures. Section 9.5 Failure to Disclose. The breach by Seller of its obligation ------------------- to give notice to Buyer under Section 4.1(cc) and the breach by Buyer of its obligation to give notice to Seller under Section 4.2(j) shall not constitute a failure of the conditions to Closing under Sections 9.1 and 9.2. From and after Closing, neither Buyer nor Seller shall have any obligation or liability under this Agreement or in connection with the transaction contemplated in this Agreement for any breach of a representation or warranty by such party prior to Closing by reason of any fact or facts of which the other party had knowledge prior to Closing if and to the extent such other party breached its obligation to give notice of such fact or facts to the other party pursuant to Section 4.1(cc) or 4.2(j), as applicable. From and after Closing, this Section 9.5 shall constitute the sole remedy of Buyer and Seller for the other party's breach of Section 4.1(cc) or 4.2(j), as the case may be. ARTICLE 10 CLOSING ------- Section 10.1 Closing. The Closing shall be held on the Closing Date at ------- 10:00 a.m., Mountain time, at the offices of the Company, Denver, Colorado, or at such other time or place as Seller and Buyer may otherwise agree in writing. Section 10.2 Seller's Closing Obligations. At Closing, Seller shall ---------------------------- execute and deliver, or cause to be executed and delivered, to Buyer the following: (a) The stock certificates representing all Company Shares, endorsed in blank or accompanied by duly executed assignment documents; (b) The officer's certificate referred to in Section 9.2(b); (c) The legal opinion referred to in Section 9.2(e); (d) Resignations or terminations of the officers and directors of the Company from their status as officers or directors effective as of the Closing that are requested by Buyer at least two Business Days prior to the Closing Date; and -40- (e) A non-foreign affidavit, as such affidavit is referred to in Section 1445(b)(2) of the Code, in form attached hereto as Exhibit 10.2(e), dated as of the Closing Date. Section 10.3 Buyer's Closing Obligations. At Closing, Buyer shall (i) --------------------------- deliver, or cause to be delivered, the Closing Payment to Seller in immediately available funds to the bank account as provided in Section 3.2 and (ii) execute and deliver, or cause to be executed and delivered, to Seller the following: (a) The officer's certificate of Buyer referred to in Section 9.1(b); (b) The legal opinion referred to in Section 9.1(e); and (c) An Assumption Agreement executed by each officer of the Company whose resignation or termination is not requested by Buyer pursuant to Section 10.2(d), in the form attached hereto as Exhibit 10.3(d). ARTICLE 11 SURVIVAL -------- Section 11.1 Survival. Except as provided in this Section 11.1, no -------- representations, warranties, covenants and agreements made herein shall survive the Closing. Each representation, warranty, covenant and agreement made herein shall terminate and cease to be of further force and effect as of the Closing or such later date after Closing as is expressly stipulated in this Section 11.1 for the survival thereof. Following the Closing or such later date stipulated in this Section 11.1 for the survival thereof, such representation, warranty, covenant or agreement shall not form the basis for or give rise to any claim, demand, cause of action, counterclaim, defense, damage, indemnity, obligation or liability which is asserted, claimed, made or filed following the Closing or such later date stipulated for survival. It is expressly agreed that the terms and provisions of Sections 5.3, 5.5, 6.5, 7.1, 7.2, 8.5, 8.6, 8.7, 8.8, 8.9, 8.11, 8.13 and 9.5, Articles VI, XI, XII, XIII and XV, and Buyer's indemnity and hold harmless of the Seller Indemnified Parties under Sections 5.1 and 5.4 shall survive the Closing indefinitely or for such shorter period of time as may be stipulated in such provisions. In addition, the definitions set forth in Appendix A to this Agreement or in any other provision of this Agreement which are used in the representations, warranties, covenants and agreements which survive the Closing pursuant to this Section 11.1 shall survive the Closing to the extent necessary to give operative effect to such surviving representations, warranties, covenants and agreements. ARTICLE 12 LIMITATIONS ----------- -41- Section 12.1 Disclaimer of Warranties. NOTWITHSTANDING ANYTHING ------------------------ CONTAINED TO THE CONTRARY IN ANY OTHER PROVISION OF THIS AGREEMENT, IT IS THE EXPLICIT INTENT OF EACH PARTY HERETO THAT SELLER IS NOT MAKING ANY REPRESENTATION OR WARRANTY WHATSOEVER, EXPRESS, IMPLIED, STATUTORY OR OTHERWISE, BEYOND THOSE REPRESENTATIONS OR WARRANTIES EXPRESSLY GIVEN IN THIS AGREEMENT, AND IT IS UNDERSTOOD THAT, SUBJECT TO SUCH EXPRESS REPRESENTATIONS AND WARRANTIES, BUYER TAKES THE COMPANY AND THE ASSETS "AS IS" AND "WHERE IS." WITHOUT LIMITING THE GENERALITY OF THE IMMEDIATELY PRECEDING SENTENCE, SELLER HEREBY (I) EXPRESSLY DISCLAIMS AND NEGATES ANY REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, AT COMMON LAW, BY STATUTE OR OTHERWISE, RELATING TO (A)THE CONDITION OF THE ASSETS (INCLUDING, WITHOUT LIMITATION, ANY IMPLIED OR EXPRESS WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE, OR OF CONFORMITY TO MODELS OR SAMPLES OF MATE, OR THE PRESENCE OR ABSENCE OF ANY HAZARDOUS MATE IN OR ON, OR DISPOSED OF OR DISCHARGED FROM, THE ASSETS) OR (B) ANY INFRINGEMENT BY SELLER OR ANY OF ITS AFFILIATES OF ANY PATENT OR PROPRIETARY RIGHT OF ANY THIRD PARTY, AND (II) NEGATES ANY RIGHTS OF BUYER UNDER STATUTES TO CLAIM DIMINUTION OF CONSIDERATION AND ANY CLAIMS BY BUYER FOR DAMAGES BECAUSE OF REDHIBITORY VICES OR DEFECTS, WHETHER KNOWN OR UNKNOWN, IT BEING THE INTENTION OF SELLER AND BUYER THAT THE ASSETS ARE TO BE ACCEPTED BY BUYER IN THEIR PRESENT CONDITION AND STATE OF REPAIR. Section 12.2 Damages. NOTWITHSTANDING ANYTHING CONTAINED TO THE CONTRARY ------- IN ANY OTHER PROVISION OF THIS AGREEMENT, SELLER AND BUYER AGREE THAT, EXCEPT AS PROVIDED IN SECTIONS 14.2 and 14.3, THE RECOVERY OF ANY DAMAGES SUFFERED OR INCURRED AS A RESULT OF ANY BREACH BY ANY PARTY OR THE COMPANY OF ANY OF ITS REPRESENTATIONS, WARRANTIES OR OBLIGATIONS UNDER THIS AGREEMENT SHALL BE LIMITED TO THE ACTUAL DAMAGES SUFFERED OR INCURRED (WHICH SHALL INCLUDE ANY INDIRECT, CONSEQUENTIAL, SPECIAL, EXEMPLARY OR PUNITIVE DAMAGES AWARDED AGAINST OR PAID BY THE INDEMNIFIED PARTY SEEKING INDEMNITY HEREUNDER TO ANY THIRD PERSON WHO IS NOT AFFILIATED WITH SUCH INDEMNIFIED PARTY) AS A RESULT OF THE BREACH BY THE BREACHING PARTY OF ITS REPRESENTATIONS, WARRANTIES OR OBLIGATIONS HEREUNDER AND IN NO EVENT SHALL THE BREACHING PARTY BE LIABLE TO THE NON-BREACHING PARTY OR ANY INDEMNIFIED PARTY FOR ANY INDIRECT, CONSEQUENTIAL, SPECIAL, EXEMPLARY OR PUNITIVE DAMAGES (INCLUDING, WITHOUT LIMITATION, ANY DAMAGES ON ACCOUNT OF LOST PROFITS OR OPPORTUNITIES OR LOST OR DELAYED PRODUCTION) SUFFERED OR INCURRED BY THE NONBREACHING PARTY OR ANY INDEMNIFIED PARTY AS A RESULT OF THE -42- BREACH BY THE BREACHING PARTY OF ANY OF ITS REPRESENTATIONS, WARRANTIES OR OBLIGATIONS HEREUNDER. This Section 12.2 shall operate only to limit a party's liability and shall not operate to increase or expand any contractual obligation of a party hereunder or cause any contractual obligation of a party hereunder to survive longer than provided in Section 11.1. Section 12.3 Plugging and Abandonment Obligations. NOTWITHSTANDING ------------------------------------ ANYTHING CONTAINED TO THE CONTRARY IN ANY OTHER PROVISION OF THIS AGREEMENT, IT IS EXPRESSLY AGREED FOR ALL PURPOSES OF THIS AGREEMENT THAT (I) THE PLUGGING AND ABANDONMENT OBLIGATIONS CONSTITUTE COMPANY LIABILITIES, (II) THE PLUGGING AND ABANDONMENT OBLIGATIONS SHALL NOT CONSTITUTE ENVIRONMENTAL CONDITIONS, ENVIRONMENTAL CLAIMS, OFFSITE ENVIRONMENTAL MATTERS, ENVIRONMENTAL LIABILITIES, ENVIRONMENTAL DEFECTS, OR ENVIRONMENTAL MATTERS, (III) SELLER MAKES NO WARRANTY OR REPRESENTATION, EXPRESS OR IMPLIED, WITH RESPECT TO THE PLUGGING AND ABANDONMENT OBLIGATIONS, AND (IV) SELLER SHALL HAVE NO LIABILITIES OR OBLIGATIONS WITH RESPECT TO PLUGGING AND ABANDONMENT OBLIGATIONS. Section 12.4 Environmental Release. From and after Closing, Buyer shall --------------------- have no rights to recovery or indemnification for Environmental Liabilities or any Environmental Matters under this Agreement or Law, and all rights or remedies which Buyer may have at or under Law with respect to any Environmental Liabilities or Environmental Matters are expressly waived. FROM AND AFTER CLOSING BUYER HEREBY AGREES, WARRANTS AND COVENANTS TO RELEASE, ACQUIT AND FOREVER DISCHARGE SELLER AND ALL SELLER INDEMNIFIED PARTIES FROM ANY AND ALL CLAIMS, DEMANDS AND CAUSES OF ACTION OF WHATSOEVER NATURE, INCLUDING WITHOUT LIMITATION ALL CLAIMS, DEMANDS AND CAUSES OF ACTION FOR CONTRIBUTION AND INDEMNITY UNDER STATUTE OR COMMON LAW, WHICH COULD BE ASSERTED NOW OR IN THE FUTURE AND THAT RELATE TO OR IN ANY WAY ARISE OUT OF ENVIRONMENTAL LIABILITIES OR ENVIRONMENTAL MATTERS. FROM AND AFTER CLOSING, BUYER, THE COMPANY AND ALL OTHER BUYER INDEMNIFIED PARTIES WARRANT, AGREE AND COVENANT NOT TO SUE OR INSTITUTE ARBITRATION AGAINST THE SELLER OR ANY SELLER INDEMNIFIED PARTY UPON ANY CLAIM, DEMAND OR CAUSE OF ACTION FOR INDEMNITY AND CONTRIBUTION THAT HAVE BEEN ASSERTED OR COULD BE ASSERTED FOR ANY ENVIRONMENTAL LIABILITIES OR ENVIRONMENTAL MATTERS. ARTICLE 13 INDEMNIFICATION --------------- Section 13.1 Indemnification By Buyer. From and after the Closing Date, ------------------------ the Company shall pay, perform, fulfill and discharge all Company Liabilities. Buyer -43- shall indemnify and hold harmless the Seller and all Seller Indemnified Parties (other than the Company), each of their respective past, present and future directors, officers, employees, consultants and agents, each of the Company's past and present (and, through the Closing, future) directors, officers, employees, consultants and agents), and each of the directors, officers, heirs, executors, successors and assigns of any of the foregoing (collectively, the "Seller Indemnified Parties") from and against any and all (i) Company Liabilities incurred by or asserted against any of the Seller Indemnified Parties, INCLUDING, WITHOUT LIMITATION, ANY COMPANY LIABILITY BASED ON NEGLIGENCE OR STRICT LIABILITY OF THE SELLER INDEMNIFIED PARTIES OR ANY OTHER THEORY OF LIABILITY, WHETHER IN LAW (WHETHER COMMON OR STATUTORY) OR EQUITY BUT NOT INCLUDING COMPANY LIABILITIES BASED ON GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF THE SELLER INDEMNIFIED PARTIES and (ii) subject to the limitations of Section 11.1 and Article XII, any Covered Liability resulting from, arising out of or on account of any breach, failure or nonfulfillment of any representation, warranty, covenant or agreement on the part of Buyer which is expressly set forth in this Agreement. Section 13.2 Third Party Claims. If a claim by a third party is made ------------------ against a Seller Indemnified Party, and if such party (the "Indemnified Party") intends to seek indemnity with respect thereto under Section 5.1, 5.4, 8.7, or 13.1, the Indemnified Party shall promptly furnish written notice to Buyer (the "Indemnitor"), of such claims. The Indemnitor shall have thirty (30) days after receipt of such notice to undertake, conduct and control, through counsel of its own choosing and at its own expense, the settlement or defense thereof, and the Indemnified Party shall cooperate with it in connection therewith; provided that the Indemnitor shall permit the Indemnified Party to participate in such settlement or defense through counsel chosen by such Indemnified Party, however, the fees and expenses of such counsel shall be borne by such Indemnified Party. So long as the Indemnitor, at Indemnitor's cost and expense, (1) has undertaken the defense of, and assumed full responsibility for all indemnified liabilities with respect to, such claim, (2) is reasonably contesting such claim in good faith, by appropriate proceedings, and (3) has taken such action (including the posting of a bond, deposit or other security) as may be necessary to prevent any action to foreclose a lien against or attachment of the property of the Indemnified Party for payment of such claim, the Indemnified Party shall not pay or settle any such claim. Notwithstanding compliance by the Indemnitor with the preceding sentence, the Indemnified Party shall have the right to pay or settle any such claim, provided that in such event it shall waive any right to indemnity therefor by the Indemnitor for such claim. If, within thirty (30) days after the receipt of the Indemnified Party's notice of a claim of indemnity hereunder, the Indemnitor does not notify the Indemnified Party that it elects, at Indemnitor's cost and expense, to undertake the defense thereof and assume full responsibility for all indemnified liabilities with respect thereto, or gives such notice and thereafter fails to contest such claim in good faith or to prevent action to foreclose a lien against or attachment of the Indemnified Party's property as contemplated above, the Indemnified Party shall have the right to contest, settle and/or compromise the claim and, to the extent the actions, if any, taken by the Indemnified Party in settling or compromising such claim are reasonable and in good faith, the Indemnified Party shall not thereby waive any right to indemnity therefor pursuant to this Agreement. -44- Section 13.3 Seller's General Liability Limitation. Notwithstanding ------------------------------------- anything herein provided to the contrary, Seller shall not have any liability to Buyer, any Affiliate of Buyer, the Company, any of their respective past, present and future directors, officers, employees, consultants and agents, or the directors, officers, heirs, executors, successors or assigns of any of the foregoing for any matter relating to the Company or arising in connection with the transactions covered by this Agreement, including without limitation Company Liabilities from and after the Closing, it being understood and agreed that all such liabilities will be resolved, settled and fully disposed of (or allowances made therefor) prior to Closing in accordance with the terms and conditions of this Agreement. ARTICLE 14 TERMINATION; REMEDIES; LIMITATIONS ---------------------------------- Section 14.1 Termination. ----------- (a) Termination of Agreement. This Agreement and the transactions ------------------------ contemplated hereby may be terminated at any time prior to the Closing: (1) By mutual written consent of Seller and Buyer; or (2) If the Closing has not occurred by the close of business on March 31, 2000, then (i) by Seller if any condition specified in Section 9.1 has not been satisfied on or before such close of business, and shall not theretofore have been waived by Seller, or (ii) by Buyer if any condition specified in Section 9.2 has not been satisfied on or before such close of business, and shall not theretofore have been waived by Buyer, or if the transactions provided for under this Agreement have not been approved by Seller's shareholders and such condition has not been waived by Seller as provided in Section 9.1(g); provided, in each case, that the failure to consummate the transactions contemplated hereby on or before such date did not result from the failure by the party or parties seeking termination of this Agreement to fulfill any undertaking or commitment provided for herein on the part of such party or parties that is required to be fulfilled on or prior to Closing. (b) Effect of Termination. Without limiting Seller's and Buyer's --------------------- respective remedies and rights in regard to the Deposit under Section 14.2, in the event of termination of this Agreement by Seller, on the one hand, or Buyer, on the other hand, pursuant to Section 14. l(a), written notice thereof shall forthwith be given by the terminating party or parties to the other party or parties hereto, and this Agreement shall thereupon terminate; provided, however, that following such termination Buyer will continue to be bound by its obligations set forth in Sections 5.1, 5.2 and 5.4. If this Agreement is terminated as provided herein all filings, -45- applications and other submissions made to any Governmental Authority shall, to the extent practicable, be withdrawn from the Governmental Authority to which they were made. Section 14.2 Remedies. -------- (a) Seller's Remedies. Notwithstanding anything herein provided to the ----------------- contrary, upon the failure by Buyer to satisfy the conditions to Closing or the Closing obligations, as the case may be, set forth in (i) item (1) of clause (a) of Section 9.1 on account of breaches of the representations and warranties made by Buyer on and as of the date of this Agreement, (ii) item (2) of clause (a) of Section 9.1, (iii) clause (b) of Section 9.1 on account of breaches of the representations and warranties made by Buyer on and as of the date of this Agreement or the failure by Buyer to satisfy the condition set forth in item (2) of clause (a) of Section 9.1, (iv) clause (e) of Section 9.1, or (v) clause (i) or (ii)(c) of Section 10.3 on or prior to the Closing Date, Seller, at its sole option, may (i) enforce specific performance of this Agreement or (ii) terminate this Agreement and, without waiving or releasing Buyer's obligations under Sections 5.1, 5.2 and 5.4, be paid the Deposit, together with all interest and other amounts earned thereon as liquidated damages, as Seller's sole and exclusive remedy for such failure, all other remedies being expressly waived by Seller. Seller and Buyer agree upon the Deposit amount together with all interest and other amounts earned thereon, as liquidated damages due to the difficulty and inconvenience of measuring actual damages and the uncertainty thereof, and Seller and Buyer agree that such amount is a reasonable estimate of Seller's loss in the event of any such failure by Buyer. (b) Buyer's Remedies. Notwithstanding anything herein provided to the ---------------- contrary, upon failure of the Seller to satisfy the conditions to Closing or the Closing obligations, as the case may be, set forth in (i) item (1) of clause (a) of Section 9.2 on account of breaches of the representations and warranties made by Seller on and as of the date of this Agreement, (ii) item (2) of clause (a) of Section 9.2, (iii) clause (b) of Section 9.2 on account of breaches of the representations and warranties made by Seller on and as of the date of this Agreement or the failure by Seller to satisfy the condition set forth in item (2) of clause (a) of Section 9.2, (iv) clause (e) of Section 9.2, or (v) clauses (a), (d) or (e) of Section 10.2 on or prior to the Closing Date, Buyer, at its sole option, may (i) enforce specific performance of this Agreement or (ii) terminate this Agreement and receive back the Deposit, together with all interest and other amounts earned thereon, as Buyer's sole and exclusive remedy for such failure, all other remedies being expressly waived by Buyer. Section 14.3 Break-Up Fee. If, as of the Closing Date, Seller has ------------ failed to obtain approval of this Agreement (and the transactions contemplated hereby) by the shareholders of Seller as required by Section 9.1(g) and this Agreement is thereafter terminated, Seller shall promptly (but in no event later than one business day after the occurrence of such event) pay to Buyer a fee in the amount of $1,500,000 and receive back the Deposit, together with all interest and other amounts earned thereon, which amounts shall be payable by wire transfer in immediately available funds to an account designated by Buyer. The parties hereto agree and -46- acknowledge that the $1,500,000 break-up fee payable pursuant to this Section 14.3 is not a penalty, and represents the parties' efforts to reasonably estimate a fair compensation for the expenses that might be suffered by Buyer in the event the transactions contemplated by this Agreement shall not be consummated for the above reason. ARTICLE 15 MISCELLANEOUS ------------- Section 15.1 Counterparts. This Agreement may be executed in one or more ------------ counterparts, all of which shall be considered one and the same agreement, and shall become effective when one or more counterparts have been signed by each of the parties and delivered to the other party. Section 15.2 Governing Law; Jurisdiction; Process. ------------------------------------ (a) THIS AGREEMENT AND THE TRANSACTIONS CONTEMPLATED HEREBY SHALL BE GOVERNED BY AND INTERPRETED IN ACCORDANCE WITH THE LAWS OF THE STATE OF COLORADO WITHOUT GIVING EFFECT TO PRINCIPLES THEREOF RELATING TO CONFLICTS OF LAW RULES THAT WOULD DIRECT THE APPLICATION OF THE LAWS OF ANOTHER JURISDICTION, EXCEPT TO THE EXTENT THAT IT IS MANDATORY THAT THE LAW OF ANOTHER JURISDICTION, WHEREIN OR ADJACENT TO WHICH THE ASSETS ARE LOCATED, SHALL APPLY. (b) SUBJECT TO THE ARBITRATION AGREEMENT SET FORTH IN SECTION 15.10, BUYER AND SELLER CONSENT TO PERSONAL JURISDICTION IN ANY LEGAL ACTION, SUIT OR PROCEEDING WITH RESPECT TO THIS AGREEMENT IN ANY COURT, FEDERAL OR STATE, WITHIN THE CITY AND COUNTY OF DENVER, COLORADO, HAVING SUBJECT MATTER JURISDICTION AND WITH RESPECT TO ANY SUCH CLAIM, BUYER AND SELLER IRREVOCABLY WAIVE, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY CLAIM, OR ANY OBJECTION THAT BUYER OR SELLER MAY NOW OR HEREAFTER HAVE, THAT VENUE OR JURISDICTION IS NOT PROPER WITH RESPECT TO ANY SUCH LEGAL ACTION, SUIT OR PROCEEDING BROUGHT IN SUCH COURT IN THE CITY AND COUNTY OF DENVER, COLORADO, INCLUDING ANY CLAIM THAT SUCH LEGAL ACTION, SUIT OR PROCEEDING BROUGHT IN SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM AND ANY CLAIM THAT BUYER OR SELLER IS NOT SUBJECT TO PERSONAL JURISDICTION OR SERVICE OF PROCESS IN SUCH CITY AND COUNTY OF DENVER, COLORADO FORUM. Section 15.3 Entire Agreement. This Agreement (including the ---------------- Confidentiality Agreement) and the Appendices, Schedules and Exhibits hereto contain the entire agreement -47- between the parties with respect to the subject matter hereof and there are no agreements, understandings, representations or warranties between the parties other than those set forth or referred to herein. Section 15.4 Expenses. Buyer shall be responsible for (i) all transfer, -------- stamp, documentary and similar Taxes imposed on the parties hereto with respect to the purchase and sale of the Company Shares contemplated pursuant to this Agreement and (ii) all recording, filing or registration fees for any assignment or conveyance delivered to Buyer under or pursuant to this Agreement. All other costs and expenses incurred by each party hereto in connection with all things required to be done by it hereunder, including attorney's fees, accountant fees and the expense of environmental and title examination, shall be borne by the party incurring same. Section 15.5 Notices. All notices hereunder shall be sufficiently given ------- for all purposes hereunder if in writing and delivered personally, sent by documented overnight delivery service or, to the extent receipt is confirmed, by United States Mail, telecopy, telefax or other electronic transmission service to the appropriate address or number as set forth below. Notices to Seller shall be addressed as follows: Bonneville Pacific Corporation 50 West 300 South, Suite 300 Salt Lake City, Utah 84101 Attention: Clark M. Mower Tel: (801) 363-2520 ext. 101 Fax: (801) 359-1735 with copies to: Bonneville Pacific Corporation 50 West 300 South, Suite 300 Salt Lake City, Utah 84101 Attention: Steven H. Stepanek Tel: (801) 363-2520 ext. 111 Fax: (801) 363-9557 and to: Welborn Sullivan Meck & Tooley, P.C. 1775 Sherman Street, Suite 1800 Denver, Colorado 80203 Attention: John F. Meck Tel: (303) 830-2500 -48- Fax: (303) 832-2366 and through Closing to the Company at: Bonneville Fuels Corporation 1660 Lincoln Street, Suite 2200 Denver, Colorado 80264 Attention: Jim Cable Tel: (303) 863-1555 ext.217 Fax: (303) 863-1558 or at such other address and to the attention of such other Person as Seller may designate by written notice to Buyer. Notices to Buyer shall be addressed to: CEC Resources Ltd. 1700 Broadway, Suite 1150 Denver, Colorado 80290 Attention: Patrick R. McDonald Tel: (303 860-1575 Fax: (303) 860-9128 with copies to: Holland & Hart, L.L.P. 555 Seventeenth Street, Suite 3200 Denver, Colorado 80201-8749 Attention: Dennis M. Jackson Tel: (303) 298-8115 Fax: (303) 295-8261 or at such other address and to the attention of such other Person as Buyer may designate by written notice to Seller. Section 15.6 Successors and Assigns. This Agreement shall be binding ---------------------- upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns. This Agreement may not be assigned by any party hereto except with the prior written consent of the other party hereto, which consent shall not be unreasonably withheld or delayed, and any such assignment shall be void and of no force or effect; provided, however, that -------- ------- Buyer may assign this Agreement to any Affiliates of Buyer or of an entity providing equity financing to Buyer for the purchase of the Company Shares with prior notice to Seller, and in that event, that Buyer shall remain fully liable for all obligations of Buyer contained herein." -49- Section 15.7 Amendments and Waivers. This Agreement may not be modified ---------------------- or amended except by an instrument or instruments in writing signed by the party against whom enforcement of any such modification or amendment is sought. Any party hereto may, only by an instrument in writing, waive compliance by another party hereto with any term or provision of this Agreement on the part of such other party hereto to be performed or complied with. The waiver by any party hereto of a breach of any term or provision of this Agreement shall not be construed as a waiver of any subsequent breach. Section 15.8 Appendices, Schedules and Exhibits. All Appendices, ---------------------------------- Schedules and Exhibits hereto which are referred to herein are hereby made a part hereof and incorporated herein by such reference. Section 15.9 Interpretation. It is expressly agreed that this Agreement -------------- shall not be construed against any party, and no consideration shall be given or presumption made, on the basis of who drafted this Agreement or any particular provision hereof or who supplied the form of Agreement. Each party agrees that it has been purposefully drawn and correctly reflects their understanding of the transaction that it contemplates. In construing this Agreement: (a) examples shall not be construed to limit, expressly or by implication, the matter they illustrate; (b) the word "includes" and its derivatives means "includes, but is not limited to" and corresponding derivative expressions; (c) a defined term has its defined meaning throughout this Agreement and each Appendix, Exhibit and Schedule to this Agreement, regardless of whether it appears before or after the place where it is defined; (d) each Exhibit and Schedule to this Agreement is a part of this Agreement, but if there is any conflict or inconsistency between the main body of this Agreement (including Appendices A and B which shall be considered part of the main body of this Agreement) and any Exhibit or Schedule, the provisions of the main body of this Agreement shall prevail; and (e) the headings and titles herein are for convenience only and shall have no significance in the interpretation hereof. Section 15.10 Arbitration. It is agreed, as a severable and independent ----------- arbitration agreement separately enforceable from the remainder of this Agreement, that if the parties hereto, the Company, the Indemnified Parties or their respective successors, assigns, heirs or legal representatives of any of the foregoing are unable to amicably resolve any dispute or difference arising under or out of, in relation to or in any way connected with this Agreement (whether contractual, tortious, equitable, statutory or otherwise) after endeavoring for a period of at least 30 days to resolve any such dispute through good faith negotiations among officers of the -50- disputing parties (except as provided in Section 6.5 or with respect to arbitration instituted prior to Closing), such matter shall be finally and exclusively referred to and settled by arbitration under the Commercial Arbitration Rules of the American Arbitration Association pursuant and subject to the arbitration procedures set forth in the Arbitration Procedures; provided that, the foregoing shall not prevent Seller, the Company or their Affiliates from seeking specific performance, an injunction or other equitable relief with respect to their rights under the Confidentiality Agreement through judicial means in any jurisdiction. In the event of any conflict between the Commercial Arbitration Rules of the American Arbitration Association and the Arbitration Procedures, the Arbitration Procedures shall govern and control. Section 15.11 Agreement for the Parties' Benefit Only. Subject to the --------------------------------------- limitations of this Section 15.11, Sections 5.1, 5.4, 6.5 and 8.7 and Article XIII are intended to benefit and to be enforceable by any of the Indemnified Parties thereunder as third party beneficiaries of this Agreement. Except for the limited rights of the Indemnified Parties, this Agreement is not intended to confer upon any Person not a party hereto any rights or remedies hereunder, and no Person, other than the parties hereto, is entitled to rely on any representation, warranty, covenant or agreement contained herein. Any Indemnified Party which is (i) an assignee of an Indemnified Party, (ii) a consultant or agent of an Indemnified Party, (iii) a director, officer, employee, consultant or agent of an assignee of an Indemnified Party, or (iv) a Person which is a director, officer, heir, executor, successor or assign of any Person in clauses (i), (ii) or (iii) above (a "Special Indemnitee") shall not be entitled to enforce this Agreement or any term hereof and shall be indemnified under the terms of this Agreement only to the extent that a party hereto elects to exercise such right of indemnity on behalf of such Special Indemnitee. No party hereto shall have any direct liability or obligation to any Special Indemnitee for any election or non-election or any act or failure to act under or in regard to any term of this Agreement. Any claim for indemnity hereunder on behalf of a Special Indemnitee must be made and administered by a party to this Agreement. Subject to the foregoing limitations on Special Indemnitees, any such third party beneficiary of this Agreement may only bring suit against the defaulting party or parties. Section 15.12 Attorneys' Fees. The prevailing party in any legal --------------- proceeding brought under or to enforce this Agreement shall be additionally entitled to recover court costs, reasonable costs of arbitration and reasonable attorneys' fees from the nonprevailing party. Section 15.13 Severability. If any term or other provision of this ------------ Agreement is invalid, illegal or incapable of being enforced by any rule of law or public policy, all other conditions and provisions of this Agreement shall nevertheless remain in full force and effect so long as the economic or legal substance of the transactions contemplated hereby is not affected in any adverse manner to any party. Upon such determination that any term or other provision is invalid, illegal or incapable of being enforced, the parties hereto shall negotiate in good faith to modify this Agreement so as to effect the original intent of the parties as closely as possible in an acceptable manner to the end that the transactions contemplated hereby are fulfilled to the extent possible. -51- Section 15.14 No Recordation. Without limiting any party's right to file -------------- suit to compel arbitration to enforce its rights under this Agreement, Buyer and Seller expressly covenant and agree not to record or place of record this Agreement or any copy or memorandum hereof. Section 15.15 Time of Essence. Time is of the essence in this Agreement. --------------- If the date specified in this Agreement for giving any notice or taking any action is not a Business Day (or if the period during which any notice is required to be given or any action taken expires on a date which is not a Business Day), then the date for giving such notice or taking such action (and the expiration date of such period during which notice is required to be given or action taken) shall be the next day which is a Business Day. IN WITNESS WHEREOF, this Agreement has been signed by or on behalf of each of the parties as of the day first above written. SELLER: BONNEVILLE PACIFIC CORPORATION Attest:_________________ By:______________________________ Name: Clark M. Mower Title: President and CEO BUYER: CEC RESOURCES LTD. Attest:_________________ By:_____________________________ Name: Patrick R. McDonald Title: President STOCK PURCHASE AGREEMENT DATED AS OF AUGUST 11, 1999 -52- EX-10.5 10 FORM OF INDEMNIFICATION AGREEMENT Exhibit 10.5 Form of INDEMNIFICATION AGREEMENT ------------------------- Carbon Energy Corporation 1. EFFECTIVE DATE: October 14, 1999 2. PARTIES: Carbon Energy Corporation 1700 Broadway, Suite 1150 Denver, CO 80290-1101 a Colorado corporation ("Corporation") ------------------------- ------------------------- ------------------------- ("*****") 3. RECITALS/AGREEMENT: (a) At the request of the Corporation, ***** currently serves as a director and/or officer (as defined below) of the Corporation. (b) ***** has indicated that it was and is a condition of *****'s acceptance and continuing in such service that, among other things, the Corporation agree to (i) indemnify ***** against liabilities, expenses and costs incurred in connection with any claims, suits or proceedings related to *****'s service to or for the Corporation and (ii) advance to him such expenses and costs incurred in connection with such claims, suits or proceedings, all in accordance with, and to the fullest extent permitted by, the Colorado Business Corporation Act. (c) The Corporation's Articles of Incorporation and the Colorado Business Corporation Act contemplate that contracts may be made between the Corporation and members of its Board of Directors and officers with respect to indemnification and advancement of expenses and costs. (d) In consideration of *****'s acceptance and continuation of service as a director of the Corporation after the date of this Agreement, and in consideration of the mutual covenants stated herein, the parties agree as follows. 4. DEFINITIONS: As used in this Agreement, the following terms have the following meanings: (a) Act. The term "Act" means the Colorado Business Corporation Act as it exists on the date of this Agreement and as it may be hereafter amended from time to time. In the case of any amendment of the Colorado Business Corporation Act after the date of this Agreement, when used in reference to an act or omission occurring prior to effectiveness of such amendment, the term "Act" shall include such amendment only to the extent that the amendment can apply to a prior act or omission and the amendment permits the Corporation to provide broader indemnification rights than the Colorado Business Corporation Act permitted the Corporation to provide at the date of this Agreement and prior to the amendment. (b) Director. The term "director and/or officer" means an individual who is or was a director or an officer, or both, of a corporation or an individual who, while a director and/or officer of a corporation, is or was serving at the corporation's request as a director, an officer, an agent, an associate, an employee, a fiduciary, a manager, a member, a partner, a promoter, or a trustee of, or to hold any similar position with, another corporation or other person or of an employee benefit plan. A director or officer is considered to be serving an employee benefit plan at the corporations' request if the director's or officer's duties to the corporation also impose duties on, or otherwise involve services by, the director or officer to the plan or to participants in or beneficiaries of the plan. The term "director and/or officer" includes (i) unless the context requires otherwise, the estate or personal representative of a director or officer and (ii) any broader definition as may be provided in the Act from time to time. (c) Expenses. The term "expenses" includes counsel fees. (d) Liability. The term "liability" means the obligation incurred with respect to a proceeding to pay a judgment, settlement, penalty, fine, including an excise tax assessed with respect to an employee benefit plan, or reasonable expenses. (e) Party. The term "party" includes a person who was, is, or is threatened to be made a defendant or respondent in a proceeding. (f) Proceeding. The term "proceeding" means any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, and whether formal or informal. 5. AGREEMENT TO INDEMNIFY: The Corporation shall indemnify and hold harmless ***** in accordance with, and to the fullest extent permitted and/or required by, the express provisions of the Act from and against any liability, judgment, penalty, fine (including but not limited to excise taxes with respect to an employee benefit plan), amounts paid in settlement and reasonable expenses (including but not limited to expenses of investigation and preparation and fees and disbursements of *****'s counsel, accountants or other experts) actually incurred by ***** in connection with any proceeding in which ***** was or is made a party or was or is involved (for example, as a witness) because ***** is or was a director or an officer of the Corporation. 6. INSURANCE: So long as ***** may be subject to any possible proceeding by reason of the fact that ***** is or was a director or officer of the Corporation, to the extent the Corporation maintains an insurance policy or policies providing directors' and 2 officers' liability insurance, ***** shall be covered by such policy or policies, in accordance with its or their terms, to the maximum extent of the coverage applicable to any then current director or officer of the Corporation. 7. ADVANCES: In the event of any proceeding in which ***** is a party or is involved and which may give rise to a right of indemnification from the Corporation pursuant to this Agreement, following written request to the Corporation by *****, the Corporation shall pay to *****, in accordance with and to the fullest extent permitted and/or required by express provisions of the Act, amounts to cover reasonable expenses incurred by ***** in such proceeding in advance of its final disposition upon (a) receipt by the Corporation of (i) a written affirmation by ***** of *****'s good faith belief that ***** has met any applicable standard of conduct described in the Act and (ii) a written undertaking executed by or on behalf of ***** to repay the advance if it shall ultimately be determined that ***** did not meet such standard of conduct and (b) the making of a determination on behalf of the Corporation (in the manner prescribed in the Act) that, based on the facts then known to the persons making the determination would not preclude indemnification under the Act. If a requested is made by ***** to the Corporation for advancement of any expenses incurred in connection with any claim, suit or proceeding for which ***** has claimed indemnification under this Agreement, ***** shall furnish to the Corporation satisfactory evidence as to the amount of such expenses. The undertaking required by clause (a) must be an unlimited general obligation of *****, but it need not be secured, and it shall be accepted without reference to the financial ability of ***** to make repayment. 8. BURDEN OF PROOF: If under applicable law, the entitlement of ***** to be indemnified by the Corporation or to receive the advancement of expenses hereunder depends upon whether a standard of conduct has been met, the Corporation shall have the burden of proof of establishing that ***** did not act in accordance with such standard. ***** shall be presumed to have acted in accordance with such standard and to be entitled to indemnification or the advancement of expenses (as the case may be) unless, based upon a preponderance of the evidence, it shall be determined that ***** has not met such standard. Such determination and any evaluation as to the reasonableness of amounts claimed by ***** shall be made by the Board of Directors of the Corporation, or such other body or persons as may be permitted by the Act, acting in good faith. For purposes of this Agreement, unless otherwise expressly stated, the termination of any proceeding by judgment, order, settlement (whether with or without court approval) or conviction, or upon a plea of nolo contendere, or its equivalent, shall not create a presumption, and is not determinative, that ***** did not meet any particular standard of conduct or have any particular belief or that a court has determined that indemnification is not permitted by applicable law. 9. NOTICE TO THE CORPORATION: ***** shall notify the Secretary of the Corporation in writing of any matter for which ***** intends to seek indemnification hereunder as soon as reasonably practicable following the receipt by ***** of written notice thereof; provided, however, that delay in so notifying the Corporation shall not constitute a waiver or release by ***** or rights hereunder. 3 10. COUNSEL FOR PROCEEDING: In the event of any proceeding in which ***** is a party or is involved and which may give rise to a right of indemnification hereunder, the Corporation shall have the right to retain counsel reasonably satisfactory to ***** to represent ***** and any others the Corporation may designate in such proceeding. In any such proceeding, ***** shall have the right to retain *****'s own counsel, but the fees and expenses of such counsel shall be at the expense of ***** unless (a) the retention of such counsel has been specifically authorized by the Corporation; (b) representation of ***** and another party by the same counsel as proposed by the Corporation would be inappropriate, in the reasonable judgment of *****, due to actual or potential differing interests between (as might be the case for representation of both the Corporation and ***** in a proceeding by or in the right of the Corporation); (c) the counsel retained by the Corporation and satisfactory to ***** has advised *****, in writing, that such counsel's representation of ***** would be likely inappropriate due to actual or potential different interests, whether it be a conflicting, inconsistent, diverse or other interest; or (d) the Corporation shall fail to retain counsel for ***** in such proceeding. Notwithstanding the foregoing, if an insurance carrier has supplied directors' and officers' liability insurance covering the liability which is the subject of a proceeding and is entitled to retain counsel for the defense of such proceeding, then the insurance carrier shall retain counsel to conduct the defense of such proceeding unless ***** and the Corporation concur in writing that the insurance carrier's doing so is undesirable. The Corporation shall not be liable under this Agreement for any settlement of any proceeding effected without its written consent. The Corporation shall not settle any proceeding in any manner which would impose any penalty or limitation on ***** without *****'s prior written consent. Consent to a proposed settlement of any proceeding shall not be unreasonably withheld or delayed by either the Corporation or *****. 11. ENFORCEMENT: The Corporation acknowledges that ***** is relying upon this Agreement in serving as a director and/or officer of the Corporation, as well as any serving in the future in any capacity as a director and/or officer of the Corporation. If a claim for indemnification or advancement of expenses is not paid in full by the Corporation within 30 days after a written claim has been received from ***** by the Corporation, ***** may at any time bring suit against the Corporation to recover the unpaid amount of the claim. If successful in whole or in part in such suit, ***** shall also be entitled to be paid all reasonable fees and expenses (including without limitation fees of counsel) in bringing and prosecuting such claim. Whether or not ***** has met any applicable standard of conduct, the Court in such suit may order indemnification or the advancement of expenses as the Court deems proper (subject to any express limitation of the Act). Further, the Corporation shall indemnify ***** from and against any and all expenses (including attorneys' fees) and, if requested by *****, shall (within 10 business days of such request) advance such expenses to *****, which are incurred by ***** in connection with any claim asserted against or suit brought by ***** for recovery under any directors' and officers' liability insurance policies maintained by the Corporation, regardless of whether ***** is unsuccessful in whole or in part in such claim or suit. 4 12. PROCEEDINGS BY *****: The Corporation shall indemnify ***** and advance expenses to ***** in connection with any proceeding (or part thereof) initiated by ***** only if such proceeding (or part thereof) was authorized by the Board of Directors of the Corporation. 13. NONEXCLUSIVITY: The rights of ***** for indemnification and advancement of expenses under this Agreement shall not be deemed exclusive of, or in limitation of, any rights to which ***** may be entitled under any applicable law, the Corporation's Articles of Incorporation or Bylaws, vote of stockholders or otherwise. 14. MISCELLANEOUS: (a) Effectiveness. This Agreement is effective for, and shall apply to, (i) any claim which is asserted or threatened before, on or after the date of this Agreement but for which no action, suit or proceeding has actually been brought prior to the date of this Agreement and (ii) any proceeding which is threatened before, on or after the date of this agreement but which is not pending prior to the date of this Agreement. Thus, this Agreement shall not apply to any action, suit or proceeding which has actually been brought before the date of this Agreement. So long as the foregoing standard of effectiveness has been satisfied, this Agreement shall be effective for and shall be applied to acts or omissions prior to, on or after the date of this Agreement. (b) Survival; Continuation. The rights of ***** hereunder shall inure to the benefit of ***** (even after ***** ceases to be a director or officer), *****'s personal representative, heirs, executors, administrators and beneficiaries; and this Agreement shall be binding upon the Corporation, its successors and assigns. The rights of ***** under this Agreement shall continue so long as ***** may be subject to any possible proceeding because of the fact that ***** was a director or officer of the Corporation. If the Corporation sells, leases, exchanges or otherwise disposes of, in a single transaction or series of related transactions, all or substantially all of its property and assets, the Corporation shall, as a condition precedent to such transaction, cause effective provision to be made so that the person or entity acquiring such property and assets shall become bound by and replace the Corporation under this Agreement. (c) Governing Law. This Agreement shall be governed by the laws of the State of Colorado. (d) Severability. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be deemed amended to accomplished the objectives of the provision as originally written and to the fullest extent permitted by law and all other provisions shall remain in full force and effect. (e) Amendment. No amendment, termination or cancellation of this Agreement shall be effective unless in writing signed by the Corporation and *****. 5 (f) Subrogation. In the event of payment under this Agreement the Corporation shall be subrogated to the extent of such payment to all of the rights of recovery of *****, who shall execute all papers required and shall do everything that may be necessary to secure such rights, including the execution of such documents necessary to enable the Corporation effectively to bring suit to enforce such rights. (g) Headings. The headings in this Agreement are for convenience only and are not to be considered in construing this Agreement. (h) Counterparts. This Agreement may be executed in counterparts, both of which shall be deemed an original, and together shall constitute one document. The parties have executed this Agreement as of the effective date first above stated. CARBON ENERGY CORPORATION [*****] By: ------------------------------- ------------------------------- Patrick R. McDonald President 6 SCHEDULE 10.5 ------------- As of October 14, 1999, the following persons have entered into Indemnification Agreements with Carbon Energy Corporation, the form of which is attached as Exhibit 10.5, issued in the 1999 Exchange Offer: Patrick R. McDonald Kevin D. Struzeski David H. Kennedy Lambros J. Lambros Bryan H. Lawrence Peter A. Leidel Harry A. Trueblood, Jr. EX-10.6 11 FORM OF EMPLOYMENT AGREEMENT-MCDONALD 9/30/99 EXHIBIT 10.6 - -------------------------------------------------------------------------------- FORM OF EMPLOYMENT AGREEMENT by and between CARBON ENERGY CORPORATION and PATRICK R. McDONALD Dated as of October 29, 1999 - -------------------------------------------------------------------------------- TABLE OF CONTENTS
Page Article I. Term of Employment .............................................................. 1 1.1 Position and Employment Period .................................................... 1 1.2 Appointment as Director ........................................................... 1 1.3 Change in Control ................................................................. 1 Article II. Duties ......................................................................... 4 2.1 Duties ............................................................................ 4 Article III. Compensation .................................................................. 4 3.1 Salary ............................................................................ 4 3.2 Options and Restricted Stock ...................................................... 4 3.3 Benefits; Life Insurance .......................................................... 5 3.4 Reimbursement of Expenses ......................................................... 5 Article IV. Death, Disability and Termination............................................... 5 4.1 Death ............................................................................. 5 4.2 Disability ........................................................................ 6 4.3 Disability Insurance .............................................................. 6 4.4 Determination of Disability ....................................................... 6 4.5 Termination ....................................................................... 6 Article V. Termination Benefits ............................................................ 7 5.1 Severance Payments ................................................................ 7 5.2 Termination for Cause ............................................................. 8 5.3 Certain Additional Payments by Company ............................................ 8 Article VI. Covenants of Executive ......................................................... 9 6.1 Confidential Information .......................................................... 9 Article VII. Miscellaneous ................................................................. 9 7.1 Disagreements ..................................................................... 9 7.2 Binding Effect; Benefits .......................................................... 9 7.3 Notices ........................................................................... 9 7.4 Entire Agreement .................................................................. 9 7.5 Amendments and Waivers ............................................................ 9 7.6 Section Headings .................................................................. 10 7.7 Severability ...................................................................... 10 7.8 Governing Law ..................................................................... 10 7.9 Counterparts; Facsimile ........................................................... 10
EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is dated and effective as of ______________________ (the "Effective Date"), by and between CARBON ENERGY CORPORATION, a Colorado corporation, with offices at 1700 Broadway, Suite 1150, Denver, Colorado 80290-1101 ("Company"), and PATRICK R. McDONALD, residing in Colorado ("Executive"). RECITALS WHEREAS, Company desires to acquire the services of Executive, and Executive desires to be employed by Company upon the terms and conditions set forth in this Agreement. AGREEMENT NOW THEREFORE, in consideration of these premises and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto do hereby agree as follows: Article I. Term of Employment 1.1 Position and Employment Period. Company hereby employs ------------------------------ Executive as its President and Chief Executive Officer, and Executive hereby accepts employment with Company, all in accordance with the terms and conditions hereof, for an initial three-year term commencing on the Effective Date and ending three years from that date, unless otherwise terminated as provided in Section 1.3 or Articles IV and V. This Agreement shall continue from year to year thereafter unless Company gives written notice of termination to Executive at least three months preceding the date of termination or Executive gives such notice to Company on or at least three months preceding the date of termination (the initial three-year term is referred to as the "Initial Employment Period," and together with any subsequent periods of employment pursuant hereto, the "Employment Period"). 1.2 Appointment as Director. Company agrees that for so long as ----------------------- Executive is an officer of Company, Company shall nominate and endorse Executive to serve as a director on Company's Board of Directors. 1.3 Change in Control. ----------------- (a) Hostile Change in Control. ------------------------- i. A Change in Control (as defined below) is hostile if it is neither solicited by Company nor supported by a majority of Company's then- existing Board of Directors ("Hostile Change in Control"). Notwithstanding anything herein to the contrary, in the event that a Hostile Change in Control of Company occurs, Company shall have the right to terminate this Agreement by paying Executive 400% of the Compensation (as defined below). ii. In the event that a Hostile Change in Control of Company occurs, Executive shall have the right to terminate this Agreement by written notice to Company and Company shall immediately pay Executive 400% of the Compensation. (b) Friendly Change in Control. -------------------------- i. A Change in Control (as defined below) is friendly if a majority of Company's then existing Board of Directors supports such Change in Control ("Friendly Change in Control"). Notwithstanding anything herein to the contrary, in the event that a Friendly Change in Control of Company occurs, Company shall have the right to terminate this Agreement by paying Executive 300% of the Compensation (as defined below). ii. In the event that a Friendly Change in Control of Company occurs, Executive shall have the right to terminate this Agreement by written notice to Company and Company shall immediately pay Executive 200% of the Compensation. (c) In addition, upon the occurrence of either a Hostile Change in Control of Company or a Friendly Change in Control of Company, the restrictions on any outstanding incentive awards (including, but not limited to, restricted stock and granted performance shares) granted to Executive under any incentive plan or arrangement shall lapse and such incentive awards shall become 100% vested, and all stock options and stock appreciation rights granted to Executive shall become immediately exercisable and shall become 100% vested. (d) Any amounts required to be paid by Company pursuant to this Section 1.3 shall be paid within five days of Executive's date of termination (the "Termination Date"). (e) As used in this Agreement, the term "Compensation" shall be the arithmetic average of Executive's annual base salary and incentive compensation for the three years prior to the Termination Date or, if Executive has been employed for less than three full years, such lesser number of calendar years during any part of which Executive has been so employed, with his base salary and incentive compensation taken into account at their full annualized rates for any partial year or years. For any partial year, the incentive compensation amount shall be deemed to be an amount equal to Executive's maximum incentive compensation which could be awarded for the fiscal year in which the Termination Date occurs had he continued in employment until the end of the fiscal year, assuming all performance targets and goals (if applicable) had been fully met by Company and by Executive, as applicable for that fiscal year. 2 (f) "Change in Control" shall be deemed to have occurred: i. At such time as a third person, including a "group" as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, becomes the beneficial owner of shares of Company having 50% or more of the total number of votes that may be cast for the election of Directors of Company; or ii. On the date on which the stockholders of Company approve: (A) any agreement for a merger or consolidation of Company with another entity, provided that there shall be no Change in Control if the persons and entities who were the stockholders of Company immediately before such merger or consolidation continue to own directly more than two-thirds of the outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the voting securities of Company outstanding immediately before such merger or consolidation; or (B) any sale, exchange or other disposition of all or substantially all of Company's assets; or iii. On the effective date of any sale, exchange or other disposition of greater than 50% in fair market value of Company's assets, other than in the ordinary course of business, whether in a single transaction or a series of related transactions; or iv. At such time that there is a change in more than a majority of Company's Board of Directors as a result of a proxy contest waged by a third person unaffiliated with Executive and not endorsed by Executive. v. A person, for purposes of this section, means an individual, corporation, partnership, joint venture, trust, unincorporated association or any other form of organization. In determining whether clause (i) of the preceding sentence has been satisfied, the third person owning shares must be someone other than Yorktown Energy Partners III, L.P., Yorktown Partners LLC, or entities controlled by Yorktown Partners LLC. For this purpose, the term "controlled" means possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether (1) through the ownership of more than 50% of the outstanding voting securities of the person, (2) by contract or (3) by a position such as a general partner or manager. (g) After Executive's termination of employment as described in this Section 1.3, Company shall continue to provide for a period of 24 months from the Termination Date, medical, dental, disability and life insurance coverage to Executive at the same levels of coverage as in effect immediately prior to such date. 3 Article II. Duties 2.1 Duties. During the term hereof: ------ (a) Executive shall, subject to the succeeding sentence, devote such time as is necessary to perform his duties and shall discharge such duties to the best of his abilities. During the Employment Period, Executive may invest his personal assets and his time in enterprises other than Company if: (i) such enterprises do not compete with Company in Company's area of operations and do not require Executive to devote substantial amounts of his time thereto, or (ii) they are enterprises which Company has evaluated and in which it has elected not to invest, subject to Executive's notification to Company's Board of Directors of Executive's intention to so participate. (b) Company shall not, without the written consent of Executive, require Executive to perform services away from the Denver area at such frequency or duration as might, in the reasonable opinion of Executive, necessitate his moving his residence from the Denver area. Article III. Compensation 3.1 Salary. Company shall pay Executive a base salary of not less ------ than $200,000 per year plus an adjustment on each July 1 hereafter for all cost of living increases (computed by dividing the preceding year's U.S. consumer price index by the year preceding such year's U.S. consumer price index and multiplying such percentage by the then base salary), to be paid at the usual times for the payment of Company's executives, subject to adjustment as provided herein. Executive's base salary shall be reviewed annually by the Board of Directors of Company and may be increased, but not decreased. Incentive compensation or bonuses (called in this Agreement incentive compensation) will be determined by the Board of Directors at its discretion. 3.2 Options and Restricted Stock. As part of Executive's ---------------------------- compensation, Company shall issue to Executive an option to acquire 70,000 shares of Company's common stock with an exercise price of $5.50 per share. The option shall be granted under Company's 1999 Stock Option Plan. The option shall vest over three years, with the right to purchase one-third of the shares vested one year from the date of grant and the right to purchase an additional one- third of the shares vested on each of the second and third anniversaries of the date of grant, and the option shall be an incentive stock option. The complete terms of such option shall be as set forth in the option agreement which shall follow the standard form of option agreement under the 1999 Stock Option Plan and also reflect the Change in Control and other provisions of this Agreement regarding vesting. In addition, as part of Executive's compensation, Company shall grant to Executive 30,000 shares of Company common stock under Company's 1999 Restricted Stock Plan. This restricted stock shall vest over three years, with one-third of the restricted stock vested one year from the date of grant and an 4 additional one-third of the restricted stock vested on each of the second and third anniversaries of the date of grant. The restricted stock grant shall be accompanied by the standard form of restricted stock agreement under Company's 1999 Restricted Stock Plan, and the restricted stock agreement shall reflect the Change in Control and other provisions of this Agreement in regard to vesting. The grants of the above-described option and restricted stock shall be made on the Effective Date. 3.3 Benefits; Life Insurance. Executive shall be entitled to ------------------------ receive all benefits (such as medical, dental, disability and life insurance and paid vacation (a maximum of four weeks)), as are currently being received by Executive from CEC Resources Ltd. Executive shall be eligible to participate in all incentive compensation, stock option, performance unit or similar plans or programs as the Board of Directors of Company may determine in its reasonable discretion based upon Company's compensation practices and Executive's responsibilities and performance. Company shall provide without cost to Executive the following: membership fees and dues relating to organizations to which Executive has historically belonged and subscription costs for publications relevant to Company's business which Executive has historically received. So long as Executive is employed under this Agreement and during the 24 months specified in Section 5.1(b), Company shall maintain for the benefit of Executive's estate, and pay the premiums for, a life insurance policy on Executive's life in the amount of $1,000,000. 3.4 Reimbursement of Expenses. In addition, Company shall promptly ------------------------- reimburse Executive for all reasonable and documented out-of-pocket expenses incurred in the performance of his duties hereunder, including without limitation, expenses for entertainment, travel, management seminars and the like. Article IV. Death, Disability and Termination 4.1 Death. If Executive dies during the Employment Period, the ----- Employment Period shall thereupon terminate for all purposes of this Agreement, and Company's obligations hereunder shall terminate immediately, and Executive's estate or legal representative shall be entitled only to the following: (a) any arrearages of salary, through the date of Executive's death; (b) any unpaid incentive compensation or compensatory options earned by Executive in respect of any calendar year prior to the calendar year in which occurs the death of Executive; (c) any incentive compensation or compensatory options to be granted, as determined in accordance with this Agreement, earned by Executive in respect of the year in which occurs the death of Executive; and 5 (d) any reimbursable expenses incurred through the date of Executive's death. 4.2 Disability. If Executive is unable to perform his duties as ---------- required under this Agreement by reason of mental or physical illness or incapacity, Company agrees to continue all payments due hereunder, including salary, for a period of 180 days from the date of disability. Notwithstanding anything to the contrary contained herein, Executive shall be considered disabled and Company may terminate this Agreement at any time Executive shall be absent from employment as a result of mental or physical illness or incapacity for a continuous period of 180 days, and all obligations of Company hereunder shall cease upon any such termination. Upon any such termination, Executive shall be entitled only to the following: (a) any arrearages of salary, through the date of such termination, including that which is payable as a result of the first sentence of this Section 4.2; (b) any unpaid incentive compensation or any options earned by Executive in respect of any calendar year prior to the calendar year in which occurs the disability of Executive; (c) any incentive compensation or options earned by Executive in respect of the year in which occurs the disability of Executive; and (d) any reimbursable expenses incurred by Executive. 4.3 Disability Insurance. While Executive is employed under this -------------------- Agreement, during the period specified in Section 5.1(b) and after the period described in Section 5.1(b) if this Agreement is terminated because of Executive's disability, Company shall provide, for the benefit of Executive, a disability insurance policy, with mutually agreeable terms determined within 60 days of the Effective Date, the premiums of which shall be paid by Company. 4.4 Determination of Disability. For purposes of this Agreement, if --------------------------- at any time a question arises as to the disability of Executive, then Company and Executive shall agree on one physician who is a member of the American Medical Association to examine Executive and determine if his physical and/or mental condition is such as to render him incapable of performing the usual duties of his employment with Company. 4.5 Termination. In addition to the foregoing provisions, the ----------- Employment Period and Executive's employment with Company may be terminated by: (a) Company for cause (as defined in Section 5.2), immediately upon determination by the Board of Directors and providing Executive with written notice of termination; 6 (b) Executive following a change in position with Company from that described in Section 1.1 or because of any other material breach of this Agreement by Company, provided Executive does not voluntarily accept the change in position and notifies Company of his non-acceptance thereof and provided, in the case of any other material breach, Executive gives a written notification to Company of the material breach and the material breach is not cured within 20 business days of Company's receipt of the notification; or (c) either party upon 30 days prior written notice from the terminating party to the other party. Article V. Termination Benefits 5.1 Severance Payments. Subject to the provisions of Section 1.3 ------------------ hereof, (i) if Executive's employment shall be terminated by the Board of Directors of Company for any reason other than "for cause" or upon the death or disability of Executive, or (ii) if Executive voluntarily terminates employment in accordance with Section 4.5(b) following a change in position with Company from that described in Section 1.1 or because of any other material breach of this Agreement by Company, then Company shall pay Executive a termination benefit as follows: (a) Company shall pay Executive in a single lump sum payment in an amount equal to 300% of the Compensation (as defined above) (the "Severance Payments"). The Severance Payments shall be paid regardless of whether Executive is able to secure alternative employment. In the event Executive should die before payment of all amounts due under this Article V, the remaining amounts shall be paid to Executive's designated beneficiary, if any, and otherwise to Executive's estate. (b) Company shall continue to provide for a period of 24 months from the Termination Date, medical, dental, disability and life insurance coverage to Executive at the same levels of coverage as in effect immediately prior to such date. (c) Notwithstanding anything to the contrary in this or any other agreement, immediately upon termination under the circumstances described in this Section 5.1, all Executive's options shall become immediately exercisable and shall become 100% vested, all of Executive's restricted stock shall become immediately 100% vested, and all performance incentives granted to Executive shall become 100% vested. (d) Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to Executive in any subsequent employment except as provided herein. 7 (e) The Severance Payments and benefits provided in this Agreement shall be in lieu of any other severance pay to which Executive may be entitled under any Company severance plan, program or arrangement. 5.2 Termination for Cause. If Executive is terminated for cause, --------------------- then he shall receive no further benefits hereunder. "Cause" shall mean a termination on account of (1) repeated refusal to obey written directions of the Board of Directors or a superior officer (so long as such directions do not involve illegal or immoral acts); (2) repeated acts of substance abuse which are materially injurious to Company or any of its subsidiaries, (3) fraud or dishonesty that is materially injurious to Company or any of its subsidiaries, (4) breach of any material obligation of nondisclosure or confidentiality owed to Company or any of its subsidiaries, (5) commission of a criminal offense involving money or other property of Company (excluding any traffic violations or similar violations), or (6) commission of a criminal offense that constitutes a felony in the jurisdiction in which the offense is committed. 5.3 Certain Additional Payments by Company. Notwithstanding -------------------------------------- anything to the contrary in this Agreement, in the event that any payment or distribution by Company to or for the benefit of the Executive, whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise (a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code or any interest or penalties with respect to such excise tax (such excise tax, together with any such interest or penalties, are hereinafter collectively referred to as the "Excise Tax"), Company shall pay to Executive an additional payment (a "Gross-up Payment") in an amount such that after payment by Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including any Excise Tax imposed on any Gross-up Payment, Executive retains an amount of the Gross-up Payment equal to the Excise Tax imposed upon the Payments. Company and Executive shall make an initial determination as to whether a Gross-up Payment is required and the amount of any such Gross-up Payment. Executive shall notify Company immediately in writing of any claim by the Internal Revenue Service which, if successful, would require such Gross-up Payment (or a Gross-up Payment in excess of that, if any, initially determined by Company and Executive) within five days of the receipt of such claim. Company shall notify Executive in writing at least five days prior to the due date of any response required with respect to such claim if it plans to contest the claim. If Company decides to contest such claim, Executive shall cooperate fully with Company in such action; provided, however, Company shall bear and pay directly or indirectly all costs and expenses (including additional interest and penalties) incurred in connection with such action and shall indemnify and hold Executive harmless, on an after- tax basis, for any Excise Tax or income tax, including interest and penalties with respect thereto, imposed as a result of Company's action. If, as a result of Company's action with respect to a claim, Executive receives a refund of any amount paid by Company with respect to such claim, Executive shall promptly pay such refund to Company. If Company fails to timely notify Executive whether it will contest such claim or Company determines not to contest such claim, then Company shall immediately pay to Executive the portion of such claim, if any, which it has not previously paid to Executive. 8 Article VI. Covenants of Executive 6.1 Confidential Information. Executive covenants and agrees that ------------------------ he will not at any time during or after the termination of his employment, whether under this Agreement, or otherwise, reveal, divulge or make known to any person any confidential or proprietary information ("Confidential Information") whatsoever made known to Executive by reason of his employment by Company. This Section 6.1 shall not apply to information made known to Executive by reason of his outside personal business interests or personal investments made in accordance with this Agreement. In the event of a breach or threatened breach by Executive of the provisions of this Section 6.1, Company shall be entitled, in addition to any remedy hereunder or under any applicable law, to an injunction restraining Executive from disclosing or using, in whole or in part, any Confidential Information. The covenants contained in this Section 6.1 shall survive the termination or expiration of this Agreement for a period of 24 months. Article VII. Miscellaneous 7.1 Disagreements. In the event that Company and Executive shall ------------- disagree as to their respective rights and obligations hereunder, then Company shall pay reasonable counsel fees incurred by Executive in connection with such disagreement, if Executive prevails in his position. 7.2 Binding Effect; Benefits. This Agreement shall inure to the ------------------------ benefit of, and shall be binding upon, the parties hereto and their respective successors, assigns, heirs and legal representatives. Insofar as Executive is concerned, this contract may not be assigned. 7.3 Notices. All notices and other communications which are ------- required or permitted hereunder shall be in writing and shall be sufficient if mailed by registered or certified mail, postage prepaid to the address specified herein in the case of Company, Executive's residential address, or such other address as any party hereto shall have specified by notice in writing to the other party hereto. All such notices and communications shall be deemed to have been received on the date of delivery thereof or the fifth business day after the mailing thereof, whichever is the earlier. 7.4 Entire Agreement. This Agreement contains the entire agreement ---------------- between the parties hereto and supersedes all prior agreements and understandings, oral or written, between the parties hereto with respect to the subject matter hereof. 7.5 Amendments and Waivers. This Agreement may not be modified or ---------------------- amended except by an instrument or instruments in writing signed by the party against whom enforcement or any such modification or amendment is sought. Either party hereto may, by an instrument in writing, waive compliance by the other party with any term or provision of this Agreement on the part of such other party hereto to be 9 performed or complied with. The waiver by any party hereto of a breach of any term or provision of this Agreement shall not be construed as a waiver of any subsequent breach. 7.6 Section Headings. The section and other headings contained in ---------------- this Agreement are for reference purposes only and shall not be deemed to be a part of this Agreement or to control or affect the meaning or construction of any provision of this Agreement. 7.7 Severability. If any term or provision of this Agreement is ------------ held or deemed to be invalid or unenforceable, in whole or in part, by a court of competent jurisdiction, this Agreement shall be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement. 7.8 Governing Law. This Agreement shall be governed by and ------------- construed and enforced in accordance with the laws of the State of Colorado without regard to its principals regarding conflicts of law. 7.9 Counterparts; Facsimile. This Agreement may be executed in any ----------------------- number of counterparts, each of which shall be deemed an original, and all of which together shall be deemed one and the same instrument. This Agreement may be delivered by facsimile. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the day and year first above written. COMPANY: CARBON ENERGY CORPORATION By:________________________________ Its:___________________________ EXECUTIVE: ___________________________________ Patrick R. McDonald 10 EX-10.7 12 FORM OF EMPLOYMENT AGREEMENT-STRUZESKI 9/30/99 EXHIBIT 10.7 - -------------------------------------------------------------------------------- FORM OF EMPLOYMENT AGREEMENT by and between CARBON ENERGY CORPORATION and KEVIN D. STRUZESKI Dated as of October 29, 1999 - -------------------------------------------------------------------------------- TABLE OF CONTENTS
Page Article I. Term of Employment............................................................... 1 1.1 Position and Employment Period ................................................... 1 1.2 Change in Control ................................................................ 1 Article II. Duties.......................................................................... 3 2.1 Duties............................................................................ 3 Article III. Compensation................................................................... 4 3.1 Salary............................................................................ 4 3.2 Benefits.......................................................................... 4 3.3 Reimbursement of Expenses......................................................... 4 Article IV. Death and Disability............................................................ 4 4.1 Death............................................................................. 4 4.2 Disability........................................................................ 5 4.3 Determination of Disability....................................................... 5 4.4 Termination....................................................................... 5 Article V. Termination Benefits............................................................. 6 5.1 Severance Payments................................................................ 6 5.2 Termination for Cause............................................................. 6 Article VI. Covenants of Executive.......................................................... 7 6.1 Confidential Information.......................................................... 7 Article VII. Miscellaneous.................................................................. 7 7.1 Disagreements..................................................................... 7 7.2 Binding Effect; Benefits.......................................................... 7 7.3 Notices........................................................................... 7 7.4 Entire Agreement.................................................................. 8 7.5 Amendments and Waivers............................................................ 8 7.6 Section Headings.................................................................. 8 7.7 Severability...................................................................... 8 7.8 Governing Law..................................................................... 8 7.9 Counterparts; Facsimile........................................................... 8
i EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (this "Agreement") is dated and effective as of _________________, 1999 (the "Effective Date"), by and between CARBON ENERGY CORPORATION, a Colorado corporation, with offices at 1700 Broadway, Suite 1150, Denver, Colorado 80290-1101 ("Company"), and Kevin D. Struzeski, residing in Colorado ("Executive"). RECITALS WHEREAS, Company desires to acquire the services of Executive, and Executive desires to be employed by Company upon the terms and conditions set forth in this Agreement. AGREEMENT NOW THEREFORE, in consideration of these premises and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto do hereby agree as follows: Article I. Term of Employment 1.1 Position and Employment Period. Company hereby employs ------------------------------ Executive as its Chief Financial Officer, and Executive hereby accepts employment with Company, all in accordance with the terms and conditions hereof, for an initial two-year term commencing on the Effective Date and ending two years from that date, unless otherwise terminated as provided in Section 1.2 or Articles IV and V. This Agreement shall continue from year to year thereafter unless Company gives written notice of termination to Executive at least three months preceding the date of termination or Executive gives such notice to Company on or at least three months preceding the date of termination (the initial two-year term is referred to as the "Initial Employment Period," and together with any subsequent periods of employment pursuant hereto, the "Employment Period"). 1.2 Change in Control. ----------------- (a) Hostile Change in Control. ------------------------- i. A Change in Control (as defined below) is hostile if it is neither solicited by Company nor supported by a majority of Company's then existing Board of Directors ("Hostile Change in Control"). Notwithstanding anything herein to the contrary, in the event that a Hostile Change in Control of Company occurs, Company shall have the right to terminate this Agreement by paying Executive 300% of the Compensation (as defined below), which he would have received if this Agreement had not been terminated. ii. In the event that a Hostile Change in Control of Company occurs, Executive shall have the right to terminate this Agreement by written notice to Company and Company shall immediately pay Executive 300% of the Compensation, which he would have received if this Agreement had not been terminated. (b) Friendly Change in Control. -------------------------- i. A Change in Control (as defined below) is friendly if a majority of Company's then existing Board of Directors supports such Change in Control ("Friendly Change in Control"). Notwithstanding anything herein to the contrary, in the event that a Friendly Change in Control of Company occurs, Company shall have the right to terminate this Agreement by paying Executive 200% of the Compensation (as defined below), which he would have received if this Agreement had not been terminated. ii. In the event that a Friendly Change in Control of Company occurs, Executive shall have the right to terminate this Agreement by written notice to Company and Company shall immediately pay Executive 100% of the Compensation, which he would have received if this Agreement had not been terminated. (c) In addition, upon the occurrence of either a Hostile Change in Control of Company or a Friendly Change in Control of Company, the restrictions on any outstanding incentive awards (including restricted stock and granted performance shares) granted to Executive under any incentive plan or arrangement shall lapse and such incentive awards shall become 100% vested, and all stock options and stock appreciation rights granted to Executive shall become immediately exercisable and shall become 100% vested. (d) Any amounts required to be paid by Company pursuant to this Section 1.2 shall be paid within five days of Executive's date of termination (the "Termination Date"). (e) As used in this Agreement, the term "Compensation" shall be determined by averaging the total value of Executive's annual base salary and incentive compensation for the two years prior to the Termination Date (pro rated on a monthly basis) or, if Executive has been employed for less than two full years, such lesser number of calendar years during any part of which Executive has been so employed, with his base salary and incentive compensation taken into account at their full annualized rates for any partial year or years (pro rated on a monthly basis), and multiplying that amount by the remaining months of the Initial Employment Period, which for purposes of this Article I shall be deemed to be no less than 12 months, or if such Compensation is determined in reference to a period of employment subsequent to the expiration of the Initial Employment Period, it shall be the annualized amount of such Compensation during such period as calculated above (pro rated on a monthly basis), multiplied by 12. The annualized amount of the average base salary and incentive compensation described 2 in this paragraph is to be pro rated to a monthly amount before multiplying by the remaining months of the Initial Employment Period or by 12, as the case may be. (f) "Change in Control" shall be deemed to have occurred: i. At such time as a third person, including a "group" as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, becomes the beneficial owner of shares of Company having 50% or more of the total number of votes that may be cast for the election of Directors of Company; or ii. On the date on which the stockholders of Company approve: (A) any agreement for a merger or consolidation of Company with another entity, provided that there shall be no Change in Control if the persons and entities who were the stockholders of Company immediately before such merger or consolidation continue to own directly more than two-thirds of the outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the voting securities of Company outstanding immediately before such merger or consolidation; or (B) any sale, exchange or other disposition of all or substantially all of Company's assets; or iii. On the effective date of any sale, exchange or other disposition of greater than 50% in fair market value of Company's assets, other than in the ordinary course of business, whether in a single transaction or a series of related transactions; or iv. At such time that there is a change in more than a majority of Company's Board of Directors as a result of a proxy contest waged by a third person unaffiliated with Executive and not endorsed by Executive. v. A person, for purposes of this section, means an individual, corporation, partnership, joint venture, trust, unincorporated association or any other form of organization. In determining whether clause (i) of the preceding sentence has been satisfied, the third person owning shares must be someone other than Yorktown Energy Partners III, L.P., Yorktown Partners LLC, or entities controlled by Yorktown Partners LLC. For this purpose, the term "controlled" means possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether (1) through the ownership of more than 50% of the outstanding voting securities of the person, (2) by contract or (3) by a position such as a general partner or manager. Article II. Duties 2.1 Duties. During the term hereof, Executive shall, subject to the ------ succeeding sentence, devote all of his available working time to perform his duties and 3 shall discharge such duties to the best of his abilities. Executive may invest his personal assets and his time in enterprises other than Company if such enterprises do not compete with Company in Company's area of operations and do not require Executive to devote substantial amounts of his time thereto. Article III. Compensation 3.1 Salary. Company shall pay Executive a base salary of not less ------ than $100,000 per year to be paid at the usual times for the payment of Company's executives, subject to adjustment as provided herein. Executive's base salary shall be reviewed annually by the Board of Directors of Company. Incentive compensation or bonuses (called in this Agreement incentive compensation) will be determined by the Board of Directors at its discretion. 3.2 Benefits. Executive shall be entitled to receive all benefits -------- (such as medical, dental, disability and life insurance, paid vacation (a maximum of three weeks)) offered by the Company to its employees generally. Executive shall be eligible to participate in all incentive compensation, stock option, performance unit or similar plans or programs as the Board of Directors of Company may determine in its reasonable discretion based upon Company's compensation practices and Executive's responsibilities and performance. 3.3 Reimbursement of Expenses. In addition, Company shall promptly ------------------------- reimburse Executive for all reasonable and documented out-of-pocket expenses incurred in the performance of his duties hereunder, including expenses for entertainment and travel. Article IV. Death and Disability 4.1 Death. If Executive dies during the Employment Period, the ----- Employment Period shall thereupon terminate for all purposes of this Agreement, and Company's obligations hereunder shall terminate immediately, and Executive's estate or legal representative shall be entitled only to the following: (a) any arrearage of salary through the date of Executive's death; (b) any unpaid incentive compensation or compensatory options earned by Executive in respect of any calendar year prior to the calendar year in which occurs the death of Executive; (c) any incentive compensation or compensatory options to be granted earned by Executive in respect of the year in which occurs the death of Executive; and 4 (d) any reimbursable expenses incurred through the date of Executive's death. 4.2 Disability. If Executive is unable to perform his duties as ---------- required under this Agreement by reason of mental or physical illness or incapacity, Company agrees to continue all payments due hereunder, including salary, for a period of 180 days from the date of disability. Notwithstanding anything to the contrary contained herein, Executive shall be considered disabled and Company may terminate this Agreement at any time Executive shall be absent from employment as a result of mental or physical illness or incapacity for a continuous period of 180 days, and all obligations of Company hereunder shall cease upon any such termination. Upon any such termination, Executive shall be entitled only to the following: (a) any arrearages of salary, through the date of such termination, including that which is payable as a result of the first sentence of this Section 4.2; (b) any unpaid incentive compensation or any options earned by Executive in respect of any calendar year prior to the calendar year in which occurs the disability of Executive; (c) any incentive compensation or options earned by Executive in respect of the year in which occurs the disability of Executive; and (d) any reimbursable expenses incurred by Executive. 4.3 Determination of Disability. For purposes of this Agreement, if --------------------------- at any time a question arises as to the disability of Executive, then Company and Executive shall agree on one physician who is a member of the American Medical Association to examine Executive and determine if his physical and/or mental condition is such as to render him incapable of performing the usual duties of his employment with Company. 4.4 Termination. In addition to the foregoing provisions, the ----------- Employment Period and Executive's employment with Company may be terminated by: (a) Company for cause (as defined in Section 5.2), immediately upon determination by the Board of Directors and providing Executive with written notice of termination; (b) Executive following a change in position with Company if the new position is not a comparable position to that described in Section 1.1, provided Executive does not voluntarily accept the change in position and notifies Company of his non-acceptance thereof; or (c) either party upon 30 days prior written notice from the terminating party to the other party. 5 Article V. Termination Benefits 5.1 Severance Payments. Subject to the provisions of Section 1.2 ------------------ hereof, (i) if Executive's employment shall be terminated by the Board of Directors of Company for any reason other than "for cause" or upon the death or disability of Executive, or (ii) if Executive voluntarily terminates employment in accordance with Section 4.5(b) following a change in position with Company if the new position is not a comparable position to that described in Section 1.1, then Company shall pay Executive a termination benefit as follows: (a) Company shall pay Executive an amount equal to Executive's Compensation (pro rated on a monthly basis) multiplied by the remaining months of this Agreement, which for purposes of this Article V shall be deemed to be no less than 12 months (the "Severance Payments"). The Severance Payments shall be paid in 12 equal monthly installments payable on or before the first day of each calendar month following the Termination Date and shall be paid regardless of whether Executive is able to secure alternative employment. In the event Executive should die before payment of all of the installments due hereunder, the remaining installments shall be paid to Executive's designated beneficiary, if any, and otherwise to Executive's estate. (b) Company shall continue to provide for a period of six months from the Termination Date, medical, dental, disability and life insurance coverage to Executive at the same levels of coverage as in effect immediately prior to such date. (c) Immediately upon termination under the circumstances described in this Section 5.1, all Executive's options shall become immediately exercisable and shall become 100% vested, and all performance incentives granted to Executive shall become 100% vested. (d) Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to Executive in any subsequent employment except as provided herein. (e) The severance pay and benefits provided in this Agreement shall be in lieu of any other severance pay to which Executive may be entitled under any Company severance plan, program or arrangement. 5.2 Termination for Cause. If Executive is terminated for cause, --------------------- then he shall receive no further benefits hereunder. "Cause" shall mean a termination on account of (1) repeated refusal to obey written directions of the Board of Directors or a superior officer (so long as such directions do not involve illegal or immoral acts); (2) repeated acts of substance abuse which are materially injurious to Company or any of its 6 subsidiaries, (3) fraud or dishonesty that is materially injurious to Company or any of its subsidiaries, (4) breach of any material obligation of nondisclosure or confidentiality owed to Company or any of its subsidiaries, (5) commission of a criminal offense involving money or other property of Company (excluding any traffic violations or similar violations), or (6) commission of a criminal offense that constitutes a felony in the jurisdiction in which the offense is committed. Article VI. Covenants of Executive 6.1 Confidential Information. Executive covenants and agrees that ------------------------ he will not at any time during or after the termination of his employment, whether under this Agreement, or otherwise, reveal, divulge or make known to any person any confidential or proprietary information ("Confidential Information") whatsoever made known to Executive by reason of his employment by Company. This Section 6.1 shall not apply to information made known to Executive by reason of his outside personal business interests or personal investments made in accordance with this Agreement. In the event of a breach or threatened breach by Executive of the provisions of this Section 6.1, Company shall be entitled, in addition to any remedy hereunder or under any applicable law, to an injunction restraining Executive from disclosing or using, in whole or in part, any Confidential Information. The covenants contained in this Section 6.1 shall survive the termination or expiration of this Agreement for a period of 24 months. Article VII. Miscellaneous 7.1 Disagreements. In the event that Company and Executive shall ------------- disagree as to their respective rights and obligations hereunder, then Company shall pay reasonable counsel fees incurred by Executive in connection with such disagreement, if Executive prevails in his position. 7.2 Binding Effect; Benefits. This Agreement shall inure to the ------------------------ benefit of, and shall be binding upon, the parties hereto and their respective successors, assigns, heirs and legal representatives. Insofar as Executive is concerned, this contract may not be assigned. 7.3 Notices. All notices and other communications which are ------- required or permitted hereunder shall be in writing and shall be sufficient if mailed by registered or certified mail, postage prepaid to the address specified herein in the case of Company, Executive's residential address, or such other address as any party hereto shall have specified by notice in writing to the other party hereto. All such notices and communications shall be deemed to have been received on the date of delivery thereof or the fifth (5th) business day after the mailing thereof, whichever is the earlier. 7 7.4 Entire Agreement. This Agreement contains the entire agreement ---------------- between the parties hereto and supersedes all prior agreements and understandings, oral or written, between the parties hereto with respect to the subject matter hereof. 7.5 Amendments and Waivers. This Agreement may not be modified or ---------------------- amended except by an instrument or instruments in writing signed by the party against whom enforcement or any such modification or amendment is sought. Either party hereto may, by an instrument in writing, waive compliance by the other party with any term or provision of this Agreement on the part of such other party hereto to be performed or complied with. The waiver by any party hereto of a breach of any term or provision of this Agreement shall not be construed as a waiver of any subsequent breach. 7.6 Section Headings. The section and other headings contained in ---------------- this Agreement are for reference purposes only and shall not be deemed to be a part of this Agreement or to control or affect the meaning or construction of any provision of this Agreement. 7.7 Severability. If any term or provision of this Agreement is ------------ held or deemed to be invalid or unenforceable, in whole or in part, by a court of competent jurisdiction, this Agreement shall be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement. 7.8 Governing Law. This Agreement shall be governed by and ------------- construed and enforced in accordance with the laws of the State of Colorado without regard to its principals regarding conflicts of law. 7.9 Counterparts; Facsimile. This Agreement may be executed in any ----------------------- number of counterparts, each of which shall be deemed an original, and all of which together shall be deemed one and the same instrument. This Agreement may be delivered by facsimile. IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement on the day and year first above written. COMPANY: CARBON ENERGY CORPORATION By:________________________________ Its:___________________________ EXECUTIVE: ___________________________________ Kevin D. Struzeski 8 EX-23.2 13 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our report dated October 21, 1999 (and to all references to our Firm) included in or made a part of this Registration Statement. ARTHUR ANDERSEN LLP Denver, Colorado October 22, 1999 EX-23.3 14 CONSENT OF HEIN & ASSOCIATES LLP EXHIBIT 23.3 INDEPENDENT AUDITOR'S CONSENT We consent to the use in the Registration Statement and Prospectus of Carbon Energy Corporation of our report dated February 26, 1999, accompanying the consolidated financial statements of Bonneville Fuels Corporation contained in such Registration Statement, and to the use of our name and the statements with respect to us, as appearing under the heading "Experts" in the Prospectus. Hein + Associates LLP Denver, Colorado October 26, 1999 EX-23.4 15 CONSENT OF PRICEWATERHOUSECOOPERS LLP EXHIBIT 23.4 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in the Prospectus constituting part of this Registration Statement on Form S-4 of Carbon Energy Corporation of our report dated February 16, 1999 relating to the financial statements of CEC Resources Ltd., which appears in such Prospectus. We also consent to the reference to us under the heading "Experts" in such Prospectus. PRICEWATERHOUSECOOPERS, LLP Calgary, Canada October 26, 1999 EX-23.5 16 CONSENT TO BEING DIRECTOR OF H.A. TRUEBLOOD Exhibit 23.5 Consent of Person About to Become Director As a person who has not signed this registration statement of Carbon Energy Corporation but who is named herein as about to become a director, I hereby consent to the inclusion of such information and my name in this registration statement. /s/ Harry A. Trueblood -------------------------- Harry A. Trueblood, Jr. EX-23.6 17 CONSENT OF REED W. FERRILL & ASSOCIATES, INC. EXHIBIT 23.6 [REED W. FERRILL & ASSOCIATES LETTERHEAD] October 13, 1999 CEC Resources, Ltd. 1700 Broadway, Suite 1150 Denver, CO 80290 Reed W. Ferrill & Associates, Inc. consents to the use of its name and its reports dated February 24, 1997 entitled "CEC Resources, Ltd. Reserve and Revenue Forecast as of November 30, 1996, Constant Prices and Costs" and February 7, 1998 entitled "CEC Resources, Ltd. Reserve and Revenue Forecast as of November 30, 1997, Constant Prices and Costs" in whole or in part, by CEC Resources, Ltd. in Carbon Energy Corporation's Form S-4 Registration Statement to the SEC. For and on behalf of Reed W. Ferrill & Associates, Inc. /s/ Reed W. Ferrill Reed W. Ferrill President RWF/mlb EX-23.7 18 CONSENT OF SPROULE ASSOCIATES EXHIBIT 23.7 [SPROULE ASSOCIATES LIMITED LETTERHEAD] October 1, 1999 CEC Resources, Ltd. 1700 Broadway, Suite 1150 Denver, CO 80290 Re: Carbon Energy Corporation's Form S-4, Registration Statement to the SEC Dear Sirs: Sproule Associates Limited consents to the use of its name and its reports dated February 10, 1999 entitled "Evaluation of the P&NG Reserves of CEC Resources Ltd. (As of November 30, 1998) Constant (SEC) Price Case" in whole or in part, by CEC Resources, Ltd. in Carbon Energy Corporation's Form S-4, Registration Statement to the SEC. Sincerely, /s/ Paul B. Jung Paul B. Jung, P. Eng. Senior Petroleum Engineer PBJ;db EX-23.8 19 CONSENT OF RYDER SCOTT COMPANY EXHIBIT 23.8 [RYDER SCOTT COMPANY LETTERHEAD] CONSENT OF INDEPENDENT PETROLEUM ENGINEERS The undersigned hereby consents to the incorporation by reference by CEC Resources in the Carbon Energy Corporation Form S-4 Registration Statement to the SEC of data derived from our reserve reports dated February 19, 1999 relating to the oil and gas reserves of Bonneville Fuels Corporation at December 31, 1998, March 4, 1998 relating to the oil and gas reserves of Bonneville Fuels Corporation at December 31, 1997, and February 18, 1997 relating to the oil and gas reserves of Bonneville Fuels Corporation at December 31, 1996. We also consent to the reference to this firm under the caption "Experts" and elsewhere in such registration statement. Very truly yours, /s/ Ryder Scott Company, L.P. RYDER SCOTT COMPANY, L.P. Denver, Colorado October 20, 1999 EX-24 20 POWER OF ATTORNEY EXHIBIT 24 POWER OF ATTORNEY Each of the undersigned directors and officers of Carbon Energy Corporation (the "Company") hereby authorizes Patrick R. McDonald and Kevin D. Struzeski and each of them as their true and lawful attorneys-in-fact and agents: (1) to sign in the name of each such person and file with the Securities and Exchange Commission a Registration Statement on an appropriate form, and any and all amendments (including post-effective amendments) to such Registration Statement, for the registration under the Securities Act of 1933, as amended, of comon stock of the Company issuable in the exchange offer by the Company for shares of CEC Resources Ltd. (in which exchange offer each holder of shares of CEC Resources Ltd. will be offered shares of the Company); and (2) to take any and all actions necessary or required in connection with such Registration Statement and amendments to comply with the Securities Act of 1933, as amended, and the rules and regulations of the Securities and Exchange Commission promulgated thereunder.
Signature Title Date - --------- ----- ---- /s/ David H. Kennedy Director September 27, 1999 - ----------------------------- David H. Kennedy /s/ Bryan H. Lawrence Director September 27, 1999 - ----------------------------- Bryan H. Lawrence /s/ Peter A. Leidel Director September 27, 1999 - ----------------------------- Peter A. Leidel /s/ Lambros J. Lambros Director September 27, 1999 - ----------------------------- Lambros J. Lambros /s/ Patrick R. McDonald Director and President September 27, 1999 - ----------------------------- Patrick R. McDonald /s/ Kevin D. Struzeski Chief Financial Officer September 27, 1999 - ----------------------------- and Treasurer Kevin D. Struzeski
EX-27.1 21 FINANCIAL DATA SCHEDULE
5 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 15,067,000 15,067,000 9,005,000 11,101,000 0 0 272,000 3,694,000 1,422,000 2,272,000 0 1,788,000 0 4,060,000 0 0
EX-27.2 22 FINANCIAL DATA SCHEDULE
5 YEAR YEAR DEC-31-1998 DEC-31-1997 JAN-01-1998 JAN-01-1997 DEC-31-1998 DEC-31-1997 2,742,000 544,000 0 0 4,972,000 2,818,000 0 0 0 0 8,489,000 3,666,000 32,921,000 28,870,000 18,891,000 16,863,000 22,840,000 16,054,000 7,677,000 2,175,000 0 0 0 0 0 0 0 0 9,313,000 9,591,000 22,840,000 16,054,000 21,092,000 16,539,000 21,092,000 16,539,000 16,815,000 11,829,000 22,970,000 15,445,000 0 0 0 0 238,000 83,000 0 0 (175,000) 279,000 (1,941,000) 732,000 0 0 0 0 0 0 (1,941,000) 732,000 0 0 0 0
EX-27.3 23 FINANCIAL DATA SCHEDULE
5 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 1,652,931 0 2,482,273 0 113,452 0 36,524,693 20,155,003 20,924,268 2,760,582 0 0 0 10 9,463,676 20,924,268 14,728,228 14,728,228 11,671,578 14,374,887 0 0 203,165 150,176 0 150,176 0 0 0 150,176 0 0
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