-----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, OEh3TzPGH3V2P3PLrFoG3i1P/uQMJwmcJPp7Mn8AGQUhimAeHssMWGL8bTZ4wfS7 /8VCBqwB0I+ynM/E3YPYWA== 0000950116-99-001616.txt : 19990820 0000950116-99-001616.hdr.sgml : 19990820 ACCESSION NUMBER: 0000950116-99-001616 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990819 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CASTLE ENERGY CORP CENTRAL INDEX KEY: 0000709355 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 760035225 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-10990 FILM NUMBER: 99696070 BUSINESS ADDRESS: STREET 1: ONE RADNOR CORPORATE CTR STE 250 STREET 2: 100 MATSONFORD RD CITY: RADNOR STATE: PA ZIP: 19087 BUSINESS PHONE: 6109959400 MAIL ADDRESS: STREET 1: ONE RADNOR CORPORATE CENTER SUITE 250 STREET 2: 100 MATSONFORD CITY: RADNOR STATE: PA ZIP: 19087 FORMER COMPANY: FORMER CONFORMED NAME: MINDEN OIL & GAS INC/NEW DATE OF NAME CHANGE: 19861117 FORMER COMPANY: FORMER CONFORMED NAME: MINDEN HOLDING CO DATE OF NAME CHANGE: 19830310 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1999 ------------------------------------------------ or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period ended ------------------------------------------------ Commission file number: 0-10990 ------- CASTLE ENERGY CORPORATION - -------------------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) Delaware 76-0035225 - -------------------------------------------------------------------------------- (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization) One Radnor Corporate Center, Suite 250, 100 Matsonford Road, Radnor, Pennsylvania 19087 - -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code (610) 995-9400 --------------------------- - -------------------------------------------------------------------------------- (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check T whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days Yes x No . --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: 2,579,329 shares of Common Stock, $.50 par value outstanding as of August 13, 1999. CASTLE ENERGY CORPORATION INDEX
Page # ------ Part I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheets - June 30, 1999 (Unaudited) and September 30, 1998 ................................................ 1 Consolidated Statements of Operations - Three Months Ended June 30, 1999 and 1998 (Unaudited) .............................. 2 Consolidated Statements of Operations - Nine Months Ended June 30, 1999 and 1998 (Unaudited) .............................. 3 Consolidated Statements of Cash Flows - Nine Months Ended June 30, 1999 and 1998 (Unaudited) .............................. 4 Consolidated Statements of Stockholders' Equity - Nine Months Ended June 30, 1999 (Unaudited) and Year Ended September 30, 1998 ..... 5 Notes to the Consolidated Financial Statements (Unaudited) ............ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Unaudited) ....................... 14 Part II. Other Information Item 1. Legal Proceedings ................................................... 24 Item 4. Submission of Matters to a Vote of Security Holders ................. 24 Item 6. Exhibits and Reports on Form 8-K .................................... 24 Signature ..................................................................................... 25
PART I. FINANCIAL INFORMATION Item 1. Financial Statements CASTLE ENERGY CORPORATION CONSOLIDATED BALANCE SHEETS ("000's" Omitted Except Share Amounts)
June 30, September 30, 1999 1998 --------- --------- (Unaudited) ASSETS Current assets: Cash and cash equivalent ............................................. $ 28,310 $ 36,600 Restricted cash ...................................................... 1,352 613 Accounts receivable .................................................. 3,068 8,381 Marketable securities - Penn Octane Corporation ...................... 1,170 471 Prepaid transportation, net .......................................... 1,123 Prepaid expenses and other current assets ............................ 144 293 Prepaid gas purchases ................................................ 852 Deferred income taxes ................................................ 2,765 Note receivable - Penn Octane Corporation ............................ 100 1,000 Estimated realizable value of discontinued net refining assets ....... 2,921 3,623 --------- --------- Total current assets ............................................... 37,065 55,721 Property, plant and equipment, net: Natural gas transmission ............................................. 59 62 Furniture, fixtures, equipment and software .......................... 311 307 Oil and gas properties, net (full cost method) ......................... 25,536 4,600 Gas contracts, net ..................................................... 6,285 Investment in Penn Octane Corporation preferred stock .................. 477 Other assets ........................................................... 15 29 --------- --------- Total assets ....................................................... $ 63,463 $ 67,004 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Dividend payable ..................................................... $ 389 Accounts payable ..................................................... 5,740 $ 8,658 Accrued expenses ..................................................... 678 1,663 Net refining liabilities retained .................................... 5,325 5,129 --------- --------- Total current liabilities .......................................... 12,132 15,450 Other long-term liabilities ............................................ 1 --------- --------- Total liabilities .................................................. 12,132 15,451 --------- --------- Commitments and contingencies Stockholders' equity: Series B participating preferred stock; par value - $1.00; 10,000,000 shares authorized; no shares issued Common stock; par value - $0.50; 25,000,000 shares authorized; 6,828,646 issued at June 30, 1999 and 6,803,646 issued at September 30, 1998 ........................................................... 3,414 3,402 Additional paid-in capital ............................................. 67,365 67,122 Retained earnings ...................................................... 40,504 34,836 --------- --------- 111,283 105,360 Treasury stock at cost - 4,237,317 shares at June 30, 1999 and 3,862,917 shares at September 30, 1998 ........................................... (59,952) (53,807) --------- --------- Total stockholders' equity ......................................... 51,331 51,553 --------- --------- Total liabilities and stockholders' equity ......................... $ 63,463 $ 67,004 ========= =========
The accompanying notes are an integral part of these financial statements. -1- CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS ("000's" Omitted Except Share Amounts) (Unaudited)
Three Months Ended June 30, -------------------------------- 1999 1998 ----------- ----------- Revenues: Natural gas marketing: Gas sales .......................................... $ 7,950 $ 16,766 ----------- ----------- Exploration and production: Oil and gas sales .................................. 1,599 641 Well operations .................................... 119 57 ----------- ----------- 1,718 698 ----------- ----------- 9,668 17,464 ----------- ----------- Expenses: Natural gas marketing: Gas purchases ...................................... 4,838 9,859 Transportation ..................................... 170 343 Operating costs .................................... 16 General and administrative ......................... 60 75 Amortization ....................................... 1,553 2,365 ----------- ----------- 6,621 12,658 ----------- ----------- Exploration and production: Oil and gas production ............................. 741 162 General and administrative ......................... 259 377 Depreciation, depletion and amortization ........... 691 175 ----------- ----------- 1,691 714 ----------- ----------- Corporate general and administrative expenses ........ 1,211 567 ----------- ----------- 9,523 13,939 ----------- ----------- Operating income ....................................... 145 3,525 ----------- ----------- Other income (expense): Interest income ...................................... 356 514 Other income (expense) ............................... 404 (2) ----------- ----------- 760 512 ----------- ----------- Income before provision for (benefit of) income taxes .. 905 4,037 ----------- ----------- Provision for (benefit of) income taxes: State ................................................ (79) Federal .............................................. 5 (2,748) ----------- ----------- 5 (2,827) ----------- ----------- Net income ............................................. $ 900 $ 6,864 =========== =========== Net income per share: Basic ................................................ $ .35 $ 2.06 =========== =========== Diluted .............................................. $ .34 $ 2.02 =========== =========== Dividend declared per share ............................ $ .15 $ .15 =========== =========== Weighted average number of common and potential dilutive common shares outstanding: Basic ................................................ 2,596,312 3,332,319 =========== =========== Diluted .............................................. 2,643,718 3,404,773 =========== ===========
The accompanying notes are an integral part of these financial statements. -3- CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS ("000's" Omitted Except Share Amounts) (Unaudited)
Nine Months Ended June 30, 1999 1998 ---------- ---------- Revenues: Natural gas marketing: Gas sales ................................................. $ 50,102 $ 54,914 ---------- ---------- Exploration and production: Oil and gas sales ......................................... 2,571 1,861 Well operations ........................................... 296 172 ---------- ---------- 2,867 2,033 ---------- ---------- 52,969 56,947 ---------- ---------- Expenses: Natural gas marketing: Gas purchases ............................................. 31,102 34,058 Transportation ............................................ 1,123 1,203 Operating costs General and administrative ................................ 216 113 Amortization .............................................. 6,284 7,096 ---------- ---------- 38,725 42,470 ---------- ---------- Exploration and production: Oil and gas production .................................... 1,222 510 General and administrative ................................ 655 684 Depreciation, depletion and amortization .................. 840 502 ---------- ---------- 2,717 1,696 ---------- ---------- Corporate general and administrative expenses ............... 3,102 2,135 ---------- ---------- 44,544 46,301 ---------- ---------- Operating income .............................................. 8,425 10,646 ---------- ---------- Other income (expense): Interest income ............................................. 1,301 1,745 Other income (expense) ...................................... 438 27 ---------- ---------- 1,739 1,772 ---------- ---------- Income before provision for income taxes ...................... 10,164 12,418 ---------- ---------- Provision for income taxes: State ....................................................... 78 5 Federal ..................................................... 2,737 185 ---------- ---------- 2,815 190 ---------- ---------- Net income .................................................... $ 7,349 $ 12,228 ========== ========== Net income per share: Basic ....................................................... $ 2.63 $ 3.01 ========== ========== Diluted ..................................................... $ 2.59 $ 2.98 ========== ========== Dividends declared per share .................................. $ .60 $ .45 ========== ========== Weighted average number of common and potential dilutive common shares outstanding: Basic ....................................................... 2,789,172 4,066,103 ========== ========== Diluted ..................................................... 2,838,797 4,109,843 ========== ==========
The accompanying notes are an integral part of these financial statements. -3- CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS ("000's" Omitted) (Unaudited)
Nine Months Ended June 30, -------------------------- 1999 1998 -------- -------- Net cash flow provided by operating activities ............. $ 20,616 $ 33,947 -------- -------- Net cash flows used in investing activities: Investment in furniture, fixtures, equipment and software (113) Investment in pipelines ................................. (47) Investment in oil and gas properties .................... (21,620) (1,585) Investment in note receivable - Penn Octane Corporation . (1,000) -------- -------- (21,733) (2,632) -------- -------- Net cash flows used in financing activities: Dividends paid to stockholders .......................... (1,283) (1,942) Acquisition of treasury stock ........................... (6,145) (27,392) Proceeds from exercise of stock options ................. 255 64 -------- -------- (7,173) (29,270) -------- -------- Net increase in cash and cash equivalents .................. (8,290) 2,045 Cash and cash equivalents - beginning of period ............ 36,600 36,338 -------- -------- Cash and cash equivalents - end of period .................. $ 28,310 $ 38,383 ======== ========
The accompanying notes are an integral part of these financial statements. -4- CASTLE ENERGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY ("000's" Omitted Except Share Amounts)
Common Stock Additional Treasury Stock ----------------------- Paid-In Retained ---------------------- Total Shares Amount Capital Earnings Shares Amount Amount --------- ---------- ---------- ---------- --------- ---------- ---------- Balance - October 1, 1997 ......... 6,798,646 $ 3,399 $ 67,061 $ 22,468 2,085,100 ($ 25,163) $ 67,765 Stock acquired .................... 1,777,817 (28,644) (28,644) Options exercised ................. 5,000 3 61 64 Dividends ......................... (1,688) (1,688) Net income ........................ 14,056 14,056 --------- ---------- ---------- ---------- --------- ---------- ---------- Balance - September 30, 1998 ...... 6,803,646 3,402 67,122 34,836 3,862,917 (53,807) 51,553 Stock acquired (Unaudited) ........ 374,400 (6,145) (6,145) Options exercised (Unaudited) ..... 25,000 12 243 255 Dividends declared (Unaudited) .... (1,681) (1,681) Net income (Unaudited) ............ 7,349 7,349 --------- ---------- ---------- ---------- --------- ---------- ---------- Balance - June 30, 1999 (Unaudited) 6,828,646 $ 3,414 $ 67,365 $ 40,504 4,237,317 ($ 59,952) $ 51,331 ========== ========== ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements. -5- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) Note 1 - Basis of Preparation The unaudited consolidated financial statements of Castle Energy Corporation (the "Company") included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain reclassifications have been made to make the periods presented comparable. Although certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, the Company believes that the disclosures included herein are adequate to make the information presented not misleading. Operating results for the three month and the nine month periods ended June 30, 1999 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 1999 or for subsequent periods. These unaudited consolidated financial statements should be read in conjunction with the financial statements for the fiscal year ended September 30, 1998 and the notes thereto included in the Company's Annual Report on Form 10-K. In the opinion of the Company, the unaudited consolidated financial statements contain all normal recurring adjustments necessary for a fair statement of the results of operations for the three and nine month periods ended June 30, 1999 and 1998 and for a fair statement of financial position at June 30, 1999. Note 2 - September 30, 1998 Balance Sheet The amounts presented in the balance sheet as of September 30, 1998 were derived from the Company's audited consolidated financial statements for the fiscal year ended September 30, 1998, which were included in its Annual Report on Form 10-K. Note 3 - Discontinued Operations From August 1989 to September 30, 1995, several of the Company's subsidiaries conducted refining operations. By December 12, 1995, the Company's refining subsidiaries had sold all of their refining assets. In addition, Powerine Oil Company ("Powerine"), one of the Company's refining subsidiaries, merged into a subsidiary of the purchaser and is no longer a subsidiary of the Company. The Company's other refining subsidiaries own no refining assets and are in the process of liquidation. As a result, the Company has accounted for its refining operations as discontinued operations since fiscal 1995. Note 4 - Contingencies/Litigation Contingent Environmental Liabilities - Refining -6- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) Until September 30, 1995, the Company, through its subsidiaries, operated in the refining segment of the petroleum business. As operators of refineries, certain of the Company's subsidiaries were potentially liable for environmental costs related to air emissions, ground and water contamination, hazardous waste disposal and third party claims related to the foregoing. Between September 29, 1995 and December 12, 1995 both of the refineries owned by the Company's refining subsidiaries were sold to outside parties. In each case the purchaser assumed all environmental liabilities. Furthermore, on January 16, 1996, Powerine, the subsidiary that previously owned a refinery in Santa Fe Springs, California ("Powerine Refinery"), was effectively acquired by Energy Merchant Corp. ("EMC"), an unrelated party. In July of 1996, the Company was named a defendant in a class action lawsuit concerning emissions from the Powerine Refinery. In April of 1997, the court granted the Company's motion to quash the plaintiff's complaint based upon lack of jurisdiction and the Company is no longer involved in the case. During fiscal 1998, the Company was informed that the United States Environmental Protection Agency ("EPA") was investigating offsite acid sludge waste found near the Indian Refinery and was also investigating and remediating surface contamination in the Indian Refinery property. The Indian Refinery, located in Lawrenceville, Illinois, was previously operated by Indian Refinery I Limited Partnership ("IRLP"), an inactive subsidiary of the Company since September 30, 1995. Neither the Company nor IRLP was named with respect to these two actions. In October 1998, the EPA named the Company and two of its subsidiaries, including IRLP, as potentially responsible parties for the expected overall clean-up of the Indian Refinery. In addition, eighteen other parties were named including Texaco Refining and Marketing, Inc., the refinery operator for approximately 50 years. The Company subsequently responded to the EPA indicating that it was neither the owner nor operator of the Indian Refinery and thus not responsible for its remediation. Estimated undiscounted clean-up costs for the Indian Refinery are $80,000 to $150,000 according to third parties. Although the Company does not believe it has any liabilities with respect to the environmental liabilities of either or both of the refineries, a court of competent jurisdiction may find otherwise. A decision by the U.S. Supreme Court in June 1998, however, supports the Company's position. As of August 13, 1999, neither of the refineries had restarted. The Powerine Refinery has been sold to an unrelated party, which, the Company has been informed, is seeking financing to restart that refinery. The purchaser of the Indian Refinery, American Western Refining Limited Partnership ("American Western"), defaulted on its $5 million note to IRLP, filed a voluntary petition for bankruptcy in the United States Bankruptcy Court in the District of Delaware under Chapter 11 of the United States Bankruptcy Code and later sold the Indian Refinery to another unrelated party. The new owner is in the process of dismantling much of the Indian Refinery. -7- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) Although the environmental liabilities related to the Indian Refinery and Powerine Refinery have been transferred to others, there can be no assurance that the parties assuming such liabilities will be able to pay them. American Western, purchaser of the Indian Refinery, filed for bankruptcy and is in the process of liquidation. The current owner of the Indian Refinery is dismantling it. The current owner of the Powerine Refinery is reported to be continuing to seek financing to restart that refinery. Furthermore, as noted above, the Company and two of its subsidiaries have been named by the EPA as potentially responsible parties for the remediation of the Indian Refinery. If funds for environmental clean-up are not provided by former and/or present owners of the refineries, it is possible that the Company and/or one or more of its former refining subsidiaries could be named parties in additional legal actions to recover remediation costs. In recent years, government and other plaintiffs have often sought redress for environmental liabilities from the party most capable of payment without regard to responsibility or fault. Whether or not the Company ultimately prevails in such a circumstance, should litigation involving the Company or any of its former or current refining subsidiaries occur, the Company would probably incur substantial legal fees and experience a diversion of management resources from other operations. There have been no material litigation developments since those reported in Item 4 of the Company's Form 10-Q for the period ended March 31, 1999. Note 5 - New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("SFAS 130") regarding reporting comprehensive income, which establishes standards for reporting and display of comprehensive income and its components. The components of comprehensive income refer to revenues, expenses, gains and losses that are excluded from net income under current accounting standards, including foreign currency translation items, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. SFAS 130 requires that all items recognized under accounting standards as components of comprehensive income be reported in a financial statement displayed in equal prominence with the other financial statements. The total of other comprehensive income for a period is required to be transferred to a component of equity that is separately displayed in a statement of financial condition at the end of an accounting period. SFAS 130 was effective for both interim and annual periods for companies having fiscal years beginning after December 15, 1997. Reclassification of financial statements for earlier periods provided for comparative purposes is required. The Company adopted SFAS 130 effective October 1, 1998 but SFAS130 has not yet impacted the Company's financial disclosures. -8- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) In June 1997, FASB issued Statement of Financial Accounting Standards Board No. 131 ("SFAS 131") regarding disclosures about segments of an enterprise and related information. SFAS 131 establishes standards for reporting information about operating segments in annual financial statements and requires the reporting of selected information about operating segments in interim financial reports issued to stockholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS 131 was effective for companies having fiscal years beginning after December 15, 1997. The Company adopted SFAS No.131 effective October 1, 1998. The provisions of SFAS 131 have not materially changed the Company's disclosures and reported financial information because the Company has presented the required segment information in its consolidated statements of operations for several years before SFAS131 was effective and continue to do so. Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"), was issued by the Financial Accounting Standards Board in June 1998. SFAS 133 is currently scheduled to become effective for the Company on October 1, 2001. SFAS 133 standardizes the accounting for derivative instruments, including certain derivative instruments embedded in other contracts. Under the standard, entities are required to carry all derivative instruments in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, on the reason for holding it. If certain conditions are met, entities may elect to designate a derivative instrument as a hedge of exposures to changes in fair values, cash flows, or foreign currencies. If the hedged exposure is a fair value exposure, the gain or loss on the derivative instrument is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness, as well as the ineffective portion of the gain or loss, are reported in earnings immediately. Accounting for foreign currency hedges is similar to the accounting for fair value and cash flow hedges. If the derivative instrument is not designated as a hedge, the gain or loss is recognized in earnings in the period of change. All hedging by the Company through June 30, 1999 was applicable to the Company's gas marketing operations. Hedging transactions applicable to gas marketing operations terminated on May 31, 1999 when all of the Company's long-term gas contracts terminated. The Company, however, recently acquired substantial oil and gas reserves from AmBrit Energy Corp. ("AmBrit") and began hedging its crude oil and natural gas production (see Notes #6 and #9). The Company will account for its crude oil and natural gas as hedges pursuant to Statement of Financial Accounting Standards No. 80, Accounting for Futures Contracts ("SFAS 80") until SFAS 133 becomes effective for the Company. Note 6 - Derivative Financial Instruments Until June 1, 1999, the Company's natural gas marketing subsidiaries utilized futures contracts and natural gas basis swaps to reduce their exposure to changes in the market price of natural gas. Effective May 31, 1999 all natural gas marketing contracts terminated. As a result of these hedging transactions, the cost of gas purchases increased $569 and $864 for the nine month periods ended June 30, 1999 and 1998, respectively. For the quarter ended June 30, 1999 the cost of gas purchases decreased $152. For the quarter ended June 30, 1998, the cost of gas purchases increased $524. -9- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) On June 1, 1999, the Company acquired all of the oil and gas assets of AmBrit (see Note 9). In July 1999, the Company hedged approximately 69.5% of its anticipated consolidated crude oil production (approximately 32,000 barrels per month) and approximately 50% of its anticipated consolidated natural gas production (approximately 300,000 mcf per month) for the period from September 1, 1999 to July 31, 2000. The Company has used futures contracts to hedge such production. The average hedged prices for crude oil and natural gas, which are based upon futures prices on the New York Mercantile Exchange, are $20.02 per barrel of crude oil and $2.64 per mcf of gas. The Company anticipates that these futures contracts will be accounted for as hedges and that differences between the hedged price and the exchange price will increase or decrease the oil and gas revenues resulting from the sale of production. Oil and gas production was not hedged through July 31, 1999. Note 7 - Information Concerning Reportable Segments During the nine month periods ended June 30, 1999 and June 30, 1998, the Company operated in two segments of the energy industry: oil and gas exploration and production and natural gas marketing. The Company does not allocate interest income, interest expense or income tax expense to these segments. The operating income (loss) achieved by each of the Company's segments was as follows:
Nine months ended June 30, 1999: Operating Segment Revenues Expenses Income -------------------------------------------- -------- --------- --------- 1. Oil and gas exploration and production .................... $ 2,867 ($ 2,717) $ 150 2. Natural gas marketing ............. 50,102 (38,725) 11,377 ------- -------- ------- $52,969 ($41,442) $11,527 ======= ======== ======= Nine months ended June 30, 1998: Operating Segment Revenues Expenses Income -------------------------------------------- -------- --------- --------- 1. Oil and gas exploration and production .................... $ 2,033 ($ 1,696) $ 337 2. Natural gas marketing ............. 54,914 (42,470) 12,444 ------- -------- ------- $56,947 ($44,166) $12,781 ======= ======== ======= Three months ended June 30, 1999: Operating Segment Revenues Expenses Income -------------------------------------------- -------- --------- --------- 1. Oil and gas exploration and production .................... $ 1,718 ($1,691) $ 27 2. Natural gas marketing ............. 7,950 (6,621) 1,329 ------- -------- ------- $ 9,668 ($8,312) $ 1,356 ======= ======== =======
-10- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited)
Three months ended June 30, 1998: Operating Income Segment Revenues Expenses (Loss) -------------------------------------------- -------- --------- --------- 1. Oil and gas exploration and production ....................... $ 698 ($ 714) ($ 16) 2. Natural gas marketing ................ 16,766 (12,658) 4,108 ------- -------- -------- $17,464 ($13,372) $ 4,092 ======= ======== ========
The individual components of revenue and expenses for each segment are set forth in the attached "Consolidated Statements of Operations." Note 8 - Penn Octane Investment In October 1997, the Company invested $1,000 in a promissory note of Penn Octane Corporation ("Penn Octane"), a public company. The note bore interest at 10% payable quarterly and was due on June 30, 1998. At June 30, 1998, Penn Octane did not repay the note. In May of 1998, Penn Octane was awarded a judgement against a bank and such judgement is in excess of the $1,000 owed to the Company by Penn Octane. In December 1998, Penn Octane assigned its interest in the bank judgement to the extent of the Company's note to the Company in return for an extension of the note until June 30, 1999. The Company also received 225,000 warrants to purchase the common stock of Penn Octane for one dollar and seventy-five cents per share as consideration for the extension. The bank owing the judgement appealed it to the Texas Supreme Court. The Company has been informed that the Texas Supreme Court has rejected such appeal. -11- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) In March 1999, the Company agreed to convert $900 of its $1,000 note to 90,000 shares of preferred stock of Penn Octane. The preferred shares provide dividends at 10% per annum to be paid semiannually. The dividends are payable in cash or common stock at Penn Octane's election. The preferred shares are convertible into 450,000 common shares of (unregistered) Penn Octane. In addition, the Company received 50,000 shares of (unregistered) Penn Octane's common stock as consideration for entering into this transaction. The Company will receive an additional 50,000 shares of Penn Octane's common stock (unregistered) if Penn Octane does not redeem the preferred stock by September 4, 1999. In July 1999, the Company agreed to exchange its remaining $100 note for 66,667 shares of Penn Octane common stock (unregistered). Penn Octane has paid all interest due on the notes through July 29, 1999. At June 30, 1999, the fair market value of the Company's investment in Penn Octane common stock (501,000 registered shares and 50,000 unregistered shares) exceeded its cost by $326. This unrealized gain has been included in earnings. At June 30, 1999, the Company owned 551,000 shares of Penn Octane common stock, a $100 note from Penn Octane, options to acquire 225,000 shares of Penn Octane common stock at $1.75/share and options to acquire 166,667 shares of Penn Octane common stock at $6.00/share. In addition, the Company agreed to convert $900 of its note into 90,000 shares of Penn Octane preferred stock. Such preferred stock will be convertible into 450,000 shares of Penn Octane common stock. The Company also agreed to convert its $100 note into 66,667 shares (unregistered) of Penn Octane common stock in July 1999. Note 9 - Acquisitions and Investments Acquisition of AmBrit Energy Corp. Assets On June 1, 1999, the Company consummated the purchase of the oil and gas properties of AmBrit. The oil and gas properties purchased include interests in approximately 230 oil and gas wells in Alabama, Louisiana, Mississippi, Montana, New Mexico, Oklahoma, Texas and Wyoming, as well as undrilled acreage in several of these states. The effective date of the sale for purposes of determining the purchase price was January 1, 1999. The Company expects the adjusted purchase price to approximate $20,224 after all transactions from January 1, 1999 to May 31, 1999 have been accounted for. A final accounting is expected not later than September 1, 1999. The Company used corporate cash to fund the acquisition. As of June 30, 1999, the Company's gross investment in the AmBrit oil and gas assets, including expenditures since June 1, 1999, was $20,613 ($20,350 net of accumulated depreciation, depletion and amortization). Based upon reserve reports initially prepared by the Company's petroleum reservoir engineers, the proved reserves associated with the AmBrit oil and gas assets approximated 2,012 barrels of crude oil and 12,528 mcf (thousand cubic feet) of natural gas. Significant increases in oil and gas prices subsequent to June 1, 1999, the acquisition date, however, have increased such reserves (since more reserves can be economically produced at higher oil/gas prices). In addition, the production acquired has increased the Company's crude oil and natural gas production by approximately 450%. The results of operations on a pro-forma basis as though the oil and gas properties of AmBrit had been acquired as of the beginning of the periods are as follows: Three Months Nine Months Ended Ended June 30, 1999 June 30, 1999 ------------- ------------- (Unaudited) (Unaudited) Revenues .................... $ 11,178 $ 59,517 Net income .................. $ 987 $ 7,925 Net income per share ........ $ .37 $ 2.79 Shares outstanding (diluted). 2,643,718 2,838,797 The investment in the South Texas Drilling Venture and the Romanian concession would not have materially impacted operations during the foregoing periods. Reference should also be made to Form 8-K dated June 1, 1999 as amended. -12- Castle Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements (Dollars in thousands) (Unaudited) Investment in Drilling Joint Venture In May 1999, the Company entered into a joint interest operating agreement with another exploration and production company to drill up to twelve exploratory wells in South Texas. The Company's commitment to the joint venture is $5,300 although most of this commitment will be released if initial drilling results are not as estimated. The Company anticipates that most of these exploratory wells will be drilled over the next year. As of June 30, 1999, the Company's investment in this exploratory program was $227. Such amount is included in "Oil and Gas Properties" in the "Consolidated Balance Sheets". Investment in Romanian Concessions In April 1999, the Company purchased an option to acquire three oil and gas concessions granted to a subsidiary of Costilla Energy Corporation ("Costilla"), by the Romanian government. The Company paid Costilla $65 for the option. In May 1999, the Company exercised the option. The Company expects that its minimum obligation for the Romanian obligations will be approximately $3,000. As of June 30, 1999, the Company's investment in Romania was $474. Such amount is included in "Oil and Gas Properties" in the "Consolidated Balance Sheets". Note 10 - Termination of Lone Star Contract The Company's long-term gas marketing contracts with Lone Star Gas Company ("Lone Star") and MG Natural Gas Corp. ("MGNG") terminated May 31, 1999. Revenue earned by the Company under these contracts represented 87%-96% of consolidated revenues and 99%-120% of consolidated operating income over the last three fiscal years. Although the Company continues to seek new gas marketing operations, its current operations only involve one segment of the energy industry - oil and gas exploration and production. -13- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. RESULTS OF OPERATIONS As noted previously, the Company had discontinued its refining operations by September 30, 1995. During the periods being compared the Company's operations were in two segments of the energy industry - natural gas marketing and oil and gas exploration and production. As a result, management's discussion and analysis focuses primarily on these two segments. All references herein to dollars are in thousands. The Company desires to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and has included a discussion of risk factors related to Management's Discussion and Analysis of Financial Condition and Results of Operations. The discussion and analysis below include forward-looking data that are based upon management's estimates, assumptions and projections. Important factors, such as the risk factors listed below, could cause results to differ materially from those expected by management. NATURAL GAS MARKETING In 1993, two of the Company's subsidiaries entered into two long-term natural gas sales contracts. The first contract was with Lone Star and required one of the Company's subsidiaries to deliver to Lone Star 45,000,000-55,700,000 cubic feet of natural gas per day ("Lone Star Contract"). The second natural gas sales contract was with MGNG and required another subsidiary of the Company to deliver approximately 6,400,000 cubic feet of natural gas per day ("MGNG Contract"). In addition, one of the Company's subsidiaries entered into a long-term supply agreement with MGNG ("Supply Contract"). All three contracts expired May 31, 1999. Gross Margin A comparison of the gross margins earned by the Company's natural gas marketing segment is as follows: Lone Star MGNG Contract Contract Consolidated --------- -------- ------------ Nine Months Ended June 30, 1999 Gas Sales ..................... $46,837 $3,265 $50,102 Gas purchases ................. (27,317) (3,785) (31,102) ------- ------ ------- Gross margin (deficit) ........ $19,520 ($520) $19,000 ======= ====== ======= Nine Months Ended June 30, 1998 Gas Sales ..................... $51,233 $3,681 $54,914 Gas purchases ................. (29,513) (4,545) (34,058) ------- ------ ------- Gross margin (deficit) ........ $21,720 ($864) $20,856 ======= ====== ======= Natural gas sales under the Lone Star Contract decreased $4,396 or 8.6% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The decrease is attributable to the -14- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) termination of the Lone Star Contract on May 31, 1999. In fiscal 1998, the Lone Star Contract was in force for nine months. In fiscal 1999, it was in force only eight months. Gas purchases for the Lone Star Contract decreased $2,196 or 7.4% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. For each of the nine month periods ended June 30, 1999 and 1998 gas purchases comprised 58.3% and 57.6%, respectively, of gas sales. The increase in the gas purchase percentage from 1998 to 1999 results primarily from a contractual price increase for the last 300 mcf (thousand cubic feet) of gas purchased under the Supply Contract. Natural gas sales under the MGNG Contract decreased $416 or 11.3% from fiscal 1998 to fiscal 1999. The decrease is entirely attributable to the termination of the MGNG Contract on May 31, 1999 since the MGNG Contract is a fixed price contract. For the nine months ended June 30, 1999, the Company realized a negative gross margin of $520 on this contract versus a negative gross margin of $864 for the nine months ended June 30, 1998. The negative margins resulted because the spot (market) prices paid by the Company for gas, plus hedging adjustments where applicable, exceeded the fixed price received by the Company from MGNG under the MGNG Contract. General and Administrative General and administrative costs increased $103 from $113 for the nine months ended June 30, 1998 to $216 for the nine months ended June 30, 1999. The increase was primarily attributable to increased legal costs related to litigation with MGNG. Transportation Transportation expense decreased $80 or 6.7% from $1,203 for the nine months ended June 30, 1998 to $1,123 for the nine months ended June 30, 1999. Transportation expense is based upon and thus proportional to deliveries made to Lone Star and represents the amortization of a $3,000 prepaid transportation asset received by one of the Company's subsidiaries in the sale of the Castle Pipeline to a subsidiary of Union Pacific Resources Company ("UPRC") in May 1997. Deliveries to Lone Star were approximately 6.7% greater during the nine months ended June 30, 1998 than during the nine months ended June 30, 1999 because deliveries to Lone Star ceased on May 31, 1999 and the $3,000 allocated to prepaid transportation had been completely amortized. Amortization Amortization of gas contracts decreased $812 or 11.4% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The decrease is entirely attributable to the termination of the Lone Star Contract on May 31, 1999. For fiscal 1998 nine months' of amortization are included in operations versus only eight months of amortization in fiscal 1999. -15- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) Both the Lone Star Contract and the MGNG Contract expired May 31, 1999. During the nine months ended June 30, 1999, the operating income from these contracts was $11,377 or 135.0% of consolidated operating income. For the nine months ended June 30, 1998, the operating income from these contracts was $12,444 or approximately 116.9% of consolidated operating income for the period. The Company has not replaced these contracts because it sold its pipeline assets to a subsidiary of UPRC in May 1997 and because it is unlikely that similar profitable long-term contracts can be negotiated since most gas purchasers buy gas on the spot market. Although the Company is currently seeking additional natural gas marketing operations, it is currently operating exclusively in the exploration and production segment of the energy industry. The Company is currently seeking to replace some or all of the operating income contribution of its former natural gas marketing operations with operating income from additional exploration and production and other energy assets. In that respect, the Company acquired the oil and gas assets of AmBrit, has entered into a drilling venture in South Texas and has acquired a 50% interest in a drilling concession in Romania (see Note 9). The Company is also currently reviewing several other possible exploration and production, pipeline and natural gas marketing acquisitions . There can, however, be no assurance the Company will succeed in these efforts. EXPLORATION AND PRODUCTION During the quarter ended June 30, 1999, the Company invested $21,314 in the acquisition of AmBrit's oil and gas properties and in exploratory drilling ventures. On June 1, 1999, the Company acquired the oil and gas properties of AmBrit Energy Corporation. AmBrit's oil and gas properties consist primarily of proved developed producing reserves. The current production from the AmBrit properties is approximately five times that of the Company's other production. In addition, the oil and gas reserves associated with the acquisition are at least 200% of the Company's current reserves. Therefore, as a result of this acquisition, the Company's exploration and production operations have increased significantly since June 1, 1999. In order to facilitate comparisons of financing data we have separately determined changes applicable to the acquisition of the AmBrit properties and those applicable to the Company's other exploration and production operations. The results are as follows:
Applicable To AmBrit Nine Months Nine Months Effect On Consolidated Properties Ended Ended Operating Nine Acquisition June 30, 1999 June 30, 1998 Income: Months Ended June 1, 1999- Other Other Increase June 30, 1999 June 30, 1999 Properties Properties (Decrease) ------------- ------------- ---------- ---------- ---------- Revenues Oil and gas sales .............. $2,571 $898 $1,673 $1,861 ($188) Well operations ................ 296 32 264 172 92 ------- ------ ------- ------- ------ 2,867 930 1,937 2,033 (96) Expenses Oil and gas .................... (1,222) (421) (801) (510) (291) General and administrative ..... (655) (15) (640) (684) 44 Depreciation, depletion and amortization ................. (840) (262) (578) (502) (76) ------- ------ ------- ------- ------ Operating Income (Loss) ............. $ 150 $232 ($ 82) $337 ($419) ======= ====== ======= ======= ======
Although the Company has also invested in exploration ventures in South Texas and Romania, drilling for such ventures has not yet commenced. No proved reserves have been associated with either venture yet because the prospects to be drilled are exploratory prospects. -16- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) Revenues Oil and Gas Sales Oil and gas sales on non-AmBrit properties decreased $188 or 10.1% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. Most of the decrease is attributable to decreased production. Although oil and gas prices have recently increased significantly, they were low during most of the nine month period ended June 30, 1999 and at least 15% lower than those in fiscal 1998. This factor also contributed to the decrease. As a result of the acquisition of the AmBrit oil and gas properties, the Company expects that its revenues from oil and gas sales will increase significantly in the future. Furthermore, since the Company has hedged approximately 69.5% of its anticipated consolidated crude oil production (approximately 32,000 barrels per month) and approximately 50% of its anticipated consolidated natural gas production (approximately 300,000 mcf per month) at average prices of $20.02 per barrel of crude oil and $2.64 per mcf of gas for the period September 1, 1999 to July 31, 2000, its oil and gas price exposure is essentially limited to unhedged production and to differences between exchange prices and spot prices for hedged production. Well Operations Revenue from non-AmBrit well operations increased $92 or 53.5% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The increase was primarily caused by the non-recurring recovery of operating fees in 1999 that had been written off in prior years. Expenses Oil and Gas Production Oil and gas production expenses, excluding those related to the acquisition of AmBrit's oil and gas properties, increased $291 or 57.1% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The increase in oil and gas production expenses results from the general maturing of the Company's oil and gas properties and the tendency for older, depleting properties to carry a higher production expense burden than recently drilled properties. Furthermore, oil and gas production expenses, especially repairs, do not generally occur evenly throughout the year and are best compared on an annual rather than on a quarterly basis. The Company expects that, although such oil and gas production expense will increase as a result of the acquisition of the AmBrit properties' and new drilling activities, such expenses will decline when compared to oil and gas sales given the lower production costs typically associated with newer production. There can be no assurance, however, that such will be the case. -17- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) General and Administration Non-AmBrit general and administrative costs decreased $44 or 6.4% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The decrease is attributable to offsetting factors. Whereas general and administrative costs increased due to increases in employee salaries and consultant costs, this was more than offset by decreases in allocated office rental costs and office costs. Depreciation, Depletion and Amortization Depreciation, depletion and amortization from non-AmBrit properties increased $76 or 15.1% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The increase is attributable to a higher depletion rate per equivalent mcf produced. The higher depletion rate results from the acquisition of the AmBrit properties and the accounting requirement under full cost accounting that depreciation, depletion and amortization be computed on a consolidated basis by country. Prior to the acquisition of the AmBrit properties, the Company's amortization rate per equivalent mcf produced was approximately $.36 whereas after acquisition the Company's rate was approximately $.60 per equivalent mcf produced. CORPORATE GENERAL AND ADMINISTRATIVE EXPENSE Corporate general and administrative expenses increased $967 or 45.3% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. Most of the increase was caused by increased consulting fees applicable to due diligence on possible acquisitions. Increased employee bonuses and increased legal costs contributed to the increase. OTHER INCOME (EXPENSE) Interest Income Interest income decreased $444 or 25.4% from the first nine months of fiscal 1998 to the first nine months of fiscal 1999. The decrease is primarily attributable to a decrease in the average balance of unrestricted cash outstanding during the periods being compared. During June 1999, the Company paid $20,613 for AmBrit's oil and gas properties and new related drilling. In addition, during the nine month period June 30, 1999, the Company spent $6,145 to acquire shares of its common stock. In addition, the interest rate applicable to the Company's investment has decreased by approximately one-half of one percent from fiscal 1998 to fiscal 1999. Other Income (Expense) The composition of other income (expense) is as follows:
Nine Months Ended March 31, --------------------------- 1999 1998 -------- ------- Write down of preferred stock ................................. ($423) Market price adjustment - common stock of Penn Octane ...................................................... 326 Litigation recovery - EMC ..................................... 355 Miscellaneous ................................................. 180 $27 ---- --- $438 $27 ==== ===
-18- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) The write down of the Company's investment in Penn Octane stock was based upon the Company's calculation of the loss that would be incurred if the Company converted its shares of Penn Octane preferred stock and sold the resulting common shares (unregistered) at a discount to the market price given the volume of shares that would be sold. The market price adjustment relates to the Company's investment in Penn Octane common stock. The Company classifies Penn Octane securities as trading securities because the Company does not currently expect to hold the Penn Octane investment for the long term. According to current generally accepted accounting principles, such securities are valued at fair market value with unrealized gains on losses included in earnings. The $326 favorable adjustment has resulted from the increase in the market price of Penn Octane common stock as of June 30, 1999. The $355 litigation recovery was a non-recurring gain related to the SWAP Litigation occurring in the second fiscal quarter of 1999 for which there was no counterpart during the nine months ended June 30, 1998. See Item #3 to the Company's September 30, 1998 Annual Report on Form 10-K and Part I, Item 1, Note 4 to the Company's quarterly report on Form 10-Q for the quarter ended March 31, 1999. TAX PROVISION The tax provisions for the nine month periods ending June 30, 1999 and 1998 consist of the following components:
Nine Months Ended June 30, ---------------------------- 1999 1998 ---- ---- 1. Increase in net deferred tax asset using 36% blended tax rate ......................................................... ($3,788) 2. Realization of deferred tax asset using 36% blended tax rate ..................................................................... $2,765 3,978 3. A tax provision of 2% on all net income in excess of that required to realize the deferred tax asset. (This 2% rate represents alternative minimum Federal corporate taxes the Company must pay despite having tax carryforwards available to offset regular Federal corporate tax) .......... 50 ------ ----- $2,815 $ 190 ====== =====
The tax provision of $2,765 applicable to the realization of the deferred tax asset during the first nine months of fiscal 1999 resulted because the Company had a $2,765 deferred tax asset, net of valuation reserves, as of September 30, 1998 based upon its expectations concerning future taxable income. During the first nine months of fiscal 1999, the Company realized that deferred tax asset. In fiscal 1998 the tax provision of $3,978 representing the realization of the deferred tax asset at September 30, 1997 was offset by a new deferred tax asset of $3,788 recorded at June 30, 1998. -19- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) LIQUIDITY AND CAPITAL RESOURCES All statements other than statements of historical fact contained in this report are forward-looking statements. Forward-looking statements in this report generally are accompanied by words such as "anticipate," "believe," "estimate," or "expect" or similar statements. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove correct. Factors that could cause the Company's results to differ materially from the results discussed in such forward-looking statements are disclosed in this report. All forward-looking statements in this report are expressly qualified in their entirety by the cautionary statements in this section. During the nine months ended June 30, 1999, the Company generated $20,616 from operating activities. During the same period the Company invested $21,620 in oil and gas drilling and paid $1,283 in stockholder dividends. The Company also spent $6,145 to acquire its common stock At June 30, 1999, the Company had $28,310 of unrestricted cash, $24,925 of working capital and no long-term debt. At the present time the probable future cash expenditures of the Company consist of the following: a. Investments in Oil and Gas Properties and Energy Sector - in addition to its drilling expectations for up to seventy additional wells in Appalachia (approximately $5,250), twelve exploratory wells in South Texas (up to $5,300), anticipated new drilling on the properties acquired from AmBrit ($5,300) and possibly several exploratory wells in Romania ($3,000), the Company is currently pursuing several other possible material investments in the energy sector. These possible investments include drilling ventures, the acquisition of oil and gas properties and oil and gas companies, as well as the acquisition of pipelines and gas marketing transactions. Although most of these possible investments involve domestic properties, some involve investments overseas. Although the Company believes it can conclude a transaction or several transactions on terms favorable to the Company, there can be no assurance that such will be the case. Oil and gas prices have recently increased significantly and many potential sellers may decide not to sell or may not be forced to sell by their lenders. In addition, several large oil and gas companies have significantly more resources than the Company and other parties may be willing to pay more than the Company for a given acquisition. b. Repurchase of Company Shares - as of August 13, 1999, the Company had repurchased 4,249,317 of its shares of common stock at a cost of $60,165. The Company's Board of Directors previously authorized the repurchase of up to 4,250,000 shares to provide an exit vehicle for investors who want to liquidate their investment in the Company. The decision whether to repurchase additional shares and/or to increase the repurchase authorization above 4,250,000 shares will depend upon the market price of the Company's stock, tax considerations, the number of stockholders seeking to sell their shares and other factors. -20- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) The Company's total drilling commitments as of August 13, 1999, as described above, aggregate approximately $18,850. The anticipated expenditures for these drilling commitments are expected to be spread out over the next 3-4 years with perhaps 30%-40% being incurred during the year ended September 30, 2000 or before. At June 30, 1999, the Company had $28,310 of unrestricted cash. The Company also has available a $30,000 line of credit from an energy bank. The Company thus expects that it can fund all of its present drilling commitments from its own unrestricted cash or from future cash flow from its current exploration and production operations. The Company can also use its unrestricted cash and future cash flow, as well as up to $30,000 from its line of credit, to acquire additional oil and gas properties or to conduct additional drilling. The Company believes it has available the financing to make acquisitions of up to approximately $50,000-$55,000 while still funding its existing drilling commitments. The Company has also negotiated with several potential industry partners who may provide financing if the Company decides to make an acquisition in excess of these amounts. Finally, the Company is exploring the formation of an energy fund which would acquire energy assets. The Company would be the general partner of the fund. The fund wold involve minimum commitments of $200,000 or more. The formation of the fund would provide the Company with additional capital in the event the Company decides to make a large acquisition. There can be no assurance, however, that the fund will be formed or, that if formed, it will be sufficiently subscribed. The foregoing discussions do not contemplate any adverse effects from the risk factors listed below: a. Contingent environmental liabilities b. Vendor liabilities of the Company's inactive refining subsidiaries c. Litigation - Long Trusts litigation and Rex Nichols litigation d. Reserve price risk - the effect of price changes on unhedged oil and gas production e. Gas contract litigation - MGNG -21- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) f. Reserve risk - the effect of differences between estimated and actual reserves and production g. Public market for Company's stock h. Future of the Company i. Foreign operation risks. Since the Company may spend approximately $3,000 drilling a Romanian concession, the Company's interests are subject to certain foreign country risks over which the Company has no control - including political risk, the risk of additional taxation and the possibility that foreign operating requirements and procedures may reduce estimated profitability. j. Other risks including general business risks, insurance claims against the Company in excess of insurance recoveries, tax liabilities resulting from tax audits, drilling risks and litigation risk. The Company has recently completed a study of the Year 2000 issue and related risks. As a result of the study, the Company replaced its oil and gas and general ledger software with new software which is Year 2000 compliant. The Company expects the cost to approximate $100. At June 30, 1999, approximately $112 had been incurred. The Company commenced using the new software in the first quarter of fiscal 1999. The Company has also made inquiries to outside parties who process transactions of the Company, e.g., payroll, commercial banks, transfer agent, reserve engineers, etc. While some outside parties have confirmed they are Year 2000 compliant, others have not done so to the Company's satisfaction. The Company is continuing to pursue the vendors whose responses appear to provide insufficient assurance. The most important systems operated by the Company are its revenue distributions, joint interest billing and general ledger. The Company replaced its software because the new systems are Year 2000 compliant. If a Year 2000 problem nevertheless occurred, the Company could process transactions for several months manually or using small computers but only with increased administrative costs. Nevertheless, in many cases, the Company is not the operator of a given well or purchaser of oil and gas production. In those cases the Company is dependent upon the operator and/or oil/gas purchaser for accurate volumetric, cost and sales information and for payments. Although the Company has made Year 2000 inquiries of such operators and purchasers and generally received satisfactory responses, there can be no assurance that such operators and purchasers will actually be Year 2000 compliant. If such is the case, the Company could find a major portion of its production revenue held in escrow until Year 2000 compliance was achieved or resulting litigation settled. The related legal cost and resulting administrative confusion could be substantial. The Company has made contingency plans in the event of non-compliance of its systems, customers or suppliers. The Company and its subsidiaries are not aware of any material Year 2000 operational risks. Readers should refer to the Management Discussion and Analysis of Financial Condition and Results of Operations Section of the Company's Form 10-K for the fiscal year ended September 30, 1998 for a description of the aforementioned risk factors. If any or several of these risks materialize, the Company's estimated financial position, cash flow and results of operations will probably be adversely impacted and the impact may be material. Given the number and variety of risks and the litigiousness of today's corporate world, it is reasonably possible that one or more of these risks may adversely impact the Company's operations. -22- Castle Energy Corporation and Subsidiaries (Dollars in thousands) (Unaudited) Item 3. Qualitative and Quantitative Disclosures About Market Risk The Company has hedged approximately 69.5% percent of its estimated consolidated crude oil production (approximately 32,000 barrels per month) and 50% of its estimated natural gas production (approximately 300,000 mcf per month) using futures contracts. Such production is hedged for the period September 1, 1999 through July 31, 2000. The average hedged prices are $20.02 per barrel for crude oil and $2.64 per mcf for natural gas. The Company therefore remains at risk primarily with respect to its unhedged production. If oil and gas prices increase, oil and gas revenues applicable to the unhedged production will increase. If oil and gas prices decrease, oil and gas revenues related to such unhedged production will decrease. The Company also remains at risk with respect to differences between the exchange price on the New York Mercantile Exchange and the field or spot prices it receives with respect to its hedged production. -23- PART II. OTHER INFORMATION Item 1. Legal Proceedings For information regarding lawsuits, reference is made to Item 3 of the Company's Form 10-K (Annual Report) for the fiscal year ended September 30, 1998. Also see Note 4 to the June 30, 1999 financial statements included in Part I. Item 4. Submission of Matters to a Vote of Security Holders The Annual Meeting of Stockholders was held on June 16, 1999. Proxies were solicited pursuant to the Notice of Annual Meeting of Stockholders, dated April 23, 1999 and the accompanying Proxy Statement. A total of 2,601,029 shares were eligible to vote of which 2,380,780 were present in person or by proxy. Mr. Martin R. Hoffmann was elected to serve as a director until the 2002 Annual Meeting. The number of votes with respect to Mr. Hoffmann was 2,376,517 votes for his election and 4,263 votes withheld. At the Annual Meeting, the stockholders also approved the appointment of KPMG Peat Marwick LLP as the Company's independent accountants for the fiscal year ending September 30, 1999 by a vote of 2,377,959 votes for such appointment, 792 against and 2,029 abstentions. In addition to the above, Joseph L. Castle II, John P. Keller, Martin R. Hoffmann and Richard E. Staedtler continued on the Board of Directors. Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits: Exhibit 10-128 - Credit Agreement by and among Castle Exploration Company, Inc. and Comerica Bank-Texas, effective May 28, 1999. Exhibit 10.129 - Purchase and Sale Agreement by and between Costilla Redeco Energy L.L.C. and Castle Exploration Company, Inc., effective May 31, 1999. Exhibit 11.1 - Statement re: Computation of Earnings Per Share Exhibit 27 - Financial Data Schedule (B) Reports on Form 8-K: None
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 18, 1999 CASTLE ENERGY CORPORATION ---------------- /s/Richard E. Staedtler ------------------------- Richard E. Staedtler Chief Financial Officer Chief Accounting Officer EX-10.128 2 EXHIBIT-10.128 [Execution] ================================================================================ CREDIT AGREEMENT ------------------------------------------------------- CASTLE EXPLORATION COMPANY, INC. as Borrower CASTLE ENERGY CORPORATION as Guarantor and COMERICA BANK - TEXAS as Lender ------------------------------------------------------- $30,000,000 May 28, 1999 ================================================================================ TABLE OF CONTENTS
Page CREDIT AGREEMENT..................................................................................................1 ARTICLE I - Definitions and References............................................................................1 Section 1.1. Defined Terms..........................................................................1 Section 1.2. Exhibits and Schedules; Additional Definitions.........................................8 Section 1.3. Amendment of Defined Instruments.......................................................8 Section 1.4. References and Titles..................................................................8 Section 1.5. Calculations and Determinations........................................................9 ARTICLE II - Loans................................................................................................9 Section 2.1. Loans..................................................................................9 Section 2.2. Requests for Loans.....................................................................9 Section 2.3. Use of Proceeds.......................................................................10 Section 2.4. Fees..................................................................................11 Section 2.5. Optional Prepayments..................................................................11 Section 2.6. Mandatory Prepayments.................................................................11 Section 2.7. Initial Borrowing Base................................................................12 Section 2.8. Subsequent Determinations of Borrowing Base...........................................12 Section 2.9. Reduction of Contract Borrowing Base..................................................13 ARTICLE III - Payments to Lender.................................................................................13 Section 3.1. General Procedures....................................................................13 Section 3.2. Capital Reimbursement.................................................................14 Section 3.3. Increased Cost of Eurodollar Loans....................................................14 Section 3.4. Availability..........................................................................15 Section 3.5. Funding Losses........................................................................15 Section 3.6. Reimbursable Taxes....................................................................15 ARTICLE IV - Conditions Precedent to Lending.....................................................................16 Section 4.1. Documents to be Delivered.............................................................16 Section 4.2. Additional Conditions Precedent.......................................................16 ARTICLE V - Representations and Warranties.......................................................................17 Section 5.1. No Default............................................................................17 Section 5.2. Organization and Good Standing........................................................17 Section 5.3. Authorization.........................................................................17 Section 5.4. No Conflicts or Consents..............................................................17 Section 5.5. Enforceable Obligations...............................................................18 Section 5.6. Initial Financial Statements..........................................................18 Section 5.7. Other Obligations and Restrictions....................................................18 Section 5.8. Full Disclosure.......................................................................18 Section 5.9. Litigation............................................................................18 Section 5.10. Names and Places of Business..........................................................18 Section 5.11. Parent's Subsidiaries.................................................................19 Section 5.12. Title to Properties; Licenses.........................................................19 Section 5.13. Government Regulation.................................................................19 Section 5.14. Solvency..............................................................................19
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Section 5.15. ERISA Plans and Liabilities...........................................................19 Section 5.16. Environmental and Other Laws..........................................................20 ARTICLE VI - Affirmative Covenants of Borrower...................................................................20 Section 6.1. Payment and Performance...............................................................20 Section 6.2. Books, Financial Statements and Reports...............................................20 Section 6.3. Other Information and Inspections.....................................................22 Section 6.4. Notice of Material Events and Change of Address.......................................22 Section 6.5. Maintenance of Properties.............................................................22 Section 6.6. Maintenance of Existence and Qualifications...........................................23 Section 6.7. Payment of Trade Liabilities, Taxes, etc..............................................23 Section 6.8. Insurance.............................................................................23 Section 6.9. Performance on Other Person's Behalf..................................................23 Section 6.10. Interest..............................................................................23 Section 6.11. Compliance with Agreements and Law....................................................23 Section 6.12. Evidence of Compliance................................................................23 Section 6.13. Agreement to Deliver Security Documents...............................................23 Section 6.14. Perfection and Protection of Security Interests and Liens.............................24 Section 6.15. Bank Accounts; Offset.................................................................24 Section 6.16. Production Proceeds...................................................................24 Section 6.17. Multiemployer ERISA Plans. ..........................................................25 Section 6.18. Environmental Matters; Environmental Reviews..........................................25 Section 6.19. Guaranties of Parent's Subsidiaries...................................................25 ARTICLE VII - Negative Covenants of Borrower.....................................................................25 Section 7.1. Indebtedness..........................................................................26 Section 7.2. Limitation on Liens...................................................................26 Section 7.3. Hedging Contracts.....................................................................26 Section 7.4. Limitation on Mergers, Issuances of Securities........................................27 Section 7.5. Limitation on Sales of Property.......................................................27 Section 7.6. Limitation on Dividends and Redemptions...............................................27 Section 7.7. Limitation on Investments and New Businesses..........................................28 Section 7.8. Limitation on Credit Extensions.......................................................28 Section 7.9. Transactions with Affiliates..........................................................28 Section 7.10. Certain Contracts; ERISA..............................................................28 Section 7.11. Current Ratio.........................................................................28 Section 7.12. Tangible Net Worth....................................................................28 ARTICLE VIII - Events of Default and Remedies....................................................................28 Section 8.1. Events of Default.....................................................................29 Section 8.2. Remedies..............................................................................31 ARTICLE IX - Miscellaneous.......................................................................................31 Section 9.1. Waivers and Amendments; Acknowledgments...............................................31 Section 9.2. Survival of Agreements; Cumulative Nature.............................................32 Section 9.3. Notices...............................................................................32 Section 9.4. Payment of Expenses; Indemnity........................................................33 Section 9.5. Joint and Several Liability; Parties in Interest.....................................34 Section 9.6. Assignments and Participations........................................................34 Section 9.7. Governing Law; Submission to Process..................................................34
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Section 9.8. Limitation on Interest................................................................35 Section 9.9. Termination; Limited Survival.........................................................35 Section 9.10. Severability..........................................................................36 Section 9.11. Counterparts; Fax.....................................................................36 Section 9.12. Waiver of Jury Trial, Punitive Damages, etc...........................................36 Schedules and Exhibits: Schedule 1 - Document Schedule Schedule 2 - Disclosure Schedule Schedule 3 - Insurance Schedule Exhibit A - Promissory Note Exhibit B - Borrowing Notice Exhibit C - Continuation/Conversion Notice Exhibit D - Certificate Accompanying Financial Statements Exhibit E - Opinion of Restricted Persons' Counsel
iii CREDIT AGREEMENT THIS CREDIT AGREEMENT is made as of May 28, 1999, by and among Castle Exploration Company, Inc., a Pennsylvania corporation (herein called "Borrower"), and Comerica Bank-Texas (herein called "Lender"). In consideration of the mutual covenants and agreements contained herein the parties hereto agree as follows: ARTICLE I - Definitions and References Section 1.1. Defined Terms. As used in this Agreement, each of the following terms has the meaning given to such term in this Section 1.1 or in the sections and subsections referred to below: "Adjusted LIBOR Rate" means, for any Eurodollar Loan for any Interest Period therefor, the per annum rate equal to the sum of (a) two and one-quarter percent (2.25%) plus (b) the rate per annum (rounded upwards, if necessary, to the nearest 1/100 of 1%) determined by Lender to be equal to the quotient obtained by dividing (i) the LIBOR Rate for such Eurodollar Loan for such Interest Period by (ii) 1 minus the Reserve Requirement for such Eurodollar Loan for such Interest Period. The Adjusted LIBOR Rate for any Eurodollar Loan shall change whenever the Reserve Requirement changes. The Adjusted LIBOR Rate shall in no event, however, exceed the Highest Lawful Rate. "Affiliate" means, as to any Person, each other Person that directly or indirectly (through one or more intermediaries or otherwise) controls, is controlled by, or is under common control with, such Person. A Person shall be deemed to be "controlled by" any other Person if such other Person possesses, directly or indirectly, power to: (a) vote 20% or more of the securities (on a fully diluted basis) having ordinary voting power for the election of directors or managing general partners; or (b) direct or cause the direction of the management and policies of such Person whether by contract or otherwise. "Agreement" means this Credit Agreement. "Base Rate" means, for any day, the rate per annum equal to the Prime Rate. The Base Rate shall in no event, however, exceed the Highest Lawful Rate. As used in this definition, "Prime Rate" means the per annum rate of interest established from time to time by Lender as its prime rate, which rate may not be the lowest rate of interest charged by Lender to its customers. The Base Rate shall in no event, however, exceed the Highest Lawful Rate. "Base Rate Loan" means a Loan that bears interest at the Base Rate. "Borrower" means Castle Exploration Company, Inc., a Pennsylvania corporation. "Borrowing" means a borrowing of a new Loan pursuant to Section 2.2(a) or a Continuation or Conversion of existing Loans into a single type (and, in the case of Eurodollar Loans, with the same Interest Period) pursuant to Section 2.2(b). 1 "Borrowing Base" means, at the particular time in question, the sum of the Contract Borrowing Base and the Hydrocarbon Borrowing Base, if in effect; provided, however, that in no event shall the Borrowing Base ever exceed the Maximum Loan Amount. "Borrowing Base Deficiency" has the meaning given to such term in Section 2.6(a). "Borrowing Notice" means a written or telephonic request, or a written confirmation, made by Borrower which meets the requirements of Section 2.2. "Business Day" means a day, other than a Saturday or Sunday, on which commercial banks are open for business with the public in Dallas, Texas; provided, however, that when used in connection with an Eurodollar Loan, "Business Day" shall exclude any day on which banks are not open for dealings in dollars in the London interbank market." "Cash Equivalents" means investments in: (a) marketable obligations, maturing within 12 months after acquisition thereof, issued or unconditionally guaranteed by the United States of America or an instrumentality or agency thereof and entitled to the full faith and credit of the United States of America. (b) demand deposits, and time deposits (including certificates of deposit) maturing within 12 months from the date of deposit thereof, with any office of Lender or with a domestic office of any national or state bank or trust company which is organized under the Laws of the United States of America or any state therein, which has capital, surplus and undivided profits of at least $500,000,000, and whose long term certificates of deposit have an investment grade rating. (c) repurchase obligations with a term of not more than seven days for underlying securities of the types described in clause (a) above entered into with any commercial bank meeting the specifications of clause (b) above. (d) open market commercial paper, maturing within 270 days after acquisition thereof, which has an investment grade rating. (e) investments in money market or other mutual funds substantially all of whose assets comprise securities of the types described in clauses (a) through (d) above. "CEC" means CEC, Inc., a Delaware corporation. "CEC Gas" means CEC Gas Marketing L.P., a Texas limited partnership. "Change of Control" means (a) the acquisition by any Person or group of Persons acting together, of a direct interest in more than twenty percent (20%) of the voting power of the voting stock of or membership interests in Parent, by way of merger or consolidation or otherwise; (b) Parent ceases to own one hundred percent (100%) of the outstanding capital stock in Borrower; or (c) Joseph L. Castle II ceases to be and act as chairman and chief executive officer of Parent and Richard E. Staedtler ceases to be and act as chief financial officer of Parent. "Collateral" means all property of any kind which is subject to a Lien in favor of Lender or which, under the terms of any Security Document, is purported to be subject to such a Lien. 2 "Consolidated" refers to the consolidation of any Person, in accordance with GAAP, with its properly consolidated subsidiaries. References herein to a Person's Consolidated financial statements, financial position, financial condition, liabilities, etc. refer to the consolidated financial statements, financial position, financial condition, liabilities, etc. of such Person and its properly consolidated subsidiaries. "Continuation/Conversion Notice" means a written or telephonic request, or a written confirmation, made by Borrower which meets the requirements of Section 2.2(b). "Continuation" shall refer to the continuation pursuant to Section 2.2(b) hereof of a Eurodollar Loan as a Eurodollar Loan from one Interest Period to the next Interest Period. "Contract Borrowing Base" means, at the particular time in question, either the amount provided for in Section 2.7 or the amount determined by Lender in accordance with the provisions of Section 2.8; provided, however, that in no event shall the Contract Borrowing Base ever exceed the amount of $7,000,000. "Conversion" shall refer to a conversion pursuant to Section 2.2(b) or Article III of one type of Loan into another type of Loan. "Default" means any Event of Default and any default, event or condition which would, with the giving of any requisite notices and the passage of any requisite periods of time, constitute an Event of Default. "Default Rate" means, for any day (i) with respect to any Base Rate Loan, the rate per annum equal to the Base Rate in effect for such Base Rate Loan for such day plus two percent (2.0%) per annum and (ii) with respect to any Eurodollar Loan, the rate per annum equal to the Adjusted LIBOR Rate in effect for such Eurodollar Loan for such day plus two percent (2.0%) per annum. The Default Rate shall in no event, however, exceed the Highest Lawful Rate. "Determination Date" has the meaning given to such term in Section 2.8. "Disclosure Report" means either a notice given by Borrower under Section 6.4 or a certificate given by Borrower's chief financial officer under Section 6.2(b). "Disclosure Schedule" means Schedule 2 hereto. "Distribution" means (a) any dividend or other distribution made by a Restricted Person on or in respect of any stock, partnership interest, or other equity interest in such Restricted Person (including any option or warrant to buy such an equity interest), or (b) any payment made by a Restricted Person to purchase, redeem, acquire or retire any stock, partnership interest, or other equity interest in such Restricted Person (including any such option or warrant). "Document Schedule" means Schedule 1 hereto. "Engineering Report" means each engineering report covering Collateral which Borrower delivers to Lender. "Environmental Laws" means any and all Laws relating to the environment or to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals, or industrial, toxic or 3 hazardous substances or wastes into the environment including ambient air, surface water, ground water, or land, or otherwise relating to the manufacture, processing, distribution use, treatment, storage, disposal, transport, or handling of pollutants, contaminants, chemicals, or industrial, toxic or hazardous substances or wastes. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time, together with all rules and regulations promulgated with respect thereto. "ERISA Affiliate" means Restricted Persons and all members of a controlled group of business organizations and all trades or businesses (whether or not incorporated) under common control that, together with Restricted Persons, are treated as a single employer under Section 414 of the Internal Revenue Code of 1986, as amended. "ERISA Plan" means any employee pension benefit plan subject to Title IV of ERISA maintained by any ERISA Affiliate with respect to which any Restricted Person has a fixed or contingent liability. "Eurodollar Loan" means a Loan that bears interest at the Adjusted LIBOR Rate. "Event of Default" has the meaning given to such term in Section 8.1. "Fiscal Quarter" means a three-month period ending on March 31, June 30, September 30 or December 31 of any year. "Fiscal Year" means a twelve-month period ending on September 30 of any year. "GAAP" means those generally accepted accounting principles and practices which are recognized as such by the Financial Accounting Standards Board (or any generally recognized successor) and which, in the case of Parent and its Consolidated Subsidiaries, are applied for all periods after the date hereof in a manner consistent with the manner in which such principles and practices were applied to the audited Initial Financial Statements. If any material change in any accounting principle or practice is required by the Financial Accounting Standards Board (or any such successor) in order for such principle or practice to continue as a generally accepted accounting principle or practice, all reports and financial statements required hereunder with respect to Parent or with respect to Parent and its Consolidated Subsidiaries may be prepared in accordance with such change, but all calculations and determinations to be made hereunder may be made in accordance with such change only after notice of such change is given to Lender and Lender agrees to such change insofar as it affects the accounting of Parent or of Parent and its Consolidated Subsidiaries. "Guarantor" means Parent, CEC, CEC Gas and any other Person who has guaranteed some or all of the Obligations pursuant to a guaranty listed on the Document Schedule or any other Person who has guaranteed some or all of the Obligations and who has been accepted by Lender as a Guarantor. "Hazardous Materials" means any substances regulated under any Environmental Law, whether as pollutants, contaminants, or chemicals, or as industrial, toxic or hazardous substances or wastes, or otherwise. "Hedging Contract" means (a) any agreement providing for options, swaps, floors, caps, collars, forward sales or forward purchases involving interest rates, commodities or commodity prices, equities, 4 currencies, bonds, or indexes based on any of the foregoing, (b) any option, futures or forward contract traded on an exchange, and (c) any other derivative agreement or other similar agreement or arrangement. "Highest Lawful Rate" means, the maximum nonusurious rate of interest that Lender is permitted under applicable Law to contract for, take, charge, or receive with respect to the Loans. "Hydrocarbon Borrowing Base" means, at the particular time in question, either the amount provided for in Section 2.7 or the amount determined by Lender in accordance with the provisions of Section 2.8; provided, however, that in no event shall the Hydrocarbon Borrowing Base ever exceed the Maximum Loan Amount. "Indebtedness" of any Person means Liabilities in any of the following categories: (a) Liabilities for borrowed money; (b) Liabilities constituting an obligation to pay the deferred purchase price of property or services; (c) Liabilities evidenced by a bond, debenture, note or similar instrument; (d) Liabilities which (i) would under GAAP be shown on such Person's balance sheet as a liability, and (ii) are payable more than one year from the date of creation thereof (other than reserves for taxes and reserves for contingent obligations); (e) Liabilities arising under Hedging Contracts; (f) Liabilities constituting principal under leases capitalized in accordance with GAAP; (g) Liabilities arising under conditional sales or other title retention agreements; (h) Liabilities owing under direct or indirect guaranties of Liabilities of any other Person or otherwise constituting obligations to purchase or acquire or to otherwise protect or insure a creditor against loss in respect of Liabilities of any other Person (such as obligations under working capital maintenance agreements, agreements to keep-well, or agreements to purchase Liabilities, assets, goods, securities or services), but excluding endorsements in the ordinary course of business of negotiable instruments in the course of collection; (i) Liabilities (for example, repurchase agreements and sale/leaseback agreements) consisting of an obligation to purchase securities or other property, if such Liabilities arises out of or in connection with the sale of the same or similar securities or property; (j) Liabilities with respect to letters of credit or applications or reimbursement agreements therefor; (k) Liabilities (other than Liabilities arising under Hedging Contracts) with respect to payments received in consideration of oil, gas, or other minerals yet to be acquired or produced at the time of payment (including obligations under "take-or-pay" contracts to deliver gas in return for payments already received and the undischarged balance of any production payment created by such Person or for the creation of which such Person directly or indirectly received payment); or (l) Liabilities with respect to other obligations to deliver goods or services in consideration of advance payments therefor; provided, however, that the "Indebtedness" of any Person shall not include Liabilities that were incurred by such Person on ordinary trade terms to vendors, suppliers, or other Persons providing goods and services for use by such Person in the ordinary course of its business, unless and until such Liabilities are outstanding more than 90 days past the original invoice or billing date therefor. "Initial Financial Statements" means the audited annual Consolidated financial statements of Parent dated as of September 30, 1998. "Insurance Schedule" means Schedule 3 attached hereto. "Interest Payment Date" means (a) with respect to each Base Rate Loan, the last Business Day of each calendar month, and (b) with respect to each Eurodollar Loan, the last day of the Interest Period that is applicable thereto and if such Interest Period is six months in length, the date specified by Lender which is approximately three months after such Interest Period begins. "Interest Period" means, with respect to each Eurodollar Loan, the period specified in the Borrowing Notice applicable thereto, beginning on and including the date specified in such Borrowing 5 Notice (which must be a Business Day), and ending three or six months thereafter, as Borrower may elect in such notice; provided that: (a) any Interest Period which would otherwise end on a day which is not a Business Day shall be extended to the next succeeding Business Day unless such Business Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Business Day; and (b) any Interest Period which begins on the last Business Day in a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Business Day in a calendar month. "Investment" means any investment, in cash or by delivery of property made, directly or indirectly in any Person, whether by acquisition of shares of capital stock, indebtedness or other obligations or securities or by loan, advance, capital contribution or otherwise. "Law" means any statute, law, regulation, ordinance, rule, treaty, judgment, order, decree, permit, concession, franchise, license, agreement or other governmental restriction of the United States or any state or political subdivision thereof or of any foreign country or any department, province or other political subdivision thereof. "Lender" means Comerica Bank-Texas and its successors and assigns. "Liabilities" means, as to any Person, all indebtedness, liabilities and obligations of such Person, whether matured or unmatured, liquidated or unliquidated, primary or secondary, direct or indirect, absolute, fixed or contingent, and whether or not required to be considered pursuant to GAAP. "LIBOR Rate" means, for any Eurodollar Loan within a Borrowing and with respect to the related Interest Period therefor, the rate per annum determined by Lender in accordance with its customary general practices to be representative of the rates at which deposits of dollars may be offered to Lender in the eurodollar market in an amount comparable to such Eurodollar Loan two Business Days prior to the first day of such Interest Period for a term comparable to such Interest Period. "Lien" means, with respect to any property or assets, any lien, mortgage, security interest, pledge, deposit, production payment, rights of a vendor under any title retention or conditional sale agreement or lease substantially equivalent thereto, tax lien, mechanic's or materialman's lien, or any other charge or encumbrance for security purposes, whether arising by Law or agreement or otherwise, but excluding any right of offset which arises without agreement in the ordinary course of business. "Loans" has the meaning given to such term in Section 2.1. "Loan Documents" means this Agreement, the Note, the Security Documents, other requested documents and all other agreements, certificates, documents, instruments and writings at any time delivered by or on behalf of Borrower or any Guarantor in connection herewith or therewith (exclusive of term sheets and commitment letters). "Lone Star Contract" means that certain Replacement Gas Purchase Contract dated effective as of February 1, 1992 between Parent, successor in interest to ARCO Oil & Gas Company, and Lone Star Gas Company. "Material Adverse Change" means a material and adverse change, from the state of affairs presented in the Initial Financial Statements or as represented or warranted in any Loan Document, to (a) Restricted Persons' Consolidated financial condition, (b) Restricted Persons' Consolidated operations, 6 properties or prospects, considered as a whole, (c) Restricted Persons' ability to timely pay the Obligations, or (d) the enforceability of the material terms of any Loan Documents. "Maturity Date" means February 28, 2001, or if earlier, the day on which the obligations of Lender to make Loans hereunder has been terminated or the Note first becomes due and payable in full. "Maximum Loan Amount" means the amount of $30,000,000. "Note" has the meaning given to such term in Section 2.1. "Obligations" means all Liabilities from time to time owing by any Restricted Person to Lender under or pursuant to any of the Loan Documents. "Obligation" means any part of the Obligations. "Parent" means Castle Energy Corporation, a Delaware corporation. "Permitted Investments" means (a) Cash Equivalents and (b) investments by any Restricted Person in any Guarantor that is a wholly owned, direct or indirect, Subsidiary of Parent. "Permitted Lien" has the meaning given to such term in Section 7.2. "Person" means an individual, corporation, partnership, limited liability company, association, joint stock company, trust or trustee thereof, estate or executor thereof, unincorporated organization or joint venture, Tribunal, or any other legally recognizable entity. "Regulation D" means Regulation D of the Board of Governors of the Federal Reserve System as from time to time in effect. "Reserve Requirement" means, at any time, the maximum rate at which reserves (including any marginal, special, supplemental, or emergency reserves) are required to be maintained under regulations issued from time to time by the Board of Governors of the Federal Reserve System (or any successor) by member banks of the Federal Reserve System against "Eurocurrency liabilities" (as such term is used in Regulation D). Without limiting the effect of the foregoing, the Reserve Requirement shall reflect any other reserves required to be maintained by such member banks with respect to (a) any category of liabilities which includes deposits by reference to which the Adjusted LIBOR Rate is to be determined, or (b) any category of extensions of credit or other assets which include Eurodollar Loans. "Restricted Person" means Borrower and each Guarantor. "Security Documents" means the instruments listed in items 3 through 7 of the Document Schedule and all other security agreements, deeds of trust, mortgages, chattel mortgages, pledges, guaranties, financing statements, continuation statements, extension agreements and other agreements or instruments now, heretofore, or hereafter delivered by any Restricted Person to Lender in connection with this Agreement or any transaction contemplated hereby to secure or guarantee the payment of any part of the Obligations or the performance of any Restricted Person's other duties and obligations under the Loan Documents. "Subsidiary" means, with respect to any Person, any corporation, association, partnership, joint venture, or other business or corporate entity, enterprise or organization which is directly or indirectly (through one or more intermediaries) controlled by or owned fifty percent (50%) or more by such Person, provided that associations, joint ventures or other relationships (a) which are established pursuant to a 7 standard form operating agreement or similar agreement or which are partnerships for purposes of federal income taxation only, (b) which are not corporations or partnerships (or subject to the Uniform Partnership Act) under applicable state Law, and (c) whose businesses are limited to the exploration, development and operation of oil, gas or mineral properties and interests owned directly by the parties in such associations, joint ventures or relationships, shall not be deemed to be "Subsidiaries" of such Person. "Termination Event" means (a) the occurrence with respect to any ERISA Plan of (i) a reportable event described in Sections 4043(b)(5) or (6) of ERISA or (ii) any other reportable event described in Section 4043(b) of ERISA other than a reportable event not subject to the provision for 30-day notice to the Pension Benefit Guaranty Corporation pursuant to a waiver by such corporation under Section 4043(a) of ERISA, or (b) the withdrawal of any ERISA Affiliate from an ERISA Plan during a plan year in which it was a "substantial employer" as defined in Section 4001(a)(2) of ERISA, or (c) the filing of a notice of intent to terminate any ERISA Plan or the treatment of any ERISA Plan amendment as a termination under Section 4041 of ERISA, or (d) the institution of proceedings to terminate any ERISA Plan by the Pension Benefit Guaranty Corporation under Section 4042 of ERISA, or (e) any other event or condition which might constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any ERISA Plan. "Tribunal" means any government, any arbitration panel, any court or any governmental department, commission, board, bureau, agency or instrumentality of the United States of America or any state, province, commonwealth, nation, territory, possession, county, parish, town, township, village or municipality, whether now or hereafter constituted and/or existing. Section 1.2. Exhibits and Schedules; Additional Definitions. All Exhibits and Schedules attached to this Agreement are a part hereof for all purposes. Reference is hereby made to the Document Schedule for the meaning of certain terms defined therein and used but not defined herein, which definitions are incorporated herein by reference. Section 1.3. Amendment of Defined Instruments. Unless the context otherwise requires or unless otherwise provided herein the terms defined in this Agreement which refer to a particular agreement, instrument or document also refer to and include all renewals, extensions, modifications, amendments and restatements of such agreement, instrument or document, provided that nothing contained in this section shall be construed to authorize any such renewal, extension, modification, amendment or restatement. Section 1.4. References and Titles. All references in this Agreement to Exhibits, Schedules, articles, sections, subsections and other subdivisions refer to the Exhibits, Schedules, articles, sections, subsections and other subdivisions of this Agreement unless expressly provided otherwise. Titles appearing at the beginning of any subdivisions are for convenience only and do not constitute any part of such subdivisions and shall be disregarded in construing the language contained in such subdivisions. The words "this Agreement", "this instrument", "herein", "hereof", "hereby", "hereunder" and words of similar import refer to this Agreement as a whole and not to any particular subdivision unless expressly so limited. The phrases "this section" and "this subsection" and similar phrases refer only to the sections or subsections hereof in which such phrases occur. The word "or" is not exclusive, and the word "including" (in its various forms) means "including without limitation". Pronouns in masculine, feminine and neuter genders shall be construed to include any other gender, and words in the singular form shall be construed to include the plural and vice versa, unless the context otherwise requires. 8 Section 1.5. Calculations and Determinations. All calculations under the Loan Documents of interest chargeable with respect to Eurodollar Loans shall be made on the basis of actual days elapsed (including the first day but excluding the last) and a year of 360 days. All other calculations under the Loan Documents of interest shall be made on the basis of actual days elapsed (including the first day but excluding the last) and a year of 365 or 366 days, as appropriate. Unless otherwise expressly provided herein or unless Lender otherwise consents, all financial statements and reports furnished to Lender hereunder shall be prepared and all financial computations and determinations pursuant hereto shall be made in accordance with GAAP. ARTICLE II - Loans Section 2.1. Loans. Subject to the terms and conditions hereof, Lender agrees to make advances to Borrower (herein called "Loans") upon request from time to time prior to the Maturity Date so long as the sum of the aggregate amount of Loans outstanding at any time does not exceed the Borrowing Base determined as of the date on which the requested Loan is to be made. Each Loan must be greater than or equal to $50,000 or must equal the unadvanced portion of the Borrowing Base. Notwithstanding the preceding sentence, each Eurodollar Loan must be greater than or equal to $4,000,000 and Borrower may have no more than four Borrowings of Eurodollar Loans outstanding at any time. The obligation of Borrower to repay to Lender the aggregate amount of all Loans made by Lender, together with interest accruing in connection therewith, shall be evidenced by a single promissory note (herein called the "Note") made by Borrower payable to the order of Lender in the form of Exhibit A with appropriate insertions. The amount of principal owing with respect to the Loans at any given time shall be the aggregate amount of all Loans theretofore made minus all payments of principal with respect to the Loans theretofore received by Lender on the Note. Interest on the Loans owing on the Note shall accrue and be due and payable as provided herein and therein. The Loans shall be due and payable as provided in the Note, and shall be due and payable in full on the Maturity Date. Subject to the terms and conditions hereof, Borrower may prior to the Maturity Date, borrow, repay, and reborrow hereunder. Section 2.2. Requests for Loans. (a) New Loans. Borrower must give at least one Business Day's prior written notice, or telephonic notice promptly confirmed in writing, of any requested Base Rate Loan and at least three Business Day's prior written notice, or telephonic notice promptly confirmed in writing, of any requested Eurodollar Loan; provided that Borrower must give at least ten Business Day's prior written notice of the first Loan requested. Each such written request or confirmation must be made in writing in the form and substance of the "Borrowing Notice" attached hereto as Exhibit B, duly completed. Each such telephonic request shall be deemed a representation, warranty, acknowledgment and agreement by Borrower as to the matters which are required to be set out in such written confirmation. If all conditions precedent to such Loan have been met, Lender will on the date requested make such Loan available to Borrower in immediately available funds at Lender's office in Dallas, Texas. (b) Continuations and Conversions of Existing Loans. Borrower may make the following elections with respect to Loans already outstanding under this Agreement: to convert Base Rate Loans to Eurodollar Loans and to convert Eurodollar Loans to Base Rate Loans on the last day of the Interest Period applicable thereto, and to continue Eurodollar Loans beyond the expiration of such Interest Period by designating a new Interest Period to take effect at the time of such expiration. In making such elections, Borrower may combine existing Loans into one new Borrowing or divide existing Loans made pursuant to one Borrowing into separate new Borrowings, provided that (i) each Eurodollar Loan must be 9 greater than or equal to $4,000,000 and (ii) Borrower may have no more than four Borrowings of Eurodollar Loans outstanding at any time. To make any such election, Borrower must give to Lender written notice, or telephonic notice promptly confirmed in writing, of any such Conversion or Continuation of existing Loans, with a separate notice given for each new Borrowing. Each such notice constitutes a "Continuation/Conversion Notice" hereunder and must: (i) specify the existing Loans made under this Agreement which are to be continued or converted; (ii) specify the aggregate amount of any Borrowing of Base Rate Loans into which such existing Loans are to be continued or converted and the date on which such Continuation or Conversion is to occur, or the aggregate amount of any Borrowing of Eurodollar Loans into which such existing Eurodollar Loans are to be continued or converted, the date on which such Continuation or Conversion is to occur (which shall be the first day of the Interest Period which is to apply to such Eurodollar Loans), and the length of the applicable Interest Period; and (iii) be received by Lender not later than 10:00 a.m., Dallas, Texas time, on the day on which any such Continuation or Conversion to Base Rate Loans is to occur, or the second Business Day preceding the day on which any such Continuation or Conversion to Eurodollar Loans is to occur. Each such written request or confirmation must be made in the form and substance of the "Continuation/ Conversion Notice" attached hereto as Exhibit C, duly completed. Each such telephonic request shall be deemed a representation, warranty, acknowledgment and agreement by Borrower as to the matters which are required to be set out in such written confirmation. Each Continuation/Conversion Notice shall be irrevocable and binding on Borrower. During the continuance of any Default, Borrower may not make any election to convert existing Loans made under this Agreement into Eurodollar Loans or continue existing Loans made under this Agreement as Eurodollar Loans. If (due to the existence of a Default or for any other reason) Borrower fails to timely and properly give any Continuation/Conversion Notice with respect to a Borrowing of existing Eurodollar Loans at least two Business Days prior to the end of the Interest Period applicable thereto, such Eurodollar Loans shall automatically be converted into Base Rate Loans at the end of such Interest Period. No new funds shall be repaid by Borrower or advanced by Lender in connection with any Continuation or Conversion of existing Loans pursuant to this section, and no such Continuation or Conversion shall be deemed to be a new advance of funds for any purpose; such Continuations and Conversions merely constitute a change in the interest rate applicable to already outstanding Loans. Section 2.3. Use of Proceeds. Borrower shall use all funds from Loans to finance the acquisition of producing oil and gas properties (and with the prior written consent of Lender, Persons substantially all of the assets of which consist of producing oil and gas properties) located within or offshore of the United States and to make advances or capital contributions to Restricted Persons, subject to the limitations set forth in Sections 7.4 and 7.8 of this Agreement and Restricted Persons shall use all funds from any such advance or capital contribution only for purposes permitted to Borrower. In no event shall the funds from any Loan be used directly or indirectly by any Person for personal, family, household or agricultural purposes or for the purpose, whether immediate, incidental or ultimate, of purchasing, acquiring or carrying any "margin stock" or any "margin securities" (as such terms are defined in Regulation U promulgated by the Board of Governors of the Federal Reserve System) or to extend credit to others directly or indirectly for the purpose of purchasing or carrying any such margin stock or margin securities. Borrower represents and warrants that Borrower is not engaged principally, 10 or as one of Borrower's important activities, in the business of extending credit to others for the purpose of purchasing or carrying such margin stock or margin securities. Section 2.4. Fees. (a) Commitment Fees. In consideration of Lender's commitment to make Loans, Borrower will pay Lender a commitment fee in the aggregate amount of $40,000, due and payable on the date hereof. (b) Funding Fees. In consideration of Lender's commitment to make Loans, Borrower will pay to Lender a funding fee equal to one-half of one percent (0.5%) of the aggregate amount of each Borrowing other than a Continuation or Conversion of existing Loans. This funding fee shall be due and payable on the date of each such Borrowing other than a Continuation or Conversion of existing Loans. Section 2.5. Optional Prepayments. Borrower may, from time to time and, except as provided in Section 3.5, without premium or penalty, prepay the Note, in whole or in part, so long as the aggregate amounts of all partial prepayments of principal on the Note equals $50,000 or any higher integral multiple of $50,000, and so long as Borrower does not make any prepayments which would reduce the unpaid principal balance of the Loan to less than $100,000 without first either (a) terminating this Agreement or (b) providing assurance satisfactory to Lender in its discretion that Lender's legal rights under the Loan Documents are in no way affected by such reduction. Any principal or interest prepaid pursuant to this section shall be in addition to, and not in lieu of, all payments otherwise required to be paid under the Loan Documents at the time of such prepayment. Section 2.6. Mandatory Prepayments. (a) If at any time the unpaid principal balance of the Loans exceeds the Borrowing Base (such excess being herein called a "Borrowing Base Deficiency"), Borrower shall, within fifteen days after Lender gives notice of such fact to Borrower, either: (i) prepay the principal of the Loans in an aggregate amount at least equal to such Borrowing Base Deficiency; or (ii) give notice to Lender electing to prepay the principal of the Loans in up to six monthly installments in an aggregate amount at least equal to such Borrowing Base Deficiency, with each installment equal to or in excess of one-sixth of such Borrowing Base Deficiency, and with the first such installment to be paid one month after notice of the Borrowing Base was given by Lender and the subsequent installments to be due and payable at one-month intervals thereafter until such Borrowing Base Deficiency has been eliminated; or (iii) give notice to Lender that Borrower desires to provide Lender with deeds of trust, mortgages, chattel mortgages, security agreements, financing statements and other security documents in form and substance satisfactory to Lender, granting, confirming, and perfecting first and prior liens or security interests in collateral acceptable to Lender, to the extent needed to allow Lender to increase the Borrowing Base (as they in their reasonable discretion deem consistent with prudent oil and gas banking industry lending standards at the time) to an amount which eliminates such Borrowing Base Deficiency, and then (1) provide property descriptions and other information which Lender may request concerning the collateral within fifteen days after Lender specifies such collateral to Borrower and (2) provide such security documents within forty-five days after Lender specifies such collateral to Borrower. If, prior to any such 11 specification by Lender, Lender determines that the giving of such security documents will not serve to eliminate such Borrowing Base Deficiency, then, within five Business Days after receiving notice of such determination, Borrower will elect to make, and thereafter make, the prepayments specified in either of the preceding subsections (i) or (ii) of this subsection (a). (b) Any principal prepaid pursuant to this section shall be in addition to, and not in lieu of, all payments otherwise required to be paid under the Loan Documents at the time of such prepayment. (c) On the date the Contract Borrowing Base is reduced to zero dollars ($0.00), Borrower will pay to Lender the amount, if any, equal to (x) the amount of all outstanding Obligations on such date minus (y) the amount of the Hydrocarbon Borrowing Base in effect on such date. Section 2.7. Initial Borrowing Base. The initial Hydrocarbon Borrowing Base will not be determined by Lender until Borrower so requests in writing and during the period from the date hereof until the initial Hydrocarbon Borrowing Base is determined by Lender, the Hydrocarbon Borrowing Base shall be zero dollars ($0.00). The initial Contract Borrowing Base shall be $1,500,000, as reduced or adjusted pursuant to Section 2.8(b) and Section 2.9 Section 2.8. Subsequent Determinations of Borrowing Base. (a) Scheduled Determinations of Hydrocarbon Borrowing Base. After the initial Hydrocarbon Borrowing Base is determined, Lender shall redetermine the Hydrocarbon Borrowing Base, if any, semi-annually based on Engineering Reports required to be delivered to Lender on October 30 and April 30 of each year pursuant to Sections 6.2(c) and 6.2(d). In connection with any such Hydrocarbon Borrowing Base redetermination, Borrower shall furnish to Lender all information, reports and data which Lender has then requested concerning Borrower's businesses and properties (including their oil and gas properties and interests and the reserves and production relating thereto and the status of their production sales contracts and price hedging contracts). Within thirty (30) days after receiving such information, reports and data, or as promptly thereafter as practicable, Lender shall by notice to Borrower designate the new Hydrocarbon Borrowing Base available to Borrower hereunder, which designation shall take effect immediately on the date such notice is sent (herein called a "Determination Date") and shall remain in effect until but not including the next date as of which the Hydrocarbon Borrowing Base is redetermined. If Borrower does not furnish all such information, reports and data by the date specified in the second sentence of this section, Lender may nonetheless designate the Hydrocarbon Borrowing Base at any amount which Lender determines and may redesignate the Hydrocarbon Borrowing Base from time to time thereafter until Lender receives all such information, reports and data, whereupon Lender shall designate a new Hydrocarbon Borrowing Base as described above. (b) Unscheduled Determinations of Hydrocarbon Borrowing Base. In addition to the scheduled redeterminations pursuant to subsection (a) above, Borrower may request that Lender redetermine the Hydrocarbon Borrowing Base once between the scheduled redeterminations described in Section 2.8(a) and Lender may redetermine the Hydrocarbon Borrowing Base at any other time and from time to time without limitation. In connection with any such Hydrocarbon Borrowing Base redetermination, Borrower shall furnish to Lender all information, reports and data which Lender has then requested concerning Borrower's businesses and properties (including their oil and gas properties and interests and the reserves and production relating thereto and the status of its production sales contracts and price hedging contracts). Lender shall by notice to Borrower designate the new Hydrocarbon Borrowing Base available to Borrower hereunder, which designation shall take effect immediately on the date such notice is sent (herein called a "Determination Date") and shall remain in effect until but not including the next date as of which the Hydrocarbon Borrowing Base is redetermined. 12 (c) Contract Borrowing Base Determination. Lender may redetermine the Contract Borrowing Base at any time and from time to time without limitation. Lender shall determine the amount of the Contract Borrowing Base based upon the loan collateral value which it in its discretion assigns to 80% of the projected net revenues based upon the minimum take-or-pay obligations of Lone Star Gas Company under the Lone Star Contract. (d) General Provisions. Lender shall determine the amount of the Borrowing Base based upon the loan collateral value which it in its discretion assign to the various natural gas contracts and the oil and gas properties of Borrower at the time in question and based upon such other credit factors (including without limitation the assets, liabilities, cash flow, hedged and unhedged exposure to price, foreign exchange rate and interest rate changes, business, properties, prospects, management and ownership of Borrower and its Affiliates) as Lender in its discretion deems significant. It is expressly understood that Lender has no obligation to agree upon or designate the Borrowing Base at any particular amount, whether in relation to the Maximum Loan Amount or otherwise, and that Lender's commitment to advance funds hereunder is determined by reference to the Borrowing Base from time to time in effect and, to the extent permitted by Law and regulatory authorities, for the purposes of capital adequacy determination and reimbursements under Article III. Section 2.9. Reduction of Contract Borrowing Base. Until the Maturity Date, the Contract Borrowing Base in effect on each date set forth below shall be automatically reduced on such date by the amount set forth opposite such date: Date Amount July 1, 1999 the amount necessary to reduce the Contract Borrowing Base to zero dollars ($0.00) On the first day after July 1, 1999, upon which (i) the Contract Borrowing Base has been reduced to zero dollars ($0.00); (ii) no Borrowing Base Deficiency exists; and (iii) no Default or Event of Default has occurred and is continuing, CEC Gas shall be released from the Guaranty of even date herewith made by CEC Gas in favor of Lender and shall cease to be a "Guarantor" or a "Restricted Person" hereunder. ARTICLE III - Payments to Lender Section 3.1. General Procedures. Borrower will make each payment which it owes under the Loan Documents not later than 11:00 a.m., Dallas, Texas time, on the date such payment becomes due and payable, in lawful money of the United States of America, without set-off, deduction or counterclaim, and in immediately available funds. Any payment received by Lender after such time will be deemed to have been made on the next following Business Day. Should any such payment become due and payable on a day other than a Business Day, the maturity of such payment shall be extended to the next succeeding Business Day, and, in the case of a payment of principal or past due interest, interest shall accrue and be payable thereon for the period of such extension as provided in the Loan Document under which such payment is due. Each payment under a Loan Document shall be due and payable at the place provided therein and, if no specific place of payment is provided, shall be due and payable at the place of payment of the Note. Amounts collected or received by Lender shall be applied as follows: (a) first, for the payment of all Obligations which are then due (and if such money is insufficient to pay all such Obligations, first to any reimbursements due Lender under Section 6.9 or 9.4 13 and then to the partial payment of all other Obligations then due in proportion to the amounts thereof, or as Lender shall otherwise agree); (b) then, for the prepayment of amounts owing under the Loan Documents if so specified by Borrower, together with accrued and unpaid interest on any principal so prepaid; and (c) last, for the payment or prepayment of any other Obligations. All payments applied to principal or interest on any Note shall be applied first to any interest then due and payable, then to principal then due and payable, and last to any prepayment of principal and interest in compliance with Sections 2.5 and 2.6, as applicable. Section 3.2. Capital Reimbursement. If after the date hereof, either (a) the introduction or implementation of or the compliance with or any change in or in the interpretation of any Law, or (b) the introduction or implementation of or the compliance with any request, directive or guideline from any central bank or other governmental authority (whether or not having the force of Law) affects or would affect the amount of capital required or expected to be maintained by Lender or any corporation controlling Lender, then, upon demand by Lender, Borrower will pay to Lender, from time to time as specified by Lender, such additional amount or amounts which Lender shall determine to be appropriate to compensate Lender or any corporation controlling Lender in light of such circumstances, to the extent that Lender reasonably determines that the amount of any such capital would be increased or the rate of return on any such capital would be reduced by or in whole or in part based on the existence of the face amount of Lender's Loan or commitments under this Agreement. Section 3.3. Increased Cost of Eurodollar Loans. If any applicable Law (whether now in effect or hereinafter enacted or promulgated, including Regulation D) or any interpretation or administration thereof by any governmental authority charged with the interpretation or administration thereof (whether or not having the force of Law) shall, after the date hereof: (a) change the basis of taxation of payments to any Lender Party of any principal, interest, or other amounts attributable to any Eurodollar Loan or otherwise due under this Agreement in respect of any Eurodollar Loan (other than taxes imposed on the overall net income of Lender by any jurisdiction in which Lender is located); or (b) change, impose, modify, apply or deem applicable any reserve, special deposit or similar requirements in respect of any Eurodollar Loan (excluding those for which Lender is fully compensated pursuant to adjustments made in the definition of LIBOR Rate) or against assets of, deposits with or for the account of, or credit extended by, Lender; or (c) impose on Lender or the interbank eurocurrency deposit market any other condition affecting any Eurodollar Loan, the result of which is to increase the cost to Lender of funding or maintaining any Eurodollar Loan or to reduce the amount of any sum receivable by Lender in respect of any Eurodollar Loan by an amount deemed by Lender to be material, then Lender shall promptly notify Borrower in writing of the happening of such event and of the amount required to compensate Lender for such event (on an after-tax basis, taking into account any taxes on such compensation), whereupon (i) Borrower shall pay such amount to Lender and (ii) Borrower may elect, by giving to Lender not less than three Business Days' notice, to convert all (but not less than all) of any such Eurodollar Loans into Base Rate Loans. 14 Section 3.4. Availability. If (a) any change in applicable Laws, or in the interpretation or administration thereof of or in any jurisdiction whatsoever, domestic or foreign, shall make it unlawful or impracticable for Lender to fund or maintain Eurodollar Loans, or shall materially restrict the authority of Lender to purchase or take offshore deposits of dollars (i.e., "eurodollars"), or (b) Lender determines that matching deposits appropriate to fund or maintain any Eurodollar Loan are not available to it, or (c) Lender determines that the formula for calculating the LIBOR Rate does not fairly reflect the cost to Lender of making or maintaining loans based on such rate, then, upon notice by Lender to Borrower, Borrower's right to elect Eurodollar Loans from Lender shall be suspended to the extent and for the duration of such illegality, impracticability or restriction and all Eurodollar Loans of Lender which are then outstanding or are then the subject of any Borrowing Notice and which cannot lawfully or practicably be maintained or funded shall immediately become or remain, or shall be funded as, Base Rate Loans of Lender. Borrower agrees to indemnify Lender and hold it harmless against all costs, expenses, claims, penalties, liabilities and damages which may result from any such change in Law, interpretation or administration. Such indemnification shall be on an after-tax basis, taking into account any taxes imposed on the amounts paid as indemnity. Section 3.5. Funding Losses. In addition to its other obligations hereunder, Borrower will indemnify Lender against, and reimburse Lender on demand for, any loss or expense incurred or sustained by Lender (including any loss or expense incurred by reason of the liquidation or reemployment of deposits or other funds acquired by Lender to fund or maintain Eurodollar Loans), as a result of (a) any payment or prepayment (whether authorized or required hereunder or otherwise) of all or a portion of a Eurodollar Loan on a day other than the day on which the applicable Interest Period ends, (b) any payment or prepayment, whether required hereunder or otherwise, of a Loan made after the delivery, but before the effective date, of a Continuation/Conversion Notice, if such payment or prepayment prevents such Continuation/Conversion Notice from becoming fully effective, (c) the failure of any Loan to be made or of any Continuation/Conversion Notice to become effective due to any condition precedent not being satisfied or due to any other action or inaction of Borrower, or (d) any Conversion (whether authorized or required hereunder or otherwise) of all or any portion of any Eurodollar Loan into a Base Rate Loan or into a different Eurodollar Loan on a day other than the day on which the applicable Interest Period ends. Such indemnification shall be on an after-tax basis, taking into account any taxes imposed on the amounts paid as indemnity. Section 3.6. Reimbursable Taxes. Borrower covenants and agrees that: (a) Borrower will indemnify Lender against and reimburse Lender for all present and future stamp and other taxes, levies, costs and charges whatsoever imposed, assessed, levied or collected on or in respect of this Agreement or any Eurodollar Loans (whether or not legally or correctly imposed, assessed, levied or collected), excluding, however, any taxes imposed on or measured by the overall net income of Lender (all such non-excluded taxes, levies, costs and charges being collectively called "Reimbursable Taxes" in this section). Such indemnification shall be on an after-tax basis, taking into account any taxes imposed on the amounts paid as indemnity. (b) All payments on account of the principal of, and interest on, Lender's Loans and Notes, and all other amounts payable by Borrower to Lender hereunder, shall be made in full without set-off or counterclaim and shall be made free and clear of and without deductions or withholdings of any nature by reason of any Reimbursable Taxes, all of which will be for the account of Borrower. In the event of Borrower being compelled by Law to make any such deduction or withholding from any payment to any Lender, Borrower shall pay on the due date of such payment, by way of additional interest, such additional amounts as are needed to cause the amount receivable by Lender after such deduction or withholding to equal the amount which would have been receivable in the absence of such deduction or 15 withholding. If Borrower should make any deduction or withholding as aforesaid, Borrower shall within sixty days thereafter forward to Lender an official receipt or other official document evidencing payment of such deduction or withholding. (c) If Borrower is ever required to pay any Reimbursable Tax with respect to any Eurodollar Loan, Borrower may elect, by giving to Lender not less than three Business Days' notice, to convert all (but not less than all) of any such Eurodollar Loan into a Base Rate Loan, but such election shall not diminish Borrower's obligation to pay all Reimbursable Taxes. ARTICLE IV - Conditions Precedent to Lending Section 4.1. Documents to be Delivered. Lender has no obligation to make its first Loan unless: (a) Lender shall have received all of the following at Lender's office in Dallas, Texas: (i) each Loan Document listed in the Document Schedule duly executed and delivered and in form, substance and date satisfactory to Lender and (ii) payment of all commitment and other fees and reimbursements (including fees and disbursement of Lender's attorneys) owing to Lender pursuant to any Loan Document or otherwise due Lender; (b) a lockbox account shall have been established by Borrower with Lender on terms acceptable to Lender if funds are to be advanced against the contract Borrowing Base; and (c) a UCC-1 financing statement covering the Collateral shall have been filed with the appropriate jurisdictions. Section 4.2. Additional Conditions Precedent. Lender has no obligation to make any Loan (including its first), unless the following conditions precedent have been satisfied: (a) All representations and warranties made by any Restricted Person in any Loan Document shall be true on and as of the date of such Loan (except to the extent that such representations by their terms relate to a separate date or the facts upon which such representations are based have been changed by the extension of credit hereunder) as if such representations and warranties had been made as of the date of such Loan. (b) No Default shall exist at the date of such Loan. (c) No Material Adverse Change shall have occurred to, and no event or circumstance shall have occurred that could cause a Material Adverse Change to, Parent's Consolidated financial condition or businesses or Borrower's financial condition or business since the date of this Agreement. (d) Each Restricted Person shall have performed and complied with all agreements and conditions required in the Loan Documents to be performed or complied with by it on or prior to the date of such Loan. (e) The making of such Loan shall not be prohibited by any Law and shall not subject Lender to any penalty or other onerous condition under or pursuant to any such Law. 16 (f) Lender shall have received all documents and instruments which Lender has then reasonably requested, in addition to those described in Section 4.1 (including corporate documents and records; documents evidencing governmental authorizations, consents, approvals, licenses and exemptions; and certificates of public officials and of officers and representatives of Borrower and other Persons), as to (i) the accuracy and validity of or compliance with all representations, warranties and covenants made by any Restricted Person in this Agreement and the other Loan Documents, (ii) the satisfaction of all conditions contained herein or therein, and (iii) all other matters pertaining hereto and thereto. All such additional documents and instruments shall be reasonably satisfactory to Lender in form, substance and date. (g) Borrower shall, prior to the making of the first Loan (or using the proceeds thereof), have paid all commitment, facility, and other fees required to be paid to Lender pursuant to any Loan Document or any commitment agreement heretofore entered into and all fees and disbursements of Lender's counsel. ARTICLE V - Representations and Warranties To confirm Lender's understanding concerning Borrower and Borrower's businesses, properties and obligations, and to induce Lender to enter into this Agreement and to extend credit hereunder, Borrower represents and warrants to Lender that: Section 5.1. No Default. No Restricted Person is in default in the performance of any of the covenants and agreements contained in any Loan Document. No event has occurred and is continuing which constitutes a Default. Section 5.2. Organization and Good Standing. Each Restricted Person is duly organized, validly existing and in good standing under the Laws of its jurisdiction of organization, having all powers required to carry on its business and enter into and carry out the transactions contemplated hereby. Each Restricted Person is duly qualified, in good standing, and authorized to do business in all other jurisdictions within the United States wherein the character of the properties owned or held by it or the nature of the business transacted by it makes such qualification necessary, except where the failure to obtain such qualification cannot reasonably be expected to result in a Material Adverse Change. Each Restricted Person has taken all actions and procedures customarily taken in order to enter, for the purpose of conducting business or owning property, each jurisdiction outside the United States wherein the character of the properties owned or held by it or the nature of the business transacted by it makes such actions and procedures desirable. Section 5.3. Authorization. Each Restricted Person has duly taken all action necessary to authorize the execution and delivery by it of the Loan Documents to which it is a party and to authorize the consummation of the transactions contemplated thereby and the performance of its obligations thereunder. Borrower is duly authorized to borrow funds hereunder. Section 5.4. No Conflicts or Consents. The execution and delivery by each Restricted Person of the Loan Documents to which it is a party, the performance by each of its obligations under such Loan Documents, and the consummation of the transactions contemplated by the various Loan Documents, do not and will not (a) conflict with any material provision of (i) any applicable Law, (ii) the organizational documents of such Person, or (iii) any agreement, judgment, license, order or permit applicable to or binding upon such Person, (b) result in the acceleration of any material Indebtedness owed by such Person, or (c) result in or require the creation of any Lien upon any material assets or properties of such 17 Person except as expressly contemplated in the Loan Documents. Except as expressly contemplated in the Loan Documents no consent, approval, authorization or order of, and no notice to or filing with, any Tribunal or third party is required in connection with the execution, delivery or performance by each Restricted Person of any Loan Document or to consummate any transactions contemplated by the Loan Documents. Section 5.5. Enforceable Obligations. The Loan Documents when duly executed and delivered will be, legal, valid and binding obligations of each Restricted Person, to the extent that each is a party thereto, enforceable in accordance with their terms except as such enforcement may be limited by bankruptcy, insolvency or similar Laws of general application relating to the enforcement of creditors' rights. Section 5.6. Initial Financial Statements. Borrower has heretofore delivered to Lender copies of the Initial Financial Statements. The Initial Financial Statements fairly present Parent's financial position at the respective dates thereof and the results of Parent's operations and Parent's cash flows for the period thereof. Since the date of the Initial Financial Statements no Material Adverse Change has occurred, except as reflected in the Disclosure Schedule. All Initial Financial Statements were prepared in accordance with GAAP. Section 5.7. Other Obligations and Restrictions. No Restricted Person has any outstanding Liabilities of any kind (including contingent obligations, tax assessments, and unusual forward or long-term commitments) which are, in the aggregate, material to such Restricted Person or material with respect to Parent and its Consolidated Subsidiaries and not shown in the Initial Financial Statements or disclosed in the Disclosure Schedule or a Disclosure Report. Section 5.8. Full Disclosure. No certificate, statement or other information delivered herewith or heretofore by any Restricted Person to Lender in connection with the negotiation of this Agreement or in connection with any transaction contemplated hereby contains any untrue statement of a material fact or omits to state any material fact known to any Restricted Person (other than industry-wide risks normally associated with the types of businesses conducted by such Persons) necessary to make the statements contained herein or therein not misleading as of the date made or deemed made. There is no fact known to any Restricted Person (other than industry-wide risks normally associated with the types of businesses conducted by any Restricted Person) that has not been disclosed to Lender in writing which could reasonably be expected to cause a Material Adverse Change. To Borrower's knowledge, there are no statements or conclusions in any Engineering Report which are based upon or include misleading information or fail to take into account material information regarding the matters reported therein, it being understood that each Engineering Report is necessarily based upon professional opinions, estimates and projections and that no Restricted Person warrants that such opinions, estimates and projections will ultimately prove to have been accurate. Section 5.9. Litigation. Except as disclosed in the Initial Financial Statements or in the Disclosure Schedule, (a) there are no actions, suits or legal, equitable, arbitrative or administrative proceedings pending, or to the knowledge of any Restricted Person, threatened, against any Restricted Person before any Tribunal which, if adversely determined, could reasonably be expected to cause a Material Adverse Change, and (b) there are no outstanding judgments, injunctions, writs, rulings or orders by any such Tribunal against any Restricted Person or their stockholders, partners, directors or officers which could reasonably be expected to cause a Material Adverse Change. Section 5.10. Names and Places of Business. No Restricted Person has, during the preceding five years, been known by, or used any other trade or fictitious name, except as disclosed in the 18 Disclosure Schedule. Except as otherwise indicated in the Disclosure Schedule or a Disclosure Report, the chief executive office and principal place of business of each Restricted Person are (and for the preceding five years have been) located at the address of Borrower set out on the signature page hereto. Except as indicated in the Disclosure Schedule or a Disclosure Report, no Restricted Person has any other office or place of business. Section 5.11. Parent's Subsidiaries. Parent does not presently have any Subsidiary or own any stock in any other corporation or association except those listed in the Disclosure Schedule or a Disclosure Report. No Restricted Person is a member of any general or limited partnership, joint venture or association of any type whatsoever except those listed in the Disclosure Schedule or a Disclosure Report. Section 5.12. Title to Properties; Licenses. Each Restricted Person has good and defensible title to all of its material properties and assets, free and clear of all Liens, other than Permitted Liens, and of all impediments to the use of such properties and assets in such Person's business, except that no representation or warranty is made with respect to any oil, gas or mineral property or interest to which no proved oil or gas reserves are properly attributed. The ownership of such properties shall not in the aggregate in any material respect obligate any Restricted Person to bear the costs and expenses relating to the maintenance, development and operations of such properties in any amount materially in excess of the working interest of such Restricted Person in such properties. Each Restricted Person has paid all royalties payable under the oil and gas leases to which it is operator, except those contested in accordance with the terms of the applicable joint operating agreement or otherwise contested in good faith by appropriate proceedings. Upon delivery of each Engineering Report furnished to Lender pursuant to Article VI, the statements made in the preceding sentences to this section shall be true with respect to such Engineering Report. All input information upon which the Engineering Reports are based is true and correct in all material respects as of the date thereof. To the best of Borrower's knowledge the information contained in each Engineering Report is true and correct an all material respects. Each Restricted Person possesses all licenses, permits, franchises, patents, copyrights, trademarks and trade names, and other intellectual property (or otherwise possesses the right to use such intellectual property without violation of the rights of any other Person) which are necessary to carry out its business as presently conducted and as presently proposed to be conducted hereafter. Section 5.13. Government Regulation. No Restricted Person is subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act, the Investment Company Act of 1940 (as any of the preceding acts have been amended) or any other Law which regulates the incurring by such Person of Indebtedness, including Laws relating to common contract carriers or the sale of electricity, gas, steam, water or other public utility services. Section 5.14. Solvency. Upon giving effect to the issuance of the Note, the execution of the Loan Documents by Borrower and the consummation of the transactions contemplated hereby, each Restricted Person will be solvent (as such term is used in applicable bankruptcy, liquidation, receivership, insolvency or similar Laws). Section 5.15. ERISA Plans and Liabilities. All currently existing ERISA Plans are listed in the Disclosure Schedule or a Disclosure Report. Except as disclosed in the Initial Financial Statements or in the Disclosure Schedule or a Disclosure Report, no Termination Event has occurred with respect to any ERISA Plan and all ERISA Affiliates are in compliance with ERISA in all material respects. No ERISA Affiliate is required to contribute to, or has any other absolute or contingent liability in respect of, any "multiemployer plan" as defined in Section 4001 of ERISA. Except as set forth in the Disclosure Schedule or a Disclosure Report: (i) no "accumulated funding deficiency" (as defined in Section 412(a) 19 of the Internal Revenue Code of 1986, as amended) exists with respect to any ERISA Plan, whether or not waived by the Secretary of the Treasury or his delegate, and (ii) the current value of each ERISA Plan's benefits does not exceed the current value of such ERISA Plan's assets available for the payment of such benefits by more than $500,000. Section 5.16. Environmental and Other Laws. Except as disclosed in the Disclosure Schedule or a Disclosure Report, (a) Restricted Persons are conducting their businesses in material compliance with all applicable Laws, including Environmental Laws, and have and are in material compliance with all licenses and permits required under any such Laws, (b) to the knowledge of Borrower none of the operations or properties of any Restricted Person is the subject of any federal, state or local investigation evaluating whether any material remedial action is needed to respond to a release of any Hazardous Materials into the environment or to the improper storage or disposal (including storage or disposal at offsite locations) of any Hazardous Materials, (c) no Restricted Person has (and to the best knowledge of Borrower, no other Person has) filed any notice under any Law indicating that any Restricted Person is responsible for the improper release into the environment, or the improper storage or disposal, of any material amount of any Hazardous Materials or that any Hazardous Materials have been improperly released, or are improperly stored or disposed of, upon any of its properties, (d) no Restricted Person has transported or arranged for the transportation of any Hazardous Material to any location which is (i) listed on the National Priorities List under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, listed for possible inclusion on such National Priorities List by the Environmental Protection Agency in its Comprehensive Environmental Response, Compensation and Liability Information System List, or listed on any similar state list or (ii) to the knowledge of Borrower the subject of federal, state or local enforcement actions or other investigations which may lead to claims against Borrower for clean-up costs, remedial work, damages to natural resources or for personal injury claims (whether under Environmental Laws or otherwise); and (e) no Restricted Person otherwise has any known material contingent liability under any Environmental Laws or in connection with the release into the environment, or the storage or disposal, of any Hazardous Materials. ARTICLE VI - Affirmative Covenants of Borrower To conform with the terms and conditions under which Lender is willing to have credit outstanding to Borrower, and to induce Lender to enter into this Agreement and extend credit hereunder, Borrower hereby covenants and agrees that from the date Borrower delivers its first Borrowing Notice to Lender until the full and final payment of the Obligations and the termination of this Agreement, unless Lender has previously agreed otherwise: Section 6.1. Payment and Performance. Each Restricted Person will pay all amounts due under the Loan Documents in accordance with the terms thereof and will observe, perform and comply with every covenant, term and condition expressed or implied in the Loan Documents. Section 6.2. Books, Financial Statements and Reports. Each Restricted Person will at all times maintain full and accurate books of account and records. Parent will maintain and will cause its Subsidiaries to maintain a standard system of accounting, will maintain its Fiscal Year, and will furnish the following statements and reports to Lender at Parent's expense: (a) As soon as available, and in any event within one hundred and five (105) days after the end of each Fiscal Year, complete Consolidated financial statements of Parent, together with all notes thereto, prepared in reasonable detail in accordance with GAAP, together with an unqualified opinion, 20 based on an audit using generally accepted auditing standards, by independent certified public accountants selected by Borrower and acceptable to Lender, stating that such Consolidated financial statements have been so prepared. These financial statements shall contain a Consolidated balance sheet as of the end of such Fiscal Year and Consolidated statements of earnings, of cash flows, and of changes in owners' equity for such Fiscal Year, each setting forth in comparative form the corresponding figures for the preceding Fiscal Year. In addition, within one hundred and five (105) days after the end of each Fiscal Year Borrower will furnish a report signed by such accountants (i) stating that they have read this Agreement, (ii) containing calculations showing compliance (or non-compliance) at the end of such Fiscal Year with the requirements of Sections 7.11 and 7.12, and (iii) further stating that in making their examination and reporting on the Consolidated financial statements described above they did not conclude that any Default existed at the end of such Fiscal Year or at the time of their report, or, if they did conclude that a Default existed, specifying its nature and period of existence. (b) As soon as available, and in any event within fifty (50) days after the end of each Fiscal Quarter, Parent's Consolidated balance sheet and Borrower's consolidating balance sheet as of the end of such Fiscal Quarter and Consolidated statements of Parent's earnings and cash flows and consolidating statements of Borrower's earnings and cash flows for the period from the beginning of the then current Fiscal Year to the end of such Fiscal Quarter, all in reasonable detail and prepared in accordance with GAAP, subject to changes resulting from normal year-end adjustments. In addition Borrower will, together with each such set of financial statements and each set of financial statements furnished under subsection (a) of this section, furnish a certificate in the form of Exhibit D signed by the chief financial officer of Borrower stating that such financial statements are accurate and complete (subject to normal year-end adjustments), stating that he has reviewed the Loan Documents, containing calculations showing compliance (or non-compliance) at the end of such Fiscal Quarter with the requirements of Sections 7.11 and 7.12 and stating that no Default exists at the end of such Fiscal Quarter or at the time of such certificate or specifying the nature and period of existence of any such Default. (c) By October 30 of each year beginning after the initial Hydrocarbon Borrowing Base is determined, an Engineering Report as of the preceding September 30 prepared by independent petroleum engineers chosen by Borrower and acceptable to Lender, concerning/all oil and gas properties and interests owned by Borrower and any other grantor under the Security Documents and which have attributable to them material proved oil or gas reserves. This report shall be satisfactory to Lender, shall take into account any materially "over-produced" status under gas balancing arrangements. This report shall distinguish (or shall be delivered together with a certificate from an appropriate officer of Borrower which distinguishes) those properties treated in the report which are Collateral from those properties treated in the report which are not Collateral. (d) By April 30 of each year, and promptly following notice of an additional Borrowing Base redetermination under Section 2.8(b), an Engineering Report prepared as of the preceding March 31 (or the first day of the preceding calendar month in the case of an additional redetermination) by petroleum engineers who are employees of Borrower, together with an accompanying report on property sales, property purchases and changes in categories, both in the same form and scope as the reports in (d) above. (e) At the request of Lender, as soon as available, and in any event within thirty (30) days after the end of each month, beginning after the initial Hydrocarbon Borrowing Base is determined, a report describing by lease or unit the gross volume of production and sales attributable to production during such month from the properties described in subsection (c) above and describing the related severance taxes, other taxes, and leasehold operating expenses and capital costs attributable thereto and incurred during such month. 21 (f) As soon as available, and in any event within forty-five (45) days after the end of the first Fiscal Quarter after the initial Hydrocarbon Borrowing Base is determined, a list, by name and address, of those Persons who have purchased production (representing at least 85% of Borrower's monthly cash flow) during such Fiscal Quarter from the Collateral giving each such purchaser's owner number for Borrower and each such purchaser's property number for each such Mortgaged Property such report to be updated annually, such update to be delivered to Lender with the Engineering Report described in Section 6.2(c). (g) If advances are made against the Contract Borrowing Base, as soon as available, and in any event within thirty (30) days after the end of each month, a report setting forth volumes, prices and margins for all marketing activities of Borrower relating to the Lone Star Contract and any other natural gas marketing contracts. Section 6.3. Other Information and Inspections. Each Restricted Person will furnish to Lender any information which Lender may from time to time reasonably request in writing concerning any covenant, provision or condition of the Loan Documents or any matter in connection with the businesses and operations of each Restricted Person. Each Restricted Person will permit representatives appointed by Lender (including independent accountants, auditors, Lenders, attorneys, appraisers and any other Persons) to visit and inspect during normal business hours any of its property, including its books of account, other books and records, and any facilities or other business assets, and to make extra copies therefrom and photocopies and photographs thereof, and to write down and record any information such representatives obtain, and will permit Lender or its representatives to investigate and verify the accuracy of the information furnished to Lender or Lender in connection with the Loan Documents and to discuss all such matters with its officers, employees and representatives. Section 6.4. Notice of Material Events and Change of Address. Borrower will promptly notify Lender in writing, stating that such notice is being given pursuant to this Agreement, of: (a) the occurrence of any Material Adverse Change, (b) the occurrence of any Default, (c) any claim of $100,000 or more, any notice of potential liability under any Environmental Laws which, if adversely determined, could reasonably be expected to exceed such amount, or any other material adverse claim asserted against any Restricted Person with respect to any Restricted Person or any Collateral, (d) the filing of any suit or proceeding against any Restricted Person in which an adverse decision could reasonably be expected to cause a Material Adverse Change, and (e) any Restricted Person's change of name or the location of its place of business or the place where it keeps its books and records concerning the Collateral, furnishing such notice to Lender at least twenty Business Days prior to the date of any such change and accompanied with any necessary financing statement amendments or requesting Lender and its counsel to prepare the same. Section 6.5. Maintenance of Properties. Each Restricted Person will maintain, preserve, protect, and keep all Collateral and all other property used or useful in the conduct of its business in good condition and in compliance with all applicable Laws, and will from time to time make all repairs, renewals and replacements needed to enable the business and operations carried on in connection therewith to be promptly and advantageously conducted at all times. 22 Section 6.6. Maintenance of Existence and Qualifications. Each Restricted Person will maintain and preserve its existence and its rights and franchises in full force and effect and will qualify to do business in all states or jurisdictions where required by applicable Law, except where the failure so to qualify will not cause a Material Adverse Change. Section 6.7. Payment of Trade Liabilities, Taxes, etc. Each Restricted Person will (a) timely file all required tax returns; (b) timely pay all taxes, assessments, and other governmental charges or levies imposed upon it or upon its income, profits or property; (c) within 90 days after the same becomes due pay all Liabilities owed by it on ordinary trade terms to vendors, suppliers and other Persons providing goods and services used by it in the ordinary course of its business; (d) pay and discharge when due all other Liabilities now or hereafter owed by it; and (e) maintain appropriate accruals and reserves for all of the foregoing in accordance with GAAP. Each Restricted Person may, however, delay paying or discharging any of the foregoing so long as it is in good faith contesting the validity thereof by appropriate proceedings and has set aside on its books adequate reserves therefor. Section 6.8. Insurance. Each Restricted Person will keep or cause to be kept insured by financially sound and reputable insurers its property in accordance with the Insurance Schedule. Each Restricted Person shall at all times maintain insurance against its liability for injury to persons or property in accordance with the Insurance Schedule, which insurance shall be by financially sound and reputable insurers. Section 6.9. Performance on Other Person's Behalf. If any Restricted Person fails to pay any taxes, insurance premiums, expenses, attorneys' fees or other amounts it is required to pay under any Loan Document, Lender may pay the same. Borrower shall immediately reimburse Lender for any such payments and each amount paid by Lender shall constitute an Obligation owed hereunder which is due and payable on the date such amount is paid by Lender. Section 6.10. Interest. Borrower hereby promises to Lender to pay interest at the Default Rate on all Obligations (including Obligations to pay fees or to reimburse or indemnify Lender) which Borrower has in this Agreement promised to pay to Lender and which are not paid when due. Such interest shall accrue from the date such Obligations become due until they are paid. Section 6.11. Compliance with Agreements and Law. Each Restricted Person will perform all material obligations it is required to perform under the terms of each indenture, mortgage, deed of trust, security agreement, lease, franchise agreement, contract or other material instrument or agreement to which it is a party or by which it or any of its properties is bound, will conduct its business and affairs in compliance in all material respects with all Laws applicable thereto and will maintain its good standing all licenses required by any governmental authority that may be necessary to carry on its general business objects and purposes except where the failure to maintain such standing or license could not reasonably be expected to result in a Material Adverse Change. Section 6.12. Evidence of Compliance. Each Restricted Person will furnish to Lender at such Restricted Person's or Borrower's expense all evidence which Lender from time to time reasonably requests in writing as to the accuracy and validity of or compliance with all representations, warranties and covenants made by any Restricted Person in the Loan Documents, the satisfaction of all conditions contained therein, and all other matters pertaining thereto. Section 6.13. Agreement to Deliver Security Documents. 23 (a) In addition to the Security Documents delivered to Lender at or before the time of the first Loan, Borrower agrees to deliver thereafter and to cause any other Restricted Person to deliver, to further secure the Obligations whenever requested by Lender in its sole and absolute discretion, deeds of trust, mortgages, chattel mortgages, security agreements, financing statements and other Security Documents in form and substance reasonably satisfactory to Lender for the purpose of granting, confirming, and perfecting first and prior liens or security interests in any real or personal property now owned or hereafter acquired by Borrower. (b) Within thirty (30) days following each Determination Date, Borrower will execute and deliver and will cause each other Restricted Person to execute and deliver deeds of trust, mortgages, chattel mortgages, security agreements, financing statements and other Security Documents in form and substance reasonably satisfactory to Lender, granting to Lender first perfected Liens on and in Borrower's interest in the oil, gas and mineral lease(s) covering each well (i) acquired or completed since the prior Determination Date which is capable of production of oil, gas or other hydrocarbons in paying quantities, insofar as such lease(s) cover the proration unit assigned to such well, and (ii) which is to be added to the Borrowing Base. Prior to the granting of such Liens, Borrower will furnish to Lender title opinions in form, substance and authorship satisfactory to Lender, concerning not less than ninety percent (90%) of the aggregate value of such properties and will furnish all other documents and information relating to such properties as Lender may reasonably request. Section 6.14. Perfection and Protection of Security Interests and Liens. Borrower will from time to time deliver, and will cause any other Restricted Person to deliver to Lender any financing statements, continuation statements, extension agreements and other documents, properly completed and executed (and acknowledged when required) by the Restricted Persons in form and substance satisfactory to Lender, which Lender requests for the purpose of perfecting, confirming, or protecting any Liens or other rights in Collateral securing any Obligations. Section 6.15. Bank Accounts; Offset. To secure the repayment of the Obligations Borrower hereby grants to Lender a security interest, a lien, and a right of offset, each of which shall be in addition to all other interests, liens, and rights of Lender at common Law, under the Loan Documents, or otherwise, and each of which shall be upon and against (a) any and all moneys, securities or other property (and the proceeds therefrom) of Borrower now or hereafter held or received by or in transit to Lender from or for the account of Borrower, whether for safekeeping, custody, pledge, transmission, collection or otherwise, (b) any and all deposits (general or special, time or demand, provisional or final) of Borrower with Lender, and (c) any other credits and claims of Borrower at any time existing against Lender, including claims under certificates of deposit. At any time and from time to time after the occurrence of any Default, Lender is hereby authorized to foreclose upon, or to offset against the Obligations then due and payable (in either case without notice to Borrower), any and all items hereinabove referred to. The remedies of foreclosure and offset are separate and cumulative, and either may be exercised independently of the other without regard to procedures or restrictions applicable to the other. To the extent that Borrower has accounts designated as royalty or joint interest owner accounts, the foregoing right to offset shall not extend to funds in such accounts which belong to, or otherwise arise from payments to Borrower for the account of, third party royalty or joint interest owners. Section 6.16. Production Proceeds. Notwithstanding that, by the terms of the various Security Documents, Borrower and any other grantor under a Security Document will be assigning Lender all of the "Production Proceeds" (as defined therein) accruing to the property covered thereby, so long as no Default has occurred Borrower and any other grantor under a Security Document may continue to receive from the purchasers of production all such Production Proceeds, subject, however, to the Liens created under the Security Documents, which Liens are hereby affirmed and ratified. Upon the occurrence of a 24 Default, Lender may exercise all rights and remedies granted under the Security Documents, including the right to obtain possession of all Production Proceeds then held by Borrower or any other grantor under a Security Document or to receive directly from the purchasers of production all other Production Proceeds. In no case shall any failure, whether purposed or inadvertent, by Lender to collect directly any such Production Proceeds constitute in any way a waiver, remission or release of any of its rights under the Security Documents, nor shall any release of any Production Proceeds by Lender to Borrower and any other grantor under a Security Document constitute a waiver, remission, or release of any other Production Proceeds or of any rights of Lender to collect other Production Proceeds thereafter. Section 6.17. Multiemployer ERISA Plans. No ERISA Affiliate will incur any obligation to contribute to any "multiemployer plan" as defined in Section 4001 of ERISA. Section 6.18. Environmental Matters; Environmental Reviews. (a) Each Restricted Person will comply in all material respects with all Environmental Laws now or hereafter applicable to it and shall obtain, at or prior to the time required by applicable Environmental Laws, all environmental, health and safety permits, licenses and other authorizations necessary for its operations and will maintain such authorizations in full force and effect. (b) Each Restricted Person will promptly furnish to Lender all written notices of violation, orders, claims, citations, complaints, penalty assessments, suits or other proceedings received by Borrower, or of which it has notice, pending or threatened against Borrower, by any governmental authority with respect to any alleged violation of or non-compliance with any Environmental Laws or any permits, licenses or authorizations in connection with its ownership or use of its properties or the operation of its business. (c) Each Restricted Person will promptly furnish to Lender all requests for information, notices of claim, demand letters, and other notifications, received by Borrower in connection with its ownership or use of its properties or the conduct of its business, relating to potential responsibility with respect to any investigation or clean-up of Hazardous Material at any location which involve a potential liability or claim in excess of $50,000. Section 6.19. Guaranties of Parent's Subsidiaries. Each Subsidiary of Parent created, acquired or coming into existence after the date hereof shall, promptly upon request by Lender, execute and deliver to Lender an absolute and unconditional guaranty of the timely repayment of the Obligations and the due and punctual performance of the obligations of Borrower hereunder, which guaranty shall be satisfactory to Lender in form and substance. Each Guarantor shall duly execute and deliver such a guaranty prior to the making of any Loan hereunder. Parent will cause each of its Subsidiaries that is a Guarantor to deliver to Lender, simultaneously with its delivery of such a guaranty, written evidence satisfactory to Lender and its counsel that such Subsidiary has taken all corporate or partnership action necessary to duly approve and authorize its execution, delivery and performance of such guaranty and any other documents which it is required to execute. ARTICLE VII - Negative Covenants of Borrower To conform with the terms and conditions under which Lender is willing to have credit outstanding to Borrower, and to induce Lender to enter into this Agreement and make the Loans, Borrower covenants and agrees that from the date Borrower delivers its first Notice to Lender Borrowing 25 until the full and final payment of the Obligations and the termination of this Agreement, unless Lender has previously agreed otherwise: Section 7.1. Indebtedness. No Restricted Person will in any manner owe or be liable for Indebtedness except: (a) the Obligations. (b) Indebtedness outstanding under the instruments and agreements described as the Disclosure Schedule, including any future advances which Borrower is presently entitled to receive through but excluding any renewals or extensions of such liability. (c) Indebtedness arising under Hedging Contracts permitted under Section 7.3. (d) Indebtedness payable to any other Restricted Person. Section 7.2. Limitation on Liens. No Restricted Person will create, assume or permit to exist any Lien upon any of the properties or assets which it now owns or hereafter acquires, except, to the extent not otherwise forbidden by the Security Documents the following ("Permitted Liens"): (a) Liens which secure Obligations only. (b) statutory Liens for taxes, statutory mechanics' and materialmen's Liens incurred in the ordinary course of business, royalty owner's and other similar Liens incurred in the ordinary course of business, provided such Liens do not secure Indebtedness and secure only obligations which are not delinquent or which are being contested as provided in 6.7. (c) Liens arising under joint operating agreements in existence on the date hereof or the date of acquisition of the subject property. (d) Liens securing purchase money debt if such Liens cover only the property acquired with the proceeds thereof, provided that the aggregate amount of Debt secured by all such Liens shall not exceed $1,000,000 without Lender's prior written consent. (e) minor defects in title which do not restrict the full use and other benefits of ownership by or the ability to receive a share of production equal to the represented interest of Borrower therein and which are ordinarily and customarily waived by reasonable and prudent operators. (f) pledges or deposits made to secure payment of worker's compensation or to participate in any fund in connection with worker's compensation, unemployment insurance, pensions or other social security programs. (g) good-faith pledges or deposits made to secure performance of bids, tenders or contracts (other than for borrowed money) or leases, not in excess of 10% of the aggregate amount due thereunder, or to secure statutory obligations, surety or appeal bonds, or indemnity, performance of other similar bonds in the ordinary course of business. Section 7.3. Hedging Contracts. No Restricted Person will be a party to or in any manner be liable on any forward, future, swap or Hedging Contract, except contracts entered into with the purpose and effect of fixing prices on oil or gas expected to be produced, provided that at all times: (a) no such 26 contract fixes a price for a term of more than twenty-four (24) months; (b) the aggregate monthly production covered by all such contracts (determined, in the case of contracts that are not settled on a monthly basis, by a monthly proration acceptable to Lender) for any single month does not in the aggregate exceed seventy percent (70%) of the aggregate Projected Oil and Gas Production anticipated to be sold in the ordinary course of businesses of Borrower and any other grantors under the Security Documents for such month, (c) no such contract requires any Restricted Person to put up assets, letters of credit or other security against the event of its nonperformance prior to actual default by such Person in performing its obligations thereunder, except cash deposits or letters of credit issued by Lender, and (d) each such contract is with a counterparty or has a guarantor of the obligation of the counterparty who at the time the contract is made has long-term obligations which have an investment grade rating. As used in this subsection, the term "Projected Oil and Gas Production" means the projected production of oil or gas (measured by volume unit or BTU equivalent, not sales price) for the term of the contracts or a particular month, as applicable, from properties and interests owned by Borrower or any other grantors under the Security Documents which are located in or offshore of the United States and which have attributable to them proved oil or gas reserves, as such production is projected in the most recent report delivered pursuant to Section 6.2(d), after deducting projected production from any properties or interests sold or under contract for sale that had been included in such report and after adding projected production from any properties or interests that had not been reflected in such report but that are reflected in a separate or supplemental reports meeting the requirements of such Section 6.2(d) above and otherwise are satisfactory to Lender. Section 7.4. Limitation on Mergers, Issuances of Securities. Except as expressly provided in this section no Restricted Person will merge or consolidate with or into any other business entity without the prior consent of Lender except that any Restricted Person may merge with Borrower so long as Borrower is the surviving entity and any Restricted Person (other than Borrower) may merge with another Restricted Person. No Subsidiary of Borrower which is a partnership will allow any diminution of Borrower's interest (direct or indirect) therein. Section 7.5. Limitation on Sales of Property. No Restricted Person will sell, transfer, lease, exchange, alienate or dispose of any of the Collateral or any other property taken into account in determining the Borrowing Base except, (a) equipment which is worthless or obsolete or which is replaced by equipment of equal suitability and value. (b) inventory (including oil and gas sold as produced and seismic data) which is sold in the ordinary course of business on ordinary trade terms. (c) interests in oil and gas leases, or portions thereof (if released or abandoned but not otherwise sold or transferred), so long as no well situated on the property transferred or located on any unit containing all or any part thereof, is capable (or is subject to being made capable through commercially feasible operations) of producing oil, gas or other hydrocarbons or minerals in commercial quantities. No Restricted Person will discount, sell, pledge or assign any notes payable to it, accounts receivable or future income except to the extent expressly permitted under the Loan Documents. Section 7.6. Limitation on Dividends and Redemptions. No Restricted Person will make any Distribution except as expressly set forth below in this section. Distributions may be made by any Subsidiary of Borrower to Borrower at any time. Distributions may be made by any Restricted Person to 27 another Restricted Person that is a Guarantor provided that no Event of Default exists or would be caused thereby. Distributions may be made by Borrower to Parent in an aggregate amount not to exceed $1,750,000.00 in any Fiscal Year and by Parent to its shareholders in an aggregate amount not to exceed $1,750,000.00 in any Fiscal Year. Section 7.7. Limitation on Investments and New Businesses. No Restricted Person will (a) make any expenditure or commitment or incur any obligation or enter into or engage in any transaction except in the ordinary course of business, (b) engage directly or indirectly in any business or conduct any operations except in connection with or incidental to its present businesses and operations, (c) make any acquisitions of or capital contributions to or other investments in any Person, other than Permitted Investments, or (d) make any significant acquisitions or investments in any properties other than oil and gas properties. Section 7.8. Limitation on Credit Extensions. Except for Permitted Investments, no Restricted Person will extend credit, make advances or make loans other than (a) normal and prudent extensions of credit to customers buying goods and services in the ordinary course of business, which extensions shall not be for longer periods than those extended by similar businesses operated in a normal and prudent manner, and (b) provided that no Event of Default exists, loans to Borrower and any Guarantor. Section 7.9. Transactions with Affiliates. No Restricted Person will engage in any material transaction with any of its Affiliates on terms which are less favorable to it than those which would have been obtainable at the time in arm's-length dealing with Persons other than such Affiliates, provided that such restriction shall not apply to transactions among Borrower and its Subsidiaries. Section 7.10. Certain Contracts; ERISA. No Restricted Person will enter into any "take-or-pay" contract or other contract or arrangement for the purchase of goods or services which obligates it to pay for such goods or service regardless of whether they are delivered or furnished to it. No Restricted Person will amend or permit any amendment to any contract or lease which releases, qualifies, limits, makes contingent or otherwise detrimentally affects the rights and benefits of Lender or Lender under or acquired pursuant to any Security Documents. No Restricted Person has any ERISA Plan or is obligated to contribute to any ERISA Plan. Section 7.11. Current Ratio. The ratio of Parent's Consolidated current assets to Parent's Consolidated current liabilities (exclusive of amounts due and payable to Lender within the twelve months following the date of determination) will never be less than 1.05 to 1.0. Section 7.12. Tangible Net Worth. Parent's Consolidated Tangible Net Worth will never be less than $40,000,000. As used in this section the term "Parent's Consolidated Liabilities" means all Consolidated liabilities which would be required to be listed on a Consolidated balance sheet of Parent prepared as of the time in question and the term "Parent's Consolidated Tangible Net Worth" means the remainder of all Consolidated assets of Parent other than intangible assets (including without limitation as intangible assets such assets as patents, copyrights, licenses, franchises, goodwill, trade names, trade secrets and leases other than oil and gas or mineral leases or leases required to be capitalized under GAAP) minus Parent's Consolidated Liabilities. 28 ARTICLE VIII - Events of Default and Remedies Section 8.1. Events of Default. Each of the following events constitutes an Event of Default under this Agreement from the date Borrower delivers its first Borrowing Notice to Lender: (a) Borrower or any Guarantor fail to pay the principal component of any Obligation when due and payable, whether at a date for the payment of a fixed installment or as a contingent or other payment becomes due and payable or as a result of acceleration or otherwise; (b) Any Restricted Person fails to pay any Obligation (other than the Obligations in clause (a) above) when due and payable, whether at a date for the payment of a fixed installment or as a contingent or other payment becomes due and payable or as a result of acceleration or otherwise, within three Business Days after the same becomes due; (c) Any "default" or "event of default" occurs under any Loan Document which defines either such term, and the same is not remedied within the applicable period of grace (if any) provided in such Loan Document; (d) Any Restricted Person fails to duly observe, perform or comply with any covenant, agreement or provision of Section 6.4 or Article VII; (e) Any Restricted Person fails (other than as referred to in subsections (a), (b), (c) or (d) above) to duly observe, perform or comply with any covenant, agreement, condition or provision of any Loan Document, and such failure remains unremedied for a period of thirty (30) days after notice of such failure is given by Lender to Borrower; (f) Any representation or warranty previously, presently or hereafter made in writing by or on behalf of any Restricted Person in connection with any Loan Document shall prove to have been false or incorrect in any material respect on any date on or as of which made, or any Loan Document at any time ceases to be valid, binding and enforceable as warranted in Section 5.5 for any reason other than its release or subordination by Lender; (g) Any Restricted Person fails to duly observe, perform or comply with any agreement with any Person or any term or condition of any instrument, if such agreement or instrument is materially significant to Borrower or to Parent and its Subsidiaries on a Consolidated basis or materially significant to any Guarantor, and such failure is not remedied within the applicable period of grace (if any) provided in such agreement or instrument; (h) Any Restricted Person (i) fails to pay any portion, when such portion is due, of any of its Indebtedness in excess of $1,000,000, unless such Restricted Person is in good faith contesting the validity thereof by appropriate proceedings and has set aside on its books adequate reserves therefor, or (ii) breaches or defaults in the performance of any agreement or instrument by which any such Indebtedness is issued, evidenced, governed, or secured, and any such failure, breach or default continues beyond any applicable period of grace provided therefor; (i) Any Change in Control occurs; 29 (j) Any Restricted Person: (i) suffers the entry against it of a judgment, decree or order for relief by a Tribunal of competent jurisdiction in an involuntary proceeding commenced under any applicable bankruptcy, insolvency or other similar Law of any jurisdiction now or hereafter in effect, including the federal Bankruptcy Code, as from time to time amended, or has any such proceeding commenced against it which remains undismissed for a period of sixty days; or (ii) commences a voluntary case under any applicable bankruptcy, insolvency or similar Law now or hereafter in effect, including the federal Bankruptcy Code, as from time to time amended; or applies for or consents to the entry of an order for relief in an involuntary case under any such Law; or makes a general assignment for the benefit of creditors; or fails generally to pay (or admits in writing its inability to pay) its debts as such debts become due; or takes corporate or other action to authorize any of the foregoing; or (iii) suffers the appointment of or taking possession by a receiver, liquidator, assignee, custodian, trustee, sequestrator or similar official of all or a substantial part of its assets or of any part of the Collateral in a proceeding brought against or initiated by it, and such appointment or taking possession is neither made ineffective nor discharged within sixty days after the making thereof, or such appointment or taking possession is at any time consented to, requested by, or acquiesced to by it; or (iv) suffers the entry against it of a final judgment for the payment of money in excess of $1,000,000 (not covered by insurance satisfactory to Lender in its discretion), unless the same is discharged within sixty days after the date of entry thereof or an appeal or appropriate proceeding for review thereof is taken within such period and a stay of execution pending such appeal is obtained; or (v) suffers a writ or warrant of attachment or any similar process to be issued by any Tribunal against all or any substantial part of its assets or any part of the Collateral, and such writ or warrant of attachment or any similar process is not stayed or released within thirty days after the entry or levy thereof or after any stay is vacated or set aside; (k) Any Termination Event occurs; (l) Either (i) any "accumulated funding deficiency" (as defined in Section 412(a) of the Internal Revenue Code of 1986, as amended) in excess of $100,000 exists with respect to any ERISA Plan, whether or not waived by the Secretary of the Treasury or his delegate, or (ii) any Termination Event occurs with respect to any ERISA Plan and the then current value of such ERISA Plan's benefit liabilities exceeds the then current value of such ERISA Plan's assets available for the payment of such benefit liabilities by more than $100,000 (or in the case of a Termination Event involving the withdrawal of a substantial employer, the withdrawing employer's proportionate share of such excess exceeds such amount); and (m) Any Material Adverse Change occurs. Upon the occurrence of an Event of Default described in subsection (j)(i), (j)(ii) or (j)(iii) of this section with respect to Borrower, all of the Obligations shall thereupon be immediately due and payable, without demand, presentment, notice of demand or of dishonor and nonpayment, protest, notice of protest, notice of intention to accelerate, declaration or notice of acceleration, or any other notice or declaration of any 30 kind, all of which are hereby expressly waived by Borrower and each other Restricted Person who at any time ratifies or approves this Agreement. Upon any such acceleration, any obligation of Lender to make any further Loans shall be permanently terminated. During the continuance of any other Event of Default, Lender at any time and from time to time may, without notice to Borrower or any other Restricted Person, do either or both of the following: (i) terminate any obligation of Lender to make Loans hereunder, and (ii) declare any or all of the Obligations immediately due and payable, and all such Obligations shall thereupon be immediately due and payable, without demand, presentment, notice of demand or of dishonor and nonpayment, protest, notice of protest, notice of intention to accelerate, declaration or notice of acceleration, or any other notice or declaration of any kind, all of which are hereby expressly waived by Borrower and each other Restricted Person who at any time ratifies or approves this Agreement. Section 8.2. Remedies. If any Default shall occur and be continuing, Lender may protect and enforce its rights under the Loan Documents by any appropriate proceedings, including proceedings for specific performance of any covenant or agreement contained in any Loan Document, and Lender may enforce the payment of any Obligations due it or enforce any other legal or equitable right which it may have. All rights, remedies and powers conferred upon Lender under the Loan Documents shall be deemed cumulative and not exclusive of any other rights, remedies or powers available under the Loan Documents or at Law or in equity. ARTICLE IX - Miscellaneous Section 9.1. Waivers and Amendments; Acknowledgments. (a) Waivers and Amendments. No failure or delay (whether by course of conduct or otherwise) by Lender in exercising any right, power or remedy which Lender may have under any of the Loan Documents shall operate as a waiver thereof or of any other right, power or remedy, nor shall any single or partial exercise by Lender of any such right, power or remedy preclude any other or further exercise thereof or of any other right, power or remedy. No waiver of any provision of any Loan Document and no consent to any departure therefrom shall ever be effective unless it is in writing and signed as provided below in this section, and then such waiver or consent shall be effective only in the specific instances and for the purposes for which given and to the extent specified in such writing. No notice to or demand on any Restricted Person shall in any case of itself entitle such Restricted Person to any other or further notice or demand in similar or other circumstances. This Agreement and the other Loan Documents set forth the entire understanding between the parties hereto with respect to the transactions contemplated herein and therein and supersede all prior discussions and understandings with respect to the subject matter hereof and thereof, and no waiver, consent, release, modification or amendment of or supplement to this Agreement or the other Loan Documents shall be valid or effective against any party hereto unless the same is in writing and signed by such party. (b) Acknowledgments and Admissions. Each Restricted Person hereby represents, warrants, acknowledges and admits that (i) it has made an independent decision to enter into this Agreement and the other Loan Documents to which it is a party, without reliance on any representation, warranty, covenant or undertaking by Lender, whether written, oral or implicit, other than as expressly set out in this Agreement or in another Loan Document delivered on or after the date hereof, (ii) there are no representations, warranties, covenants, undertakings or agreements by Lender as to the Loan Documents except as expressly set out in this Agreement or in another Loan Document delivered on or after the date hereof, (iii) Lender has no fiduciary obligation toward it with respect to any Loan Document or the transactions contemplated thereby, (iv) the relationship pursuant to the Loan Documents between the 31 Restricted Persons, on one hand, and Lender, on the other hand, is and shall be solely that of debtor (or guarantor) and creditor, respectively, (v) no partnership or joint venture between the Restricted Persons and Lender exists with respect to the Loan Documents, (vi) should an Event of Default or Default occur or exist, Lender will determine in its sole discretion and for its own reasons what remedies and actions it will or will not exercise or take at that time, (vii) without limiting any of the foregoing, no Restricted Person is relying upon any representation or covenant by Lender, or any representative thereof, and no such representation or covenant has been made, that Lender will, at the time of an Event of Default or Default, or at any other time, waive, negotiate, discuss, or take or refrain from taking any action permitted under the Loan Documents with respect to any such Event of Default or Default or any other provision of the Loan Documents, and (viii) Lender has relied upon the truthfulness of the acknowledgments in this section in deciding to execute and deliver this Agreement and to become obligated hereunder. (c) Joint Acknowledgment. THIS WRITTEN AGREEMENT AND THE OTHER LOAN DOCUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES. Section 9.2. Survival of Agreements; Cumulative Nature. All of the various representations, warranties, covenants and agreements in the Loan Documents shall survive the execution and delivery of this Agreement and the other Loan Documents and the performance hereof and thereof, including the making or granting of the Loans and the delivery of the Note and the other Loan Documents, and shall further survive until all of the Obligations are paid in full to Lender and all of Lender's obligations to Borrower are terminated. All statements and agreements contained in any certificate or other instrument delivered by any Restricted Person to Lender under any Loan Document shall be deemed representations and warranties by Borrower or agreements and covenants of Borrower under this Agreement. The representations, warranties, indemnities, and covenants made by the Restricted Persons in the Loan Documents, and the rights, powers, and privileges granted to Lender in the Loan Documents, are cumulative, and, except for expressly specified waivers and consents, no Loan Document shall be construed in the context of another to diminish, nullify, or otherwise reduce the benefit to Lender of any such representation, warranty, indemnity, covenant, right, power or privilege. In particular and without limitation, no exception set out in this Agreement to any representation, warranty, indemnity, or covenant herein contained shall apply to any similar representation, warranty, indemnity, or covenant contained in any other Loan Document, and each such similar representation, warranty, indemnity, or covenant shall be subject only to those exceptions which are expressly made applicable to it by the terms of the various Loan Documents. Section 9.3. Notices. All notices, requests, consents, demands and other communications required or permitted under any Loan Document shall be in writing, unless otherwise specifically provided in such Loan Document, and shall be deemed sufficiently given or furnished if delivered by personal delivery, by facsimile or telex, by delivery service with proof of delivery, or by registered or certified United States mail, postage prepaid, to the parties hereto at the address for such Person specified on the signature pages hereto (unless changed by similar notice in writing given by the particular Person whose address is to be changed). Any such notice or communication shall be deemed to have been given (a) in the case of personal delivery or delivery service, as of the date of first attempted delivery during normal business hours at the address provided herein, (b) in the case of facsimile or telex, upon receipt, 32 or (c) in the case of registered or certified United States mail, three days after deposit in the mail; provided, however, that no Borrowing Notice shall become effective until actually received by Lender. Section 9.4. Payment of Expenses; Indemnity. (a) Payment of Expenses. Whether or not the transactions contemplated by this Agreement are consummated, Borrower will promptly (and in any event, within 30 days after any invoice or other statement or notice) pay: (i) all transfer, stamp, mortgage, documentary or other similar taxes, assessments or charges levied by any governmental or revenue authority in respect of this Agreement or any of the other Loan Documents or any other document referred to herein or therein, (ii) all reasonable costs and expenses incurred by or on behalf of Lender, including attorneys' fees, engineering fees (whether for work by Lender's in-house petroleum engineer or independent petroleum engineers), travel costs and miscellaneous expenses, in connection with (A) the negotiation, preparation, execution and delivery of the Loan Documents, and any and all consents, waivers or other documents or instruments relating thereto (provided, that the amount payable by Borrower in connection with the negotiation, preparation, execution and delivery of this Agreement and the other Loan Documents executed contemporaneously herewith shall not exceed $40,000), (B) the filing, recording, refiling and re-recording of any Loan Documents and any other documents or instruments or further assurances required to be filed or recorded or refiled or re-recorded by the terms of any Loan Document, (C) the borrowings hereunder and other action reasonably required in the course of administration hereof, (D) monitoring or confirming (or preparation or negotiation of any document related to) Borrower's compliance with any covenants or conditions contained in this Agreement or in any Loan Document, and (iii) all reasonable costs and expenses incurred by or on behalf of Lender (including attorneys' fees, consultants' fees and accounting fees) in connection with the defense or enforcement of any of the Loan Documents (including this section) or the defense of Lender's exercise of its rights thereunder. In addition to the foregoing, until all Obligations have been paid in full, Borrower will also pay or reimburse Lender for all reasonable out-of-pocket costs and expenses of Lender or its Lender or employees in connection with the continuing administration of the Loan and the related due diligence of Lender, including travel and miscellaneous expenses and fees and expenses of Lender's outside counsel and consultants engaged in connection with the Loan Documents. (b) Indemnity. Borrower agrees to indemnify Lender, upon demand, from and against any and all liabilities, obligations, claims, losses, damages, penalties, fines, actions, judgments, suits, settlements, costs, expenses or disbursements (including reasonable fees of attorneys, accountants, experts and advisors) of any kind or nature whatsoever (in this section collectively called "liabilities and costs") which to any extent (in whole or in part) may be imposed on, incurred by, or asserted against Lender growing out of, resulting from or in any other way associated with any of the Collateral, the Loan Documents and the transactions and events (including the enforcement or defense thereof) at any time associated therewith or contemplated therein (including any violation or noncompliance with any Environmental Laws by any Restricted Person or any liabilities or duties of Borrower, any Restricted Person, or Lender with respect to Hazardous Materials found in or released into the environment). THE FOREGOING INDEMNIFICATION SHALL APPLY WHETHER OR NOT SUCH LIABILITIES AND COSTS ARE IN ANY WAY OR TO ANY EXTENT OWED, IN WHOLE OR IN PART, UNDER ANY CLAIM OR THEORY OF STRICT LIABILITY, OR ARE CAUSED, IN WHOLE OR IN PART, BY ANY NEGLIGENT ACT OR OMISSION OF ANY KIND BY LENDER, provided only that Lender shall not be entitled under this section to receive indemnification for that portion, if any, of any liabilities and costs which is proximately caused by its own gross negligence or willful misconduct, as determined in a final judgment. If any Person (including Borrower or any of their 33 Affiliates) ever alleges such gross negligence or willful misconduct by Lender, the indemnification provided for in this section shall nonetheless be paid upon demand, subject to later adjustment or reimbursement, until such time as a court of competent jurisdiction enters a final judgment as to the extent and effect of the alleged gross negligence or willful misconduct. As used in this section the term "Lender" shall refer not only to the Person designated as such but also to each director, officer, Lender, attorney, employee, representative and Affiliate of such Lender. Section 9.5. Joint and Several Liability; Parties in Interest. All Obligations which are incurred by two or more Restricted Persons shall be their joint and several obligations and liabilities. All grants, covenants and agreements contained in the Loan Documents shall bind and inure to the benefit of the parties thereto and their respective successors and assigns; provided, however, that no Restricted Person will assign or transfer any of its rights or delegate any of its duties or obligations under any Loan Document without the prior consent of Lender. Neither Borrower nor any Affiliates of Borrower shall directly or indirectly purchase or otherwise retire any Obligations owed to Lender. Section 9.6. Assignments and Participations. Lender will not sell, assign or transfer all or a portion of its rights and obligations under the Loan Documents to any Person without the consent of Borrower, which consent shall not be unreasonably withheld; provided that no such consent shall be required if an Event of Default has occurred and is continuing or if such sale, assignment or transfer is made to an Affiliate of Lender; and provided further, that Lender shall remain obligated to perform this Agreement and the other Loan Documents in accordance with the terms thereof if such assignment or transfer to an Affiliate of Lender is made without the consent of Borrower when no Event of Default exists. In addition, Lender may grant participations under the Loan Documents at any time without the consent of Borrower. Section 9.7. Governing Law; Submission to Process. EXCEPT TO THE EXTENT THAT THE LAW OF ANOTHER JURISDICTION IS EXPRESSLY ELECTED IN A LOAN DOCUMENT, THE LOAN DOCUMENTS SHALL BE DEEMED CONTRACTS AND INSTRUMENTS MADE UNDER THE LAWS OF THE STATE OF TEXAS AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH AND GOVERNED BY THE LAWS OF THE STATE OF TEXAS AND THE LAWS OF THE UNITED STATES OF AMERICA, WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAW. CHAPTER 346 OF THE TEXAS FINANCE CODE (WHICH REGULATES CERTAIN REVOLVING CREDIT LOAN ACCOUNTS AND REVOLVING TRI- PARTY ACCOUNTS) DOES NOT APPLY TO THIS AGREEMENT OR TO THE NOTE. BORROWER AND EACH RESTRICTED PERSON HEREBY IRREVOCABLY SUBMITS ITSELF TO THE JURISDICTION OF THE STATE AND FEDERAL COURTS SITTING IN THE STATE OF TEXAS AND AGREES AND CONSENTS THAT SERVICE OF PROCESS MAY BE MADE UPON IT IN ANY LEGAL PROCEEDING RELATING TO THE LOAN DOCUMENTS OR THE OBLIGATIONS BY ANY MEANS ALLOWED UNDER TEXAS OR FEDERAL LAW. ANY LEGAL PROCEEDING ARISING OUT OF OR IN ANY WAY RELATED TO ANY OF THE LOAN DOCUMENTS SHALL BE BROUGHT AND LITIGATED EXCLUSIVELY IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF TEXAS, DALLAS DIVISION, TO THE EXTENT IT HAS SUBJECT MATTER JURISDICTION, AND OTHERWISE IN THE TEXAS DISTRICT COURTS SITTING IN DALLAS COUNTY, TEXAS. THE PARTIES HERETO HEREBY WAIVE AND AGREE NOT TO ASSERT, BY WAY OF MOTION, AS A DEFENSE OR OTHERWISE, THAT ANY SUCH PROCEEDING IS BROUGHT IN AN INCONVENIENT FORUM OR THAT THE VENUE THEREOF IS IMPROPER, AND FURTHER AGREE TO A TRANSFER OF ANY SUCH PROCEEDING TO A FEDERAL COURT SITTING IN THE STATE OF TEXAS TO THE EXTENT THAT IT HAS SUBJECT MATTER JURISDICTION, AND OTHERWISE TO A STATE COURT IN DALLAS, TEXAS. IN FURTHERANCE THEREOF, BORROWER, EACH OTHER RESTRICTED PERSON, AND LENDER HEREBY ACKNOWLEDGES AND AGREES THAT IT WAS NOT INCONVENIENT FOR IT TO NEGOTIATE AND RECEIVE FUNDING OF THE TRANSACTIONS CONTEMPLATED BY THIS AGREEMENT IN SUCH COUNTY AND THAT IT 34 WILL BE NEITHER INCONVENIENT NOR UNFAIR TO LITIGATE OR OTHERWISE RESOLVE ANY DISPUTES OR CLAIMS IN A COURT SITTING IN SUCH COUNTY. Section 9.8. Limitation on Interest. Lender intends to contract in strict compliance with applicable usury Law from time to time in effect. In furtherance thereof Lender and Borrower stipulate and agree that none of the terms and provisions contained in the Loan Documents shall ever be construed to create a contract to pay, for the use, forbearance or detention of money, interest in excess of the maximum amount of interest permitted to be charged by applicable Law from time to time in effect. Neither Borrower nor any present or future guarantors, endorsers, or other Persons hereafter becoming liable for payment of any Obligation shall ever be liable for unearned interest thereon or shall ever be required to pay interest thereon in excess of the maximum amount that may be lawfully charged under applicable Law from time to time in effect, and the provisions of this section shall control over all other provisions of the Loan Documents which may be in conflict or apparent conflict herewith. Lender expressly disavows any intention to charge or collect excessive unearned interest or finance charges in the event the maturity of any Obligation is accelerated. If (a) the maturity of any Obligation is accelerated for any reason, (b) any Obligation is prepaid and as a result any amounts held to constitute interest are determined to be in excess of the legal maximum, or (c) Lender or any other holder of any or all of the Obligations shall otherwise collect moneys which are determined to constitute interest which would otherwise increase the interest on any or all of the Obligations to an amount in excess of that permitted to be charged by applicable Law then in effect, then all sums determined to constitute interest in excess of such legal limit shall, without penalty, be promptly applied to reduce the then outstanding principal of the related Obligations or, at Lender's or holder's option, promptly returned to Borrower or the other payor thereof upon such determination. In determining whether or not the interest paid or payable, under any specific circumstance, exceeds the maximum amount permitted under applicable Law, Lender and Borrower (and any other payors thereof) shall to the greatest extent permitted under applicable Law, (i) characterize any non-principal payment as an expense, fee or premium rather than as interest, (ii) exclude voluntary prepayments and the effects thereof, and (iii) amortize, prorate, allocate, and spread the total amount of interest throughout the entire contemplated term of the instruments evidencing the Obligations in accordance with the amounts outstanding from time to time thereunder and the maximum legal rate of interest from time to time in effect under applicable Law in order to lawfully charge the maximum amount of interest permitted under applicable Law. In the event applicable Law provides for an interest ceiling under Chapter 303 of the Texas Finance Code (the "Texas Finance Code") and Chapter 1D of Title 79, Tex.Rev.Civ.Stats. 1925 ("Chapter 1D") as amended, respectively for that day, the ceiling shall be the "weekly ceiling" as defined in the Texas Finance Code and Chapter 1D. As used in this section the term "applicable Law" means the Laws of the State of Texas or the Laws of the United States of America, whichever Laws allow the greater interest, as such Laws now exist or may be changed or amended or come into effect in the future. Section 9.9. Termination; Limited Survival. In its sole and absolute discretion Borrower may at any time that no Obligations are owing elect in a written notice delivered to Lender to terminate this Agreement. Upon receipt by Lender of such a notice, if no Obligations are then owing this Agreement and all other Loan Documents shall thereupon be terminated and the parties thereto released from all prospective obligations thereunder. Notwithstanding the foregoing or anything herein to the contrary, any waivers or admissions made by any Restricted Person in any Loan Document, any Obligations which any Person may have to indemnify or compensate Lender shall survive any termination of this Agreement or any other Loan Document. At the request and expense of Borrower, Lender shall prepare and execute all necessary instruments to reflect and effect such termination of the Loan Documents. 35 Section 9.10. Severability. If any term or provision of any Loan Document shall be determined to be illegal or unenforceable all other terms and provisions of the Loan Documents shall nevertheless remain effective and shall be enforced to the fullest extent permitted by applicable Law. Section 9.11. Counterparts; Fax. This Agreement may be separately executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to constitute one and the same Agreement. This Agreement may be validly executed and delivered by facsimile or other electronic transmission. Section 9.12. Waiver of Jury Trial, Punitive Damages, etc. BORROWER AND LENDER HEREBY KNOWINGLY, VOLUNTARILY, INTENTIONALLY, AND IRREVOCABLY (A) WAIVES, TO THE MAXIMUM EXTENT NOT PROHIBITED BY LAW, ANY RIGHT IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR DIRECTLY OR INDIRECTLY AT ANY TIME ARISING OUT OF, UNDER OR IN CONNECTION WITH THE LOAN DOCUMENTS OR ANY TRANSACTION CONTEMPLATED THEREBY OR ASSOCIATED THEREWITH, BEFORE OR AFTER MATURITY; (B) WAIVES, TO THE MAXIMUM EXTENT NOT PROHIBITED BY LAW, ANY RIGHT IT MAY HAVE TO CLAIM OR RECOVER IN ANY SUCH LITIGATION ANY "SPECIAL DAMAGES", AS DEFINED BELOW, (C) CERTIFIES THAT NO PARTY HERETO NOR ANY REPRESENTATIVE OR LENDER OR COUNSEL FOR ANY PARTY HERETO HAS REPRESENTED, EXPRESSLY OR OTHERWISE, OR IMPLIED THAT SUCH PARTY WOULD NOT, IN THE EVENT OF LITIGATION, SEEK TO ENFORCE THE FOREGOING WAIVERS, AND (D) ACKNOWLEDGES THAT IT HAS BEEN INDUCED TO ENTER INTO THIS AGREEMENT, THE OTHER LOAN DOCUMENTS AND THE TRANSACTIONS CONTEMPLATED HEREBY AND THEREBY BY, AMONG OTHER THINGS, THE MUTUAL WAIVERS AND CERTIFICATIONS CONTAINED IN THIS SECTION. AS USED IN THIS SECTION, "SPECIAL DAMAGES" INCLUDES ALL SPECIAL, CONSEQUENTIAL, EXEMPLARY, OR PUNITIVE DAMAGES (REGARDLESS OF HOW NAMED), BUT DOES NOT INCLUDE ANY PAYMENTS OR FUNDS WHICH ANY PARTY HERETO HAS EXPRESSLY PROMISED TO PAY OR DELIVER TO ANY OTHER PARTY HERETO. [THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK] 36 IN WITNESS WHEREOF, this Agreement is executed as of the date first written above. CASTLE EXPLORATION COMPANY, INC., Borrower By: /s/Richard E. Staedtler ------------------------------------- Richard E. Staedtler Chief Financial Officer Address: c/o Castle Energy Corporation One Radner Corporate Center, Suite 250 Radner, Pennsylvania 19087 Attention: Mr. Richard E. Staedtler Telephone: (610) 995-9400 Fax: (610) 995-0409 CASTLE ENERGY CORPORATION, Parent and Guarantor By: /s/Richard E. Staedtler ------------------------------------- Richard E. Staedtler Chief Financial Officer Address: c/o Castle Energy Corporation One Radner Corporate Center, Suite 250 Radner, Pennsylvania 19087 Attention: Mr. Richard E. Staedtler Telephone: (610) 995-9400 Fax: (610) 995-0409 37 COMERICA BANK - TEXAS, Lender By: /s/Martin W. Wilson ------------------------------------- Martin W. Wilson Vice President Address: 1601 Elm Street, 2nd Floor Dallas, TX 75219 Attention: Martin W. Wilson Telephone: (214) 969-6563 Fax: (214) 969-6561 38 EX-10.129 3 EXHIBIT 10.129 PURCHASE AND SALE AGREEMENT This Purchase and Sale Agreement (the "Agreement") is entered into effective as of May 31, 1999, by and between Costilla Redeco Energy L.L.C., a limited liability company formed and existing under the laws of the State of Texas ("CRE") and Castle Exploration Company, Inc., a company formed and existing under the laws of Pennsylvania ("CECI"). The companies and individuals named above may sometimes individually be referred to as "Party" and collectively as the "Parties". RECITALS WHEREAS Costilla Energy, Inc., a corporation formed and existing under the laws of the State of Delaware ("Costilla") is the sole member of CRE, which is in turn the sole member of Resource Development Company, Ltd. L.L.C. (DE), a limited liability company formed and existing under the laws of the State of Delaware ("Resource"); and WHEREAS CRE owns 100% of the beneficial interest in the Ordinary Shares of Redeco Petroleum Company Limited, a company formed and existing under the laws of the Isle of Guernsey, Channel Island, U.K. ("Petroleum") and 100% of the membership interest in Resource Development Company Limited LLC (DE), a limited liability company organized and existing under the laws of the State of Delaware ("Resource"); and WHEREAS Petroleum has been awarded by the Republic of Romania a 50% interest in three concessions in Romania covering Block EP I-15 Constanta, Block EP I-11 Alexandria, and Block EP II-1 Sud Bucuresti (the "Romanian Concessions"); and WHEREAS Resource holds an oil and gas exploration and production concession with the Republic of Moldova under that certain Concession Agreement of July 5, 1995. WHEREAS Costilla is a party to that certain Purchase and Sale Agreement with Redeco Energy Inc. dated as of October 1, 1998 as amended April 30, 1999 and May 25, 1999 (the "Redeco Agreement") the terms of which are more fully described below. NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements and obligations set out below and to be performed, the Parties agree as follows: WITNESSETH: This Agreement when executed by all parties hereto states the terms of the acquisition ("Acquisition") by CECI of the Assets, as hereinafter defined. 1. Assets to be Acquired. Subject to the terms of this Agreement, CECI is purchasing and Page 1 of 5 CRE is selling all of CRE's right, title and interest in Petroleum, and thereby the Romanian Concessions held by Petroleum and, subject to the escrow terms described in Section 4 below, all of CRE's right, title and interest in Resource, and thereby the Moldovan Concession. CECI is purchasing and CRE is selling all tangible property owned by CRE and located in the CRE office in Oklahoma City, Oklahoma as well as all rights held by CRE and its affiliates to the trade name "Redeco". All of the above, including the leases, contracts, data and liabilities associated therewith (hereinafter collectively called the "Assets") are scheduled on CRE's pro forma consolidated balance sheet, and the attachments thereto, prepared as of May 1, 1999 (the "Closing Balance Sheet"), a copy of which is attached hereto as Exhibit A. CRE shall be responsible for all accounts payable shown on the Closing Balance Sheet and other payables incurred before May 1, 1999, and CECI shall be responsible for accounts payable accruing thereafter. CECI will assume no other liabilities other than the lease for CRE's offices and office equipment in Oklahoma City, Oklahoma, as set forth in Exhibit A. 2. Consideration. As consideration for the Assets, CECI agrees to assume the office and equipment leases held by CRE in Oklahoma City as described on Exhibit A, assumes Costilla's rights and obligation under the Redeco Agreement, and to bear the next $100,000 in expenses to be incurred to Resource in Moldova as described in Section 4 hereof. The Assets being conveyed hereby are subject to the Redeco Agreement. Costilla granted to Redeco a net profits interest equal to 25% of the 50% interest in each of the Romanian Concessions held by CRE (the "Romanian Net Profits Interests") and a net profits interest equal to 12 1/2% of the 100% interest held by CRE in the Moldovan Concession (the "Moldovan Net Profits Interest"), both of which net profits interests to be computed and paid as set forth in the Redeco Agreement. 3. Assignment of Petroleum. CRE shall execute to the benefit of CECI documents in the forms attached hereto as Exhibit C to transfer the beneficial interest in all of the Ordinary Shares of Petroleum. 4. Moldova Escrow. CRE will assign the membership interest held by it in Resource into an escrow pursuant to the terms of the Escrow Agreement attached hereto as Exhibit C. CECI shall bear the next $100,000 in expenses accruing to Resource in Moldova. At any time up until June 30, 2000, CECI may elect to take assignment from escrow all of CRE's membership interest in Resource by payment of $1.00 to CRE. The CRE membership interest is subject to the Letter Agreement with Tahmah Energy dated April 16, 1999, a true and correct copy of which has been previously provided to CECI. 5. Representations of CRE. The recitations stated in this Agreement as to CRE and its related subsidiaries and assets are true and correct. CRE has good and marketable title to the Assets and there are no claims or encumbrances on any of the Assets other than as Page 2 of 5 disclosed herein that would impair CECI's ownership after transfer. The Closing Balance Sheet is complete and correct in all material respects and there are no other liabilities, contingent or otherwise, that exist with respect to the Assets which CECI will assume, or which will otherwise have a material adverse effect with respect to the Assets. Since the date of the Closing Balance Sheet, there has not been any material adverse change with respect to the Assets. All required tax returns due to be filed by Petroleum and its affiliates, and all taxes due in connection therewith have been paid, and no taxing authority, or other governmental authority, has any claim with respect to Resource or Petroleum generally, or the Assets in particular. There is no suit, action or legal, administrative, arbitration or other proceedings or governmental investigation pending to which CRE is a party, or, to the knowledge of CRE, threatened which affects Resource, Petroleum or the Assets other than the litigation brought by Randolph T. Walker against Resource et al previously disclosed to CECI. No consent, approval or authorization of, or filing or registration with, any governmental or regulatory authority or any other person or entity is required to be made or obtained by CRE in connection with the execution, delivery or performance of this Agreement, or the consummation of the transactions. Resource and Petroleum possesses all permits necessary under law or otherwise to own, operate, maintain and use the Assets in the manner in which they are now being owned, operated, maintained and used. None of such permits shown have been, or to the knowledge of CRE, are threatened to be, revoked, canceled, suspended or modified. 6. Representations of CECI. The recitations stated in this Agreement as to CECI are true and correct. 7. Notice. Except as otherwise specifically provided, all notices authorized or required between the Parties by any of the provisions of this Agreement, shall be in writing, in English and delivered in person or by courier service or by any electronic means of transmitting written communications which provides written confirmation of complete transmission, and addressed to such Parties as designated below. Oral communication does not constitute notice for purposes of this Agreement, and telephone numbers and e-mail for the Parties are listed below as a matter of convenience only. Each Party shall have the right to change its address at any time and/or designate that copies of all such notices be directed to another person at another address, by giving written notice thereof to all other Parties. CRE CECI Costilla Redeco Energy LLC Castle Energy Corporation Attn: Henry G. Mussellman Attn: Joe Castle 400 N. Illinois, 10th Floor One Radnor Corporate Center, Suite 250 Midland, TX 79701 Radnor, PA 19087 Phone: (915) 683-3092 Phone: (610-995-9400 Fax: (915) 688-4089 Fax: (610) 995-0409 Page 3 of 5 8. Confidentiality. The Parties further agree that all data furnished to CECI by CRE and by CECI to CRE will be on a confidential basis. 9. Public Disclosure. The parties agree that prior to, at or subsequent to Closing, neither party will make any public announcement, press release, or other public or private disclosure relating to the purchase and sale or any details thereof except such disclosure as might be required by governmental authority, securities exchange press release or normal company policy. 10. Expenses. Each party shall pay the fees and expenses of its own counsel and accountants incurred in connection with the Acquisition. 11. Brokers. No outside parties have participated in the negotiations of the Acquisition on behalf of either party, and no firm or person shall be entitled to any finder's or broker's fee with respect to the acquisition. 12. Trade Name. Upon request by CECI, the Parties will execute such other documentation required to effect the transfer of the trade name. CECI may require CRE and its subsidiaries and affiliates, to cease use of the name "Redeco" within a commercially reasonable period of time upon written request. 13. Assignment. Parties have the right to sell or assign all or a part of their interest; provided, however, that any assignment by CECI of its interest in the Moldovan Concession or the Romanian Concessions shall be made expressly subject to the Net Profits Interests granted pursuant to this Agreement. 14. Choice of Law. This Agreement shall be governed by, construed, interpreted and applied in accordance with the laws of the State of Texas, United States of America, excluding any choice of law rules which would refer the matter to the laws of another jurisdiction. 15. Dispute Resolution. The terms of the Dispute Resolution Procedure attached hereto as Exhibit E dealing with the resolution of disputed matters shall be specifically incorporated into and made a part of this Agreement. 16. Non-Waiver. No waiver by any Party of any one or more defaults by another Party in the performance of this Agreement shall operate or be construed as a waiver of any future default or defaults by the same Party, whether of a like or of a different character. Except as expressly provided in this Agreement, no Party shall be deemed to have waived, released or modified any of its rights under this Agreement unless such Party has expressly stated, in writing, that it does waive, release or modify such right. 17. Severability. If and for so long as any provision of this Agreement shall be deemed to be judged invalid for any reason whatsoever, such invalidity shall not affect the validity or operation of any other provision of this Agreement except as shall be necessary to give effect to the construction of such invalidity, and any invalid provision shall be deemed Page 4 of 5 severed from this Agreement without affecting the validity of the balance hereof. 18. Modification. There shall be no modification of this Agreement except by written consent of all Parties. 19. Counterpart Execution. This Agreement is executed in multiple original counterparts and each such counterpart shall be deemed an original Agreement for all purposes; provided no Party shall be bound to this Agreement unless and until all Parties have executed a counterpart. 20. Entirety. This Agreement is the entire agreement of the Parties with respect to the subject matter contained herein and supersedes all prior understandings and negotiations of the Parties. IN WITNESS of their agreement each Party has caused its duly authorized representative to sign this instrument effective as of this the 31st day of May, 1999. Costilla Redeco Energy, LLC By: /s/Henry G. Mussellman ---------------------------------------------------- Henry G. Mussellman, as Executive Vice President & Chief Operating Officer of Costilla Energy, Inc., Sole Member of Costilla Redeco Energy, L.L.C. CECI: Castle Exploration Company, Inc. By: /s/Richard E. Staedtler ---------------------------------------------------- Richard E. Staedtler Chief Financial Officer of Castle Exploration Company, Inc. Page 5 of 5 EX-11.1 4 EXHIBIT 11.1 Exhibit 11.1 (1 of 2) Castle Energy Corporation Statement of Computation of Earnings Per Share (Dollars in thousands, except per share amounts) (Unaudited)
Three Months Ended June 30, ------------------------------------------------------------- 1999 1998 ------------------------ -------------------------- Basic Diluted Basic Diluted ----- ------- ----- ------- I. Shares Outstanding April 1 2,601,029 2,601,029 3,546,029 3,546,029 II. Stock Purchased During the Period: Options Exercised (weighted) 825 825 2,940 2,940 Purchase of Treasury Stock (weighted) (5,542) (5,542) (216,650) (216,650) --------- --------- --------- --------- 2,596,312 2,596,312 3,332,319 3,332,319 II. Weighted Equivalent Shares: Assumed Options Exercised 47,406 72,454 --------- --------- --------- --------- III. Weighted Average Shares and Equivalent Shares 2,596,312 2,643,718 3,332,319 3,404,773 ========= ========= ========= ========= IV. Net Income $ 900 $ 900 $ 6,864 $ 6,864 ========= ========= ========= ========= V. Net Income Per Share $ .35 $ .34 $ 2.06 $ 2.02 ========= ========= ========= =========
Exhibit 11.1 (2 of 2) Castle Energy Corporation Statement of Computation of Earnings Per Share (Dollars in thousands, except per share amounts) (Unaudited)
Nine Months Ended June 30, ------------------------------------------------------------ 1999 1998 ------------------------ ------------------------- Basic Diluted Basic Diluted ----- ------- ----- ------- I. Shares Outstanding October 1 2,940,729 2,940,729 4,713,546 4,713,546 II. Stock Purchased During the Period: Options Exercised (weighted) 275 275 2,728 2,728 Purchase of Treasury Stock (weighted) (151,832) (151,832) (650,171) (650,171) --------- --------- --------- --------- 2,789,172 2,789,172 4,066,103 4,066,103 II. Weighted Equivalent Shares: Assumed Options Exercised 49,625 43,740 --------- --------- --------- --------- III. Weighted Average Shares and Equivalent Shares 2,789,172 2,838,797 4,066,103 4,109,843 ========= ========= ========= ========= IV. Net Income $ 7,349 $ 7,349 $ 12,228 $ 12,228 ========= ========= ========= ========= V. Net Income Per Share $ 2.63 $ 2.59 $ 3.01 $ 2.98 ========= ========= ========= =========
EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL DATA EXTRACTED FROM THE COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS FOR THE QUARTER ENDED JUNE 30, 1999 INCLUDED IN PART I FINANCIAL INFORMATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 3-MOS SEP-30-1999 JUN-30-1999 28,310 1,170 3,068 0 0 37,065 34,537 8,631 63,463 12,140 0 0 0 3,414 47,917 63,463 9,668 9,668 4,838 9,523 760 0 0 905 5 900 0 0 0 900 .35 .34
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