Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**x****        QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE********SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2008**

 

**OR**

 

**o****        TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from               to            **

 

**Commission file number 0-22149**

 

 

**EDGE PETROLEUM CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                             | ** ** | **76-0511037**      |
|------------------------------------------|------------|---------------------|
| (State or other jurisdiction of          |       | (I.R.S. Employer    |
| incorporation or organization)           |       | Identification No.) |
|                                     |       |                |
| **1301 Travis, Suite 2000**         | ** ** | ** **          |
| **Houston, Texas**                       | ** ** | **77002**           |
| (Address of principal executive offices) |       | (Zip code)          |
|                                     |       |                |

** **

**(713) 654-8960**

(Registrant’s telephone number, including area code)

 

Indicateby checkmark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15 (d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

x  Yes   o  No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.:

 

| o Large accelerated filer                                              |   | x Accelerated Filer         |
|------------------------------------------------------------------------|--------|-----------------------------|
| o Non-accelerated filer (Do not check if a  smaller reporting company) |   | o Smaller reporting company |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  o Yes x No

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

| **Class**    | ** ** | **Outstanding at November 7, 2008** |
|--------------|------------|------------------------------------------|
| Common Stock |       | 28,833,384                               |

 

 

 

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**EDGE PETROLEUM CORPORATION**

 

**Table of Contents**

** **
| ** **                                                                                                   | **Page No.** |
|--------------------------------------------------------------------------------------------------------------|-------------------|
| Part I.  Financial Information                                                                          |              |
| Item 1. Financial  Statements (Unaudited):                                                                   |              |
| Consolidated Balance  Sheets as of September 30, 2008 and December 31, 2007                        | 3                 |
| Consolidated Statements of  Operations for the Three and Nine Months Ended September 30, 2008 and  2007 | 4                 |
| Consolidated Statements of  Cash Flows for the Nine Months Ended September 30, 2008 and 2007            | 5                 |
| Consolidated  Statement of Stockholders’ Equity for the Nine Months Ended  September 30, 2008      | 6                 |
| Notes to the Consolidated Financial Statements                                                               | 7                 |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations         | 26                |
| Item 3. Qualitative and Quantitative Disclosures About  Market Risk                                          | 54                |
| Item 4. Controls and Procedures                                                                              | 56                |
| Part II.  Other Information                                                                             |              |
| Item 1. Legal Proceedings                                                                                    | 57                |
| Item 1A. Risk Factors                                                                                        | 58                |
| Item 2. Unregistered Sale of Equity Securities and Use  of Proceeds                                          | 60                |
| Item 3. Defaults Upon Senior Securities                                                                      | 60                |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                 | 60                |
| Item 5. Other  Information                                                                                   | 60                |
| Item  6. Exhibits                                                                                            | 60                |
| Signatures                                                                                                   | 66                |

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

**EDGEPETROLEUM CORPORATION**

 

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                | ** ** | **September 30,  2008**                              | ** ** | **December 31,  2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                | ** ** | **(Unaudited)**                                           | ** ** | ** **                  | ** ** |
| ** **                                                                                                                                                                                                                                | ** ** | **(in thousands, except share data)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                | ** ** | ** **                                                | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                           |       |                                                      |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                 |       | $                                                         | 15,722     |                        | $          | 7,163 |   |
| Accounts receivable, trade, net of  allowance                                                                                                                                                                                             |       | 20,212                                                    |       | 21,845                      |       |
| Accounts receivable, joint interest owners,  net of allowance                                                                                                                                                                             |       | 8,016                                                     |       | 14,460                      |       |
| Deferred tax asset                                                                                                                                                                                                                        |       | —                                                    |       | 5,818                       |       |
| Derivative financial instruments                                                                                                                                                                                                          |       | 181                                                       |       | 619                         |       |
| Other current assets                                                                                                                                                                                                                      |       | 3,008                                                     |       | 4,079                       |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| Total current assets                                                                                                                                                                                                                      |       | 47,139                                                    |       | 53,984                      |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| PROPERTY AND EQUIPMENT, net – full cost  method of accounting for oil and natural gas properties (including unproved  costs of $27.0 million and $34.9 million at September 30, 2008 and  December 31, 2007, respectively) |       | 548,129                                                   |       | 717,290                     |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| DEFERRED TAX ASSET – long term                                                                                                                                                                                                       |       | 29,899                                                    |       | —                      |       |
| OTHER ASSETS                                                                                                                                                                                                                              |       | 2,514                                                     |       | 3,231                       |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| TOTAL ASSETS                                                                                                                                                                                                                              |       | $                                                         | 627,681    |                        | $          | 774,505 |   |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                             |       |                                                      |       |                        |       |
| CURRENT LIABILITIES:                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| Accounts payable, trade                                                                                                                                                                                                                   |       | $                                                         | 8,838      |                        | $          | 7,665 |   |
| Accrued liabilities                                                                                                                                                                                                                       |       | 21,791                                                    |       | 29,616                      |       |
| Accrued interest payable                                                                                                                                                                                                                  |       | 651                                                       |       | 1,006                       |       |
| Deferred tax liability                                                                                                                                                                                                                    |       | 454                                                       |       | —                      |       |
| Asset retirement obligation                                                                                                                                                                                                               |       | 491                                                       |       | 589                         |       |
| Derivative financial instruments                                                                                                                                                                                                          |       | 3,577                                                     |       | 12,846                      |       |
| Total current liabilities                                                                                                                                                                                                                 |       | 35,802                                                    |       | 51,722                      |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| ASSET RETIREMENT OBLIGATION – long-term                                                                                                                                                                                              |       | 5,844                                                     |       | 6,045                       |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| DERIVATIVE FINANCIAL INSTRUMENTS –  long-term                                                                                                                                                                                        |       | 530                                                       |       | 102                         |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| DEFERRED TAX LIABILITY – long-term                                                                                                                                                                                                   |       | —                                                    |       | 21,326                      |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| OTHER NON-CURRENT LIABILITIES                                                                                                                                                                                                             |       | 102                                                       |       | 534                         |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| LONG-TERM DEBT                                                                                                                                                                                                                            |       | 239,000                                                   |       | 260,000                     |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| Total liabilities                                                                                                                                                                                                                         |       | 281,278                                                   |       | 339,729                     |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| COMMITMENTS AND CONTINGENCIES (NOTE 13)                                                                                                                                                                                                   |       |                                                      |       |                        |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                                                                |       |                                                      |       |                        |       |
| Preferred stock, $0.01 par value; 5,000,000  shares authorized; 2,875,000 issued and outstanding at September 30,  2008 and December 31, 2007                                                                                   |       | 29                                                        |       | 29                          |       |
| Common stock, $0.01 par value; 60,000,000  shares authorized; 28,720,292 and 28,544,160 shares issued and outstanding at  September 30, 2008 and December 31, 2007, respectively                                                |       | 287                                                       |       | 285                         |       |
| Additional paid-in capital                                                                                                                                                                                                                |       | 423,644                                                   |       | 421,808                     |       |
| Retained earnings (deficit)                                                                                                                                                                                                               |       | (77,557                                                   | )          | 12,654                      |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| Total stockholders’ equity                                                                                                                                                                                                           |       | 346,403                                                   |       | 434,776                     |       |
|                                                                                                                                                                                                                                      |       |                                                      |       |                        |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                           |       | $                                                         | 627,681    |                        | $          | 774,505 |   |

 

See accompanying notes to consolidated financial statements.

 

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**EDGEPETROLEUM CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)**

 
| ** **                                                    | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                                              | ** ** | **2007**                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                    | ** ** | **(in thousands, except per share amounts)** |
| OIL AND NATURAL GAS REVENUE:                                  |       |                                                                  |       |                                                |       |   |   |   |   |
| Oil and natural gas sales                                     |       | $                                                                     | 43,136     |                                                | $          | 42,045 |   | $ | 139,212 |   | $ | 128,645 |   |
| Gain (loss) on derivatives                                    |       | 63,505                                                                |       | 6,139                                               |       | (22,452 | ) | (3,676 | ) |
| Total revenue                                                 |       | 106,641                                                               |       | 48,184                                              |       | 116,760 |   | 124,969 |   |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| OPERATING EXPENSES:                                           |       |                                                                  |       |                                                |       |   |   |   |   |
| Oil and natural gas operating expenses                        |       | 4,039                                                                 |       | 4,525                                               |       | 12,452 |   | 11,953 |   |
| Severance and ad valorem taxes                                |       | 2,654                                                                 |       | 3,755                                               |       | 8,136 |   | 9,951 |   |
| Depletion, depreciation, amortization and  accretion          |       | 21,874                                                                |       | 23,815                                              |       | 70,767 |   | 63,421 |   |
| Impairment of oil and natural gas  properties                 |       | 129,520                                                               |       | —                                              |       | 129,520 |   | — |   |
| General and administrative expenses                           |       | 6,380                                                                 |       | 4,269                                               |       | 15,592 |   | 14,199 |   |
| Total operating expenses                                      |       | 164,467                                                               |       | 36,364                                              |       | 236,467 |   | 99,524 |   |
| OPERATING INCOME (LOSS)                                       |       | (57,826                                                               | )          | 11,820                                              |       | (119,707 | ) | 25,445 |   |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| OTHER INCOME AND EXPENSE:                                     |       |                                                                  |       |                                                |       |   |   |   |   |
| Interest income                                               |       | 82                                                                    |       | 109                                                 |       | 174 |   | 288 |   |
| Interest expense, net of amounts  capitalized                 |       | (2,815                                                                | )          | (2,201                                              | )          | (9,323 | ) | (7,891 | ) |
| Gain on ARO settlement                                        |       | 74                                                                    |       | —                                              |       | 83 |   | — |   |
| Amortization of deferred loan costs                           |       | (239                                                                  | )          | (242                                                | )          | (717 | ) | (738 | ) |
| INCOME (LOSS) BEFORE INCOME TAXES                             |       | (60,724                                                               | )          | 9,486                                               |       | (129,490 | ) | 17,104 |   |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| INCOME TAX BENEFIT (EXPENSE)                                  |       | 20,714                                                                |       | (3,460                                              | )          | 45,478 |   | (6,229 | ) |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| NET INCOME (LOSS)                                             |       | (40,010                                                               | )          | 6,026                                               |       | (84,012 | ) | 10,875 |   |
| Preferred Stock Dividends                                     |       | (2,066                                                                | )          | (2,066                                              | )          | (6,199 | ) | (5,510 | ) |
| NET INCOME (LOSS) AVAILABLE TO COMMON  STOCKHOLDERS           |       | $                                                                     | (42,076    | )                                                   | $          | 3,960 |   | $ | (90,211 | ) | $ | 5,365 |   |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| BASIC EARNINGS (LOSS) PER SHARE                               |       | $                                                                     | (1.47      | )                                                   | $          | 0.14 |   | $ | (3.15 | ) | $ | 0.20 |   |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| DILUTED EARNINGS (LOSS) PER SHARE                             |       | $                                                                     | (1.47      | )                                                   | $          | 0.14 |   | $ | (3.15 | ) | $ | 0.19 |   |
|                                                          |       |                                                                  |       |                                                |       |   |   |   |   |
| BASIC WEIGHTED AVERAGE NUMBER OF COMMON  SHARES OUTSTANDING   |       | 28,690                                                                |       | 28,523                                              |       | 28,636 |   | 27,300 |   |
| DILUTED WEIGHTED AVERAGE NUMBER OF COMMON  SHARES OUTSTANDING |       | 28,690                                                                |       | 28,859                                              |       | 28,636 |   | 27,577 |   |

 

See accompanying notes to consolidated financial statements.

 

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**EDGE PETROLEUM CORPORATION**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

** **
| ** **                                                                                | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)**                                 | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                 | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net income (loss)                                                                         |       | $                                                       | (84,012    | ) | $ | 10,875 |   |
| Adjustments to reconcile net income (loss)  to net cash provided by operating activities: |       |                                                    |       |   |   |
| Unrealized (gain) loss on the fair value of  derivatives                                  |       | (8,402                                                  | )          | 7,968 |   |
| Loss on property                                                                          |       | 34                                                      |       | — |   |
| Deferred income taxes                                                                     |       | (45,491                                                 | )          | 6,147 |   |
| Depletion, depreciation, amortization and  accretion                                      |       | 70,767                                                  |       | 63,421 |   |
| Impairment of oil and natural gas  properties                                             |       | 129,520                                                 |       | — |   |
| Gain on ARO settlement                                                                    |       | (83                                                     | )          | — |   |
| Amortization of deferred loan costs                                                       |       | 717                                                     |       | 738 |   |
| Bad debt expense                                                                          |       | 90                                                      |       | 482 |   |
| Stock based compensation costs                                                            |       | 2,371                                                   |       | 3,065 |   |
| Changes in assets and liabilities:                                                        |       |                                                    |       |   |   |
| Decrease (increase) in accounts receivable,  trade                                        |       | 1,555                                                   |       | (3,545 | ) |
| Decrease (increase) in accounts receivable,  joint interest owners                        |       | 6,432                                                   |       | (10,112 | ) |
| Decrease (increase) in other assets                                                       |       | 244                                                     |       | (971 | ) |
| Increase in accounts payable, trade                                                       |       | 1,173                                                   |       | 6,075 |   |
| Increase in accrued liabilities                                                           |       | 2,647                                                   |       | 13,826 |   |
| Increase (decrease) in accrued interest  payable                                          |       | (355                                                    | )          | 603 |   |
|                                                                                      |       |                                                    |       |   |   |
| Net cash provided by operating activities                                                 |       | 77,207                                                  |       | 98,572 |   |
|                                                                                      |       |                                                    |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                 |       |                                                    |       |   |   |
| Oil and natural gas property and equipment  additions                                     |       | (50,515                                                 | )          | (102,495 | ) |
| January 2007 acquisition                                                             |       | —                                                  |       | (379,876 | ) |
| Decrease in drilling advances                                                             |       | 798                                                     |       | 310 |   |
| Proceeds from the sale of oil and natural  gas properties                                 |       | 19,173                                                  |       | 1,302 |   |
| Overhedge derivative settlements                                                          |       | (10,905                                                 | )          | — |   |
|                                                                                      |       |                                                    |       |   |   |
| Net cash used in investing activities                                                     |       | (41,449                                                 | )          | (480,759 | ) |
|                                                                                      |       |                                                    |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                 |       |                                                    |       |   |   |
| Borrowings of long-term debt                                                              |       | —                                                  |       | 255,000 |   |
| Repayments of long-term debt                                                              |       | (21,000                                                 | )          | (144,000 | ) |
| Preferred dividends paid                                                                  |       | (6,199                                                  | )          | (3,788 | ) |
| Proceeds of preferred stock offering                                                      |       | —                                                  |       | 143,750 |   |
| Costs of preferred stock offering                                                         |       | —                                                  |       | (5,315 | ) |
| Proceeds of common stock offering                                                         |       | —                                                  |       | 144,756 |   |
| Costs of common stock offering                                                            |       | —                                                  |       | (6,665 | ) |
| Net proceeds from issuance of common stock                                                |       | —                                                  |       | 42 |   |
| Deferred loan costs                                                                       |       | —                                                  |       | (3,674 | ) |
|                                                                                      |       |                                                    |       |   |   |
| Net cash provided by (used in) financing  activities                                      |       | (27,199                                                 | )          | 380,106 |   |
|                                                                                      |       |                                                    |       |   |   |
| **NET INCREASE (DECREASE) IN CASH AND CASH  EQUIVALENTS**                                 |       | 8,559                                                   |       | (2,081 | ) |
| ** **                                                                                |       |                                                    |       |   |   |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF  PERIOD**                                       |       | 7,163                                                   |       | 2,081 |   |
| ** **                                                                                |       |                                                    |       |   |   |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                              |       | $                                                       | 15,722     |   | $ | — |   |

 

See accompanying notes to consolidated financial statements.

 

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**EDGE PETROLEUM CORPORATION**

**CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY(Unaudited)**

 
| ** **                                                           | ** ** | ** **               | ** ** | ** **            | ** ** | ** **  | ** ** | ** **   | ** ** | **Additional**         | ** ** | **Retained**  | ** ** | **Total**  | ** ** |
|----------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|-------------|------------|--------------|------------|------------------------|------------|---------------|------------|------------|------------|
| ** **                                                           | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Earnings** | ** ** | **Stockholders’** | ** ** |
| ** **                                                           | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**  | ** ** | **Amount**   | ** ** | **Capital**            | ** ** | **(Deficit)** | ** ** | **Equity** | ** ** |
| ** **                                                           | ** ** | **(in thousands)**  | ** ** |
| BALANCE, DECEMBER 31, 2007                                           |       | 2,875                    |       | $                     | 29         |        | 28,544     |         | $          | 285                    |       | $             | 421,808    |       | $          | 12,654 |   | $ | 434,776 |   |
| Issuance of common stock                                             |       | —                   |       | —                |       | 176         |       | 2            |       | 460                    |       | —        |       | 462        |       |
| Stock based compensation costs                                       |       | —                   |       | —                |       | —      |       | —       |       | 1,909                  |       | —        |       | 1,909      |       |
| Tax benefit associated with exercise of  non-qualified stock options |       | —                   |       | —                |       | —      |       | —       |       | (533                   | )          | —        |       | (533       | )          |
| Preferred stock dividends ($0.71875 per  share)                      |       | —                   |       | —                |       | —      |       | —       |       | —                 |       | (6,199        | )          | (6,199     | )          |
| Net loss                                                             |       | —                   |       | —                |       | —      |       | —       |       | —                 |       | (84,012       | )          | (84,012    | )          |
| BALANCE, SEPTEMBER 30, 2008                                          |       | 2,875                    |       | $                     | 29         |        | 28,720     |         | $          | 287                    |       | $             | 423,644    |       | $          | (77,557 | ) | $ | 346,403 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

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**EDGE PETROLEUM CORPORATION**

 

**NOTES TOTHE CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.     SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

Thefinancial statements included herein have been prepared by Edge PetroleumCorporation, a Delaware corporation (“we”, “our”, “us” or the “Company”),without audit pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”), and reflect all adjustments which are, in theopinion of management, necessary to present a fair statement of the results forthe interim periods on a basis consistent with the annual audited consolidatedfinancial statements.  All suchadjustments are of a normal recurring nature, except for the impairment of theCompany’s oil and natural gas properties, as discussed below.  The results of operations for the interimperiods are not necessarily indicative of the results to be expected for anentire year.  Certain information,accounting policies and footnote disclosures normally included in financialstatements prepared in accordance with accounting principles generally acceptedin the United States of America have been omitted pursuant to such rules andregulations, although we believe that the disclosures are adequate to make theinformation presented not misleading. These financial statements should be readin conjunction with our audited consolidated financial statements included inour Annual Report on Form 10-K for the year ended December 31, 2007.

 

***Strategic Alternative Process andProposed Merger*** -In late 2007, the Company announced the hiring of a financial advisor to assistits Board of Directors with an assessment of strategic alternatives. On February 7,2008, the Company provided an update on the strategic alternative process andannounced publicly that it would implement a process to explore a merger orsale of the Company. As a result of the strategic alternative process, on July 15,2008, Chaparral Energy, Inc. (“Chaparral”), a privately held company,together with the Company, announced that they had entered into a definitivemerger agreement that provides for Chaparral to acquire the Company in anall-stock transaction (see Note 11). Through the merger, Chaparral will becomea publicly traded company.

 

Althoughthe Company is working toward completion of the proposed merger with Chaparralduring the fourth quarter of 2008, there is no assurance that the merger willbe completed in that time frame or at all. If the proposed merger withChaparral is not completed, the Company’s current forecast for 2009 projectssufficient funds through the upcoming fiscal year to meet the Company’soperational requirements, fund a limited capital program and reduce outstandingdebt. The Company expects to undergo a borrowing base redetermination under itsRevolving Facility (defined below) on November 15, 2008 (see Note 2). Inthe event a borrowing base redetermination results in the reduction of theCompany’s borrowing base, further availability to borrow under the Company’sRevolving Facility would be limited or possibly eliminated for the near future(see Note 2). Additionally, if a reduced borrowing base requires significantdebt repayments, the Company may be required to curtail its capital program furtheror sell assets to meet its obligations. In addition, it may be difficult for the Company to consummate any debtor equity financing in the near future to meet such obligations, particularlydue to the Company’s recent financial performance, the current worldwidefinancial and credit crisis and the decline of the Company’s stock prices.

 

***Oil and Natural Gas Properties*****-**Investments in oil and natural gas propertiesare accounted for using the full-cost method of accounting. The accounting forour business is subject to special accounting rules that are unique to theoil and gas industry.  There are twoallowable methods of accounting for oil and gas business activities: thesuccessful-efforts method and the full-cost method. There are several significantdifferences between these methods. Among these differences is that, under thesuccessful-efforts method, costs such as geological and geophysical (“G&G”),exploratory dry holes and delay rentals are expensed as incurred whereas underthe full-cost method these types of charges are capitalized to their respectivefull-cost pool. In accordance with the full-cost method of accounting, allcosts associated with the exploration, development and acquisition of oil andnatural gas properties, including salaries, benefits and other internal costsdirectly attributable to these activities are capitalized within a costcenter.  The Company’s oil and naturalgas properties are located within the United States of America, whichconstitutes one cost center. The Company also capitalizes a portion of interestexpense on borrowed funds.

 

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Inthe measurement of impairment of oil and gas properties, the successful-effortsmethod follows the guidance provided in Statement of Financial AccountingStandards (“SFAS”) No. 144, Accounting*for the Impairment or Disposal of Long-Lived Assets*, where the firstmeasurement for impairment is to compare the net book value of the relatedasset to its undiscounted future cash flows using commodity prices consistentwith management expectations. The full-cost method follows guidance provided inSEC Regulation S-X Rule 4-10, where impairment is determined by the “ceilingtest,” whereby to the extent that such capitalized costs subject toamortization in the full-cost pool (net of accumulated depletion, depreciationand amortization, prior impairments, and related tax effects) exceed thepresent value (using a 10% discount rate) of estimated future net after-taxcash flows from proved oil and natural gas reserves, such excess costs arecharged to expense.  Once incurred, animpairment of oil and natural gas properties is not reversible at a later date.  A ceiling test impairment could result in asignificant loss for a reporting period; however, future depletion expensewould be correspondingly reduced. Impairment of oil and natural gas propertiesis assessed on a quarterly basis in conjunction with the Company’s quarterlyand annual SEC filings. The Company recorded a non-cash ceiling test impairmentof $129.5 million ($84.2 million, net of tax) during the quarter ended September 30,2008 as a result of declines in commodity prices and negative revisions in itsproved reserve quantities. No ceiling test impairment was required during thequarter ended September 30, 2007.

 

Inaccordance with SEC Staff Accounting Bulletin (“SAB”) No. 103, *Update of Codification of Staff Accounting Bulletins*,derivative instruments qualifying as cash flow hedges are to be included in thecomputation of limitation on capitalized costs. Since January 1, 2006, the Company has not applied cash flow hedgeaccounting to any derivative contracts (see Note 8), therefore the ceilingtests at September 30, 2008 and 2007 were not impacted by the value of ourderivatives.

 

Oiland natural gas properties are amortized based on a unit-of-production methodusing estimates of proved reserve quantities. Oil and natural gas liquids (“NGL”s)are converted to a gas equivalent basis (“Mcfe”) at the rate of one barrelequals six Mcf. In accordance with SAB No. 106, *Interaction of Statement 143 and the Full Cost Rules,*theamortizable base includes estimated future development and dismantlement costs,and restoration and abandonment costs, net of estimated salvage values.Investments in unproved properties are not amortized until proved reservesassociated with the prospects can be determined or until impairment occurs.Unproved properties are evaluated quarterly, and as needed, for impairment on aproperty-by-property basis. If the results of an assessment indicate that anunproved property is impaired, the amount of impairment is added to the provedoil and natural gas property costs to be amortized. Costs excluded fromamortization related to unproved properties were $27.0 million and $34.9million at September 30, 2008 and December 31, 2007, respectively.

 

Salesof proved and unproved properties are accounted for as adjustments ofcapitalized costs with no gain or loss recognized, unless such adjustmentswould significantly alter the relationship between capitalized costs and provedreserves.

 

***Revenue Recognition and GasBalancing -*** TheCompany recognizes oil and natural gas revenue from its interests in producingwells as oil and natural gas is produced and sold from those wells. Oil andnatural gas sold by the Company is typically not significantly different fromthe Company’s share of production. But gas imbalances can occur when sales aremore or less than the Company’s entitled ownership percentage of total gasproduction. Gas imbalances may be accounted for under either the (1) entitlementsmethod, whereby revenue is recorded on the Company’s interest in the gasproduction actually sold or (2) sales method, whereby revenue is recordedon the basis of total gas actually sold by the Company. The Company uses thesales method of accounting for gas balancing and an asset or a liability isrecognized to the extent that there is a material imbalance in excess of theremaining gas reserves on the underlying properties.  As of September 30,2008 and December 31, 2007, our gas production was materially in balance,i.e., our cumulative portion of gas production taken and sold from wells inwhich we have an interest was not materially different from our entitledinterest in gas production from those wells.

 

***Delivery Commitments –***During 2007, the Company executed a gasgathering and compression services agreement with Frontier Midstream, LLC (“Frontier”).Following execution of such agreement, Frontier expedited the installation ofthe Rose Bud system in White County, Arkansas, including the high and lowpressure gathering lines, dehydration, compression and the interconnect withOzark, in order to accommodate the Company’s desire to be able to delivernatural gas as soon as its wells were completed. At the time of signing thecontract, the Company had completed and tested two productive wells in theMoorefield shale in Arkansas. The Rose Bud system was 

 

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installed,operational and ready to receive the Company’s production in June 2007.The contract minimum commitment to Frontier is 2.7 Bcf over a three year periodfor the pipeline interconnect. This line carries a $0.29 per Mcf deficiencyrate, for a total commitment for the pipeline of approximately $0.8 million.The Company has delivered approximately $59,100 of this commitment through September 30,2008. In addition to the pipeline, Frontier also built and installed lateralgathering lines to eight locations. The remaining commitment on these lateralsis approximately $1.3 million. The original total potential liability ofapproximately $2.0 million is to be paid by June 2010 if the minimumvolumes are not delivered. The Company currently has not recorded a liabilityfor these commitments. The Company is taking steps aimed at increasing itsproduction in this area, but if it is unable to do so and if the Company wereto cease efforts to develop the area, it may not be able to meet the minimumphysical delivery based on estimated future production and thus would record aliability for the remaining amount of the commitment.

 

Thesecontracts are not considered derivatives, but have been designated as annualsales contracts under Statement ofFinancial Accounting Standards (“SFAS”) No. 133, *Accounting for Derivative Instruments and HedgingActivities* (as amended).

 

***Accounts Receivable and Allowancefor Doubtful Accounts*** - The Company routinely assesses the recoverability of all materialtrade and other receivables to determine its ability to collect the receivablesin full. Accounts Receivable, Joint Interest Owners included an allowance fordoubtful accounts of $15,300 and $3,200 at September 30, 2008 and December 31,2007, respectively. Accounts Receivable, Trade included an allowance fordoubtful accounts of $64,500 at September 30, 2008 and none at December 31,2007.

 

***Inventories –***Inventories consist principally of tubulargoods and production equipment for wells and facilities. They are stated at thelower of weighted-average cost or market and are included in Other CurrentAssets on the consolidated balance sheet.

 

***Asset Retirement Obligations –***The Company records a liability for legalobligations associated with the retirement of tangible long-lived assets in theperiod in which they are incurred in accordance with SFAS No. 143, *Accounting for Asset Retirement Obligations.*Under SFAS No. 143, when liabilities for dismantlement and abandonmentcosts, excluding salvage values, are initially recorded, the carrying amount ofthe related oil and gas properties is increased. Accretion of the liability isrecognized each period using the interest method of allocation, and thecapitalized cost is depleted over the useful life of the related asset. Thechanges to the Asset Retirement Obligations (“ARO”) for oil and natural gasproperties and related equipment during the nine months ended September 30,2008 and 2007 are as follows:

 
| ** **                                      | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                      | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| * *                                        | * *   | **(in thousands)**                                      | * *   |
| ARO, Beginning of Period                        |       | $                                                       | 6,634      |   | $ | 3,371 |   |
| Liabilities incurred in the current period      |       | 615                                                     |       | 1,018 |   |
| Liabilities settled/sold in the current  period |       | (1,349                                                  | )          | (26 | ) |
| Accretion expense                               |       | 283                                                     |       | 206 |   |
| Revisions                                       |       | 152                                                     |       | — |   |
| ARO, End of Period                              |       | $                                                       | 6,335      |   | $ | 4,569 |   |
|                                            |       |                                                    |       |   |   |
| Current Portion                                 |       | $                                                       | 491        |   | $ | 407 |   |
| Long-Term Portion                               |       | $                                                       | 5,844      |   | $ | 4,162 |   |

 

Duringthe nine months ended September 30, 2008, ARO liabilities were recordedfor 46 new obligations and liabilities settled include ten properties that wereplugged and abandoned and 123 properties that were sold. During the nine monthsended September 30, 2008, we also recorded a net gain of approximately$82,700 related to ARO settlements and revisions to various properties’balances for changes in anticipated timing of ultimate abandonment.

 

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***Share-Based Compensation*** – The Company accounts for share-basedcompensation in accordance with the provisions of SFAS No. 123R, *Share-Based Payment*, which requires that the compensationcost relating to share-based payment transactions be recognized in financialstatements. Share-based compensation for the nine months ended September 30,2008 was approximately $1.9 million, of which $1.5 million was included ingeneral and administrative expenses (“G&A”) and $0.4 million wascapitalized to oil and natural gas properties. Share-based compensation for thenine months ended September 30, 2007 was approximately $2.3 million, ofwhich $1.9 million was included in general and administrative expenses (“G&A”)and $0.4 million was capitalized to oil and natural gas properties.

 

Duringthe nine months ended September 30, 2008, 1,600 restricted stock units (“RSUs”)were granted. At September 30, 2008, there were 409,460 RSUs outstanding,all of which were classified as equity instruments.  No options were granted during the ninemonths ended September 30, 2008, and at period end, there were 643,600vested unexercised options outstanding.

 

***Income Taxes*** - Effective January 1, 2007, theCompany adopted FASB Interpretation No. 48 *Accountingfor Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)*(“FIN 48”).  This interpretationclarified the accounting for uncertainty in income taxes recognized in thefinancial statements by prescribing a recognition threshold and measurementattribute for a tax position taken or expected to be taken in a taxreturn.  FIN 48 also provides guidance onde-recognitions, classification, interest and penalties, accounting in interimperiods, disclosure and transition. The Company also adopted FASB StaffPosition (“FSP”) No. FIN 48-1, *Definition of Settlementin FASB Interpretation No. 48* as of January 1, 2007.  FSP FIN 48-1 provides that a company’s taxposition will be considered settled if the taxing authority has completed itsexamination, the company does not plan to appeal, and it is remote that thetaxing authority would reexamine the tax position in the future (see Note 6).

 

***Total Comprehensive Income (Loss)*** – For the periods presented, totalcomprehensive income (loss) consisted of:

 
| ** **                                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                          | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(in thousands)**                                  | ** ** |
| Net Income (Loss)                                   |       | $                                                        | (40,010    | )                                                       | $          | 6,026 |   | $ | (84,012 | ) | $ | 10,875 |   |
| Preferred Dividends                                 |       | (2,066                                                   | )          | (2,066                                                  | )          | (6,199 | ) | (5,510 | ) |
| Net Income (Loss) Available to Common  Stockholders |       | (42,076                                                  | )          | 3,960                                                   |       | (90,211 | ) | 5,365 |   |
|                                                |       |                                                     |       |                                                    |       |   |   |   |   |
| Other Comprehensive Income (Loss), Net of  Tax      |       | —                                                   |       | —                                                  |       | — |   | — |   |
| Total Comprehensive Income (Loss)                   |       | $                                                        | (42,076    | )                                                       | $          | 3,960 |   | $ | (90,211 | ) | $ | 5,365 |   |

 

***Fair Value Measurements –***Effective January 1, 2008, the Companypartially adopted SFAS No. 157, *FairValue Measurements,* which provides a common definition of fairvalue, establishes a framework for measuring fair value and expands disclosuresabout fair value measurements, but does not require any new fair valuemeasurements. The partial adoption of SFAS No. 157 had no impact on theCompany’s financial statements, but it did result in additional requireddisclosures as set forth in Note 9. In February 2008, the FASB issued FSP157-2, *Effective Date of FASB Statement No. 157*,which delays the effective date of SFAS No. 157 for all non-financialassets and non-financial liabilities, except those that are recognized ordisclosed at fair value in the financial statements on a recurring basis (atleast annually). Accordingly, the Company has not yet applied the provisions ofSFAS No. 157 to its AROs.

 

Inconjunction with the adoption of SFAS No. 157, the Company also adoptedSFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities – Including an Amendment of FASBStatement No. 115,*effective January 1, 2008. SFAS No. 159allows a company the option to value its financial assets and liabilities, on 

 

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aninstrument by instrument basis, at fair value, and include the change in fairvalue of such assets and liabilities in its results of operations. The Companydid not apply the provisions of SFAS No. 159 to any of its financialassets or liabilities. Accordingly, there was no impact to the Company’sfinancial statements resulting from the adoption of SFAS No. 159.

 

***Recent Accounting Pronouncements***– In December 2007, the FASB issued SFASNo. 141R, *Business Combinations*(“SFAS No. 141R”). SFAS No. 141R expands the definition oftransactions and events that qualify as business combinations; requires thatthe acquired assets and liabilities, including contingencies, be recorded atthe fair value determined on the acquisition date and changes thereafterreflected in earnings, not goodwill; changes the recognition timing forrestructuring costs; and requires acquisition costs to be expensed as incurred.Adoption of SFAS No. 141R is required prospectively for businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008.Early adoption and retroactive application of SFAS No. 141R to fiscalyears preceding the effective date are not permitted. However, accounting forchanges in valuation allowances for acquired deferred tax assets and theresolution of uncertain tax positions for prior business combinations willimpact income tax expense instead of impacting the prior business combinationaccounting starting January 1, 2009. The Company is currently evaluatingthe changes provided in SFAS No. 141R and believes it could have amaterial impact on the Company’s consolidated financial statements if it wereto undertake a significant acquisition or business combination.

 

*** ***In December 2007, the FASB issued SFAS No. 160, *Noncontrolling Interest in Consolidated FinancialStatements*(“SFAS No. 160”). SFAS No. 160 re-characterizesminority interests in consolidated subsidiaries as non-controlling interestsand requires the classification of minority interests as a component of equity.Under SFAS No. 160, a change in control will be measured at fair value,with any gain or loss recognized in earnings. The effective date for SFAS No. 160is for annual periods beginning on or after December 15, 2008. Earlyadoption and retroactive application of SFAS No. 160 to fiscal yearspreceding the effective date are not permitted. The Company currently does not expectadoption of this statement to have an impact on its consolidated financialstatements.

 

In March 2008, the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and HedgingActivities – an amendment of FASB Statement No. 133*(“SFAS No. 161”).SFAS No. 161 requires entities to provide enhanced disclosures about (a) howand why an entity uses derivative instruments, (b) how derivativeinstruments and related hedged items are accounted for under SFAS No. 133and its related interpretations, and (c) how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance, and cash flows. SFAS No. 161 is effective for annual periodsbeginning on or after November 15, 2008. Early application of SFAS No. 161is encouraged, as are comparative disclosures for earlier periods at initialadoption. The Company will adopt SFAS No. 161 on January 1, 2009 anddoes not expect adoption of this statement to impact its consolidated financialstatements, but it does expect it to impact disclosures made in its futurequarterly and annual filings.

 

In May 2008, the FASB issued SFAS No. 162,*The Hierarchy of Generally AcceptedAccounting Principles*(“SFAS No. 162”), which identifies thesources of accounting principles and the framework for selecting the principlesused in the preparation of financial statements of nongovernmental entitiesthat are presented in conformity with generally accepted accounting principles(“GAAP”) in the United States of America (the “GAAP hierarchy”).  SFAS No. 162 is effective November 15, 2008, which is 60 daysfollowing the SEC’s approval of Public Company Accounting Oversight Boardamendments to AU Section 411, *TheMeaning of Present Fairly in Conformity With Generally Accepted Accounting Principles*.The Company does not expect adoption of this statement to impact itsconsolidated financial statements or related disclosures.

 

**2.****             ****LONG-TERM DEBT**

 

OnJanuary 30, 2007, the Company entered into a Fourth Amended and RestatedCredit Agreement (the “Agreement”) for a new Revolving Credit Facility withUnion Bank of California (“UBOC”), as administrative agent and issuing lender,and the other lenders party thereto (together with UBOC, the “Lenders”).Pursuant to the Agreement, UBOC acts as the administrative agent for asenior, first lien secured borrowing base revolving credit facility (the “RevolvingFacility”) in favor of the Company and certain of its wholly-owned subsidiariesin an amount equal to $750 million, of which $250 million and $225 million wereavailable under the borrowing base and 

 

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conformingborrowing base, respectively, at September 30, 2008. The RevolvingFacility has a letter of credit sub-limit of $20 million.

 

TheRevolving Facility matures on January 31, 2011 and bears interest at LIBORplus an applicable margin ranging from 1.25% to 2.5% or Prime plus a margin ofup to 0.50%, with an unused commitment fee ranging from 0.50% to 0.25%, all ofwhich depend on the utilization percentage of the conforming borrowing base. AtSeptember 30, 2008, the interest rates applied to the Company’soutstanding Prime and LIBOR borrowings were 5.50% and 5.19%, respectively, andthe Company had a rate of 0.25% applied to its unused borrowing capacity. Inearly May 2008, our Revolving Facility’s borrowing base and conformingborrowing base were redetermined by our banks and set at $250 million and $225million, respectively. As of September 30, 2008, $239 million in totalborrowings were outstanding under the Revolving Facility. Although the Company’savailable borrowing capacity under the Revolving Facility was $11 million at September 30,2008, this availability was effectively reduced to $1 million on November 5,2008 and may be eliminated for the near future as a result of the upcomingborrowing base redetermination (see below).

 

OnJuly 11, 2008, in connection with the proposed merger with Chaparral, theCompany entered into a Consent agreement (the “Consent”) under theAgreement. Pursuant to the Consent and subject to the terms thereof, theLenders deferred their right to conduct a borrowing base redetermination on orbefore June 30, 2008 and agreed to conduct the redetermination on October 31,2008. The Company paid the Lenders a fee of approximately $0.4 million inconnection with the deferral of the redetermination. On November 5, 2008,the Lenders agreed to delay the interim redetermination from October 31,2008 until November 15, 2008. In consideration for this deferral, theLenders placed a restriction upon the current borrowing base such that it waseffectively lowered to $240 million until the interim redetermination occurs.Pursuant to the terms of the Revolving Facility, upon completion of theredetermination, the Company’s borrowing base will also be the conformingborrowing base. This redetermination process is ongoing and the Lenders as yethave not established a new borrowing base under the Revolving Facility.However, the Company would seek to satisfy any borrowing base deficiencycreated by the upcoming redetermination through a combination of cash on hand,adjustments to its planned capital spending, offering additional properties toserve as collateral and proceeds from asset divestitures.  However, there can be no assurance that anyof these alternative solutions will be attainable, especially in light of therecent global economic crisis. The Company’s Revolving Facility is expected tobe refinanced by Chaparral contemporaneously with the closing of the proposedmerger.

 

TheRevolving Facility is secured by substantially all of the Company’s assets. TheRevolving Facility provides for certain restrictions, including, but notlimited to, limitations on additional borrowings, sales of oil and natural gasproperties or other collateral, and engaging in merger or consolidationtransactions. The Revolving Facility restricts dividends on common stock andcertain distributions of cash or properties and certain liens and also containsfinancial covenants including, without limitation, the following:

 

·                  An EBITDAX to interest expense ratio requiresthat as of the last day of each fiscal quarter the ratio of (a) Edge’sconsolidated EBITDAX (defined as EBITDA plus similar non-cash items andexploration and abandonment expenses for such period) to (b) Edge’sconsolidated interest expense, not be less than 2.5 to 1.0, calculated on a rollingfour quarter basis.

 

·                  A current ratio requires that as of the lastday of each fiscal quarter the ratio of Edge’s consolidated current assets toEdge’s consolidated current liabilities, as defined in the Revolving Facility,be at least 1.0 to 1.0.

 

·                  A maximum leverage ratio requires that as ofthe last day of each fiscal quarter the ratio of (a) Total Indebtedness(as defined in the Agreement) to (b) an amount equal to consolidatedEBITDAX be not greater than 3.0 to 1.0, calculated on a rolling four quarterbasis.

 

ConsolidatedEBITDAX is a component of negotiated covenants with our lender and is discussedhere as part of the Company’s disclosure of its covenant obligations. TheRevolving Facility includes other covenants and events of default that arecustomary for similar facilities. It is an event of default under the RevolvingFacility if the Company undergoes a change in control. “Change in control,” asdefined in the Revolving Facility, means any of the 

 

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followingevents: (a) any “person” or “group” (within the meaning of Section 13(d) or14(d) of the Exchange Act) has become, directly or indirectly, the “beneficialowner” (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, exceptthat a person shall be deemed to have “beneficial ownership” of all such sharesthat any such person has the right to acquire, whether such right isexercisable immediately or only after the passage of time, by way of merger,consolidation or otherwise), of a majority or more of the common stock of theCompany on a fully-diluted basis, after giving effect to the conversion andexercise of all outstanding warrants, options and other securities of theCompany (whether or not such securities are then currently convertible orexercisable), (b) during any period of two consecutive calendar quarters,individuals who at the beginning of such period were members of the Company’sBoard of Directors cease for any reason to constitute a majority of the directorsthen in office unless (i) such new directors were elected by a majority ofthe directors of the Company who constituted the Board of Directors at thebeginning of such period (or by directors so elected) or (ii) the reasonfor such directors failing to constitute a majority is a result of retirementby directors due to age, death or disability, or (c) the Company ceases toown directly or indirectly all of the equity interests of each of itssubsidiaries.

 

**3.****             ****SHELF REGISTRATION STATEMENT**

 

Inthe third quarter 2007, the SEC declared effective the Company’s registrationstatement filed with the SEC that registered securities of up to $500 millionof any combination of debt securities, preferred stock, common stock, warrantsfor debt securities or equity securities of the Company and guarantees of debtsecurities by the Company’s subsidiaries. Net proceeds, terms and pricing ofthe offering of securities issued under the shelf registration statement willbe determined at the time of the offerings. The shelf registration statementdoes not provide assurance that the Company will or could sell any suchsecurities. The Company’s ability to utilize the shelf registration statementfor the purpose of issuing, from time to time, any combination of debt securities,preferred stock, common stock or warrants for debt securities or equitysecurities will depend upon, among other things, market conditions and theexistence of investors who wish to purchase the Company’s securities at pricesacceptable to the Company.  As of November 10,2008, the Company had $500 million available under its shelf registrationstatement. However, because the aggregate market value of the Company’soutstanding common stock is less than $75 million, the type and amount of anysecurities offering under the registration statement may be limited.

 

**4.****             ****PREFERRED STOCK**

 

InJanuary 2007, 2,875,000 shares of its 5.75% Series A cumulativeconvertible perpetual preferred stock (“Convertible Preferred Stock”) wereissued in a public offering.

 

*Dividends*.  The Convertible PreferredStock accumulates dividends at a rate of $2.875 for each share of ConvertiblePreferred Stock per year. Dividends are cumulative from the date of firstissuance and, to the extent payment of dividends is not prohibited by theCompany’s debt agreements, assets are legally available to pay dividends andthe Board of Directors or an authorized committee of the board declares adividend payable, the Company will pay dividends in cash, every quarter. Thefirst payment was made on April 15, 2007.

 

Nodividends or other distributions (other than a dividend payable solely inshares of a like or junior ranking) may be paid or set apart for payment uponany shares ranking equally with the Convertible Preferred Stock (“parity shares”)or shares ranking junior to the Convertible Preferred Stock (“junior shares”),nor may any parity shares or junior shares be redeemed or acquired for anyconsideration by the Company (except by conversion into or exchange for sharesof a like or junior ranking) unless all accumulated and unpaid dividends havebeen paid or funds therefor have been set apart on the Convertible PreferredStock and any parity shares.

 

*Liquidation preference*.  Inthe event of the Company’s voluntary or involuntary liquidation, winding-up ordissolution, each holder of Convertible Preferred Stock will be entitled toreceive and to be paid out of the Company’s assets available for distributionto our stockholders, before any payment or distribution is made to holders ofjunior stock (including common stock), but after any distribution on any of ourindebtedness or senior stock, a liquidation preference in the amount of $50.00per share of the Convertible Preferred Stock, plus accumulated and unpaiddividends on the shares to the date fixed for liquidation, winding-up ordissolution.

 

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*Ranking*.  Our Convertible PreferredStock ranks:

 

·                  senior to all of the shares of common stockand to all of the Company’s other capital stock issued in the future unless theterms of such capital stock expressly provide that it ranks senior to, or on aparity with, shares of the Convertible Preferred Stock;

 

·                  on a parity with all of the Company’s othercapital stock issued in the future, the terms of which expressly provide thatit will rank on a parity with the shares of the Convertible Preferred Stock;and

 

·                  junior to all of the Company’s existing andfuture debt obligations and to all shares of its capital stock issued in thefuture, the terms of which expressly provide that such shares will rank seniorto the shares of the Convertible Preferred Stock.

 

*Mandatory conversion*. On or after January 20, 2010, theCompany may, at its option, cause shares of its Convertible Preferred Stock tobe automatically converted to shares of common stock of the Company at theapplicable conversion rate, but only if the closing sale price of its commonstock for 20 trading days within a period of 30 consecutive trading days endingon the trading day immediately preceding the date the Company gives theconversion notice equals or exceeds 130% of the conversion price in effect oneach such trading day.

 

*Optional redemption*. If fewer than 15% of the shares ofConvertible Preferred Stock issued in the Convertible Preferred Stock offering(including any additional shares issued pursuant to the underwriters’over-allotment option) are outstanding, the Company may, at any time on or afterJanuary 20, 2010, at its option, redeem for cash all such ConvertiblePreferred Stock at a redemption price equal to the liquidation preference of$50.00 plus any accrued and unpaid dividends, if any, on a share of ConvertiblePreferred Stock to, but excluding, the redemption date, for each share ofConvertible Preferred Stock.

 

*Conversion rights*. Each share of Convertible Preferred Stockmay be converted at any time, at the option of the holder, into approximately3.0193 shares of the Company’s common stock (which is based on an initialconversion price of $16.56 per share of common stock, subject to adjustment)plus cash in lieu of fractional shares, subject to the Company’s right tosettle all or a portion of any such conversion in cash or shares of its commonstock. If the Company elects to settle all or any portion of its conversionobligation in cash, the conversion value and the number of shares of its commonstock the Company will deliver upon conversion (if any) will be based upon a 20trading day averaging period.

 

Uponany conversion, the holder will not receive any cash payment representingaccumulated and unpaid dividends on the Convertible Preferred Stock, whether ornot in arrears, except in limited circumstances. The conversion rate is equalto $50.00 divided by the conversion price at the time. The conversion price issubject to adjustment upon the occurrence of certain events. The conversionprice on the conversion date and the number of shares of the Company’s commonstock, as applicable, to be delivered upon conversion may be adjusted ifcertain events occur.

 

*Purchase upon fundamental change*. If the Company becomes subject to afundamental change (as defined below), each holder of shares of ConvertiblePreferred Stock will have the right to require the Company to purchase any orall of its shares at a purchase price equal to 100% of the liquidationpreference, plus accumulated and unpaid dividends, to the date of the purchase.The Company will have the option to pay the purchase price in cash, shares ofcommon stock or a combination of cash and shares. The Company’s ability topurchase all or a portion of the Convertible Preferred Stock for cash issubject to its obligation to repay or repurchase any outstanding debt requiredto be repaid or repurchased in connection with a fundamental change and to anycontractual restrictions then contained in our debt.

 

*Conversion in connection with a fundamental change*. If a holder elects to convert itsshares of the Convertible Preferred Stock in connection with certainfundamental changes, the Company will in certain circumstances increase theconversion rate for such Convertible Preferred Stock. Upon a conversion inconnection with a fundamental change, the holder will be entitled to receive acash payment for all accumulated and unpaid dividends.

 

A“fundamental change” will be deemed to have occurred upon the occurrence of anyof the following:

 

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1.a “person” or “group” subject to specified exceptions, discloses that theperson or group has become the direct or indirect ultimate “beneficial owner”of the Company’s common equity representing more than 50% of the voting powerof its common equity other than a filing with a disclosure relating to atransaction which complies with the proviso in subsection 2 below;

 

2.consummation of any share exchange, consolidation or merger of the Companypursuant to which its common stock will be converted into cash, securities orother property or any sale, lease or other transfer in one transaction or aseries of transactions of all or substantially all of the consolidated assetsof the Company and its subsidiaries, taken as a whole, to any person other thanone of its subsidiaries; provided, however, that a transaction where theholders of more than 50% of all classes of its common equity immediately priorto the transaction own, directly or indirectly, more than 50% of all classes ofcommon equity of the continuing or surviving corporation or transfereeimmediately after the event shall not be a fundamental change;

 

3.the Company is liquidated or dissolved or holders of its capital stock approveany plan or proposal for its liquidation or dissolution; or

 

4.the Company’s common stock is neither listed on a national securities exchangenor listed nor approved for quotation on an over-the-counter market in theUnited States.

 

However,a fundamental change will not be deemed to have occurred in the case of a shareexchange, merger or consolidation, or in an exchange offer having the resultdescribed in subsection 1 above, if 90% or more of the consideration in theaggregate paid for common stock (and excluding cash payments for fractionalshares and cash payments pursuant to dissenters’ appraisal rights) in the shareexchange, merger or consolidation or exchange offer consists of common stock ofa United States company traded on a national securities exchange (or which willbe so traded or quoted when issued or exchanged in connection with suchtransaction).

 

*Voting rights*. If the Company fails to pay dividendsfor six quarterly dividend periods (whether or not consecutive) or if thecompany fails to pay the purchase price on the purchase date for theConvertible Preferred Stock following a fundamental change, holders of theConvertible Preferred Stock will have voting rights to elect two directors tothe board.

 

Inaddition, the Company may generally not, without the approval of the holders ofat least 66 2/3% of the shares of the Convertible Preferred Stock thenoutstanding:

 

·                  amend the restated certificate ofincorporation, as amended, by merger or otherwise, if the amendment would alteror change the powers, preferences, privileges or rights of the holders ofshares of the Convertible Preferred Stock so as to adversely affect them;

 

·                  issue, authorize or increase the authorizedamount of, or issue or authorize any obligation or security convertible into orevidencing a right to purchase, any senior stock; or

 

·                  reclassify any of its authorized stock intoany senior stock of any class, or any obligation or security convertible intoor evidencing a right to purchase any senior stock.

 

**5.****             ****EARNINGS PER SHARE**

 

TheCompany accounts for earnings per share in accordance with SFAS No. 128, *Earnings per Share*, which establishes therequirements for presenting earnings per share (“EPS”).  SFAS No. 128 requires the presentationof “basic” and “diluted” EPS on the face of the statement of operations.  Basic EPS amounts are calculated using theweighted average number of common shares outstanding during each period.  Diluted EPS assumes the exercise of all stockoptions and warrants having exercise prices less than the average market priceof the common stock during the periods, using the treasury stock method. When aloss from continuing operations exists, as in the three and nine months ended September 30,2008, potential common shares are excluded in the computation of diluted EPSbecause their inclusion would result in an anti-dilutive effect on per shareamounts.

 

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DilutedEPS also includes the effect of convertible securities by application of the “if-converted”method.  Under this method, if an entityhas convertible preferred stock outstanding, the preferred dividends applicableto the convertible preferred stock are added back to the numerator. Theconvertible preferred stock is assumed to have been converted at the beginningof the period (or at time of issuance, if later) and the resulting commonshares are included in the denominator of the EPS calculation.  In applying the if-converted method,conversion is not assumed for purposes of computing diluted EPS if the effectwould be anti-dilutive. During all periods presented below, conversion of theconvertible preferred stock is not assumed because the effect would beanti-dilutive. The following tables present the computations of EPS for theperiods indicated:

 
| ** **                                          | ** ** | **Three Months Ended September 30, 2008**    | ** ** | **Three Months Ended September 30, 2007** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **Loss  (Numerator)**                                                 | ** ** | **Shares  (Denominator)(1)**                                       | ** ** | **Per   Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)(2)** | ** ** | **Per  Share  Amount** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net income (loss)                                   |       | $                                                                     | (40,010    | )                                                                  |       |   |   |   | $ | 6,026 |   |   |   |   |   |
| Preferred stock dividends                           |       | (2,066                                                                | )          |                                                               |       |   |   | (2,066 | ) |   |   |   |   |
|                                                |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| **Basic EPS**                                       |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net income (loss) available to common  stockholders |       | (42,076                                                               | )          | 28,690                                                             |       | $ | (1.47 | ) | 3,960 |   | 28,523 |   | $ | 0.14 |   |
| Effect of dilutive securities:                      |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Restricted stock units                              |       | —                                                                |       | —                                                             |       | — |   | — |   | 101 |   | — |   |
| Common stock options                                |       | —                                                                |       | —                                                             |       | — |   | — |   | 235 |   | — |   |
| Convertible preferred stock                         |       | —                                                                |       | —                                                             |       | — |   | — |   | — |   | — |   |
| **Diluted EPS**                                     |       |                                                                  |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net income (loss) available to common  stockholders |       | $                                                                     | (42,076    | )                                                                  | 28,690     |   | $ | (1.47 | ) | $ | 3,960 |   | 28,859 |   | $ | 0.14 |   |

 
| ** **                                          | ** ** | **Nine Months Ended September 30, 2008**     | ** ** | **Nine Months Ended September 30, 2007** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **Loss  (Numerator)**                                                 | ** ** | **Shares  (Denominator)(1)**                                      | ** ** | **Per  Share  Amount** | ** ** | **Income  (Numerator)** | ** ** | **Shares  (Denominator)(2)** | ** ** | **Per  Share  Amount** | ** ** |
| ** **                                          | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net income (loss)                                   |       | $                                                                     | (84,012    | )                                                                 |       |   |   |   | $ | 10,875 |   |   |   |   |   |
| Preferred stock dividends                           |       | (6,199                                                                | )          |                                                              |       |   |   | (5,510 | ) |   |   |   |   |
|                                                |       |                                                                  |       |                                                              |       |   |   |   |   |   |   |   |   |
| **Basic EPS**                                       |       |                                                                  |       |                                                              |       |   |   |   |   |   |   |   |   |
| Net income (loss) available to common  stockholders |       | (90,211                                                               | )          | 28,636                                                            |       | $ | (3.15 | ) | 5,365 |   | 27,300 |   | $ | 0.20 |   |
| Effect of dilutive securities:                      |       |                                                                  |       |                                                              |       |   |   |   |   |   |   |   |   |
| Restricted stock units                              |       | —                                                                |       | —                                                            |       | — |   | — |   | 37 |   | — |   |
| Common stock options                                |       | —                                                                |       | —                                                            |       | — |   | — |   | 240 |   | (0.01 | ) |
| Convertible preferred stock                         |       | —                                                                |       | —                                                            |       | — |   | — |   | — |   | — |   |
| **Diluted EPS**                                     |       |                                                                  |       |                                                              |       |   |   |   |   |   |   |   |   |
| Net income (loss) available to common  stockholders |       | $                                                                     | (90,211    | )                                                                 | 28,636     |   | $ | (3.15 | ) | $ | 5,365 |   | 27,577 |   | $ | 0.19 |   |

 

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(1)          In the calculation of diluted EPS for the three and nine months ended September 30,2008, the 8.7 million shares of common stock resulting from an assumedconversion of the Company’s Convertible Preferred Stock is excluded because theconversion would be 

 

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anti-dilutive. Additionally, for the three and nine months ended September 30,2008, 20,361 and 53,031, respectively, equivalent shares of the Company’srestricted stock units and common stock options were excluded because theconversion would also be anti-dilutive.

 

(2)          In the calculation of diluted EPS for the three and nine months ended September 30,2007, the 8.7 million shares of common stock resulting from an assumedconversion of the Company’s Convertible Preferred Stock is excluded because theconversion would be anti-dilutive.

 

**6.****             ****INCOME TAXES**

 

TheCompany accounts for income taxes under the provisions of SFAS No. 109, *Accounting for Income Taxes*, whichprovides for an asset and liability approach in accounting for incometaxes.  Under this approach, deferred taxassets and liabilities are recognized based on anticipated future taxconsequences, using currently enacted tax laws, attributable to temporary differencesbetween the carrying amounts of assets and liabilities for financial reportingpurposes and the amounts calculated for income tax purposes.

 

TheCompany currently estimates that its effective tax rate for the year ending December 31,2008 will be approximately 35%.  Anincome tax benefit of $45.5 million (35.1% of pre-tax loss) was reported forthe nine months ended September 30, 2008. This amount includes an incometax benefit of approximately $0.4 million, recorded in the second quarter of2008 as a result of the conclusion of a state audit where no prior benefit wastaken for an uncertain tax position, which is now effectively settled withoutadjustment by the state tax authorities. A provision for income taxes of $6.2million (36.3% of pre-tax income) was reported for the nine months ended September 30,2007. The Company’s income tax provision in 2008 is primarily non-cash as theCompany has NOL carryforwards available that were generated from drillingactivity.  However, in light of theproposed merger with Chaparral, the Company cannot provide any assurance thatthe availability of its NOL carryforward and other federal income taxattributes will not be significantly limited or possibly eliminated. Currently,the Company anticipates that it will incur federal alternative minimum tax forthe year ended 2008 in excess of amounts paid at September 30, 2008. TheCompany estimates an alternative minimum tax liability for 2008 and afterapplication of an overpayment of approximately $229,000 related to 2007, apayment of $220,000 was made during the third quarter of 2008.  Further payments may be required but theamounts will depend upon the resolution of the pending merger with Chaparral.

 

TheCompany also accounts for income taxes under the provisions of FIN 48,which clarifies the accounting for uncertainty in income taxes recognized inaccordance with SFAS No. 109*,*and FSP FIN 48-1, which provides that a company’s tax position will beconsidered settled if the taxing authority has completed its examination, thecompany does not plan to appeal, and it is remote that the taxing authoritywould reexamine the tax position in the future. FIN 48 prescribes abenefit recognition model with a two-step approach, a more-likely-than-notrecognition criterion and a measurement attribute that measures the position asthe largest amount of tax benefit that is greater than 50% likely of beingultimately realized upon ultimate settlement. If it is not more likely than notthat the benefit will be sustained on its technical merits, no benefit will berecorded. FIN 48 also requires that the amount of interest expense to berecognized related to uncertain tax positions be computed by applying theapplicable statutory rate of interest to the difference between the taxposition recognized in accordance with FIN 48 and the amount previouslytaken or expected to be taken in a tax return. The Company recognizes interestand penalties related to unrecognized tax benefits in tax expense. However, theCompany has accrued no interest or penalties at September 30, 2008. TheCompany files income tax returns in the United States and various statejurisdictions. The Company’s tax returns for 2005 and 2006 remain open forexamination by the taxing authorities in the respective jurisdictions wherethose returns were filed. The calculation of the net operating losscarryforwards from years prior to 2005 also remain open for examination.

 

**7.****             ****SUPPLEMENTAL DISCLOSURE OFCASH FLOW INFORMATION AND NON-CASH INVESTING AND FINANCING ACTIVITIES**

 

TheCompany considers all highly liquid debt instruments purchased with an originalmaturity of three months or less to be cash equivalents. A summary of non-cashinvesting and financing activities is presented below:

 

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| **Description**                                                                                           | ** ** | **Number of  Shares Issued** | ** ** | **Fair Market Value** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                | ** ** | **(in thousands)**                | ** ** |
| **Nine months ended September 30, 2008:**                                                            |       |                                   |       |                            |       |
| Shares issued to satisfy restricted stock  grants                                                         |       | 86                                     |       | $                               | 1,639      |   |
| Shares issued to fund the Company’s  matching contribution under the Company’s 401(k) plan |       | 90                                     |       | $                               | 462        |   |
| **Nine months ended September 30, 2007:**                                                            |       |                                   |       |                            |       |
| Shares issued to satisfy restricted stock  grants                                                         |       | 130                                    |       | $                               | 2,359      |   |
| Shares issued to fund the Company’s matching  contribution under the Company’s 401(k) plan |       | 27                                     |       | $                               | 372        |   |

 

Forthe nine months ended September 30, 2008 and 2007, the non-cash portion ofAsset Retirement Costs was $0.6 million and $1.0 million, respectively.Dividends declared but not yet paid were $2.1 million, of which $1.7 millionwas accrued at September 30, 2008 and 2007. A supplemental disclosure ofcash flow information is presented below:

 
| ** **                               | ** ** | **For the Nine Months  Ended September 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                                              | ** ** | **2007** | ** ** |
| ** **                               | ** ** | **(in thousands)**                                               | ** ** |
| Cash paid during the period for:         |       |                                                                  |       |   |   |
| Interest, net of amounts capitalized     |       | $                                                                     | 9,678      |   | $ | 13,136 |   |
| Current state income tax                 |       | 7                                                                     |       | 5 |   |
| Federal alternative minimum tax payments |       | 220                                                                   |       | — |   |
|                                          |            |                                                                       |            |  |  |  |  |

 

**8.****             ****HEDGING AND DERIVATIVEACTIVITIES**

 

Dueto the volatility of oil and natural gas prices, the Company periodicallyenters into price-risk management transactions (e.g. swaps, collars and floors)for a portion of its expected oil and natural gas production to seek to achievea more predictable cash flow, as well as to reduce exposure from commodityprice fluctuations.  While the use ofthese arrangements may limit the Company’s ability to benefit from increases inthe price of oil and natural gas, it is also intended to reduce the Company’spotential exposure to significant price declines. As a result of changes to theCompany’s forecasted 2008 production and the impact of certain divestitures,both of which have reduced expected production as compared to that expected atthe time the Company entered into the derivative contracts, the Company currentlyhas approximately 110% and 160% of its anticipated 2008 natural gas and crudeoil production, respectively, covered by derivative contracts.  The Company’s arrangements, to the extent itenters into any, are intended to apply to only a portion of its expectedproduction, and thereby provide only partial price protection against declinesin oil and natural gas prices. None of these instruments were, at the time oftheir execution, intended to be used for trading or speculative purposes, butmay be deemed as such because of the decrease in the Company’s expected 2008production. These derivative transactions are generally placed with majorfinancial institutions that the Company believes are financially stable;however, in light of the recent global financial crisis, there can be noassurance of the foregoing. On a quarterly basis, the Company’s management setsall of the Company’s price-risk management policies, including volumes, typesof instruments and counterparties. The Board of Directors reviews the Company’spolicies and trades monthly.

 

Allof these price-risk management transactions are considered derivativeinstruments and accounted for in accordance with SFAS No. 133 (as amended)*.* These derivative instruments areintended to hedge the Company’s price risk and may be considered hedges foreconomic purposes, but certain of these transactions may not qualify for cashflow hedge accounting. All derivative instrument contracts are recorded on thebalance sheet at fair value. The cash flows resulting from settlement ofderivative transactions which relate to economically hedging the Company’sphysical production volumes are classified in operating activities on thestatement of cash flows and the cash flows resulting from settlement ofderivative transactions considered “overhedged” positions are classified ininvesting activities on the statement of cash flows. For those derivatives inwhich mark-to-market accounting treatment is applied, the changes in fair valueare not deferred through other comprehensive income on the balance sheet.Rather they are immediately recorded in total revenue on the statement ofoperations. While the contract is outstanding, the unrealized gain or loss mayincrease or decrease until settlement of the contract depending on the fairvalue at the 

 

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measurementdates. The Company evaluates the terms of new contracts entered into to determinewhether cash flow hedge accounting treatment or mark-to-market accountingtreatment will be applied. The Company has applied mark-to-market accountingtreatment to all outstanding contracts since January 1, 2006.

 

Thefollowing table reflects the realized and unrealized gains and losses includedin revenue on the statement of operations:

 
| ** **                                              | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                              | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                                  | ** ** |
| Natural gas derivative realized settlements             |       | $                                                        | (5,011     | )                                                       | $          | 3,160 |   | $ | (11,381 | ) | $ | 3,729 |   |
| Crude oil derivative realized settlements               |       | (7,195                                                   | )          | (515                                                    | )          | (19,473 | ) | 563 |   |
| Natural gas derivative unrealized change in  fair value |       | 56,417                                                   |       | 6,010                                                   |       | (61 | ) | (1,262 | ) |
| Crude oil derivative unrealized change in  fair value   |       | 19,294                                                   |       | (2,516                                                  | )          | 8,463 |   | (6,706 | ) |
| Gain (loss) on derivatives                              |       | $                                                        | 63,505     |                                                    | $          | 6,139 |   | $ | (22,452 | ) | $ | (3,676 | ) |

 

Thefair value of outstanding derivative contracts reflected on the balance sheetwas as follows:

 
| ** **             | ** ** | ** **            | ** ** | ** **    | ** ** | ** ** | ** ** | ** **               | ** ** | ** **                |       | **Fair Value of Outstanding  Derivative Contracts as of** |       |
|------------------------|------------|-----------------------|------------|---------------|------------|------------|------------|--------------------------|------------|---------------------------|------------|-----------------------------------------------------------------------------------------|------------|
| **Transaction  Date**  | ** ** | **Transaction  Type** | ** ** | **Beginning** | ** ** | **Ending** | ** ** | **Price  Per Unit** | ** ** | **Volumes  Per Day** | ** ** | **September 30,  2008**                                                            | ** ** | **December 31,  2007** |   |
| ** **             | ** ** | ** **            | ** ** | ** **    | ** ** | ** ** | ** ** | ** **               | ** ** | ** **                | ** ** | **(in thousands)**                                                                 |       |
| ***Natural Gas (1):*** |       |                  |       |          |       |       |       |                     |       |                      |       |                                                                                    |       |   |   |
| 01/07                  |       | Collar                |       | 01/01/2008    |       | 12/31/2008 |       | $7.50-$9.00              |       | 20,000 MMBtu              |       | $                                                                                       | 375        |   | $ | 1,096 |   |
| 01/07                  |       | Collar                |       | 01/01/2008    |       | 12/31/2008 |       | $7.50-$9.00              |       | 10,000 MMBtu              |       | 181                                                                                     |       | 619 |   |
| 01/07                  |       | Collar                |       | 01/01/2008    |       | 12/31/2008 |       | $7.50-$9.02              |       | 10,000 MMBtu              |       | 179                                                                                     |       | 599 |   |
| 09/08                  |       | Collar                | (2)        | 10/01/2008    |       | 12/31/2008 |       | $9.00-$7.50              |       | 10,000 MMBtu              |       | (187                                                                                    | )          | — |   |
| 04/07                  |       | Collar                |       | 01/01/2009    |       | 12/31/2009 |       | $7.75-$10.00             |       | 10,000 MMBtu              |       | 984                                                                                     |       | 125 |   |
| 10/07                  |       | Collar                |       | 01/01/2009    |       | 12/31/2009 |       | $7.75-$10.08             |       | 10,000 MMBtu              |       | 1,033                                                                                   |       | 187 |   |
|                   |       |                  |       |          |       |       |       |                     |       |                      |       |                                                                                    |       |   |   |
| ***Crude Oil (3):***   |       |                  |       |          |       |       |       |                     |       |                      |       |                                                                                    |       |   |   |
| 12/06                  |       | Swap                  |       | 01/01/2008    |       | 12/31/2008 |       | $66.00                   |       | 1,500 Bbl                 |       | (4,723                                                                                  | )          | (14,541 | ) |
| 10/07                  |       | Collar                |       | 01/01/2009    |       | 12/31/2009 |       | $70.00-$93.55            |       | 300 Bbl                   |       | (1,768                                                                                  | )          | (414 | ) |
|                   |       |                  |       |          |       |       |       |                     |       |                      |       | $                                                                                       | (3,926     | ) | $ | (12,329 | ) |

 

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(1)          The Company’s natural gas contracts were entered into on a per MMBtudelivered price basis, using the NYMEX Natural Gas Index. Mark-to-marketaccounting treatment is applied to these contracts and the change in fair valueis reflected in total revenue.

 

(2)          This contract was entered into as a reverse collar with the intent ofreducing the Company’s overhedge exposure on natural gas.

 

(3)          The Company’s crude oil contracts were entered into on a per barreldelivered price basis, using the West Texas Intermediate Light Sweet Crude OilIndex. Mark-to-market accounting treatment is applied to these contracts andthe change in fair value is reflected in total revenue.

 

Subsequent to September 30, 2008, the Company entered into a newcrude oil swap derivative for 800 Bbl per day for November and December 2008production at $65.75 per Bbl. This contract is a reverse swap intended tooffset a portion of the volumes that are currently overhedged by the crude oilswap already in place and thereby reduce the Company’s exposure to significantincreases in crude oil prices.

 

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**9.     FAIR VALUEMEASUREMENTS**

 

Asdefined in SFAS No. 157, fair value is the price that would be received tosell an asset or paid to transfer a liability in an orderly transaction betweenmarket participants at the measurement date (an exit price). Where available,fair value is based on observable market prices or parameters or derived fromsuch prices or parameters. Where observable prices or inputs are not available,valuation models are applied. These valuation techniques involve some level ofmanagement estimation and judgment, the degree of which is dependent on theprice transparency for the instruments or market and the instruments’complexity.

 

*Valuation Techniques*

 

Inaccordance with SFAS No. 157, valuation techniques used for assets andliabilities accounted for at fair value are generally categorized into threetypes:

 

·                  Market Approach*.* Market approach valuation techniques useprices and other relevant information from market transactions involvingidentical or comparable assets or liabilities.

 

·                  Income Approach*.*Income approach valuation techniques convertfuture amounts, such as cash flows or earnings, to a single present amount, ora discounted amount. These techniques rely on current market expectations offuture amounts.

 

·                  Cost Approach*.*Cost approach valuation techniques are basedupon the amount that, at present, would be required to replace the servicecapacity of an asset, or the current replacement cost. That is, from theperspective of a market participant (seller), the price that would be receivedfor the asset is determined based on the cost to a market participant (buyer)to acquire or construct a substitute asset of comparable utility.

 

Thethree approaches described within SFAS No. 157 are consistent withgenerally accepted valuation methodologies. While all three approaches are notapplicable to all assets or liabilities accounted for at fair value, whereappropriate and possible, one or more valuation techniques may be used. Theselection of the valuation method(s) to apply considers the definition ofan exit price and the nature of the asset or liability being valued andsignificant expertise and judgment is required. For assets and liabilitiesaccounted for at fair value, valuation techniques are generally a combinationof the market and income approaches. Accordingly, the Company aims to utilizevaluation techniques that maximize the use of observable inputs and minimizethe use of unobservable inputs.

 

*Input Hierarchy*

 

SFASNo. 157 establishes a fair value hierarchy that prioritizes the inputs tovaluation techniques used to measure fair value directly related to the amountof subjectivity associated with the inputs. The hierarchy gives the highestpriority to unadjusted quoted prices in active markets for identical assets orliabilities (Level 1 measurement) and the lowest priority to unobservableinputs (Level 3 measurement). The three levels of the fair value hierarchydefined by SFAS No. 157 are as follows:

 

·                  Level 1 – Inputs are unadjusted, quoted prices in active markets for identicalassets or liabilities at the measurement date. Active markets are those inwhich transactions for the asset or liability occur in sufficient frequency andvolume to provide pricing information on an ongoing basis.

 

·                  Level 2 – Inputs (other than quoted prices included in Level I) are eitherdirectly or indirectly observable for the asset or liability throughcorrelation with market data at the measurement date and for the duration ofthe instrument’s anticipated life. Level 2 includes those financial instrumentsthat are valued using models or other valuation methodologies, which considervarious assumptions, including quoted forward prices for commodities, timevalue, volatility factors, and current market and contractual prices for theunderlying instruments, as well as other relevant economic measures.

 

·                  Level 3 – Inputs reflect management’s best estimate of what market participantswould use in pricing the asset or liability at the measurement date.

 

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*Fair Value on a Recurring Basis*

 

Thefollowing table sets forth by level within the fair value hierarchy the Company’sfinancial assets and liabilities that were accounted for at fair value on arecurring basis as of September 30, 2008. As required by SFAS No. 157,financial assets and liabilities are classified in their entirety based on thelowest level of input that is significant to the fair value measurement. TheCompany’s assessment of the significance of a particular input to the fairvalue measurement requires judgment, and may affect the valuation of fair valueassets and liabilities and their placement within the fair value hierarchylevels.

 
| ** **             | ** ** | ** **                 | ** ** | **Fair Value Measurements Using:**           | ** ** |
|------------------------|------------|----------------------------|------------|-------------------------------------------------------------|------------|
| ** **             | ** ** | **Total Fair  Value** | ** ** | **Quoted  Prices in  Active  Markets  (Level 1)** | ** ** | **Significant  Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** |
| ** **             |
| ** **             | ** ** | **(in thousands)**    | ** ** |
| Assets:                |       |                       |       |                                                        |       |   |   |   |   |
| Derivative instruments |       | $                          | 181        |                                                        | $          | — |   | $ | — |   | $ | 181 |   |
|                   |       |                       |       |                                                        |       |   |   |   |   |
| Liabilities:           |       |                       |       |                                                        |       |   |   |   |   |
| Derivative instruments |       | $                          | (4,107     | )                                                           | $          | — |   | $ | — |   | $ | (4,107 | ) |

 

Thefollowing table sets forth a reconciliation of changes in the fair value of theCompany’s derivative instruments classified as Level 3 in the fair valuehierarchy.

 
| ** **                                                                                            | ** ** | **Three Months Ended  September 30, 2008** | ** ** | **Nine Months Ended  September 30, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **Assets**                                                     | ** ** | **Liabilities**                                               | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
| ** **                                                                                            | ** ** | **(in thousands)**                                        | ** ** |
| Balance as of beginning of period                                                                     |       | $                                                              | —     |                                                          | $          | (79,638 | ) | $ | — |   | $ | (12,329 | ) |
| Realized and unrealized gains included in  earnings                                                   |       | 1,395                                                          |       | 86,523                                                        |       | 2,939 |   | 36,318 |   |
| Realized and unrealized gains (losses)  included in other comprehensive income                        |       | —                                                         |       | —                                                        |       | — |   | — |   |
| Settlements                                                                                           |       | (1,214                                                         | )          | (10,992                                                       | )          | (2,758 | ) | (28,096 | ) |
| Transfers in and/or out of Level 3                                                                    |       | —                                                         |       | —                                                        |       | — |   | — |   |
| Balance as of September 30, 2008                                                                 |       | $                                                              | 181        |                                                          | $          | (4,107 | ) | $ | 181 |   | $ | (4,107 | ) |
|                                                                                                  |       |                                                           |       |                                                          |       |   |   |   |   |
| Change in unrealized gains (losses)  relating to instruments still held as of September 30, 2008 |       | $                                                              | (2,027     | )                                                             | $          | (13,024 | ) | $ | (380 | ) | $ | 76 |   |

 

Gainsand losses (realized and unrealized) for Level 3 recurring items are includedin total revenue on the Consolidated Statements of Operations. Settlementsrepresent cash settlements of contracts during the period, which are includedin total revenue on the Consolidated Statements of Operations.

 

Transfersin and/or out represent existing assets or liabilities that were eitherpreviously categorized as a higher level for which the inputs to the modelbecame unobservable or assets and liabilities that were previously classifiedas Level 3 for which the lowest significant input became observable during theperiod. There were no transfers in or out of Level 3 during the periodspresented.

 

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*Fair Value on a Nonrecurring Basis*

 

InFebruary 2008, the FASB issued FSP 157-2, which postpones the effectivedate of SFAS No. 157 for non-financial assets and liabilities. Therefore,the Company has not adopted the provisions of SFAS No. 157 for its assetretirement obligations (“ARO”). The Company uses fair value measurements on anonrecurring basis in its AROs. These liabilities are recorded at fair valueinitially and assessed for revisions periodically thereafter. The lowest levelof significant inputs for fair value measurements for ARO liabilities are Level3. A reconciliation of the beginning and ending balances of the Company’s AROis presented in Note 1, in accordance with SFAS No. 143, and the Companyexpects to expand its disclosures regarding its ARO upon complete adoption ofSFAS No. 157.

 

**10.  DIVESTITURES**

 

During the first nine months of 2008, the Company completed sales ofcertain non-core assets, which included a pipeline and approximately 120properties in Texas, to various buyers for aggregate proceeds of approximately$19.2 million.

 

**11.  SUBSEQUENT EVENTS**

 

OnOctober 23, 2008, the Company adjourned its annual meeting of stockholdersand announced its plans to reconvene the meeting on December 4, 2008, whenthe Company’s common stockholders will vote on the adoption of the Agreementand Plan of Merger (the “Merger Agreement”) dated July 14, 2008, among theCompany, Chaparral and Chaparral Exploration, LLC that provides for Chaparralto acquire the Company in an all-stock transaction and the Company’s commonstock to be converted into Chaparral common stock (the “Merger”).  Thetransaction is expected to qualify as a tax-free reorganization under Section 368(a) ofthe Internal Revenue Code of 1986. The Merger Agreement was unanimouslyapproved by the Company’s Board of Directors and Chaparral’s Board of Directorsand stockholders. Completion of the Merger is conditioned upon, among otherthings, adoption of the Merger Agreement by the Company’s common stockholdersand the accuracy of representations and warranties (subject to materialityexceptions) as of the date of the Merger Agreement and the closing date of theMerger, and the performance by the parties in all material respects of theircovenants under the Merger Agreement. The Merger is expected to be effective December 5,2008. The adjournment to the later date is intended to allow additional timefor the Company’s common stockholders to receive and consider additionalinformation regarding the proposed merger with Chaparral, including thefollowing:

 

·                  Merger Financing - The Merger Agreementcontemplates that Chaparral will enter into a new senior secured revolvingcredit facility.  As of October 21, 2008, the syndication efforts forthe new secured credit facility were still ongoing.  As a result of recentmarket turmoil and related developments worldwide, companies have experiencedincreased difficulty in obtaining debt financing and these factors havecomplicated the syndication effort.  The terms of the new secured creditfacility have not been finalized. Chaparral has informed the Company that itcontinues to work diligently on the syndication of the new secured creditfacility so the financing can be available at the time of the closing of the Merger.There can be no assurance that the financing will be available at such time orthat the terms of such financing will be as the parties had anticipated.

 

Thepurchase agreement setting forth the terms of Chaparral’s proposed sale of Series Bpreferred stock contains closing conditions that require, among other things, (i) Chaparralto consummate its secured credit facility financing in accordance with thefinancing commitment with an initial borrowing base of $1 billion, (ii) Chaparral’savailability under the secured credit facility to be at least $325 million asof the closing date, (iii) the applicable margins under the secured creditfacility to be not more than 125 basis points above those presented in thepricing grid of the financing commitment term sheet and (iv) the Merger tohave been consummated in accordance with the terms of the Merger Agreement,without any amendment, modification or waiver of such terms and conditions(other than those the purchaser of the Series B preferred stock hasapproved).  The failure to meet these conditions may jeopardize theclosing of Chaparral’s proposed sale of Series B preferred stock, which inturn may jeopardize Chaparral’s ability to obtain the new senior revolvingcredit facility financing necessary for Chaparral to close the Merger. Asa

 

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resultof recent market turmoil and related developments, companies have had increaseddifficulty in obtaining debt and/or equity financing.

 

·                  Listing of Chaparral Common and Series APreferred Stock - It is a condition to the consummation of the Merger (the “NYSEcondition”) that (i) the Chaparral common stock and Chaparral Series Apreferred stock issuable to former stockholders of the Company pursuant to theMerger Agreement, (ii) the shares of Chaparral common stock issuable tothe holders of the Chaparral Series A preferred stock upon conversionthereof and (iii) the shares of Chaparral common stock issuable uponexercise of Company options be approved for listing on the New York StockExchange (“NYSE”), subject to official notice of issuance.  As of November 10,2008, the NYSE condition had not been met. To meet the NYSE condition, it isexpected that Chaparral  must satisfy the following listing standards: (i) minimumprice of at least $4.00 per share, (ii) at least 400 U.S. stockholders of100 shares or more, (iii) at least 1,100,000 publicly held sharesoutstanding in the U.S., (iv) aggregate market value of publicly heldshares of at least $60 million in the U.S. and (v) pre-tax earnings fromcontinuing operations and after minority interest, amortization and equity inthe earnings or losses of investees, as adjusted, of at least $10,000,000 inthe aggregate for the last three fiscal years together with a minimum of$2,000,000 in each of the two most recent fiscal years, and positive amounts inall three years. The ability of Chaparral to meet the NYSE listingstandards described above that are related to the minimum $4.00 per share priceand the minimum $60 million aggregate market value of publicly held shares is afunction of the trading price of Edge’s common stock.  Based on theclosing price of Edge common stock on November 7, 2008 of $0.69 per share,neither of these standards would be met and there can be no assurance thatthe NYSE condition will ever be met.

 

**12.  RETENTION BONUSPLAN**

 

TheCompany’s Board of Directors adopted a Retention Bonus Plan effective May 21,2008. Awards under the Retention Bonus Plan are permitted under the MergerAgreement.  The Retention Bonus Planprovided for awards to each non-executive employee and additional awards tocertain key non-executive employees, in each case if the employee remainedemployed by Edge through the earliest to occur of (1) October 1,2008, (2) the date of the employee’s termination by Edge, provided thatsuch termination was not a termination for cause (as defined in the employee’sseverance agreement) or (3) the date of the employee’s involuntarytermination with the company (as defined in the employee’s severanceagreement). C.W. MacLeod and Kirsten A. Hink were not executive officers at thetime of the adoption of the Retention Bonus Plan and were therefore eligible toparticipate in the Retention Bonus Plan. Subject to the terms of the plan, Mr. MacLeod and Ms. Hinkreceived retention bonus awards of $97,600 and $78,000, respectively. This planwas adopted to provide an incentive to employees to remain with the Companyduring the remainder of the strategic alternatives process and proposed mergerwith Chaparral. For the three and nine months ended September 30, 2008,the Company recorded general and administrative expense related to retentionbenefits of approximately $2.1 million and $2.8 million, respectively. Thesebonuses were paid in full on October 1, 2008.

 

**13.  COMMITMENTS ANDCONTINGENCIES**

 

Fromtime to time the Company is a party to various legal proceedings arising in theordinary course of business.  While theoutcome of lawsuits cannot be predicted with certainty, the Company is notcurrently a party to any proceeding that it believes, if determined in a manneradverse to the Company, could have a material adverse effect on its financialcondition, results of operations or cash flows, except as set forth below.

 

**David Blake, et al. v. Edge Petroleum Corporation** — On September 19, 2005, David Blakeand David Blake, Trustee of the David and Nita Blake 1992 Children’s Trust,filed suit against the Company in state district court in Goliad County, Texasalleging breach of contract for failure and refusal to transfer overridingroyalty interests to plaintiffs in several leases in the Nita and Austin prospectsin Goliad County, Texas and failure and refusal to pay monies to Blake pursuantto such overriding royalty interests for wells completed on the leases. Theplaintiffs seek relief of (1) specific performance of the allegedagreement, including granting of overriding royalty interests by the Company toBlake; (2) monetary damages for failure to grant the overriding royaltyinterests; (3) exemplary damages for his claims of business disparagementand slander; (4) monetary damages for tortious

 

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interference;and (5) attorneys’ fees and court costs. Venue of the case was transferredto Harris County, Texas by agreement of the litigants. The Company filed acounterclaim against Plaintiff Blake and joined various related entities thatare controlled by Blake, seeking lease interests in which the Company contendsit had been wrongfully denied participation. The parties have moved for summaryjudgment on each others’ claims and counterclaims, which the trial court hasdenied as to both sides. In November 2007, the Company filed a separatemotion for summary judgment based on the statute of frauds; the court has notruled on this separate motion. The trial, originally scheduled to begin September 10,2007, has been reset several times, and most recently has been reset for December 8,2008. Extensive written discovery has occurred in the case, and the parties areengaging in fact and expert witness depositions.  In June 2008, the Blake Plaintiffs fileda Sixth Amended Petition conditionally adding claims for certain prospects thathad been previously settled by means of a Compromise and Settlement Agreement(the “Settlement Agreement”), entered in settlement of prior litigation amongsome of the parties, but only to the extent that rescission of the priorSettlement Agreement was being sought by the Company. The Company is notseeking rescission of the prior Settlement Agreement and responded accordinglyin its Fourth Amended Original Counterclaim and Claims Against AdditionalParties filed on October 16, 2008. On October 17, 2008, the BlakePlaintiffs filed their Seventh Amended Petition adding a claim for breach ofthe Settlement Agreement. The Company has responded and will continue torespond aggressively to this lawsuit, and believes it has meritorious defensesand counterclaims.

 

**Diana Reyes, et al. v. Edge Petroleum OperatingCompany, Inc., et al.** - On January 8, 2008, the Company was served with a wrongfuldeath action filed in Hidalgo County, Texas. Plaintiffs allege negligence and gross negligence resulting from afatality accident at the Slick State B-12 well site, on the Company’s BloombergFlores lease in Starr County, Texas.  Theplaintiffs are the widow and minor children of Mr. Reyes, who was killedin a one-car fatality accident on August 5, 2007. Mr. Reyes was anemployee of Payzone Logging, one of the Company’s vendors.   In September 2008, the defendants inthis case, including the Company, reached a settlement with the plaintiffs inthe amount of $175,000, all of which was paid by third party insurance.  Neither the Company nor its insurance carrierwere required to contribute to the settlement pool.  Pending court approval of the settlement,this matter will be dismissed.

 

**Lexington Insurance Company v. Edge PetroleumExploration Company, et al.** - On March 13, 2008, Lexington Insurance Company (“Lexington”)filed a declaratory judgment action in the 125th Judicial DistrictCourt of Harris County, Texas.  Lexingtonsought a judgment that it was not obligated to pay any claims of the Companyand the Sfondrini Partnerships (as defined below) in connection with aconsolidated suit that the Company and the Sfondrini Partnerships settled withall of the plaintiffs in 2007. The suit that was settled,** **Wade and Joyce Montet, et al., v.Edge Petroleum Corp of Texas, et al., consolidated with Rolland L. Broussard,et al., v. Edge Petroleum Corp of Texas, et al., and the settlementthereof, is described in detail in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007. In general, the action was aconsolidated suit by mineral/royalty owners under two wells, who claimed thatthe third party operator of the wells had failed to “block squeeze” thesections of one of the wells, as a prudent operator, according to theirallegations, would have done, to protect the gas reservoir from being floodedwith water from adjacent underground formations, and was negligent in notcreating a field-wide unit to protect their interests.  Along with the Sfondrini Partnerships, theCompany was a defendant in the suit as a working interest owner in the wells,owning 2.8% and 14.7%, respectively, at the time of the alleged acts oromissions.  In the case of thesettlements with some, but not all, of the plaintiffs, two other insurerscovered the settlement amounts in exchange for mutual releases. The Company andthe Sfondrini Partnerships bore the costs of the settlements with the remainingplaintiffs in accordance with their proportionate interests.  The Sfondrini Partnerships are partnershipsthat are directly or indirectly controlled by John Sfondrini, one of theCompany’s directors.  Vincent Andrews,also a director of the Company, owns a minority interest in the corporategeneral partner of one of the partnerships.

 

Lexingtonasserted that it is not obligated to pay any claims of the Company and theSfondrini Partnerships under its commercial, general liability insurance policyas related to the lawsuit that was settled because there was no “occurrence,”under the terms of their policy, of physical injury to or destruction oftangible property and other reasons. The Company’s position was that thedamages to the reservoir and attendant losses incurred by the defendants werelosses covered by Lexington’s policy, for which Lexington was legally obligatedto pay. By agreement of the parties, an answer was due 30 days from notice oftermination of settlement discussions.

 

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InJune 2008, the Company and the Sfondrini Partnerships reached a settlementwith Lexington pursuant to which Lexington would pay the Company and theSfondrini Partnerships $75,000 (proportionate to their interests in theunderlying mineral leases that were the subject of the prior action) in returnfor a complete release. All parties have executed the release and the case wasdismissed on September 8, 2008.

 

**Mary Jane Carol Trahan Champagne, et al. v. EdgePetroleum Exploration Company, et al.** — On September 19, 2008 the Company wasserved with a lawsuit in state court in Vermilion Parish, Louisiana allegingbreach of obligations under mineral leases in Vermilion Parish regarding theTrahan No. 1 well and the Trahan No. 3 well (MT RC SUB reservoir).Plaintiffs are seeking unspecified damages for lost revenue, lost royalties anddevaluation of property interest sustained as a result of the defendants’alleged negligent and improper drilling operations on the Trahan No. 1well and the Trahan No. 3 well, including alleged failure to preventunderground water from flooding and destroying plaintiffs’ portion of thereservoir beneath plaintiffs’ property. Plaintiffs also allege defendants failed to “block squeeze” sections ofthe Trahan No. 3 well as would a prudent operator.  This lawsuit has been removed from the statecourt to the federal district court for the Western District of Louisiana,Lafayette Division. The Company may have insurance for all or part of thisclaim. The Company has not established a reserve with respect to this claim andit is not possible to determine what, if any, its ultimate exposure might be inthis matter. The Company intends to vigorously defend itself in this lawsuit.

 

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Thefollowing is Management’s Discussion and Analysis (“MD&A”) of significantfactors that have affected certain aspects of our financial position andoperating results during the periods included in the accompanying unauditedcondensed consolidated financial statements. The following MD&A is intendedto help the reader understand Edge Petroleum Corporation (“Edge”). Thisdiscussion should be read in conjunction with the accompanying unaudited condensedconsolidated financial statements included elsewhere in this Form 10-Q andwith MD&A of Financial Condition and Results of Operations and our auditedconsolidated financial statements included in our annual report on Form 10-Kfor the year ended December 31, 2007 (“2007 Annual Report”).

 

### **FORWARDLOOKING STATEMENTS**

###  

Certainof the statements contained in all parts of this document, including, but notlimited to, those relating to our drilling plans (including scheduled andbudgeted wells), the effect of changes in strategy and business discipline,future tax matters, our 3-D project portfolio, changes in wells operated andreserves, future growth and expansion, future exploration, future seismic data(including timing and results), the assessment of strategic alternatives, theproposed merger with Chaparral (including the benefits, results, effect andtiming thereof), expansion of operation, our ability to generate additionalprospects, review of outside generated prospects and acquisitions, divestitures,additional reserves and reserve increases, our ability to replace productionand manage our asset base, enhancement of visualization and interpretationstrengths, expansion and improvement of capabilities, integration of newtechnology into operations, credit facilities, redetermination of our borrowingbase, attraction of new members to the technical team, future compensationprograms, new focus on core areas, new prospects and drilling locations, newalliances, future capital expenditures (or funding thereof) and workingcapital, sufficiency of future working capital, borrowings and capitalresources and liquidity, projected rates of return, retained earnings anddividend policies, projected cash flows from operations, future commodity priceenvironment, expectation or timing of reaching payout, the outcome, effects ortiming of any legal proceedings or contingencies, the impact of any change inaccounting policies on our financial statements, the number, timing or resultsof any wells, the plans for timing, interpretation and results of new orexisting seismic surveys or seismic data, future production or reserves, futureacquisition of leases, lease options or other land rights, any other statementsregarding future operations, financial results, opportunities, growth, businessplans and strategy and other statements that are not historical facts areforward-looking statements. These forward-looking statements reflect ourcurrent view of future events and financial performance. When used in thisdocument, the words “budgeted,” “anticipate,” “estimate,” “expect,” “may,” “project,”“believe,” “intend,” “plan,” “potential,” “forecast,” “might,” “predict,” “should”and similar expressions are intended to be among the expressions that identifyforward-looking statements. These forward-looking statements speak only as oftheir dates and should not be unduly relied upon. We undertake no obligation topublicly update or revise any forward-looking statement, whether as a result ofnew information, future events, or otherwise. Such statements involve risks anduncertainties, including, but not limited to, those set forth under “ITEM 1A.RISK FACTORS” of our 2007 Annual Report, our Quarterly Report on Form 10-Qfor the period ended June 30, 2008 and this Quarterly Report on Form 10-Q,the assessment of strategic alternatives, the proposed merger with Chaparral,actions by regulatory authorities or other third parties, costs anddifficulties related to integration of acquired businesses, delays, costs anddifficulties related to the transactions, availability of financing in theevent the proposed merger is delayed or abandoned, market conditions, thecombined companies’ financial results and performance, consummation offinancing, satisfaction of closing conditions, ability to repay debt and timingthereof, availability and terms of any financing, and other factors detailed inthis document and our other filings with the Securities and Exchange Commission(the “SEC”). Should one or more of these risks or uncertainties materialize, orshould underlying assumptions prove incorrect, actual outcomes may varymaterially from those indicated. All subsequent written and oralforward-looking statements attributable to us or to persons acting on ourbehalf are expressly qualified in their entirety by reference to these risksand uncertainties.

 

## **GENERAL OVERVIEW**

##  

EdgePetroleum Corporation (“Edge”, “we” or the “Company”) is a Houston-basedindependent energy company that focuses its exploration, development,production, acquisition and marketing activities in selected

 

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onshorebasins of the United States. In late 1998, we began a shift in strategy frompure exploration, which focused more on prospect generation, to our currentstrategy which focuses on a balanced program of exploration, exploitation anddevelopment and acquisition of oil and natural gas properties. We generaterevenue, income and cash flows by producing and marketing oil and natural gasproduced from our oil and natural gas properties. We make significant capitalexpenditures in our exploration, development, and production activities thatallow us to continue generating revenue, income and cash flows. We have alsospent considerable efforts on acquisitions, including both corporate and assetacquisitions.

 

Thisoverview provides our perspective on the individual sections of MD&A. OurMD&A includes the following sections:

 

·                  **Industry and EconomicFactors** – a generaldescription of value drivers of our business as well as opportunities,challenges and risks related to the oil and gas industry.

 

·                  **Approach to the Business** – information regarding our approach andstrategy.

 

·                  **Divestitures** – information about our sales anddivestitures.

 

·                  **Assessment of StrategicAlternatives and Proposed Merger**– information about our future, the strategic alternatives process andproposed merger.

 

·                  **Outlook** – discussion relating to management’s outlookto the future of our business.

 

·                  **Critical Accounting Policiesand Estimates** – a discussionof certain accounting policies that require critical judgments and estimates.

 

·                  **Results of Operations** – an analysis of our consolidated resultsfor the periods presented in our financial statements.

 

·                  **Liquidity and CapitalResources**–****an analysis of cash flows, sources anduses of cash, and contractual obligations.

 

·                  **Fair Value Measurements**–****supplementarydiscussion regarding fair value measurements and implementation of SFAS No. 157,*Fair Value Measurements.*

 

·                  **Risk Management Activities**–****supplementaryinformation regarding our price-risk management activities.

 

·                  **Tax Matters** – supplementary discussion of income taxmatters.

 

·                  **Recently Issued AccountingPronouncements** – adiscussion of certain recently issued accounting pronouncements that may impactour future results.

 

# **Industry and Economic Factors**

#  

Inmanaging our business, we must deal with many factors inherent in ourindustry.  First and foremost is thefluctuation of oil and natural gas prices. Historically, oil and natural gas markets have been cyclical andvolatile, which makes future price movements difficult to predict.  While our revenue is a function of bothproduction and prices, wide swings in commodity prices have most often had thegreatest impact on our results of operations. We have little ability to predictthose prices or to control them without losing some advantage of the upsidepotential.

 

Althoughcertain of our costs and expenses are affected by general inflation, inflationdoes not normally have a significant effect on our business. Our costs andexpenses tend to react to activity levels in our industry and commodity pricemovements.

 

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Ouroperations entail significant complexities. Advanced technologies requiringhighly trained personnel are utilized in both exploration and production.  Even when the technology is properly used, wemay still not know conclusively if hydrocarbons will be present or the rate atwhich they will be produced.  Explorationis a high-risk activity, often times resulting in no commercially productivereserves being discovered.  Thesefactors, together with increased demand for rigs, equipment, supplies andservices, have made it difficult at times for us to further our growth, andmade timely execution of our planned activities difficult.

 

Ourbusiness, as with other extractive businesses, is a depleting one in which eachgas equivalent produced must be replaced or our asset base and capacity togenerate revenue in the future will shrink.

 

Theoil and gas industry is highly competitive. We compete with major and diversifiedenergy companies, independent oil and gas businesses and individual operatorsin exploration, production, marketing and acquisition activities.  In addition, the industry as a whole competeswith other businesses that supply energy to industrial and commercial endusers.

 

Extensivefederal, state and local regulation of the industry significantly affects ouroperations.  In particular, ouractivities are subject to stringent operational and environmental regulations.  These regulations have increased the costs ofplanning, designing, drilling, installing, operating and abandoning oil andnatural gas wells and related facilities. These regulations may become more demanding in the future.

 

Thegrowing global economic crisis created an environment of uncertainty during thethird quarter of 2008 that has continued in the fourth quarter of 2008. Theprice of crude oil fell from $142 per barrel at the beginning of the period to$100 per barrel at the close, and was trading in the mid-$60s range near theend of October. At the same time, reported day rates for rigs continued at highlevels, which impact our drilling costs. We are unable to predict the impact onour business of a continued decline in commodity prices and the global economy.Possible negative impacts, among others, could include a decline in revenue,cash flows and liquidity.

 

# **Approach to the Business**

#  

Profitablegrowth of our business will largely depend upon our ability to successfullyfind and develop new proved reserves of oil and natural gas in a cost-effectivemanner.  In order to achieve an overallacceptable rate of growth, we seek to maintain a prudent blend of low, moderateand higher risk exploration and development projects.  We have chosen to seek geologic andgeographic diversification by operating in multiple basins in order to mitigaterisk in our operations. In recent years, we have also made selectedacquisitions of oil and natural gas properties to augment our growth andprovide future drilling opportunities.

 

Wenormally hedge our exposure to volatile oil and natural gas prices on a portionof our expected production to reduce price risk. As a result of changes to ourforecasted 2008 production and the impact of certain asset divestitures, bothof which have reduced expected production as compared to that expected at thetime we entered into the derivative contracts, we currently have approximately110% and 160% of our anticipated 2008 natural gas and crude oil production,respectively, covered by derivative contracts. This overhedged position hasexposed us to greater risk of commodity price increases because at times wehave not had the physical production cash inflows to offset the losses incurredon the portion of the contracts that are overhedged. During September and October 2008,we entered into two new contracts for certain fourth quarter 2008 productionthat are intended to offset a portion of the volumes that are currentlyoverhedged and thereby reduce our exposure to significant increases in naturalgas and crude oil prices.

 

Generally, our goal is to fund ongoing exploration and developmentprojects with cash flow provided by operating activities, occasionallysupplemented with external sources of capital. As a result of the strategicalternatives process that began in late 2007 (see discussion below), our Boardapproved an interim capital expenditure budget for 2008. We currently expectthat capital expenditures for the year will be approximately $66 million. Underthe terms of the Merger Agreement discussed below, we agreed to limit, subjectto certain exceptions, our capital expenditures beyond that previously budgetedto capital expenditures made with Chaparral’s consent. Based on currentexpectations for production volumes and commodity prices, we expect to fundthose

 

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capitalexpenditures from internally generated cash from operating activities. Anydecision to expand our drilling program will depend in large part on the timingand successful completion of the proposed merger with Chaparral. Our long-termdebt balance as of September 30, 2008 was $239 million and ourdebt-to-total capital ratio was 40.8%. In early May 2008, our RevolvingFacility’s (as defined below) borrowing base and conforming borrowing base wereredetermined by our banks and set at $250 million and $225 million,respectively.****The interimredetermination was postponed until October 31, 2008, subject to certain terms(see Note 2 to our consolidated financial statements). We paid the Lenders afee of approximately $0.4 million in connection with the deferral of the secondquarter redetermination. On November 5, 2008, the Lenders (defined below)agreed to delay the interim redetermination from October 31, 2008 until November 15,2008. In consideration for this deferral, the Lenders placed a restriction uponthe current borrowing base such that it was effectively lowered to $240 millionuntil the interim redetermination occurs (see Note 2 to our consolidatedfinancial statements). Although our available borrowing capacity under theRevolving Facility was $11 million at September 30, 2008, thisavailability was effectively reduced to $1 million on November 5, 2008 andmay be eliminated for the near future as a result of the upcoming borrowingbase redetermination.

 

**Divestitures**

 

We regularly review our asset base for the purpose of identifyingnon-core assets, the disposition of which would increase capital resources availablefor other activities and create organizational and operational efficiencies.While we generally do not dispose of assets solely for the purpose of reducingdebt, such dispositions can have the result of furthering our objective offinancial flexibility through reduced debt levels. During the first nine monthsof 2008, we completed sales of a pipeline and certain working interests inapproximately 120 properties located in Texas to various buyers for aggregateproceeds of approximately $19.2 million. The Merger Agreement (defined below)limits our ability to engage in acquisitions and dispositions of assets untilthe closing of the proposed merger with Chaparral, although those limitationsare subject to certain exceptions agreed to by the parties and also may bewaived by Chaparral.

 

**Assessment of Strategic Alternatives and Proposed Merger**

 

Inlate 2007, we announced the hiring of a financial advisor to assist our Boardof Directors with an assessment of strategic alternatives. On February 7,2008, we provided an update on the strategic alternatives process and announcedpublicly that we would implement a process to explore a merger or sale of thecompany. As a result of the strategic alternatives process, on July 14,2008, we entered into an Agreement and Plan of Merger (the “Merger Agreement”)with Chaparral and Chaparral Exploration, L.L.C., a Delaware limited liabilitycompany and wholly owned direct subsidiary of Chaparral (“Sub”), whereby wewill merge with and into Sub (the “Merger”). Through the Merger, Chaparral willbecome a publicly traded company. The transaction is expected to qualify as atax-free reorganization under Section 368(a) of the Internal RevenueCode of 1986. The Merger Agreement was unanimously approved by our Board ofDirectors and Chaparral’s Board of Directors and stockholders. Completion ofthe Merger is conditioned upon, among other things, adoption of the MergerAgreement by our common stockholders and the accuracy of representations andwarranties (subject to materiality exceptions) as of the date of the MergerAgreement and the closing date of the Merger, and the performance by theparties in all material respects of their covenants under the Merger Agreement.

 

Atthe effective time of the Merger, each share of our common stock will beconverted automatically into the right to receive 0.2511 shares of commonstock, par value $0.01 per share, of Chaparral (the “Common MergerConsideration”), and each share of our 5.75% Series A cumulativeconvertible perpetual preferred stock will be converted automatically into theright to receive one share of 5.75% Series A Cumulative ConvertiblePerpetual Preferred Stock, par value $0.01 per share, of Chaparral.  TheChaparral Series A preferred stock will have the same terms, rights, preferencesand limitations as our preferred stock, subject to appropriate adjustments toreflect the Merger and the exchange ratio for our common stock. The initialconversion price per share of Chaparral preferred stock will be $65.95 pershare of Chaparral common stock.

 

Inaddition, each option to purchase a share of our common stock that isoutstanding as of the effective time of the Merger will be assumed by Chaparraland will be converted into the right to purchase 0.2511 shares of Chaparral

 

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commonstock at an adjusted exercise price. Each share of restricted stock and eachunit with respect to our common stock will become fully vested and will beconverted into the right to receive the Common Merger Consideration.

 

We,along with Chaparral and Sub, have made representations, warranties andcovenants in the Merger Agreement, including, among others, covenants toconduct business in the ordinary course between the execution of the MergerAgreement and the consummation of the Merger. We, and to a lesser extent, Chaparral, have agreed to covenants not toengage in certain kinds of transactions and activities during that period. Wehave made certain additional covenants, including, among others, covenants,subject to certain exceptions, (1) not to solicit proposals regardingalternative business combination transactions, (2) not to enter intodiscussions concerning, or provide confidential information in connection with,alternative business combination transactions, (3) not to approve orrecommend any alternative business combination transaction proposals, (4) tocause a common stockholder meeting to be held to consider approval of theMerger and (5) for our Board of Directors to recommend approval of theMerger Agreement by our common stockholders.

 

TheMerger Agreement contains various termination rights for both parties,including if (1) our Board of Directors changes its recommendation to ourcommon stockholders or authorizes us to enter into a definitive agreement inconnection with a Superior Proposal (as defined in the Merger Agreement), (2) theMerger Agreement is not adopted by the holders of our common stock, or (3) Chaparralfails to enter into a new credit facility or obtain or consummate alternativefinancing within two business days after the satisfaction or waiver of allother conditions to the Merger.  The Merger Agreement includes atermination right for Chaparral only, if an event of default occurs and iscontinuing under our Revolving Facility that has not been cured within aspecified period of time or the administrative agent under the RevolvingFacility has accelerated our repayment obligations thereunder.  Upontermination of the Merger Agreement under specified circumstances, one partywill be required to pay the other party a termination fee of $15 million. With certain exceptions, all costs and expenses incurred in connection with theMerger Agreement will be paid by the party incurring such expenses, whether ornot the Merger is consummated.  The Merger Agreement includes provisionslimiting the maximum aggregate liability of the parties to $25 million in theevent the Merger is not consummated.

 

Theseprovisions are set forth in the Merger Agreement and are more fully describedin the proxy statement/prospectus filed by us and Chaparral.

 

OnOctober 23, 2008, we adjourned our annual meeting of shareholders andannounced our plans to reconvene the meeting on December 4, 2008, when ourcommon stockholders will vote on the adoption of the Merger Agreement. TheMerger is expected to be effective December 5, 2008. The adjournment tothe later date is intended to allow additional time for Edge common stockholdersto receive and consider additional information regarding the proposed mergerwith Chaparral, including the following:

 

·                  Merger Financing - The Merger Agreementcontemplates that Chaparral will enter into a new senior secured revolvingcredit facility.  As of October 21, 2008, the syndication efforts forthe new secured credit facility were still ongoing.  As a result of recentmarket turmoil and related developments worldwide, companies have experiencedincreased difficulty in obtaining debt financing and these factors havecomplicated the syndication effort.  The terms of the new secured creditfacility have not been finalized. Chaparral has informed us that it continues to work diligently on thesyndication of the new secured credit facility so the financing can beavailable at the time of the closing of the Merger. There can be no assurancethat the financing will be available at such time or that the terms of suchfinancing will be as the parties had anticipated.

 

Thepurchase agreement setting forth the terms of Chaparral’s proposed sale of Series Bpreferred stock contains closing conditions that require, among other things, (i) Chaparralto consummate its secured credit facility financing in accordance with thefinancing commitment with an initial borrowing base of $1 billion, (ii) Chaparral’savailability under the secured credit facility to be at least $325 million asof the closing date, (iii) the applicable margins under the secured creditfacility to be not more than 125 basis points above those presented in thepricing grid of the financing commitment term sheet and (iv) the Merger tohave been consummated in accordance with the terms of the Merger Agreement,without any amendment, modification or waiver of such terms and conditions (otherthan those the purchaser of the Series B

 

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preferredstock has approved). The failure to meet these conditions may jeopardizethe closing of Chaparral’s proposed sale of Series B preferred stock,which in turn may jeopardize Chaparral’s ability to obtain the new seniorrevolving credit facility financing necessary for Chaparral to close the Merger. Asa result of recent market turmoil and related developments, companies have hadincreased difficulty in obtaining debt and/or equity financing.

 

·                  Listing of Chaparral Common and Series APreferred Stock - It is a condition to the consummation of the Merger (the “NYSEcondition”) that (i) the Chaparral common stock and Chaparral Series Apreferred stock issuable to former Edge stockholders pursuant to the Merger Agreement,(ii) the shares of Chaparral common stock issuable to the holders of theChaparral Series A preferred stock upon conversion thereof and (iii) theshares of Chaparral common stock issuable upon exercise of Edge options beapproved for listing on the New York Stock Exchange (“NYSE”), subject toofficial notice of issuance.   As of November 10, 2008, the NYSEcondition had not been met. To meet the NYSE condition, it is expected thatChaparral  must satisfy the following listing standards: (i) minimumprice of at least $4.00 per share, (ii) at least 400 U.S. stockholders of100 shares or more, (iii) at least 1,100,000 publicly held sharesoutstanding in the U.S., (iv) aggregate market value of publicly heldshares of at least $60 million in the U.S. and (v) pre-tax earnings fromcontinuing operations and after minority interest, amortization and equity inthe earnings or losses of investees, as adjusted, of at least $10,000,000 inthe aggregate for the last three fiscal years together with a minimum of$2,000,000 in each of the two most recent fiscal years, and positive amounts inall three years. The ability of Chaparral to meet the NYSE listingstandards described above that are related to the minimum $4.00 per share priceand the minimum $60 million aggregate market value of publicly held shares is afunction of the trading price of Edge’s common stock.  Based on theclosing price of Edge common stock on November 7, 2008 of $0.69 per share,neither of these standards would be met and there can be no assurance thatthe NYSE condition will ever be met.

 

Althoughwe are working toward the completion of the proposed merger with Chaparral,there is no assurance that the Merger will be completed in the fourth quarterof 2008 or at all. If the proposed merger with Chaparral is not completed, ourcurrent forecast for 2009 projects sufficient funds through the upcoming fiscalyear to meet our operational requirements, fund a limited capital program andreduce outstanding debt. In the event a borrowing base redetermination resultsin the reduction of our borrowing base, further availability to borrow underour Revolving Facility would be limited or possibly eliminated for the nearfuture (see Note 2 to our consolidated financial statements). Additionally, ifa reduced borrowing base requires significant debt repayments, we may berequired to curtail our capital program further or sell assets to meet ourobligations. In addition, it may be difficult for us to consummate any debt orequity financing in the near future to meet such obligations, particularly dueto our recent financial performance, the recent worldwide financial and creditcrisis and the decline of our stock prices. There can be no assurance that ourefforts will be successful.

 

**Outlook**

 

·                  During the remainder of 2008, we expect tospend considerable effort to complete the proposed merger with Chaparral. Inconnection with the strategic alternatives process, our Board of Directorsadopted a Retention Bonus Plan on May 21, 2008, which was intended toretain key employees as we moved through the process and help secure theirassistance with the proposed merger with Chaparral. The approximate $2.8million payout under the Retention Bonus Plan occurred October 1, 2008. Weunderstand that the risk of loss of key personnel is a risk we face in the nearfuture, see “Item 1A. - Risk Factors — The loss of key personnel couldadversely affect us.”

·                  Given the backdrop of the strategicalternatives process that began in late 2007, we have been operating under aninterim capital spending budget during 2008. This interim program calls for thedrilling of 27 to 30 wells (10.4 to 10.7, net) during 2008, primarily in southTexas and, to a lesser extent, in southeast New Mexico, and complemented byselected expenditures for land and seismic. During the first nine months of2008, we logged 20 wells, 19 of which were apparent successes. We currentlyexpect that capital expenditures for the year will be approximately $66 millionand any increase to that amount for the remainder of the year will be somewhatdependent upon the timing and successful completion of the proposed merger withChaparral.

 

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·                  We completed several non-core assetdivestitures during the first nine months of 2008, but we do not expect to sellany further properties as we work toward the proposed merger with Chaparral andthe upcoming borrowing base redetermination.

·                  We recorded a $129.5 million ($84.2 million,net of tax) non-cash impairment relating to our oil and natural gas propertiesduring the third quarter of 2008 resulting from our full-cost ceiling test. Acombination of lower natural gas and crude oil prices and negative revisions toour reserve quantities led to the impairment. Should prices continue to decline in the fourth quarter, the potentialfor an additional impairment at December 31, 2008 exists if the proposedmerger with Chaparral is not completed and we are operating on a standalonebasis (see sensitivity analysis in “Critical Accounting Estimates” below). Theimpairment will reduce our oil and natural gas property depletion base infuture periods and thereby decrease our quarterly depletion rate.

·                  We apply mark-to-market accounting treatmentto our outstanding derivative contracts, rather than cash flow hedge accountingtreatment, and therefore significant volatility from the changes in fair valueof those outstanding contracts has impacted our earnings in 2008 (see Note 8 toour consolidated financial statements). See “Approach to the Business” abovefor information regarding our current derivatives position in light of recentchanges in expected production and dispositions. As a result of the decline incommodity prices in the third quarter of 2008, we recorded a net non-cashunrealized gain associated with our derivative contracts of approximately $75.7million in the third quarter of 2008 that resulted in a year-to-date unrealizedgain of $8.4 million. We have also entered into contracts for both natural gasand crude oil for the remainder of 2008 intended to partially offset ouroverhedge positions (see Note 8 to our consolidated financial statements). Aswe move through the remainder of 2008, we will continue to be impacted bycommodity price volatility.

 

Ouroutlook and the expected results described above are both subject to changebased upon factors that include, but are not limited to, drilling results,commodity prices, the results of our strategic alternatives process andproposed merger with Chaparral, access to capital and factors referred to in “ForwardLooking Statements.”

 

**Critical Accounting Policies and Estimates**

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and assumptions that affect the reported amounts of assets,liabilities, revenue, expenses, contingent assets and liabilities and therelated disclosures in the accompanying financial statements. Changes in theseestimates and assumptions could materially affect our financial position,results of operations or cash flows. Management considers an accountingestimate to be critical if:

 

·      itrequires assumptions to be made that were uncertain at the time the estimatewas made, and

 

·                  changes in the estimate or differentestimates that could have been selected could have a material impact on ourconsolidated results of operations or financial condition.

 

Allother significant accounting policies that we employ are presented in the notesto the consolidated financial statements. The following discussion presentsinformation about the nature of our most critical accounting estimates, ourassumptions or approach used and the effects of hypothetical changes in thematerial assumptions used to develop each estimate.

 

*Nature of Critical Estimate Item:*Oil and Natural Gas Reserves - Our estimate of proved reserves is based onthe quantities of oil and natural gas which geological and engineering datademonstrate, with reasonable certainty, to be recoverable in future years fromknown reservoirs under existing economic and operating conditions.  The accuracy of any reserve estimate is afunction of the quality of available data, engineering and geologicalinterpretation, and judgment, as well as prices and cost levels at that pointin time. Any significant variance in these assumptions could materially affectthe estimated quantity and value of our reserves. Despite the inherentimprecision in these engineering estimates, our reserves are used throughoutour financial statements.

 

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*Assumptions/ApproachUsed:*Units-of-productionmethod to amortize our oil and natural gas properties - The quantity of reserves is used incalculating depletion expense and could significantly impact our depletionexpense.

 

* *“Ceiling” Test - The full-cost method of accounting for oiland natural gas properties requires a quarterly calculation of a limitation oncapitalized costs, often referred to as a full-cost ceiling test. The ceilingis the discounted present value of our estimated total proved reserves (using a10% discount rate) adjusted for taxes and the impact of cash flow hedges onpricing, if cash flow hedge accounting is applied. The ceiling test calculationdictates that prices and costs in effect as of the last day of the period areto be used in calculating the discounted present value of our estimated totalproved reserves.  However, if pricesincrease subsequent to the balance sheet date, but before the filing date, SECguidelines allow a company to use the subsequent date’s higher prices incalculating the full-cost ceiling. We made this election for the third andfourth quarters of 2007. To the extent that our capitalized costs (net ofaccumulated depletion and deferred taxes) exceed the ceiling, the excess mustbe written off to expense. Once incurred, this impairment of oil and naturalgas properties is not reversible at a later date even if oil and natural gasprices increase. A ceiling test impairment could result in a significant lossfor a reporting period; however, future depletion expense would becorrespondingly reduced.  Our estimatedproved reserves volumes have decreased during the period from year-end 2007 to September 30,2008, and the average oil, NGL and natural gas prices at the balance sheet dateas of September 30, 2008 were $100.64 per barrel, $60.38 per barrel and$7.12 per MMBtu, respectively. As a result, we recorded a ceiling testimpairment for the three months ended September 30, 2008 of $129.5 million($84.2 million, net of tax). This impairment will significantly affect thecomparability of results between the 2008 and 2007 periods.

 

*Effect if Different AssumptionsUsed:*Units-of-productionmethod to amortize our oil and natural gas properties - A 10% increase or decrease in reserveswould have decreased or increased, respectively, our depletion expense for thequarter by approximately 10%.

 

“Ceiling”limitation test -Factors that contribute to a ceiling test impairment include the price used tocalculate the reserve limitation threshold and reserve quantities. A reductionin prices at a measurement date could trigger a full-cost ceiling impairment.We recorded an impairment of $84.2 million, net of tax, at September 30,2008. A 10% increase or decrease in prices would have decreased or increasedour impairment by approximately 85%, net of tax, respectively. Therefore,should prices continue to decline in the fourth quarter of 2008,  the potential for an additional impairment atDecember 31, 2008 exists if the proposed merger with Chaparral is notcompleted and we are operating on a standalone basis. Although our hedgingprogram is intended to mitigate the economic impact of any significant pricedecline, it did not impact our ceiling test at September 30, 2008 becausewe do not apply cash flow hedge accounting to our derivative contracts. Had weapplied cash flow hedge accounting to our outstanding derivative contracts,there would have been a minimal impact due to the level of prices at themeasurement date falling within the collars. A 10% increase or decrease inreserve volume would have decreased or increased the impairment calculated at September 30,2008 by approximately 60%.

 

*Nature of Critical Estimate Item:*Asset Retirement Obligations**-**Wehave certain obligations to remove tangible equipment and restore land at theend of oil and natural gas production operations.  Our removal and restoration obligations areprimarily associated with plugging and abandoning wells. Prior to the adoptionof Statement of Financial Accounting Standards (“SFAS”) No. 143, *Accounting for Asset Retirement Obligations,*costs associated with this activity were capitalized to the full-cost pool asthey were incurred and charged to income through depletion expense. SFAS No. 143significantly changed the method of accruing for costs which an entity islegally obligated to incur related to the retirement of fixed assets (“assetretirement obligations” or “ARO”). Primarily, SFAS No. 143 requires us to estimate asset retirementcosts for all of our assets upon acquisition of the asset, adjust those costsfor inflation to the forecast abandonment date, discount that amount using acredit-adjusted-risk-free rate back to the date we acquired the asset orobligation to retire the asset and record an ARO liability in that amount witha corresponding addition to our asset value. When new obligations are incurred,i.e. a new well is drilled or acquired, we add to the ARO liability. Shouldeither the estimated life or the estimated abandonment costs

 

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ofa property change upon our quarterly review, our estimate must be revised. Whenwell obligations are relieved by sale of the property or plugging andabandoning the well, the related estimated liability and asset costs areremoved from our balance sheet and replaced by the costs actually spent onretiring the asset.

 

Estimatingthe future asset removal costs is difficult and requires management to makeestimates and judgments because most of the removal obligations are many yearsin the future, and contracts and regulations often have vague descriptions ofwhat constitutes removal.  Asset removaltechnologies and costs are constantly changing, as are regulatory, political,environmental, safety and public relations considerations. Inherent in theestimate of the present value calculation of our AROs are numerous assumptionsand judgments including the ultimate settlement amounts, inflation factors,credit-adjusted-risk-free-rates, timing of settlement, and changes in thelegal, regulatory, environmental and political environments.

 

*Assumptions/Approach Used:*  Sincethere are so many variables in estimating AROs, we attempt to limit the impactof management’s judgment on certain of these variables by using input ofqualified third parties. We engage independent engineering firms to evaluateour properties annually. We use the remaining estimated useful life from theperiod-end reserve reports prepared by our independent reserve engineers inestimating when abandonment could be expected for each property. We utilize athree-year average rate for inflation to diminish any significant volatilitythat may be present in the short term. We have developed a standard costestimate based on historical costs, industry quotes and depth of wells. Thiscost estimate is reviewed annually to determine whether it is a reasonableestimate in the current environment. Unless we expect a well’s plugging to besignificantly different than a normal abandonment, we use this estimate.

 

*Effect if Different AssumptionsUsed:* We expect tosee our calculations for new properties and revisions to existing propertiesimpacted significantly if interest rates rise, as the credit-adjusted-risk-freerate is one of the variables used on a quarterly basis. We also expect thatsignificant changes to the cost of retiring assets or the reserve life of ourassets would have significant impact on our estimated ARO. The resultingestimate, after application of a discount factor and some significantcalculations, could differ from actual results, despite all our efforts to makean accurate estimate.

 

*Nature of Critical Estimate Item:*Income Taxes**-**In accordance with SFAS No. 109, *Accounting for Income Taxes,* we haverecorded a deferred tax asset and liability to account for the expected futuretax benefits and consequences, respectively, of events that have beenrecognized in our financial statements and our tax returns. There are severalitems that result in deferred tax assets and liabilities on the balance sheet,the largest of which are deferred liabilities attributable to book basis inexcess of tax basis in oil and natural gas properties and the impact of netoperating loss (“NOL”) carryforwards. We routinely assess our ability to useall of our NOL carryforwards that resulted from substantial income taxdeductions, prior year losses and acquisitions. We consider future taxable incomein making such assessments.  If weconclude that it is more likely than not that some portion or all of thedeferred tax assets will not be realized under accounting standards, it isreduced by a valuation allowance to remove the benefit of those NOL carryforwardsfrom our financial statements. Additionally, in accordance with FinancialAccounting Standards Board (“FASB”) Interpretation 48, *Accounting for Uncertainty in Income Taxes, anInterpretation of FASB Statement No. 109* (“FIN 48”)**we have recorded a liability of $0.1million associated with uncertain tax positions. FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  We are required to determine whether it is more likely thannot (a likelihood of more than 50 percent) that a tax position will besustained upon examination, including resolution of any related appeals orlitigation processes, based on the technical merits of the position in order torecord any financial statement benefit.  If that step is satisfied, thenwe must measure the tax position to determine the amount of benefit torecognize in the financial statements.  The tax position is measured atthe largest amount of benefit that is greater than 50 percent likely of beingrealized upon ultimate settlement.

 

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*Assumptions/Approach Used:*Numerous judgments and assumptions areinherent in the determination of future taxable income and tax return filingpositions that we take, including factors such as future operating conditions(particularly as related to prevailing oil and natural gas prices).

 

*Effect ifDifferent Assumptions Used:* Our in-house tax department, along with consultation from anindependent public accounting firm used in tax consultation, continuallyevaluate complicated tax law requirements and their effect on our current andfuture tax liability and our tax filing positions.  Despite our attempt to make an accurateestimate, the ultimate utilization of our NOL carryforwards is highly dependentupon our actual production, the realization of taxable income in futureperiods, Internal Revenue Code Section 382 limitations and potential taxelections.  If we estimate that some orall of our NOL carryforwards are more likely than not going to expire orotherwise not be utilized to reduce future tax, we would record a valuationallowance to remove the benefit of those NOL carryforwards from our financialstatements. Our liability for uncertain tax positions is dependent upon ourjudgment on the amount of financial statement benefit that an uncertain taxposition will realize upon ultimate settlement and on the probabilities of theoutcomes that could be realized upon ultimate settlement of an uncertain taxposition using the facts, circumstances and information available at thereporting date to establish the appropriate amount of financial statementbenefit. To the extent that a valuation allowance or uncertain tax position isestablished or increased or decreased during a period, we may be required toinclude an expense or benefit within tax expense in the statement ofoperations.

 

*Nature of Critical Estimate Item:*Derivative and Hedging Activities**-**Due to the instability of oil and natural gasprices, we may enter into, from time to time, price-risk managementtransactions (e.g. swaps, collars and floors) related to our expected oil andnatural gas production to seek to achieve a more predictable cash flow, as wellas to reduce exposure from commodity price fluctuations. While thesetransactions are intended to be economic hedges of price risk, different accountingtreatment may apply depending on if they qualify for cash flow hedgeaccounting. In accordance with SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities (asamended),*all derivatives, other than those that meet the normalpurchases and sales exception, are recorded on the balance sheet at fair value.

 

CashFlow Hedge Accounting- For transactions accounted for under cash flow hedge accounting treatment,the effective portion of the change in fair value of outstanding derivative contractsis deferred through other comprehensive income (“OCI”) on the balance sheet,rather than recorded immediately in total revenue on the statement ofoperations. Ineffective portions of the changes in the fair value of thederivative contracts are recognized in revenue as they occur. While the hedgecontract is outstanding, the fair value may increase or decrease untilsettlement of the contract. The cash flows resulting from settlement ofderivative transactions which relate to economically hedging our physicalproduction volumes are classified in operating activities on the statement ofcash flows, and the cash flows resulting from settlement of derivativetransactions considered “overhedged” positions are classified in investingactivities on the statement of cash flows.

 

Mark-to-MarketAccounting - Fortransactions accounted for using mark-to-market accounting treatment, until thecontract settles, the entire change in the fair value of the outstandingderivative contract is recorded in total revenue immediately, and not deferredthrough OCI, and there is no measurement of effectiveness. Since January 1,2006, we have applied mark-to-market accounting treatment to all outstandingderivative contracts.

 

*Assumptions/Approach Used:*Estimating the fair values of derivativeinstruments requires complex calculations, including the use of a discountedcash flow technique, estimates of risk and volatility, and subjective judgmentin selecting an appropriate discount rate. In addition, the calculations use futuremarket commodity prices, which although posted for trading purposes, are merelythe market consensus of forecasted price trends. The results of the fair valuecalculations cannot be expected to represent exactly the fair value of ourcommodity derivatives. We currently obtain the fair value of our positions fromour counterparties. Our practice of relying on our counterparties who are morespecialized and knowledgeable in preparing these complex calculations reducesour management’s input. It also approximates the fair

 

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valueof the contracts as that would be the cost to us to terminate a contract atthat point in time, as well as the potential inflows or outflows of cash forthe expiration of the contracts. Due to the fact that we apply mark-to-marketaccounting treatment, the offset to the balance sheet asset or liability, orthe change in fair value of the contracts, is included in total revenue on thestatement of operations rather than deferred in OCI on the balance sheet.

 

*Effect if Different AssumptionsUsed:* At September 30,2008, a 10% change in the commodity price per unit would cause the fair valuetotal of our derivative financial instruments to increase or decrease byapproximately $0.9 million. Had we applied cash flow hedge accounting treatmentto all of our derivative contracts outstanding at September 30, 2008, ournet loss to common stockholders for the nine months would have beenapproximately $95.8 million, or $3.34 per basic and diluted loss per share,assuming that all hedges were fully effective.

 

# **Results of Operations**

#  

This section includes discussion of our results ofoperations for the three and nine months ended September 30, 2008 ascompared to the same period of the prior year. We are an independent oil and natural gas company engaged in theexploration, development, acquisition and production of crude oil and naturalgas properties in the United States.  Ourresources and assets are managed and our results reported as one operatingsegment. We conduct our operations primarily along the onshore United StatesGulf Coast, with our primary emphasis in Texas, Mississippi, New Mexico andLouisiana.

 

**Third Quarter 2008 Compared to the Third Quarter 2007**

 

**Revenue and Production**

 

Total revenue increased 121% from the third quarter of 2007 to thecomparable 2008 period, primarily as a result of our derivative gains.Excluding the effects of derivative activity, revenue increased 3% from thethird quarter of 2007 to the comparable 2008 period.  For the three months ended September 30,2008 and 2007, our product mix contributed the following percentages of revenueand production volumes:

 
| ** **               | ** ** | **REVENUE (1)**                                     | ** ** | **REVENUE (2)** | ** ** | **PRODUCTION  VOLUMES (MCFE)** | ** ** |
|--------------------------|------------|----------------------------------------------------------|------------|----------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** |
| ** **               | ** ** | **2008**                                                 | ** ** | **2007**             | ** ** | **2008**                            | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Natural gas              |       | 73                                                       | %          | 72                   | %          | 61                                  | %          | 61 | % | 70 | % | 70 | % |
| Natural gas liquids      |       | 8                                                        | %          | 15                   | %          | 20                                  | %          | 17 | % | 20 | % | 18 | % |
| Crude oil and condensate |       | 19                                                       | %          | 13                   | %          | 19                                  | %          | 22 | % | 10 | % | 12 | % |
|                     |       |                                                     |       |                 |       |                                |       |   |   |   |   |   |   |
| Total                    |       | 100                                                      | %          | 100                  | %          | 100                                 | %          | 100 | % | 100 | % | 100 | % |

 

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(1) Includes effect of derivativetransactions

(2) Excludes effect of derivativetransactions

 

The following table summarizes volume and price information withrespect to our oil and natural gas production:

 

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| ** **                                   | ** ** | ** **                                                                 | ** ** | ** **   | ** ** | **2008 Period Compared  to 2007 Period** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------|------------|--------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Three Months Ended  September 30,**                       | ** ** | **Increase** | ** ** | **%  Increase**                                              | ** ** |
| ** **                                   | ** ** | **2008**                                                                   | ** ** | **2007**     | ** ** | **(Decrease)**                                               | ** ** | **(Decrease)** | ** ** |
| ** **                                   | ** ** | **(in thousands, except prices and percentages)** | ** ** |
| **Production Volumes:**                      |       |                                                                       |       |         |       |                                                         |       |   |   |
| Natural gas (MMcf)                           |       | 2,789                                                                      |       | 4,365        |       | (1,576                                                       | )          | (36 | )% |
| Natural gas liquids (MBbls)                  |       | 132                                                                        |       | 187          |       | (55                                                          | )          | (29 | )% |
| Crude oil and condensate (MBbls)             |       | 68                                                                         |       | 124          |       | (56                                                          | )          | (45 | )% |
| Natural gas equivalent (MMcfe)               |       | 3,989                                                                      |       | 6,228        |       | (2,239                                                       | )          | (36 | )% |
| **Average Sales Price(1):**                  |       |                                                                       |       |         |       |                                                         |       |   |   |
| Natural gas ($ per Mcf)(2)              |       | $                                                                          | 9.45       |         | $          | 5.83                                                         |       | $ | 3.62 |   | 62 | % |
| Natural gas liquids ($ per Bbl)         |       | 64.53                                                                      |       | 38.93        |       | 25.60                                                        |       | 66 | % |
| Crude oil and condensate ($ per Bbl)(2) |       | 122.05                                                                     |       | 75.74        |       | 46.31                                                        |       | 61 | % |
| Natural gas equivalent ($ per Mcfe)(2)  |       | 10.82                                                                      |       | 6.75         |       | 4.07                                                         |       | 60 | % |
| Natural gas equivalent ($ per Mcfe)(3)  |       | 26.73                                                                      |       | 7.74         |       | 18.99                                                        |       |   | * |
| **Operating Revenue:**                       |       |                                                                       |       |         |       |                                                         |       |   |   |
| Natural gas (2)                              |       | $                                                                          | 26,375     |         | $          | 25,414                                                       |       | $ | 961 |   | 4 | % |
| Natural gas liquids                          |       | 8,516                                                                      |       | 7,273        |       | 1,243                                                        |       | 17 | % |
| Crude oil and condensate (2)                 |       | 8,245                                                                      |       | 9,358        |       | (1,113                                                       | )          | (12 | )% |
| Gain on derivatives                          |       | 63,505                                                                     |       | 6,139        |       | 57,366                                                       |       |   | * |
| Total revenue                                |       | $                                                                          | 106,641    |         | $          | 48,184                                                       |       | $ | 58,457 |   | 121 | % |

 

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(1) Prices are calculated based on wholenumbers, not rounded numbers.

(2) Excludes the effect of derivativetransactions.

(3) Includes the effect of derivativetransactions. 

* Not meaningful

 

**Average sales price****–** Our sales revenue is sensitive to thechanges in prices received for our products. A substantial portion of our production is sold at prevailing marketprices, which fluctuate in response to many factors that are outside of ourcontrol. Imbalances in the supply and demand for oil and natural gas can have adramatic effect on the prices we receive for our production. Politicalinstability and availability of alternative fuels could impact worldwidesupply, while the economy, weather and other factors outside of our controlcould impact demand.

 

**Production****–**For the three months ended September 2008,production volumes for all commodities decreased as compared to the same prioryear period. The decrease in production was primarily the result of normalproduction declines, asset sales completed during the first nine months of 2008and decreased re-investment in replacing production as compared to historicallevels. To a lesser extent, Hurricane Ike during September caused somewells to be shut-in for a short period resulting in additional productiondeclines.

 

**Natural gas revenue** - For the three months ended September 30,2008, natural gas revenue, excluding derivative activity, increased 4% over thesame period in 2007 due primarily to 62% higher average realized prices. Theincrease in the average pre-derivative price received resulted in increasedrevenue of approximately $10.1 million (based on current period production).This increase was partially offset by declines in production volumes comparedto the prior year period (see above) resulting in a decrease in revenue ofapproximately $9.2 million (based on 2007 comparable period pre-derivativeprices). See below for a discussion of the impact of natural gas derivatives onprices and revenue.

 

**Natural gas liquids (“NGL”) revenue**- For the three months ended September 30,2008, NGL revenue increased 17% over the same period in 2007 due to increasesin prices realized, partially offset by lower production volumes (see above).The price increase resulted in an increase in revenue of approximately $3.3million (based on current period production). We do not hedge our NGLproduction.  The decrease in NGLproduction decreased revenue by approximately $2.1 million (based on 2007comparable period average prices).

 

**Crude oil and condensate revenue**- For the three months ended September 30,2008, oil and condensate sales revenue, excluding derivative activity,decreased 12% from the comparable period in 2007, due to the 45% decrease inproduction volumes (see above), partially offset by the 61% increase in pricesrealized. The decrease in oil and condensate production resulted in a decreasein revenue of approximately $4.2 million (based on 2007 comparable periodpre-derivative prices).****Theincreased average realized price for oil and condensate for the three monthsended September 30, 2008 resulted in an increase in revenue ofapproximately $3.1 million (based on current period production). See below fora discussion of the impact of crude oil derivatives on prices and revenue.

 

**Derivatives******–The volume and price contract terms of ourderivative contracts vary from period to period and therefore interactdifferently with the changing pricing environment, which makes thecomparability of the results for each period difficult. In both periods, weapplied mark-to-market accounting treatment to our derivative contracts;therefore the full volatility of the non-cash change in fair value of ouroutstanding contracts is reflected in

 

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revenueand will continue to affect revenue until the contracts expire. Since thesegains/losses are not a function of the operating performance of our oil andnatural gas assets, excluding their impact from the above discussions helpsisolate the operating performance of those assets. The following tablesummarizes the various components of the total gain on derivatives and theimpact each component had on our realized prices:

 
| ** **                                                    | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                                                    | ** ** | **$**                                                    | ** ** | **$ per unit (1)** | ** ** | **$** | ** ** | **$ per unit(1)** | ** ** |
| * *                                                      | * *   | **(in  thousands, except per unit prices)**              | * *   |
| * *                                                      | * *   | ** **                                               | * *   |
| Natural gas derivative contract settlements  (Mcf)            |       | $                                                        | (5,011     | ) | $ | (1.79 | ) | $ | 3,160 |   | $ | 0.72 |   |
|                                                          |       |                                                     |       |   |   |   |   |   |   |
| Crude oil derivative contract settlements  (Bbl)              |       | (7,195                                                   | )          | (106.50 | ) | (515 | ) | (4.17 | ) |
|                                                          |       |                                                     |       |   |   |   |   |   |   |
| Natural gas derivative unrealized change in  fair value (Mcf) |       | 56,417                                                   |       | 20.20 |   | 6,010 |   | 1.38 |   |
|                                                          |       |                                                     |       |   |   |   |   |   |   |
| Crude oil derivative unrealized change in  fair value (Bbl)   |       | 19,294                                                   |       | 285.61 |   | (2,516 | ) | (20.36 | ) |
|                                                          |       |                                                     |       |   |   |   |   |   |   |
| Gain on derivatives (Mcfe)                                    |       | $                                                        | 63,505     |   | $ | 15.91 |   | $ | 6,139 |   | $ | 0.99 |   |

 

----

(1) Prices per unit are calculated basedon whole numbers, not rounded numbers.

 

Should crude oil or natural gas prices increase or decrease from thecurrent levels, it could materially impact our revenue. Our physical sales ofthese commodities are vulnerable to the volatility of market pricemovements.  Therefore, we enter intocontracts covering our anticipated production to ensure certain cash flows thatwe expect will allow us to plan our business activities. In a high priceenvironment, hedged positions could result in lost opportunities if there is acap in place, thus lowering our effective realized prices on hedged production,but in an environment of falling prices, these transactions offer some pricingprotection for hedged production. Although our overall 2008 derivative positionexceeds our total 2008 expected production, we have entered into contracts forcertain fourth quarter 2008 production (see Note 8 to our consolidatedfinancial statements) to reduce the overhedge exposure to high prices that mayresult in cash losses that exceed the offsetting cash inflows from productionrevenue, see “Approach to the Business” above.

 

**Costs and Operating Expenses**

 

Thetable below details our expenses:

 
| ** **                                            | ** ** | ** **                                           | ** ** | **2008 Period Compared  to 2007 Period** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **$  Increase**                                              | ** ** | **%  Increase** | ** ** |
| ** **                                            | ** ** | **2008**                                             | ** ** | **2007**                                                     | ** ** | **(Decrease)** | ** ** | **(Decrease)** | ** ** |
| ** **                                            | ** ** | **(in  thousands, except percentages)**              | ** ** |
| Oil and natural gas operating expenses                |       | $                                                    | 4,039      |                                                         | $          | 4,525 |   | $ | (486 | ) | (11 | )% |
| Severance and ad valorem taxes                        |       | 2,654                                                |       | 3,755                                                        |       | (1,101 | ) | (29 | )% |
| Depletion, depreciation, amortization and  accretion: |       |                                                 |       |                                                         |       |   |   |   |   |
| Oil and gas property and equipment                    |       | 21,601                                               |       | 23,593                                                       |       | (1,992 | ) | (8 | )% |
| Other assets                                          |       | 181                                                  |       | 151                                                          |       | 30 |   | 20 | % |
| ARO accretion                                         |       | 92                                                   |       | 71                                                           |       | 21 |   | 30 | % |
| Impairment of oil and natural gas  properties         |       | 129,520                                              |       | —                                                       |       | 129,520 |   |   | * |
| General and administrative expenses                   |       | 6,380                                                |       | 4,269                                                        |       | 2,111 |   | 49 | % |
| Total operating expenses                              |       | $                                                    | 164,467    |                                                         | $          | 36,364 |   | $ | 128,103 |   |   | * |
|                                                  |       |                                                 |       |                                                         |       |   |   |   |   |
| Other expense, net                                    |       | $                                                    | 2,898      |                                                         | $          | 2,334 |   | $ | 564 |   | 24 | % |
| Income tax expense (benefit)                          |       | (20,714                                              | )          | 3,460                                                        |       | (24,174 | ) |   | * |
| Preferred stock dividends                             |       | 2,066                                                |       | 2,066                                                        |       | — |   |   | * |

 

----

* Not meaningful

 

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**Oil and natural gas operating expenses** - For the three months ended September 30,2008, operating expenses decreased as compared to 2007 due to certain non-coreproperties being divested in the first nine months of 2008. Average oil andnatural gas operating expenses were $1.01 per Mcfe and $0.73 per Mcfe for thethree months ended September 30, 2008 and 2007, respectively. Thisincrease in cost per Mcfe partially resulted from the decrease in productionvolumes discussed previously.

 

**Severance and ad valorem taxes** – In total, severance and ad valorem taxesdecreased from the third quarter of 2007 to 2008. Severance tax expense for thethree months ended September 30, 2008 was 3% higher than the prior yearperiod primarily as a result of higher revenue. Our severance tax expense islevied on our revenue excluding derivative activity. For the three months endedSeptember 30, 2008 and 2007, severance tax expense was approximately 5.8%of revenue subject to severance taxes. Offsetting the higher severance tax waslower ad valorem tax expense. For the third quarter of 2008, ad valorem taxexpense was significantly lower than the prior year period due to reducedvaluations in 2008 which are based on reserves. In addition, we overestimatedthe cost of the newly acquired properties in 2007 leading to higher expense in2007 as compared to 2008. On an equivalent basis, severance and ad valoremtaxes averaged $0.67 per Mcfe and $0.61 per Mcfe for the three months ended September 30,2008 and 2007, respectively.

 

**Depletion, depreciation, and amortization (“DD&A”)and accretion**-Full-cost depletion on our oil and natural gas properties has decreased as aresult of 36% lower production volumes, partially offset by an increase in ourdepletion rate. Our depletion rate for the three months ended September 30,2008 increased 12% since year-end 2007 to $5.41 per Mcfe, and 43% from $3.79per Mcfe in the third quarter of 2007. The depletion rate has increased overthe past year due to negative revisions to our proved reserves at year-end 2007and third quarter 2008. Depreciation of other assets for the third quarter of2008 increased as a result of our office expansion that occurred during 2007.Accretion expense associated with our ARO for the three months ended September 30,2008 increased due to revisions made in the ARO balances during the fourthquarter of 2007 and additions of properties throughout 2007 and 2008, partiallyoffset by 10 properties plugged and over 120 properties retired from our ARO asa result of the sales completed during the first half of 2008.

 

**Impairment of oil and natural gas properties** - At September 30, 2008 we recorded anon-cash full-cost ceiling test impairment of oil and natural gas properties inthe amount of $129.5 million ($84.2 million net of tax), as discussed in Note 1to the consolidated financial statements. The write-down was the result ofdeclines in commodity prices and negative revisions in our proved reservequantities at year-end 2007 and during 2008.

 

**General and administrative (“G&A”) expenses** – G&A expense in total increased 49%between the three months ended September 30, 2008 and 2007. The majorreasons for the cost increase were costs related to the Retention Bonus Planand the pending proposed merger with Chaparral. On May 21, 2008, our Board of Directors adopted a Retention BonusPlan to retain employees through the strategic alternatives process, includingthe completion of the proposed merger with Chaparral (see Note 12 to ourconsolidated financial statements). The Retention Bonus Plan addedapproximately $2.1 million of cost to third quarter 2008 G&A expense thatwas not included in 2007. In connection with the strategic alternatives processand pending proposed merger with Chaparral, we spent $1.8 million during thethird quarter of 2008. These costs include legal expenses, auditor costs, costsof outside consultants and travel and meals costs. Offsetting these increasesin 2008 costs were decreases in compensation for our Board of Directors, legalfees unrelated to the strategic alternatives process, non-cash share-basedcompensation and salaries expense. Capitalized G&A costs for third quarter2008 were 19% higher than the third quarter of 2007. G&A expense on aunit-of-production basis increased for the three months ended September 30,2008, due to both the higher costs previously mentioned and the decline inproduction volumes, to $1.60 per Mcfe from $0.69 per Mcfe for the comparable2007 period. G&A expense, excluding non-cash share-based compensation costsand bad debt expense, for the three months ended September 30, 2008 alsoincreased as a result of both the higher costs previously mentioned and lowerproduction volumes, averaging $1.45 per Mcfe as compared to $0.56 per Mcfe inthe same period in 2007.

 

**Other expense, net** - During the three months ended September 30,2008, our other income and expense increased primarily due to a decrease incapitalized interest. For the third quarter of 2008, we capitalized much lessinterest due to a 62% lower unproved property base (as compared to the thirdquarter of 2007) on which we calculate interest expense subject tocapitalization.

 

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| ** **                 | ** ** | **Three Months Ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                                 | ** ** | **2007** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                  | ** ** |
| Gross interest expense     |       | $                                                        | 3,470      |   | $ | 4,404 |   |
| Less: capitalized interest |       | (655                                                     | )          | (2,203 | ) |
| Interest expense, net      |       | $                                                        | 2,815      |   | $ | 2,201 |   |
|                       |       |                                                     |       |   |   |
| Weighted average debt      |       | $                                                        | 239,913    |   | $ | 235,489 |   |

 

We also recorded less interest income in 2008 as compared to 2007 dueto lower interest rates. We recorded amortization of deferred loan costsrelated to our Revolving Facility during the three months ended September 30,2008 and 2007. These costs were comparable in both periods. Lastly, we recordeda gain on the settlement of asset retirement obligations associated withproperties sold during the third quarter 2008 as compared to none in thecomparable 2007 period.

 

**Income tax expense (benefit)** - An income tax benefit was recorded duringthe three months ended September 30, 2008 because we generated a pre-taxnet loss primarily as a result of the impairment of oil and natural gasproperties. This compares to income tax expense that was recorded on pre-taxnet income in the third quarter of 2007. There has not been a substantialchange to our effective income tax rate since the third quarter of 2007. We aresubject to state and federal income taxes and we expect, as a result of taxablegains on property divestitures, to pay alternative minimum tax in 2008.

 

**Preferred stock dividends** – Our Board of Directors declared quarterlydividends on our 5.75% Series A cumulative convertible perpetual preferredstock in December 2007, and March, June, and September 2008. Dividendexpense for the three months ended September 30, 2008 and 2007 wasapproximately the same.

 

**Earnings (loss) per share** – We reported a net loss for the quarterended September 30, 2008 primarily as a result of the impairment of oiland natural gas properties. This compares to net income in the same quarter of2007. Basic weighted average shares outstanding for the three months ended September 30,2008 were comparable to the same period in 2007. At September 30, 2008, weexcluded the effect of restricted stock units and common stock options in thecalculation of diluted earnings per share. Additionally, we excludedapproximately 8.7 million shares of if-converted common stock attributable toour 5.75% Series A cumulative convertible perpetual preferred stock which,when converted, have an anti-dilutive effect and, therefore, are not includedin the calculation of diluted earnings per share for the three months ended September 30,2008 and 2007.

 

**Nine Months Ended September 30, 2008 Compared tothe Nine Months Ended September 30, 2007**

 

**Revenue and Production**

 

Total revenue decreased 7% from the first nine months of 2007 to thecomparable 2008 period due to our derivative losses.  Excluding the effects of derivative activity,revenue increased 8% from the first nine months of 2007 to the comparable 2008period.  Our product mix contributed thefollowing percentages of revenue and production volumes:

 
| ** **               | ** ** | **REVENUE (1)**                                    | ** ** | **REVENUE (2)** | ** ** | **PRODUCTION  VOLUMES (MCFE)** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|----------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **Nine months ended September 30,** | ** ** |
| ** **               | ** ** | **2008**                                                | ** ** | **2007**             | ** ** | **2008**                            | ** ** | **2007** | ** ** | **2008** | ** ** | **2007** | ** ** |
| Natural gas              |       | 66                                                      | %          | 74                   | %          | 63                                  | %          | 70 | % | 70 | % | 74 | % |
| Natural gas liquids      |       | 21                                                      | %          | 12                   | %          | 18                                  | %          | 12 | % | 20 | % | 14 | % |
| Crude oil and condensate |       | 13                                                      | %          | 14                   | %          | 19                                  | %          | 18 | % | 10 | % | 12 | % |
|                     |       |                                                    |       |                 |       |                                |       |   |   |   |   |   |   |
| Total                    |       | 100                                                     | %          | 100                  | %          | 100                                 | %          | 100 | % | 100 | % | 100 | % |

 

40

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----

(1) Includes effect of derivative transactions

 

(2) Excludes effect of derivative transactions

 

The following table summarizes volume and price information withrespect to our oil and natural gas production for the nine months ended September 30,2008 and 2007:

 
| ** **                                   | ** ** | ** **                                          | ** ** | ** **   | ** ** | **2008 Period Compared  to 2007 Period** | ** ** |
|----------------------------------------------|------------|-----------------------------------------------------|------------|--------------|------------|--------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Nine Months Ended**                     | ** ** | ** **   | ** ** | **%**                                                        | ** ** |
| ** **                                   | ** ** | **September 30,**                              | ** ** | **Increase** | ** ** | **Increase**                                                 | ** ** |
| ** **                                   | ** ** | **2008**                                            | ** ** | **2007**     | ** ** | **(Decrease)**                                               | ** ** | **(Decrease)** | ** ** |
| ** **                                   | ** ** | **(in  thousands, except prices and percentages )** | ** ** |
| **Production Volumes:**                      |       |                                                |       |         |       |                                                         |       |   |   |
| Natural gas (MMcf)                           |       | 9,604                                               |       | 13,623       |       | (4,019                                                       | )          | (30 | )% |
| Natural gas liquids (MBbls)                  |       | 449                                                 |       | 433          |       | 16                                                           |       | 4 | % |
| Crude oil and condensate (MBbls)             |       | 230                                                 |       | 350          |       | (120                                                         | )          | (34 | )% |
| Natural gas equivalent (MMcfe)               |       | 13,678                                              |       | 18,319       |       | (4,641                                                       | )          | (25 | )% |
| **Average Sales Price(1):**                  |       |                                                |       |         |       |                                                         |       |   |   |
| Natural gas ($ per Mcf)(2)              |       | $                                                   | 9.17       |         | $          | 6.65                                                         |       | $ | 2.52 |   | 38 | % |
| Natural gas liquids ($ per Bbl)         |       | 55.35                                               |       | 35.38        |       | 19.97                                                        |       | 56 | % |
| Crude oil and condensate ($ per Bbl)(2) |       | 114.41                                              |       | 65.28        |       | 49.13                                                        |       | 75 | % |
| Natural gas equivalent ($ per Mcfe)(2)  |       | 10.18                                               |       | 7.02         |       | 3.16                                                         |       | 45 | % |
| Natural gas equivalent ($ per Mcfe)(3)  |       | 8.54                                                |       | 6.82         |       | 1.72                                                         |       | 25 | % |
| **Operating Revenue:**                       |       |                                                |       |         |       |                                                         |       |   |   |
| Natural gas (2)                              |       | $                                                   | 88,069     |         | $          | 90,492                                                       |       | $ | (2,423 | ) | (3 | )% |
| Natural gas liquids                          |       | 24,861                                              |       | 15,314       |       | 9,547                                                        |       | 62 | % |
| Crude oil and condensate (2)                 |       | 26,282                                              |       | 22,839       |       | 3,443                                                        |       | 15 | % |
| Loss on derivatives                          |       | (22,452                                             | )          | (3,676       | )          | (18,776                                                      | )          |   | * |
| Total revenue                                |       | $                                                   | 116,760    |         | $          | 124,969                                                      |       | $ | (8,209 | ) | (7 | )% |

 

----

(1) Prices are calculated based on whole numbers, not roundednumbers.

(2) Excludes the effect of derivative transactions.

(3) Includes the effect of derivative transactions.

*  Not meaningful

 

**Average Sales Price**– Our sales revenue is sensitive to thevolatility of commodity prices.  Asubstantial portion of our production is sold at prevailing market prices,which fluctuate in response to many factors that are outside of our control.Imbalances in the supply and demand for oil and natural gas can have a dramaticeffect on the prices we receive for our production. Political instability andavailability of alternative fuels could impact worldwide supply, while theeconomy, weather and other factors outside of our control could impact demand.

 

**Production****–**For the nine months ended September 2008,natural gas and crude oil production volumes decreased as compared to the sameprior year period. The decrease in production was primarily the result ofnormal production declines, asset sales completed during the first nine monthsof 2008 and decreased re-investment in replacing production as compared tohistorical levels. Production volumes for NGLs increased for the nine monthsended September 30, 2008 compared to the same prior year period due toincreases in processing at our Flores/Bloomberg field and other propertiesacquired in early 2007 as well as a new processing agreement on certainnon-operated production in Jim Hogg county, Texas, which began in June 2007.To a lesser extent, Hurricane Ike during September caused some wells to beshut-in for a short period resulting in additional production declines for allcommodities.

 

**Natural gas revenue** - For the first nine months of 2008, naturalgas revenue, excluding derivative activity, decreased due to lower productionvolumes (see above), partially offset by higher realized prices. The decreasein production volumes compared to the prior year period resulted in decreasedrevenue of approximately $26.7 million (based on 2007 comparable periodpre-derivative prices). The increase in average price received resulted inincreased revenue of approximately $24.3 million (based on current periodproduction). See below for a discussion of the impact of natural gasderivatives on prices and revenue.

 

**NGL revenue**- For the nine months ended September 30,2008, NGL sales revenue increased 62% over the same period in 2007 as a resultof both higher production volumes (see above) and average realized prices. Wedo not hedge our NGL production. Higher average realized NGL prices for thenine months ended September 30, 2008 resulted in increased revenue ofapproximately $9.0 million (based on current period production). Increased

 

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NGL production volumes led to increased revenue of approximately $0.5million (based on 2007 comparable period prices).

 

**Crude oil and condensate revenue**- For the nine months ended September 30,2008, oil and condensate sales revenue, excluding derivative activity,increased as compared to the same period in 2007, due to higher averagerealized prices partially offset by lower production (see above). Higheraverage realized prices resulted in increased revenue of approximately $11.3million (based on current period production). The decrease in oil and condensate production resulted in a decrease inrevenue of approximately $7.9 million (based on 2007 comparable periodpre-derivative prices). See below for a discussion of the impact of crude oilderivatives on prices and revenue.

 

**Derivatives**– The volume and price contract terms of ourderivative contracts vary from period to period and therefore interactdifferently with the changing pricing environment, which makes thecomparability of the results for each period difficult. In both periods, weapplied mark-to-market accounting treatment to our derivative contracts;therefore the full volatility of the non-cash change in fair value of ouroutstanding contracts is reflected in revenue and will continue to affectrevenue until the contracts expire. Since these gains/losses are not a functionof the operating performance of our oil and natural gas assets, excluding theirimpact from the above discussions helps isolate the operating performance ofthose assets. The following table summarizes the various components of thetotal loss on derivatives and the impact each component had on our realizedprices.

 
| ** **                                                                             | ** ** | **Nine Months Ended September 30,**             | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2008**                                                            | ** ** | **2007** | ** ** |
| ** **                                                                             | ** ** | **$**                                                               | ** ** | **$ per unit (1)** | ** ** | **$** | ** ** | **$ per unit(1)** | ** ** |
| ** **                                                                             | ** ** | **(in thousands, except per unit prices)** | ** ** |
| Natural gas contract settlements (Mcf)                                                 |       | $                                                                   | (11,381    | ) | $ | (1.18 | ) | $ | 3,729 |   | $ | 0.27 |   |
| Crude oil contract settlements (Bbl)                                                   |       | (19,473                                                             | )          | (84.77 | ) | 563 |   | 1.61 |   |
| Natural gas derivative reversal of prior  period unrealized change in fair value (Mcf) |       | (2,626                                                              | )          | (0.27 | ) | (4,686 | ) | (0.34 | ) |
| Natural gas derivative unrealized change in  fair value (Mcf)                          |       | 2,565                                                               |       | 0.26 |   | 3,424 |   | 0.25 |   |
| Crude oil derivative reversal of prior  period unrealized change in fair value (Bbl)   |       | 14,954                                                              |       | 65.10 |   | (501 | ) | (1.43 | ) |
| Crude oil derivative unrealized change in  fair value (Bbl)                            |       | (6,491                                                              | )          | (28.25 | ) | (6,205 | ) | (17.74 | ) |
| Loss on derivatives (Mcfe)                                                             |       | $                                                                   | (22,452    | ) | $ | (1.64 | ) | $ | (3,676 | ) | $ | (0.20 | ) |

 

----

(1) Prices per unit are calculated based on whole numbers, notrounded numbers.

 

Should crude oil or natural gas prices increase or decrease from thecurrent levels, it could materially impact our revenue. Our physical sales ofthese commodities are vulnerable to the volatility of market pricemovements.  Therefore, we enter intocontracts covering our anticipated production to ensure certain cash flows thatwe expect will allow us to plan our business activities. In a high priceenvironment, hedged positions could result in lost opportunities if there is acap in place, thus lowering our effective realized prices on hedged production,but in an environment of falling prices, these transactions offer some pricingprotection for hedged production. Although our overall 2008 derivative positionexceeds our total 2008 expected production, we have entered into contracts forcertain fourth quarter 2008 production (see Note 8 to our consolidated financialstatements) to reduce the overhedge exposure to high prices that may result incash losses that exceed the offsetting cash inflows from production revenue,see “Approach to the Business” above.

 

**Costs and Operating Expenses**

 

Thetable below details our expenses:

 

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| ** **                                            | ** ** | ** **                              | ** ** | ** **   | ** ** | **2008 Period Compared  to 2007 Period** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|--------------|------------|--------------------------------------------------------------|------------|
| ** **                                            | ** ** | **Nine Months Ended**         | ** ** | **$**        | ** ** | **%**                                                        | ** ** |
| ** **                                            | ** ** | **September 30,**                  | ** ** | **Increase** | ** ** | **Increase**                                                 | ** ** |
| ** **                                            | ** ** | **2008**                                | ** ** | **2007**     | ** ** | **(Decrease)**                                               | ** ** | **(Decrease)** | ** ** |
| ** **                                            | ** ** | **(in  thousands, except percentages)** | ** ** |
| Oil and natural gas operating expenses                |       | $                                       | 12,452     |         | $          | 11,953                                                       |       | $ | 499 |   | 4 | % |
| Severance and ad valorem taxes                        |       | 8,136                                   |       | 9,951        |       | (1,815                                                       | )          | (18 | )% |
| Depletion, depreciation, amortization and  accretion: |       |                                    |       |         |       |                                                         |       |   |   |
| Oil and gas property and equipment                    |       | 69,926                                  |       | 62,817       |       | 7,109                                                        |       | 11 | % |
| Other assets                                          |       | 558                                     |       | 398          |       | 160                                                          |       | 40 | % |
| ARO accretion                                         |       | 283                                     |       | 206          |       | 77                                                           |       | 37 | % |
| Impairment of oil and natural gas  properties         |       | 129,520                                 |       | —       |       | 129,520                                                      |       |   | * |
| General and administrative expenses                   |       | 15,592                                  |       | 14,199       |       | 1,393                                                        |       | 10 | % |
| Total operating expenses                              |       | $                                       | 236,467    |         | $          | 99,524                                                       |       | $ | 136,943 |   |   | * |
|                                                  |       |                                    |       |         |       |                                                         |       |   |   |
| Other expense, net                                    |       | $                                       | 9,783      |         | $          | 8,341                                                        |       | $ | 1,442 |   | 17 | % |
| Income tax expense (benefit)                          |       | (45,478                                 | )          | 6,229        |       | (51,707                                                      | )          |   | * |
| Preferred stock dividends                             |       | 6,199                                   |       | 5,510        |       | 689                                                          |       | 13 | % |

 

----

*Not meaningful.

 

**Oil and natural gas operating expenses** - For the nine months ended September 30,2008, operating expenses increased as compared to the same period of 2007 dueto increased expensed workovers and higher costs for compressor rent, gasprocessing, and salt-water disposal during the first half of 2008, as well asoverall cost inflation in our industry. These increases were partially offsetby decreases caused by the sale of certain non-core assets during the firstnine months of 2008. This along with the decline in production lead to anincrease in our average oil and natural gas operating expenses, which were$0.91 per Mcfe for the nine months ended September 30, 2008 as compared to$0.65 per Mcfe in the same period of 2007.

 

**Severance and ad valorem taxes** - For the nine months ended September 30,2008, severance and ad valorem taxes decreased from the first nine months of2007.  Severance tax expense for the ninemonths ended September 30, 2008 was 26% higher than the prior year perioddue to higher revenue and slightly higher realized rates.  Our severance tax expense is levied on ouroil and natural gas revenue from physical production (i.e. excluding derivativeactivity). For the nine months ended September 30, 2008, severance taxexpense was approximately 5.8% of revenue subject to severance taxes comparedto 5.0% of revenue subject to severance taxes for the first nine months of2007. We recorded severance tax abatements related to prior year periods duringearly 2007, which effectively lowered the 2007 expense. In addition, the higherrate in 2008 is primarily due to our new production in New Mexico, includingthe Prairie Fire #1 well, which carries a higher rate than Texas production. Advalorem tax expense for the first nine months of 2008 was 97% lower than theprior year because we reduced our estimates in 2008 as a result of the actual2007 costs coming in lower than originally anticipated in 2007 accrual estimates.In addition, the 2008 ad valorem tax valuations, which are based on reserves,were lower in 2008 than in the prior year which resulted in lower costs for2008. On an equivalent basis, severance and ad valorem taxes averaged $0.59 perMcfe and $0.54 per Mcfe for the nine months ended September 30, 2008 and2007, respectively.

 

**DD&A and accretion**- Depletion on our oil and natural gasproperties increased for the first nine months of 2008 compared to the sameperiod of 2007 due to an increase in our unit-of-production depletion ratepartially offset by declines in production, which are discussed under “Revenueand Production” above. The depletion rate increased from $3.79 per Mcfe at September 30,2007 to $5.41 per Mcfe at September 30, 2008, primarily as a result ofnegative revisions to our proved reserves at year-end 2007 and during 2008. Theaverage depletion rate for the nine months ended September 30, 2008 and2007 was $5.11 per Mcfe and $3.43 per Mcfe, respectively. Depreciation offurniture and fixtures increased compared to the prior year first nine monthsdue to our office expansion that occurred in late 2007 and additional computerequipment associated with an increased number of employees. Accretion expenseassociated with our asset retirement obligations for the nine months ended September 30,2008 increased due to revisions made in the ARO balances during the fourthquarter of 2007 and additions of properties throughout 2007 and 2008, partiallyoffset by over 120 properties retired from our ARO as a result of the salescompleted and plugging of 10 wells during the first nine months of 2008.

 

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**Impairment of oil and natural gas properties** - At September 30, 2008 we recorded anon-cash full-cost ceiling test impairment of oil and natural gas properties inthe amount of $129.5 million ($84.2 million, net of tax), as discussed in Note1 to the consolidated financial statements. The write-down was the result ofdeclines in commodity prices and negative revisions in our proved reservequantities at year-end 2007 and during 2008. No such impairment was reported inthe first and second quarters 2008 or the first nine months of 2007.

 

**G&A expense** - G&A expense increased for the firstnine months of 2008 as compared to the same 2007 period, primarily due to costsassociated with the proposed merger with Chaparral and the retention bonusprogram adopted during the second quarter of 2008 (see Note 12 to ourconsolidated financial statements). We incurred costs of approximately $2.1million related to the strategic alternatives process and pending proposedmerger with Chaparral and approximately $2.8 million of retention bonuses. Inaddition, within total G&A expense, there were increases in healthinsurance and rent expense, and offsetting all of these increases were decreasesin professional fees such as audit and legal unrelated to the strategicalternatives process, non-cash share-based compensation, salaries, contractlabor, Board of Director compensation and bad debt expense. G&A expense istypically reduced by overhead reimbursements and capitalized G&A. Overheadreimbursements increased in 2008 which lowered G&A expense more than in2007. Capitalized G&A costs for the first nine months of 2008 were slightlyhigher at $3.6 million as compared to $3.5 million for the comparable prioryear period. G&A expense on a unit-of-production basis for the nine monthsended September 30, 2008 increased to $1.14 per Mcfe as compared to $0.78per Mcfe for the comparable 2007 period, as a result of both increased costsand lower production volumes. G&A, excluding non-cash share-basedcompensation costs and bad debt expense, for the nine months ended September 30,2008, averaged $0.99 per Mcfe as compared to $0.62 per Mcfe for the comparable2007 period.

 

**Other expense, net** - During the nine months ended September 30,2008, other income and expense in total increased primarily due to a decreasein the amount of interest expense we capitalized. For the first nine months of2008, approximately 18% of our gross interest expense was capitalized, ascompared to approximately 42% in the same 2007 period. We calculate the amountof interest we can capitalize based on the comparison of our unproved propertycosts and our weighted average debt balance. Gross interest expense in 2007 washigher than 2008 due to commitment fees of $1.3 million paid to our lenderrelated to an unused bridge loan facility. Although average debt balancesoutstanding in 2008 were higher, the interest rates were lower, thus resultingin lower gross interest expense (excluding the commitment fee) between periods.

 
| ** **                 | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                                   | ** ** |
| Gross interest expense     |       | $                                                                         | 11,368     |   | $ | 13,661 |   |
| Less: capitalized interest |       | (2,045                                                                    | )          | (5,770 | ) |
| Interest expense, net      |       | $                                                                         | 9,323      |   | $ | 7,891 |   |
|                       |       |                                                                      |       |   |   |
| Weighted average debt      |       | $                                                                         | 246,825    |   | $ | 222,154 |   |

 

We also recorded lower interest income in 2008 as compared to 2007. Ouramortization of deferred loan costs related to our Revolving Facility werecomparable between the nine months ended September 30, 2008 and 2007.During the nine months ended September 30, 2008, we recorded a gain on AROsettlements of approximately $82,700, as compared to none in the comparable2007 period.

 

**Income tax expense** - An income tax benefit was recorded for thenine months ended September 30, 2008 as a result of the pre-tax net losswe incurred. This compares to an income tax expense provision for the firstnine months of 2007 recorded on pre-tax net income. There was not a substantialdifference in our effective income tax rate for the two periods.

 

**Preferred stock dividends** — Our Board of Directors declared dividendson our 5.75% Series A cumulative convertible perpetual preferred stock inMarch, June and September of 2007 and 2008.  The preferred stock was issued in connectionwith a public offering in January 2007, therefore 2007 reflects a partialperiod as compared to a full period in 2008.

 

**Earnings (loss) per share** - For the first nine months of 2008, wereported a loss per share as compared to earnings per share in the same periodin 2007 mainly as a result of decreased net income resulting from the

 

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impairmentof oil and natural gas properties recorded during the third quarter of 2008.Basic weighted average shares outstanding for the nine months ended September 30,2008 increased approximately 5% as a result of normal stock activity, includingstock option exercises and restricted stock units vesting, and as a result ofthe common stock issued in the January 2007 offering not being outstandingfor the entire period in 2007. We excluded approximately 8.7 million shares ofif-converted common stock attributable to our 5.75% Series A cumulativeconvertible perpetual preferred stock which, when converted, have ananti-dilutive effect and, therefore, are not included in the calculation ofdiluted earnings per share for the nine months ended September 30, 2008 or2007.

 

## **Liquidity and Capital Resources**

##  

Ourprimary ongoing source of capital is the cash flow generated from our operatingactivities supplemented by borrowings under our Revolving Facility. Net cashgenerated from operating activities is a function of production volumes andcommodity prices, both of which are inherently volatile and unpredictable, aswell as operating efficiency and costs. Our business, as with other extractivebusinesses, is a depleting one in which each gas equivalent unit produced mustbe replaced or our asset base and capacity to generate revenue in the futurewill shrink. Our overall expected future production decline is estimated to beapproximately 26% per year. Less predictable than production declines from ourproved reserves is the impact of constantly changing oil and natural gas priceson cash flows. We attempt to mitigate the price risk with our hedging program.Reserves and production volumes are influenced, in part, by the amount offuture capital expenditures. In turn, capital expenditures are influenced bymany factors including drilling results, oil and natural gas prices, industryconditions, availability and cost of goods and services and the extent to whichoil and natural gas properties are acquired.

 

Ourprimary cash requirements are for exploration, development and acquisition ofoil and natural gas properties, payment of preferred stock dividends, paymentof derivative loss settlements and the repayment of principal and interest onoutstanding debt. We attempt to fund our exploration and development activitiesprimarily through internally generated cash flows and budget capitalexpenditures based largely on projected cash flows. We routinely adjust capitalexpenditures in response to changes in oil and natural gas prices, drilling andacquisition costs, and cash flow. We typically have funded acquisitions fromborrowings under our credit facilities, cash flow from operations and sales ofcommon stock and preferred stock.

 

Significantchanges to working capital may affect our liquidity in the short term. Ourderivative instrument liability is indicative of potential future cashsettlement outflows on our outstanding oil and natural gas derivativepositions, which are scheduled to settle in future months. The fair marketvalue represents the potential settlement for those contracts if the marketprices remain unchanged. Should commodity prices increase or decrease, the fairvalue of those outstanding contracts would change, as evidenced in the thirdquarter of 2008 when lower prices lead to significant gains that partiallyoffset year-to-date derivative losses (See “Outlook” section above). Subsequentincreases or decreases in commodity prices will continue to result inadditional changes to the fair market value of these contracts. When ourderivatives result in cash settlement outflows, we receive higher cash inflowson the sale of our physical production at those higher market prices, thusproviding us with funds to cover at least a portion of any derivative paymentsthat may come due in the future. This will not be true, however, for theportion of our 2008 production that is overhedged. Currently we expect to haveapproximately 110% of our anticipated natural gas production and approximately160% of our anticipated crude oil production hedged in 2008 as a result of adecrease in expected future production since the time we entered into our 2008derivative positions. We have no derivatives covering our substantialproduction of NGLs, which have historically received a price of approximately40% to 60% of our realized crude oil price. As a result, even though we do notbenefit from increases in oil prices and might suffer increased losses as oilprices increase, those increased losses may be partially offset by increasedrevenue from NGL production.  See “Approachto the Business” above.

 

Wehad $239 million of total borrowings outstanding under our Revolving Facilityat September 30, 2008. Our Revolving Facility matures on January 31,2011. We have historically used our credit facilities to supplement anydeficiencies between operating cash flow and capital expenditures. Ouroutstanding debt balance at November 10, 2008 has not changed since September 30,2008. Although the Company’s available borrowing capacity under the Revolving Facilitywas $11 million at September 30, 2008, this availability was effectivelyreduced to $1 million on November 5, 2008 and may be eliminated for thenear future as a result of the upcoming borrowing base redetermination (seebelow). We typically do not rely on the sale of assets as a source of cash, butrealized

 

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approximately$19.2 million related to the sale of a pipeline and approximately 120properties in Texas to various buyers during the first nine months of 2008, andwe used the proceeds to reduce outstanding debt and fund ongoing capitalspending.

 

Asa result of the strategic alternatives process we began in late 2007, wereduced our planned capital spending for 2008 as compared to recent years.During the first quarter of 2008, our Board of Directors approved an interimcapital budget. This interim program calls for the drilling of 27 to 30 wells(10.4 to 10.7, net) during 2008, primarily in south Texas and, to a lesserextent, in southeast New Mexico, complemented by selected expenditures for landand seismic. We currently expect that capital expenditures for the year will beapproximately $66 million. Under the terms of the Merger Agreement discussedabove, we agreed to limit, subject to certain exceptions, our capitalexpenditures beyond that previously budgeted to capital expenditures made withChaparral’s consent. Depending on the volatility of our derivative cashsettlements, we expect capital expenditures to be less than our cash flow fromoperating activities, thereby allowing us to either reduce outstanding debt orincrease capital spending, with Chaparral’s consent, as we move through theremainder of the year. By adjusting our operations and planned capitalspending, we believe we have sufficient capital resources to meet our projectedcash flow requirements for the next 12 months. We expect capital expendituresfor the remainder of the year to be somewhat dependent upon the timing of andsuccessful completion of the proposed merger with Chaparral and the ultimateoutcome of our borrowing base redetermination by our Lenders.

 

Ifthe proposed merger with Chaparral is not consummated, we may need to obtainadditional financing if we choose to expand our operational activities beyondour current reduced level. The recent worldwide financial and credit crisis hasreduced the availability of liquidity and credit worldwide, and the recentsubstantial declines in worldwide equity markets, including our stock prices,make it more difficult to effectively raise capital through equity issuances.If during the remainder of 2008 and thereafter, we are not successful ingenerating sufficient liquidity from operations (even though we currentlyexpect cash flow from operating activities to be sufficient to meet ourobligations, as discussed above) or raising alternative capital resources onterms acceptable to us, our reduced level of liquidity could have a materialadverse effect on our business, results of operations and financial condition.If additional financing is not available or is not available on acceptableterms, we may sell assets or further curtail our operations. See “Item 1A—RiskFactors—We have limited available borrowing capacity under our RevolvingFacility, and it may be difficult to access capital on attractive terms or atall, which could significantly limit our ability to fund our operations andcould have a material adverse effect on us if the proposed merger withChaparral is not completed.”

 

AtSeptember 30, 2008, we had $15.7 million in cash and cash equivalents ascompared to $7.2 million at December 31, 2007.  Our working capital surplus was $11.3 millionat September 30, 2008, as compared to a working capital surplus of $2.3million at December 31, 2007. Our sources and uses of cash were asfollows:

** **

| ** **                                             | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                                  | ** ** | **2007** | ** ** |
| * *                                               | * *   | **(in thousands)**                                                        | * *   |
| *Net Cash Provided By Operating Activities*            |       | $                                                                         | 77,207     |   | $ | 98,572 |   |
| * *                                               |       |                                                                      |       |   |   |
| *Net Cash Used In Investing Activities*                |       | (41,449                                                                   | )          | (480,759 | ) |
| * *                                               |       |                                                                      |       |   |   |
| *Net Cash Provided by (Used In) Financing  Activities* |       | (27,199                                                                   | )          | 380,106 |   |
|                                                        |            |                                                                           |            |  |  |  |  |

 

**Net Cash Provided By Operating Activities***-*The decrease in cash flows provided byoperating activities for the first nine months of 2008 as compared to the sameperiod in 2007 is primarily a result of cash settlement losses of approximately$20.0 million on our derivative contracts as compared to cash settlement gainsof $4.3 million in the first nine months of 2007. In the first nine months of2008, higher revenue on physical production resulting from increased averagerealized prices partially offset the derivative losses. Another contributor tothe decrease in cash flows in the first nine months of 2008 was an increase incash costs such as severance taxes, oil and natural gas operating expenses andretention bonus payments. Changes in working capital increased total cash flowsby $11.7 million in the first nine months of 2008 as compared to $5.9 million inthe same period of 2007.

 

**Net Cash Used In Investing Activities***-*We reinvest a substantial portion of our cashflows in our drilling, acquisition, land and geophysical activities.  During the first nine months of 2008, wespent $46.7 million on our

 

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drillingand operating program. We drilled 20 wells in the first nine months of 2008, 19of which were apparent successes. Leasehold and geological and geophysical activities accounted forexpenditures of $3.8 million through September 30, 2008. There were alsominimal capital expenditures associated with computer hardware, officeequipment and other miscellaneous capital charges. This limited programcompares to the prior year in which our largest expenditure was the acquisitionthat occurred in January 2007. During the first nine months of 2007, wespent $88.8 million on our drilling and operating program.  We logged 38 wells in the first nine monthsof 2007, 33 of which were apparent successes. Leasehold and geological and geophysical activities accounted forexpenditures of $12.3 million through September 30, 2007. The remainingcapital expenditures were associated with computer hardware, office equipmentand other miscellaneous capital charges. During the nine months ended September 30,2008, proceeds from the sale of certain non-core properties in Texas and apipeline to various buyers totaled approximately $19.2 million. In the sameperiod last year, proceeds from the sale of an interest in one of our Louisianaoil and natural gas properties totaled $1.1 million.

 

Due to the overhedged position in 2008, the cash settlements related tooverhedged production are reflected in investing activities because they do notapply to operating revenue and are similar in nature to an investment.Approximately 45% of our oil settlements and approximately 19% of our naturalgas settlements are represented by the $10.9 million of speculative settlementsin this section of the statement of cash flows. The remainder of cashsettlements is located in net cash provided by operating activities. Forfurther discussion of our overhedged position, see “Approach to the Business”above.

 

**Net Cash Provided By (Used In) Financing Activities***-*During the nine months ended September 30,2008, we repaid $21.0 million under our Revolving Facility (as defined below)using proceeds from our asset sales. We also paid quarterly dividends on ourpreferred stock in January, April and July 2008.

 

*Revolving Facility*

 

OnJanuary 30, 2007, we entered into a Fourth Amended and Restated CreditAgreement (the “Agreement”) for a new revolving credit facility with Union Bankof California (“UBOC”), as administrative agent and issuing lender, and theother lenders party thereto (together with UBOC, the “Lenders”).Pursuant to the Agreement, UBOC acts as the administrative agent for asenior, first lien secured borrowing base revolving credit facility (the “RevolvingFacility”) in favor of the Company and certain of its wholly-owned subsidiariesin an amount equal to $750 million, of which only $250 million and $225 millionare available under the borrowing base and conforming borrowing base,respectively, currently in effect. The Revolving Facility has a letter ofcredit sub-limit of $20 million.

 

TheRevolving Facility matures on January 31, 2011 and bears interest at LIBORplus an applicable margin ranging from 1.25% to 2.5% or Prime plus a margin ofup to 0.50%, with an unused commitment fee ranging from 0.50% to 0.25%, all ofwhich depend on the utilization percentage of the conforming borrowingbase.  At September 30, 2008, theinterest rates applied to our outstanding Prime and LIBOR borrowings were 5.50%and 5.19%, respectively and we had a rate of 0.25% applied to our unusedborrowing capacity.  As of September 30,2008, $239 million in total borrowings were outstanding under the RevolvingFacility. The borrowing base was reduced from $320 million to $300 millionduring the fourth quarter of 2007 and the conforming borrowing base was reducedfrom $300 million to $250 million. In early May 2008, our RevolvingFacility’s borrowing base and conforming borrowing base were redetermined byour banks and set at $250 million and $225 million, respectively. They werereduced primarily as a result of the sale of certain non-core assets during thefirst quarter of 2008 and the reduction of total proved reserves as reported inthe year-end reserve reports of our independent reserve engineers. Although ouravailable borrowing capacity under the Revolving Facility was $11 million at September 30,2008, this availability was effectively reduced to $1 million on November 5,2008 and may be eliminated for the near future as a result of the upcomingborrowing base redetermination.

 

OnJuly 11, 2008, in connection with the proposed merger with Chaparral, weentered into a Consent agreement (the “Consent”) under theAgreement. Pursuant to the Consent and subject to the terms thereof, theLenders deferred their right to conduct a borrowing base redetermination on orbefore June 30, 2008 and agreed to conduct the redetermination on October 31,2008. We paid the Lenders a fee of approximately $0.4 million in connectionwith the deferral of the redetermination. On November 5, 2008, the Lendersagreed to delay the interim redetermination from October 31, 2008 until November 15,2008. In consideration for this deferral, the Lenders

 

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placeda restriction upon the current borrowing base such that it was effectivelylowered to $240 million until the interim redetermination occurs. Pursuant tothe terms of the Revolving Facility, upon the completion of theredetermination, our borrowing base will also be the conforming borrowing base.This redetermination process is ongoing and the Lenders as yet have notestablished a new borrowing base under the Revolving Facility. We would seek tosatisfy any borrowing base deficiency created by the upcoming redeterminationthrough a combination of cash on hand, adjustments to our planned capitalspending, offering additional properties to serve as collateral, and proceedsfrom asset divestitures.  However, therecan be no assurance that any of these alternative solutions will be attainable,especially in light of the recent global economic crisis. Our RevolvingFacility is expected to be refinanced by Chaparral contemporaneously with theclosing of the proposed merger.

 

TheRevolving Facility is secured by substantially all of our assets. The RevolvingFacility provides for certain restrictions, including, but not limited to,limitations on additional borrowings, sales of oil and natural gas propertiesor other collateral, and engaging in merger or consolidation transactions. TheRevolving Facility restricts common stock dividends and certain distributionsof cash or properties and certain liens and also contains financial covenantsincluding, without limitation, the following:

 

·                  An EBITDAX to interest expense ratio requiresthat as of the last day of each fiscal quarter the ratio of (a) ourconsolidated EBITDAX (defined as EBITDA plus similar non-cash items andexploration and abandonment expenses for such period) to (b) ourconsolidated interest expense, not be less than 2.5 to 1.0, calculated on arolling four quarter basis.

 

·                  A current ratio requires that as of the lastday of each fiscal quarter the ratio of our consolidated current assets to ourconsolidated current liabilities, as defined in the Revolving Facility, be atleast 1.0 to 1.0.

 

·                  A maximum leverage ratio requires that as ofthe last day of each fiscal quarter the ratio of (a) Total Indebtedness(as defined in the Agreement) to (b) an amount equal to consolidatedEBITDAX be not greater than 3.0 to 1.0, calculated on a rolling four quarterbasis.

 

ConsolidatedEBITDAX is a component of negotiated covenants with our lender and is discussedhere as part of the disclosure of our covenant obligations. The RevolvingFacility includes other covenants and events of default that are customary forsimilar facilities. It is an event of default under the Revolving Facility ifwe undergo a change in control. “Change in control,” as defined in theRevolving Facility, means any of the following events: (a) any “person” or“group” (within the meaning of Section 13(d) or 14(d) of theExchange Act) has become, directly or indirectly, the “beneficial owner” (asdefined in Rules 13d-3 and 13d-5 under the Exchange Act, except that aperson shall be deemed to have “beneficial ownership” of all such shares thatany such person has the right to acquire, whether such right is exercisableimmediately or only after the passage of time, by way of merger, consolidationor otherwise), of a majority or more of our common stock on a fully-dilutedbasis, after giving effect to the conversion and exercise of all of ouroutstanding warrants, options and other securities (whether or not such securitiesare then currently convertible or exercisable), (b) during any period oftwo consecutive calendar quarters, individuals who at the beginning of suchperiod were members of our Board of Directors cease for any reason toconstitute a majority of the directors then in office unless (i) such newdirectors were elected by a majority of our directors who constituted the Boardof Directors at the beginning of such period (or by directors so elected) or (ii) thereason for such directors failing to constitute a majority is a result ofretirement by directors due to age, death or disability, or (c) we ceaseto own directly or indirectly all of the equity interests of each of oursubsidiaries.

 

*Shelf Registration Statement & Offerings*

 

Inthe third quarter of 2007, the SEC declared effective our registrationstatement filed with the SEC that registered securities of up to $500 millionof any combination of debt securities, preferred stock, common stock, warrantsfor debt securities or equity securities of the Company and guarantees of debtsecurities by our subsidiaries. Net proceeds, terms and pricing of the offeringof securities issued under the shelf registration statement will be determinedat the time of the offerings. The shelf registration statement does not provideassurance that we will or could sell any such securities. Our ability toutilize our shelf registration statement for the purpose of issuing, from timeto time, any combination of debt securities, preferred stock, common stock orwarrants for debt securities or

 

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equitysecurities will depend upon, among other things, market conditions and theexistence of investors who wish to purchase our securities at prices acceptableto us.  However, because the aggregatemarket value of our outstanding common stock is less than $75 million, the typeand amount of any securities offering under the registration statement may belimited.

 

*Convertible Preferred Stock*

 

Wecompleted the public offering of 2,875,000 shares of 5.75% Series Acumulative convertible perpetual preferred stock (“Convertible Preferred Stock”)in January 2007.

 

*Dividends*.  The Convertible PreferredStock accumulates dividends at a rate of $2.875 for each share of ConvertiblePreferred Stock per year. Dividends are cumulative from the date of firstissuance and, to the extent payment of dividends is not prohibited by our debtagreements, assets are legally available to pay dividends and our Board ofDirectors or an authorized committee of our board declares a dividend payable,we will pay dividends in cash, every quarter. The first payment was made on April 15, 2007.

 

Nodividends or other distributions (other than a dividend payable solely inshares of a like or junior ranking) may be paid or set apart for payment uponany shares ranking equally with the Convertible Preferred Stock (“parity shares”)or shares ranking junior to the Convertible Preferred Stock (“junior shares”),nor may any parity shares or junior shares be redeemed or acquired for anyconsideration by us (except by conversion into or exchange for shares of a likeor junior ranking) unless all accumulated and unpaid dividends have been paidor funds therefor have been set apart on the Convertible Preferred Stock andany parity shares.

 

*Liquidation preference*.  Inthe event of our voluntary or involuntary liquidation, winding-up ordissolution, each holder of Convertible Preferred Stock will be entitled toreceive and to be paid out of our assets available for distribution to ourstockholders, before any payment or distribution is made to holders of juniorstock (including common stock), but after any distribution on any of ourindebtedness or senior stock, a liquidation preference in the amount of $50.00per share of the Convertible Preferred Stock, plus accumulated and unpaiddividends on the shares to the date fixed for liquidation, winding-up ordissolution.

 

*Ranking*.  Our Convertible PreferredStock ranks:

 

·                  senior to all of the shares of our commonstock and to all of our other capital stock issued in the future unless theterms of such capital stock expressly provide that it ranks senior to, or on aparity with, shares of our Convertible Preferred Stock;

 

·                  on a parity with all of our other capitalstock issued in the future, the terms of which expressly provide that it willrank on a parity with the shares of our Convertible Preferred Stock; and

 

·                  junior to all of our existing and future debtobligations and to all shares of our capital stock issued in the future, theterms of which expressly provide that such shares will rank senior to theshares of our Convertible Preferred Stock.

 

*Mandatory conversion*. On or after January 20, 2010, we may,at our option, cause shares of our Convertible Preferred Stock to beautomatically converted to shares of our common stock at the applicableconversion rate, but only if the closing sale price of our common stock for 20trading days within a period of 30 consecutive trading days ending on thetrading day immediately preceding the date we give the conversion notice equalsor exceeds 130% of the conversion price in effect on each such trading day.

 

*Optional redemption*. If fewer than 15% of the shares ofConvertible Preferred Stock issued in the Convertible Preferred Stock offering(including any additional shares issued pursuant to the underwriters’over-allotment option) are outstanding, we may, at any time on or after January 20,2010, at our option, redeem for cash all such Convertible Preferred Stock at aredemption price equal to the liquidation preference of $50.00 plus any accruedand unpaid dividends, if any, on a share of Convertible Preferred Stock to, butexcluding, the redemption date, for each share of Convertible Preferred Stock.

 

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*Conversion rights*. Each share of Convertible Preferred Stockmay be converted at any time, at the option of the holder, into approximately3.0193 shares of our common stock (which is based on an initial conversionprice of $16.56 per share of common stock, subject to adjustment) plus cash inlieu of fractional shares, subject to our right to settle all or a portion ofany such conversion in cash or shares of our common stock. If we elect tosettle all or any portion of our conversion obligation in cash, the conversionvalue and the number of shares of our common stock we will deliver uponconversion (if any) will be based upon a 20 trading day averaging period.

 

Uponany conversion, the holder will not receive any cash payment representingaccumulated and unpaid dividends on the Convertible Preferred Stock, whether ornot in arrears, except in limited circumstances. The conversion rate is equalto $50.00 divided by the conversion price at the time. The conversion price issubject to adjustment upon the occurrence of certain events. The conversionprice on the conversion date and the number of shares of our common stock, asapplicable, to be delivered upon conversion may be adjusted if certain eventsoccur.

 

*Purchase upon fundamental change*. If we become subject to a fundamentalchange (as defined herein), each holder of shares of Convertible PreferredStock will have the right to require us to purchase any or all of its shares ata purchase price equal to 100% of the liquidation preference, plus accumulatedand unpaid dividends, to the date of the purchase. We will have the option topay the purchase price in cash, shares of common stock or a combination of cashand shares. Our ability to purchase all or a portion of the ConvertiblePreferred Stock for cash is subject to our obligation to repay or repurchaseany outstanding debt required to be repaid or repurchased in connection with afundamental change and to any contractual restrictions then contained in ourdebt.

 

*Conversion in connection with a fundamental change*. If a holder elects to convert itsshares of our Convertible Preferred Stock in connection with certainfundamental changes, we will in certain circumstances increase the conversionrate for such Convertible Preferred Stock. Upon a conversion in connection witha fundamental change, the holder will be entitled to receive a cash payment forall accumulated and unpaid dividends.

 

A“fundamental change” will be deemed to have occurred upon the occurrence of anyof the following:

 

1.a “person” or “group” subject to specified exceptions, discloses that theperson or group has become the direct or indirect ultimate “beneficial owner”of our common equity representing more than 50% of the voting power of ourcommon equity other than a filing with a disclosure relating to a transactionwhich complies with the proviso in subsection 2 below;

 

2.consummation of any share exchange, consolidation or merger of us pursuant towhich our common stock will be converted into cash, securities or otherproperty or any sale, lease or other transfer in one transaction or a series oftransactions of all or substantially all of the consolidated assets of us andour subsidiaries, taken as a whole, to any person other than one of oursubsidiaries; provided, however, that a transaction where the holders of morethan 50% of all classes of our common equity immediately prior to thetransaction own, directly or indirectly, more than 50% of all classes of commonequity of the continuing or surviving corporation or transferee immediatelyafter the event shall not be a fundamental change;

 

3.we are liquidated or dissolved or holders of our capital stock approve any planor proposal for our liquidation or dissolution; or

 

4.our common stock is neither listed on a national securities exchange nor listednor approved for quotation on an over-the-counter market in the United States.

 

However,a fundamental change will not be deemed to have occurred in the case of a shareexchange, merger or consolidation, or in an exchange offer having the resultdescribed in subsection 1 above, if 90% or more of the consideration in theaggregate paid for common stock (and excluding cash payments for fractionalshares and cash payments pursuant to dissenters’ appraisal rights) in the shareexchange, merger or consolidation or exchange offer consists of common stock ofa United States company traded on a national securities exchange (or which willbe so traded or quoted when issued or exchanged in connection with suchtransaction).

 

*Voting rights*. If we fail to pay dividends for sixquarterly dividend periods (whether or not consecutive) or if we fail to paythe purchase price on the purchase date for the Convertible Preferred Stockfollowing a fundamental change, holders of our Convertible Preferred Stock willhave voting rights to elect two directors to our board.

 

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Inaddition, we may generally not, without the approval of the holders of at least66 2/3% of the shares of our Convertible Preferred Stock then outstanding:

 

**·**                 amend our restated certificate ofincorporation, as amended, by merger or otherwise, if the amendment would alteror change the powers, preferences, privileges or rights of the holders ofshares of our Convertible Preferred Stock so as to adversely affect them;

 

·                  issue, authorize or increase the authorizedamount of, or issue or authorize any obligation or security convertible into orevidencing a right to purchase, any senior stock; or

 

·                  reclassify any of our authorized stock intoany senior stock of any class, or any obligation or security convertible intoor evidencing a right to purchase any senior stock.

 

*Off Balance Sheet Arrangements*

 

We currently do not have any off balance sheet arrangements.

 

*Contractual Cash Obligations*

 

During 2007, we executed a gas gathering and compression servicesagreement with Frontier Midstream, LLC (“Frontier”). Following execution ofsuch agreement, Frontier expedited the installation of the Rose Bud system inWhite County, Arkansas, including the high and low pressure gathering lines,dehydration, compression and the interconnect with Ozark, in order toaccommodate our desire to be able to deliver natural gas as soon as our wellswere completed. At the time of signing the contract, we had completed andtested two productive wells in the Moorefield shale in Arkansas. The Rose Budsystem was installed, operational and ready to receive our production in June 2007.The contract minimum commitment to Frontier is 2.7 Bcf over a three year periodfor the pipeline interconnect. This line carries a $0.29 per Mcf deficiencyrate, for a total commitment for the pipeline of approximately $0.8 million. Wehave delivered approximately $59,100 of this commitment through September 30,2008. In addition to the pipeline, Frontier also built and installed lateralgathering lines to eight locations. The remaining commitment on these lateralsis approximately $1.3 million. The original total potential liability ofapproximately $2.0 million is to be paid by June 2010 if the minimumvolumes are not delivered. We currently have not recorded a liability for thesecommitments. We are taking steps aimed at increasing our production in thisarea, but if we are unable to do so and if we were to cease efforts to developthe area, we may not be able to meet the minimum physical delivery based onestimated future production and thus would record a liability for the remainingamount of the commitment.

 

**Fair Value Measurements**

 

EffectiveJanuary 1, 2008, we partially adopted SFAS No. 157, *Fair Value Measurements* which provides acommon definition of fair value, establishes a framework for measuring fairvalue and expands disclosures about fair value measurements, but does notrequire any new fair value measurements. The partial adoption of SFAS No. 157had no impact on our financial statements, but it did result in additionalrequired disclosures as set forth in Note 9 to our consolidated financialstatements. In February 2008, the FASB issued FSP 157-2, *Effective Date of FASB Statement No. 157*,which delays the effective date of SFAS No. 157 for all non-financialassets and non-financial liabilities, except those that are recognized ordisclosed at fair value in the financial statements on a recurring basis (atleast annually). Accordingly, we have not yet applied the provisions of SFAS No. 157to our AROs.

 

SFASNo. 157 defines fair value as the price that would be received to sell anasset or transfer a liability in an orderly transaction between marketparticipants at the measurement date. Currently the only fair valuemeasurements we utilize are related to our AROs and derivative instruments.While our derivative instruments are executed in liquid markets where pricetransparency exists, we are not involved in the monthly calculation of fairvalue. We utilize valuations provided by our counterparties, which includeinputs such as commodity exchange prices, over-the-counter quotes, volatility,historical correlations of pricing data and LIBOR and other liquid money marketinstrument rates. Our counterparties utilize internally developed basis curvesthat incorporate observable and unobservable market data. Although we believethese valuations are the best estimates of the fair value of the derivativecontracts we have executed, the ultimate market prices realized could differfrom these estimates, and the differences could be material.

 

SFASNo. 157 establishes a fair value hierarchy that prioritizes the inputs tovaluation techniques used to measure fair value based on observable andunobservable data and categorizes the inputs into three levels, with thehighest priority given to Level 1 and the lowest priority given to Level 3. Thethree levels of the fair value hierarchy defined by SFAS No. 157 are asfollows:

 

·                  Level 1 – Inputs are unadjusted, quoted prices in active markets for identicalassets or liabilities.

 

·                  Level 2 – Significant observable pricing inputs other than quoted pricesincluded within Level 1 that are either directly or indirectly observable as ofthe reporting date. Essentially, inputs that are derived principally from orcorroborated by observable market data.

 

·                  Level 3 – Generally, inputs are unobservable, developed based on the bestinformation available and reflect management’s best estimate of what marketparticipants would use in pricing the asset or liability at the measurementdate.

 

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Determiningthe appropriate classification of our fair value measurements within the fairvalue hierarchy requires management’s judgment regarding the degree to whichmarket data is observable or corroborated by observable marketdata. Currently we have categorized derivative instruments’ fair valuemeasurements as Level 3 and expect to categorize our AROs’ fair valuemeasurements as Level 3 upon full adoption of SFAS No. 157. Asinterpretations of SFAS No. 157 evolve, our classification of certaininstruments within the hierarchy may be revised. See “Critical AccountingPolicies and Estimates — Derivative and Hedging Activities” above, “RiskManagement Activities” below and Note 8 to our consolidated financialstatements for additional discussion of our derivative instruments.

 

Inconjunction with the adoption of SFAS No. 157, we also adopted SFAS No. 159,*The Fair Value Option for Financial Assetsand Financial Liabilities – Including an Amendment of FASB Statement No. 115,*effective January 1, 2008. SFAS No. 159 allows a companythe option to value its financial assets and liabilities, on an instrument byinstrument basis, at fair value, and include the change in fair value of suchassets and liabilities in its results of operations. The Company did not electto apply the provisions of SFAS No. 159 to any of its financial assets orliabilities. Accordingly, there was no impact to the Company’s financialstatements resulting from the adoption of SFAS No. 159.

 

**Risk Management Activities**

 

Dueto the volatility of oil and natural gas prices, we may enter into, from timeto time, price-risk management transactions (e.g., swaps, collars and floors)related to our expected oil and natural gas production to seek to achieve amore predictable cash flow, as well as to reduce exposure to commodity pricefluctuations.  While the use of thesearrangements may limit our ability to benefit from increases in the prices ofoil and natural gas, it is also intended to reduce our potential exposure toadverse price movements.  See “Approachto the Business” for a discussion of our current level of derivative contractsas it relates to expected production. Our arrangements, to the extent we enterinto any, are intended to apply to only a portion of our expected production,and thereby provide only partial price protection against declines in oil andnatural gas prices. None of these instruments were, at the time of theirexecution, intended to be used for trading or speculative purposes, but may bedeemed as such because of the expected decrease in our anticipated 2008production. The use of derivative instruments involves some credit risk, butgenerally we place our derivative transactions with major financialinstitutions that we believe are financially stable; however, in light of therecent global financial crisis, there can be no assurance of theforegoing.  On a quarterly basis, ourmanagement sets all of our price-risk management policies, including volumes,types of instruments and counterparties. Our Board of Directors monitors the Company’s price-risk managementpolicies and trades on a monthly basis.

 

Allof these price-risk management transactions are considered derivative instrumentsand accounted for in accordance with SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*(as amended). These derivative instruments are intendedto hedge our price risk and may be considered hedges for economic purposes.There are two types of accounting treatments for derivatives, (i) mark-to-marketaccounting and (ii) cash flow hedge accounting. For discussion of theseaccounting treatments, see Note 8 to our consolidated financial statements. Wecurrently apply mark-to-market accounting treatment to all of our derivativecontracts. All derivatives are recorded on the balance sheet at fair value andthe changes in fair value are presented in total revenue on the statement ofoperations. Cash flows from resulting derivative settlements are included inoperating activities and investing activities on the statement of cash flows.The following table provides additional information regarding our variousderivative transactions that were recorded at fair value on the balance sheet asof September 30, 2008.

 
| ** **                                                                              | ** ** | **(in thousands)** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of contracts outstanding at  December 31, 2007                          |       | $                       | (12,329    | ) |
| Contracts realized or otherwise settled  during the period                              |       | (30,854                 | )          |
| Fair value at September 30, 2008 of  new contracts entered into during 2008:       |       |                    |       |
| Asset                                                                                   |       | —                  |       |
| Liability                                                                               |       | (187                    | )          |
| Changes in fair values attributable to  changes in valuation techniques and assumptions |       | —                  |       |
| Other changes in fair values                                                            |       | 39,444                  |       |
| Fair values of contracts outstanding at  September 30, 2008                        |       | $                       | (3,926     | ) |

 

 

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Thefollowing table details the fair value of our commodity-based derivativecontracts by year of maturity and valuation methodology as of September 30,2008.

 
| ** **                                           | ** ** | **Fair Value of Contracts at September 30, 2008** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| **Source of Fair Value**              | ** ** | **Maturity less  than 1 year**                                        | ** ** | **Maturity  1-3 years** | ** ** | **Maturity  4-5 years** | ** ** | **Maturity in  excess of 5  years** | ** ** | **Total fair  value** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                                              | ** ** |
| Prices actively quoted:                              |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Prices provided by other external sources:           |       |                                                                                 |       |   |   |   |   |   |   |   |   |
| Asset                                                |       | 181                                                                                  |       | — |   | — |   | — |   | 181 |   |
| Liability                                            |       | (3,577                                                                               | )          | (530 | ) | — |   | — |   | (4,107 | ) |
| Prices based on models and other valuation  methods: |       | —                                                                               |       | — |   | — |   | — |   | — |   |
| Total                                                |       | $                                                                                    | (3,396     | ) | $ | (530 | ) | $ | — |   | $ | — |   | $ | (3,926 | ) |
|                                                      |            |                                                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Tax Matters**

 

AtSeptember 30, 2008, we had cumulative net operating loss carryforwards (“NOLs”)for federal income tax purposes of approximately $146.8 million that expirebeginning in 2012. We also had state NOL carryforwards at September 30,2008 of approximately $21.3 million, without consideration of valuationallowances, which will expire in varying amounts between 2008 and 2027. Theseestimated NOLs assume that certain items, primarily intangible drilling costs,have been written off for tax purposes in the current year. However, we havenot made a final determination if an election will be made to capitalize all orpart of these items for tax purposes in the future. Our ability to utilizefederal NOL carryforwards in cases where the NOL was acquired in areorganization may be subject to limitations under Section 382 of theInternal Revenue Code of 1986, as amended (“Section 382”) if we undergo amajority ownership change as defined by Section 382.

 

Wewould undergo a majority ownership change if, among other things, thestockholders who own or have owned, directly or indirectly, five percent ormore of our common stock or are otherwise treated as five percent stockholdersunder Section 382 and the regulations promulgated thereunder, increasetheir aggregate percentage ownership of our stock by more than 50 percentagepoints over the lowest percentage of stock owned by these stockholders at anytime during the testing period, which is generally the three-year periodpreceding the potential ownership change. In the event of a majority ownershipchange, Section 382 imposes an annual limitation on the amount of taxableincome a corporation may offset with the NOL carryforwards. Any unused annuallimitation may be carried over to later years until the applicable expirationof the respective NOL carryforwards. The amount of the limitation may, undercertain circumstances, be increased by built-in gains held by us at the time ofthe change that are recognized in the five year period after the change. Anybuilt in losses on assets held subsequent to a merger are subject to thelimitation.  If we were to undergo amajority ownership change during 2008, we will likely be required to record areserve for some or all of the asset currently recorded on our balance sheet.During 2007, we believe that there was a change of ownership pursuant to Section 382as a result of the concurrent public offerings of our common and preferredstock that occurred in January 2007. The 2007 limitation did not result inthe requirement to record a reserve.  Wecannot make assurances that we will not undergo a majority ownership change inthe future because an ownership change for federal tax purposes can occur basedon trades among our existing stockholders. Whether we undergo a majorityownership change may be a matter beyond our control. However, in light of theproposed merger with Chaparral, we cannot provide any assurance that theavailability of our NOL carryforward and other federal income tax attributeswill not be significantly limited or possibly eliminated.

 

In 2007, we adopted FIN 48, which clarifies the accounting foruncertainty in income taxes recognized in accordance with SFAS No. 109,*Accounting for Income Taxes*.   As a result of the adoption of FIN 48 on January 1,2007, we recognized a liability of approximately $0.5 million which reduced theJanuary 1, 2007 retained earnings balance. The amount recorded did not include interest as the anticipatedadjustments more likely than not will result in no current tax due as a resultof NOL carryovers.  All of the amounts ofunrecognized tax benefits reported affect the effective tax rate throughdeferred tax accounting. We also adopted FSP FIN 48-1 during 2007, whichprovides that a company’s tax position will be considered settled if the taxingauthority has completed its examination, the company does not plan to appeal,and it is remote that the taxing authority would reexamine the tax position inthe future. We had no accrued liabilities prior to adoption at January 1,2007. We recognize interest and penalties related 

 

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to unrecognized tax benefits in tax expense as a period cost. However,we accrued no interest or penalties at September 30, 2008.

 

During second quarter 2008 an income tax benefit of approximately $0.4million was recorded as a result of the conclusion of a state audit where noprior benefit was taken for an uncertain tax position, which is now effectivelysettled without adjustment by the state tax authorities.

 

**Recently Issued Accounting Pronouncements**

 

InDecember 2007, the FASB issued SFAS No. 141R, *Business Combinations* (“SFAS No. 141R”).SFAS No. 141R expands the definition of transactions and events thatqualify as business combinations; requires that the acquired assets andliabilities, including contingencies, be recorded at the fair value determinedon the acquisition date and changes thereafter reflected in earnings, notgoodwill; changes the recognition timing for restructuring costs; and requiresacquisition costs to be expensed as incurred. Adoption of SFAS No. 141R isrequired prospectively for business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008. Early adoption and retroactive application ofSFAS No. 141R to fiscal years preceding the effective date are notpermitted. However, accounting for changes in valuation allowances for acquireddeferred tax assets and the resolution of uncertain tax positions for priorbusiness combinations will impact tax expense instead of impacting the priorbusiness combination accounting starting January 1, 2009. We are currentlyevaluating the changes provided in SFAS No. 141R and believe it could havea material impact on our consolidated financial statements if we were toundertake a significant acquisition or business combination.

 

*** ***In December 2007, the FASB issued SFAS No. 160, *Noncontrolling Interest in Consolidated FinancialStatements*(“SFAS No. 160”). SFAS No. 160 re-characterizesminority interests in consolidated subsidiaries as non-controlling interestsand requires the classification of minority interests as a component of equity.Under SFAS No. 160, a change in control will be measured at fair value,with any gain or loss recognized in earnings. The effective date for SFAS No. 160is for annual periods beginning on or after December 15, 2008. Earlyadoption and retroactive application of SFAS No. 160 to fiscal yearspreceding the effective date are not permitted. We currently do not expectadoption of this statement to have an impact on our consolidated financialstatements.

 

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments andHedging Activities – an amendment of FASB Statement No. 133*(“SFASNo. 161”). SFAS No. 161 requires entities to provide enhanceddisclosures about (a) how and why an entity uses derivative instruments, (b) howderivative instruments and related hedged items are accounted for under SFAS No. 133and its related interpretations, and (c) how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance, and cash flows. SFAS No. 161 is effective for annual periodsbeginning on or after November 15, 2008. Early application of SFAS No. 161is encouraged, as are comparative disclosures for earlier periods at initialadoption. We will adopt SFAS No. 161 on January 1, 2009 and do notexpect adoption of this statement to impact our consolidated financialstatements, but we do expect it to impact disclosures made in our futurequarterly and annual filings.

 

In May 2008, the FASB issued SFAS No. 162,*The Hierarchy of Generally AcceptedAccounting Principles*(“SFAS No. 162”), which identifies thesources of accounting principles and the framework for selecting the principlesused in the preparation of financial statements of nongovernmental entitiesthat are presented in conformity with generally accepted accounting principles(“GAAP”) in the United States of America (the “GAAP hierarchy”).  SFAS No. 162 is effective on November 15, 2008, which is 60 daysfollowing the SEC’s approval of Public Company Accounting Oversight Boardamendments to AU Section 411, *TheMeaning of Present Fairly in Conformity With Generally Accepted AccountingPrinciples*. We do not expect adoption of this statement to impactour consolidated financial statements or related disclosures.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Weare exposed to market risk from changes in interest rates and commodityprices.  We use a Revolving Facility witha floating interest rate. We are not subject to fair value risk resulting fromchanges in our floating

 

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interestrates.  The use of floating rate debtinstruments provides a benefit due to downward interest rate movements but doesnot limit us to exposure from future increases in interest rates.  Based on the September 30, 2008outstanding borrowings and interest rates of 5.50% and 5.19% applied to variousborrowings, a 10% change in interest rates would result in an increase ordecrease of interest expense of approximately $1.2 million on an annual basis.

 

Inthe normal course of business, we enter into derivative transactions, includingcommodity price collars, swaps and floors to mitigate our exposure to commodityprice movements. They are not intended for trading or speculativepurposes.  While the use of thesearrangements may limit the benefit to us of increases in the prices of oil andnatural gas, it also limits the downside risk of adverse price movements.  During early 2007, we put in place severalnatural gas and crude oil derivative contracts to hedge our expected 2008 and2009 production to achieve a more predictable cash flow. As a result of recentchanges to our forecasted 2008 production and the impact of certain assetdivestitures, both of which have reduced expected production as compared tothat expected at the time we entered into the derivative contracts, wecurrently have approximately 110% and 160% of our anticipated 2008 natural gasand crude oil production, respectively, covered by derivative contracts. Thisoverhedged position has exposed us to greater risk of commodity price increasesbecause at times we have not had the physical production cash inflows to offsetthe losses incurred on the portion of the contracts that were overhedged.Please refer to Note 8 to our consolidated financial statements for adiscussion of these contracts. The following is a list of contracts outstandingat September 30, 2008:

 
| **Transaction Date**        | ** ** | **Transaction  Type** | ** ** | **Beginning** | ** ** | **Ending** | ** ** | **Price  Per Unit** | ** ** | **Volumes Per  Day** | ** ** | **Fair Value  Outstanding as of  September 30, 2008** | ** ** |
|----------------------------------|------------|-----------------------|------------|---------------|------------|------------|------------|--------------------------|------------|---------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | ** **            | ** ** | ** **    | ** ** | ** ** | ** ** | ** **               | ** ** | ** **                | ** ** | **(in thousands)**                                                        | ** ** |
| ***Natural Gas (1):*** | ** ** | ** **            | ** ** | ** **    | ** ** | ** ** | ** ** | ** **               | ** ** | ** **                | ** ** | ** **                                                                     | ** ** |
| 01/07                            |       | Collar                |       | 01/01/08      |       | 12/31/08   |       | $7.50-$9.00              |       | 20,000 MMBtu              |       | $                                                                              | 375        |   |
| 01/07                            |       | Collar                |       | 01/01/08      |       | 12/31/08   |       | $7.50-$9.00              |       | 10,000 MMBtu              |       | 181                                                                            |       |
| 01/07                            |       | Collar                |       | 01/01/08      |       | 12/31/08   |       | $7.50-$9.02              |       | 10,000 MMBtu              |       | 179                                                                            |       |
| 09/08                            |       | Collar                | (2)        | 10/01/08      |       | 12/31/08   |       | $9.00-$7.50              |       | 10,000 MMBtu              |       | (187                                                                           | )          |
| 04/07                            |       | Collar                |       | 01/01/09      |       | 12/31/09   |       | $7.75-$10.00             |       | 10,000 MMBtu              |       | 984                                                                            |       |
| 10/07                            |       | Collar                |       | 01/01/09      |       | 12/31/09   |       | $7.75-$10.08             |       | 10,000 MMBtu              |       | 1,033                                                                          |       |
|                             |       |                  |       |          |       |       |       |                     |       |                      |       |                                                                           |       |
| ***Crude Oil (3):***             |       |                  |       |          |       |       |       |                     |       |                      |       |                                                                           |       |
| 12/06                            |       | Swap                  |       | 01/01/08      |       | 12/31/08   |       | $66.00                   |       | 1,500 Bbl                 |       | (4,723                                                                         | )          |
| 10/07                            |       | Collar                |       | 01/01/09      |       | 12/31/09   |       | $70.00-$93.55            |       | 300 Bbl                   |       | (1,768                                                                         | )          |
|                             |       |                  |       |          |       |       |       |                     |       |                      |       | $                                                                              | (3,926)    |   |

 

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(1)   Our natural gas contracts were entered intoon a per MMBtu delivered price basis, using the NYMEX Natural Gas Index.Mark-to-market accounting treatment is applied to these contracts and thechange in fair value is reflected in total revenue.

 

(2)   This contract was entered as a reverse collarwith the intent to reduce our overhedge exposure on natural gas.

 

(3)   Our crude oil contracts were entered into ona per barrel delivered price basis, using the West Texas Intermediate LightSweet Crude Oil Index. Mark-to-market accounting treatment is applied to thesecontracts and the change in fair value is reflected in total revenue.

 

AtSeptember 30, 2008, the fair value of the outstanding derivatives was anet liability of approximately $3.9 million. A 10% change in the commodityprice per unit, as long as the price is either above the ceiling or below thefloor price, would cause the fair value total of the derivative instruments toincrease or decrease by approximately $0.9 million.

 

Subsequent to September 30, 2008, the Company entered into a newcrude oil swap derivative for 800 Bbl per day for November and December 2008production at $65.75 per Bbl. This contract is a reverse swap intended tooffset a portion of the volumes that are currently overhedged by the crude oilswap already in place and thereby reduce the Company’s exposure to significantincreases in crude oil prices.

 

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##### **ITEM 4.CONTROLS AND PROCEDURES**

#####  

Inaccordance with Exchange Act Rules 13a-15 and 15d-15, we carried out anevaluation, under the supervision and with the participation of management,including our Chief Executive Officer and Acting Chief Financial Officer, ofthe effectiveness of our disclosure controls and procedures as of the end ofthe period covered by this report.  Basedon that evaluation, our Chief Executive Officer and Acting Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof September 30, 2008 to provide reasonable assurance that informationrequired to be disclosed in our reports filed or submitted under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms.

 

Therehas been no change in our internal controls over financial reporting thatoccurred during the three months ended September 30, 2008 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrols over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 1 -Legal Proceedings**

 

Fromtime to time we are a party to various legal proceedings arising in theordinary course of our business.  Whilethe outcome of lawsuits cannot be predicted with certainty, we are notcurrently a party to any proceeding that we believe, if determined in a manneradverse to us, could have a material adverse effect on our financial condition,results of operations or cash flows, except as set forth below.

 

**David Blake, et al. v. Edge Petroleum Corporation** — On September 19, 2005, David Blakeand David Blake, Trustee of the David and Nita Blake 1992 Children’s Trust,filed suit against us in state district court in Goliad County, Texas allegingbreach of contract for failure and refusal to transfer overriding royaltyinterests to plaintiffs in several leases in the Nita and Austin prospects inGoliad County, Texas and failure and refusal to pay monies to Blake pursuant tosuch overriding royalty interests for wells completed on the leases. Theplaintiffs seek relief of (1) specific performance of the allegedagreement, including granting of overriding royalty interests by us to Blake; (2) monetarydamages for failure to grant the overriding royalty interests; (3) exemplarydamages for his claims of business disparagement and slander; (4) monetarydamages for tortious interference; and (5) attorneys’ fees and courtcosts. Venue of the case was transferred to Harris County, Texas by agreementof the litigants.  We filed acounterclaim against Plaintiff Blake and joined various related entities thatare controlled by Blake, seeking lease interests in which we contend we had beenwrongfully denied participation. The parties have moved for summary judgment oneach others’ claims and counterclaims, which the trial court has denied as toboth sides.  In November 2007, wefiled a separate motion for summary judgment based on the statute of frauds;the court has not ruled on this separate motion.  The trial, originally scheduled to begin September 10,2007, has been reset several times, and most recently has been reset for December 8,2008. Extensive written discovery has occurred in the case, and the parties areengaging in fact and expert witness depositions.  In June 2008, the Blake Plaintiffs fileda Sixth Amended Petition conditionally adding claims for certain prospects thathad been previously settled by means of a Compromise and Settlement Agreement(the “Settlement Agreement”), entered in settlement of prior litigation amongsome of the parties, but only to the extent that rescission of the priorSettlement Agreement was being sought by us. We are not seeking rescission ofthe prior Settlement Agreement and responded accordingly in our Fourth AmendedOriginal Counterclaim and Claims Against Additional Parties filed on October 16,2008.  On October 17, 2008, theBlake Plaintiffs filed their Seventh Amended Petition adding a claim for breachof the Settlement Agreement.  We haveresponded and will continue to respond aggressively to this lawsuit, andbelieve we have meritorious defenses and counterclaims.

 

**Diana Reyes, et al. v. Edge Petroleum OperatingCompany, Inc., et al.** - On January 8, 2008, we were served with a wrongful death actionfiled in Hidalgo County, Texas. Plaintiffs allege negligence and gross negligence resulting from afatality accident at the Slick State B-12 well site, on our Bloomberg Floreslease in Starr County, Texas.  Theplaintiffs are the widow and minor children of Mr. Reyes, who was killedin a one-car fatality accident on August 5, 2007.   Mr. Reyes was an employee of PayzoneLogging, a vendor of ours.   In September 2008,the defendants in this case, including us, reached a settlement with theplaintiffs in the amount of $175,000, all of which was paid by third partyinsurance.  Neither we nor our insurancecarrier were required to contribute to the settlement pool.  Pending court approval of the settlement,this matter will be dismissed.

 

**Lexington Insurance Company v. Edge PetroleumExploration Company, et al.** - On March 13, 2008, Lexington Insurance Company (“Lexington”)filed a declaratory judgment action in the 125th Judicial DistrictCourt of Harris County, Texas.  Lexingtonsought a judgment that it was not obligated to pay any claims of ours and theSfondrini Partnerships (as defined below) in connection with a consolidatedsuit that we and the Sfondrini Partnerships settled with all of the plaintiffsin 2007.  The suit that was settled,** **Wade and Joyce Montet, et al., v.Edge Petroleum Corp of Texas, et al., consolidated with Rolland L. Broussard,et al., v. Edge Petroleum Corp of Texas, et al., and the settlementthereof, is described in detail in “Item 3. Legal Proceedings” of our AnnualReport on Form 10-K for the year ended December 31, 2007. In general,the action was a consolidated suit by mineral/royalty owners under two wells,who claimed that the third party operator of the wells had failed to “blocksqueeze” the sections of one of the wells, as a prudent operator, according totheir allegations, would have done, to protect the gas reservoir from beingflooded with water from adjacent underground formations, and was negligent in

 

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notcreating a field-wide unit to protect their interests.  Along with the Sfondrini Partnerships, wewere defendants in the suit as a working interest owner in the wells, owning2.8% and 14.7%, respectively, at the time of the alleged acts oromissions.  In the case of thesettlements with some, but not all, of the plaintiffs, two other insurerscovered the settlement amounts in exchange for mutual releases. We and theSfondrini Partnerships bore the costs of the settlements with the remainingplaintiffs in accordance with their proportionate interests.  The Sfondrini Partnerships are partnershipsthat are directly or indirectly controlled by John Sfondrini, a director ofours.  Vincent Andrews, also a directorof ours, owns a minority interest in the corporate general partner of one ofthe partnerships.

 

Lexingtonasserted that it is not obligated to pay any claims of ours and the SfondriniPartnerships under its commercial, general liability insurance policy asrelated to the lawsuit that was settled because there was no “occurrence,”under the terms of their policy, of physical injury to or destruction oftangible property and other reasons. Our position was that the damages to thereservoir and attendant losses incurred by the defendants were losses coveredby Lexington’s policy, for which Lexington was legally obligated to pay. Byagreement of the parties, an answer was due 30 days from notice of termination ofsettlement discussions.

 

InJune 2008, we and the Sfondrini Partnerships reached a settlement withLexington pursuant to which Lexington would pay us and the SfondriniPartnerships $75,000 (proportionate to their interests in the underlyingmineral leases that were the subject of the prior action) in return for acomplete release.  All parties haveexecuted the release and the case was dismissed on September 8, 2008.

 

**Mary Jane Carol Trahan Champagne, et al. v. EdgePetroleum Exploration Company, et al.** — On September 19, 2008 we were servedwith a lawsuit in state court in Vermilion Parish, Louisiana alleging breach ofobligations under mineral leases in Vermilion Parish regarding the Trahan No. 1well and the Trahan No. 3 well (MT RC SUB reservoir).  Plaintiffs are seeking unspecified damagesfor lost revenue, lost royalties and devaluation of property interest sustainedas a result of the defendants’ alleged negligent and improper drillingoperations on the Trahan No. 1 well and the Trahan No. 3 well, includingalleged failure to prevent underground water from flooding and destroyingplaintiffs’ portion of the reservoir beneath plaintiffs’ property.  Plaintiffs also allege defendants failed to “blocksqueeze” sections of the Trahan No. 3 well as would a prudent operator.This lawsuit has been removed from the state court to the federal districtcourt for the Western District of Louisiana, Lafayette Division.  We may have insurance for all or part of thisclaim. We have not established a reserve with respect to this claim and it isnot possible to determine what, if any, our ultimate exposure might be in thismatter.  We intend to vigorously defendourselves in this lawsuit.

 

 **Item 1A – Risk Factors**

 

Inaddition to the other information and risk factors set forth in this report,you should carefully consider the factors discussed in Part I, “Item 1A.Risk Factors” in our 2007 Annual Report on Form 10-K, which couldmaterially affect our business, financial condition or future results. Therisks described below and in our 2007 Annual Report on Form 10-K andQuarterly Report on Form 10-Q for the period ended June 30, 2008 arenot the only risks facing our Company. Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

 

**Economic conditions could negatively impact our business.**

 

Ouroperations are affected by local, national and worldwide economic conditions.The consequences of a recession may include a lower level of economic activityand uncertainty regarding energy prices and the capital and commoditymarkets.  A lower level of economic activity might result in a decline inenergy consumption, which may adversely affect our revenue, liquidity andfuture growth.  Instability in the financial markets, as a result ofrecession or otherwise, also may affect the cost of capital and our ability toraise capital, if needed, and Chaparral’s ability to raise capital to completethe pending merger. The events discussed above, together with our liquiditylevel and our recent financial performance, increase the likelihood that wewould become highly vulnerable to further adverse general economic consequencesand industry conditions and that our cash flow and financial condition may bematerially adversely affected as a result thereof.  See “—We have limited available borrowingcapacity under our

 

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RevolvingFacility, and it may be difficult to access capital on attractive terms or atall, which could significantly limit our ability to fund our operations andcould have a material adverse effect on us if the proposed merger withChaparral is not completed.”

 

Inaddition, the instability and uncertainty in the financial markets has made itdifficult to assess the risk of counterparties to current and future financingarrangements, investments, derivative contracts and other contracts.  The financial markets and U.S. economy havealtered the ability and willingness of certain financial institutions toperform their obligations under certain financial arrangements.  Reduced liquidity or financial lossesresulting from exposure to the risk of counterparties could have a materialadverse effect on our cash flow and financial condition.

 

Theeconomic situation could also have an impact on our customers and suppliers,causing them to fail to meet their obligations to us, and on our operatingpartners, resulting in delays in operations or failure to make requiredpayments. Additionally, the current economic situation could lead to reduceddemand for natural gas and oil, or further reductions in the prices of naturalgas and oil, or both, which could have a negative impact on our financialposition, results of operations and cash flows. While the ultimate outcome and impact of the current financial crisiscannot be predicted, it may have a material adverse effect on our futureliquidity and financial condition.

 

**The loss of key personnel could adversely affect us.**

 

Wedepend to a large extent on the services of certain key management personnel,including our executive officers and other key employees, the loss of any ofwhich could have a material adverse effect on our operations.  Currently there is a strong demand forprofessionals in the oil and natural gas industry including geologists,geophysicists, engineers and other professionals.  We believe that our success is dependent uponour ability to continue to employ and retain skilled technical personnel,however, current market conditions for professionals as well as uncertaintyrelating to the outcome of the pending merger with Chaparral, or the failure ofChaparral to offer post-merger employment to specified employees, has resultedin the departure of employees. Although we believe that we have thus farobtained replacements adequate for our current needs, the cumulative effect ofthese employee departures with additional departures could materially adverselyaffect us.

 

**We have limited available borrowing capacity under ourRevolving Facility, and it may be difficult to access capital on attractiveterms or at all, which could significantly limit our ability to fund ouroperations and could have a material adverse effect on us if the proposedmerger with Chaparral is not completed.**

 

Althoughour available borrowing capacity under the Revolving Facility was $11 millionat September 30, 2008, it was effectively reduced to $1 million on November 5,2008 and may be eliminated for the near future as a result of the upcomingborrowing base redetermination. The Revolving Facility is expected to berefinanced by Chaparral contemporaneously with the closing of the proposedmerger, but if the proposed merger is not completed and we continue on astandalone basis, we may be required to repay any borrowing base deficiency andeven upon the satisfaction of such deficiency, the resulting borrowing baseavailability may not be sufficient for our liquidity needs. Our businessrequires substantial working capital needs to fund ongoing exploration,development and acquisition programs, and our financial condition is dependent,at least in part, upon our ability to access capital at rates and on terms wedetermine to be attractive.  Currently,we anticipate that, if sources of liquidity become available, the terms andconditions of any financing may be significantly more onerous than our currentarrangements.  In addition, thesignificant declines in the prices of our stock have made it even moredifficult for us to effectively raise liquidity by accessing the equitymarkets. Further sales of producing properties may reduce our ability to borrowand to benefit from any future cash flow attributable to those properties. Ifour operations do not provide the liquidity required to operate our business,our drilling and other activities may be further curtailed, our cash flow andfinancial condition would be materially adversely affected and we would becomehighly vulnerable to further adverse general economic consequences and industryconditions.

 

**The condition to the proposed merger that certain Chaparralshares must be listed for trading on the New York Stock Exchange has not been met.**

 

Itis a condition to the consummation of the proposed merger (the “NYSE condition”)that (i) the Chaparral common stock and Chaparral Series A preferredstock issuable to former Edge stockholders of the Company pursuant to themerger agreement, (ii) the shares of Chaparral common stock issuable tothe holders of the Chaparral Series A

 

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preferredstock upon conversion thereof and (iii) the shares of Chaparral commonstock issuable upon exercise of Company options be approved for listing on theNew York Stock Exchange (“NYSE”), subject to official notice of issuance. Theability of Chaparral to meet the NYSE listing standards described above thatare related to the minimum $4.00 per share price and the minimum $60 millionaggregate market value of publicly held shares is a function of the tradingprice of Edge’s common stock. Based on the closing price of Edge common stockon November 7, 2008 of $0.69 per share, the NYSE condition would not bemet, and there can be no assurance that the NYSE condition will ever be met.

 
| **Item 2 - Unregistered Sale of Equity Securities and  Use of Proceeds** |   | None |
|--------------------------------------------------------------------------|--------|------|
| **Item 3 - Defaults Upon Senior Securities**                             |   | None |
| **Item 4 - Submission of Matters to a Vote of Security  Holders**        |   | None |

** **

**Item 5 -Other Information**

 

OnNovember 5, 2008, we entered into a letter agreement withthe Lenders under our Revolving Facility regarding a redetermination ofour borrowing base.  See “Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations—Liquidity and Capital Resources—Revolving Credit Facility” for adescription of the letter agreement, our Revolving Facility and other borrowingbase redeterminations under our Revolving Facility.

 

The abovereferenced description of the letter agreement does not purport to becomplete and is qualified in its entirety by reference to the letteragreement, which is filed as Exhibit 4.11 hereto and is incorporated intothis Quarterly Report on Form 10-Q by reference.

 

**Item 6 -Exhibits**

 

Thefollowing exhibits are filed as part of this report:

 

# **INDEX TO EXHIBITS**

 
| **Exhibit  No.** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              | —     | Amended  and Restated Combination Agreement by and among (i) Edge Group II  Limited Partnership, (ii) Gulfedge Limited Partnership, (iii) Edge  Group Partnership, (iv) Edge Petroleum Corporation, (v) Edge  Mergeco, Inc. and (vi) the Company, dated as of January 13,  1997 (Incorporated by reference from exhibit 2.1 to the Company’s  Registration Statement on Form S-4 (Registration No. 333-17269)). |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.2              | —     | Agreement  and Plan of Merger dated as of May 28, 2003 among Edge Petroleum  Corporation, Edge Delaware Sub Inc. and Miller Exploration Company (“Miller”)  (Incorporated by reference from Annex A to the Joint Proxy  Statement/Prospectus contained in the Company’s Registration Statement on  Form S-4/A filed on October 31, 2003 (Registration  No. 333-106484)).                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.3              | —     | Asset  Purchase Agreement by and among Contango STEP, L.P., Contango Oil &  Gas Company, Edge Petroleum Exploration Company and Edge Petroleum  Corporation, dated as of October 7, 2004 (Incorporated by reference from  exhibit 2.1 to the Company’s Current Report on Form 8-K filed  October 12, 2004).                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 2.4              | —     | Purchase  and Sale Agreement, dated as of September 21, 2005 among Pearl Energy  Partners, Ltd., and Cibola Exploration Partners, L.P., as Sellers; and Edge  Petroleum Exploration Company as Buyer and Edge PetroleumCorporation as  Guarantor (Incorporated by reference from exhibit 2.1 to the Company’s  Current Report on Form 8-K filed October 19, 2005).                                                                                 |
|                  |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |  |

 

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| 2.5    | — | Stock  Purchase Agreement by and among Jon L. Glass, Craig D. Pollard, Leigh T.  Prieto, Yorktown Energy Partners V, L.P., Yorktown Energy Partners VI, L.P.,  Cinco Energy Corporation, and Edge Petroleum Exploration Company and Edge  Petroleum Corporation, dated as of September 21, 2005 (Incorporated by  reference from exhibit 2.5 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended September 30, 2005).                                                                                                |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.6    | — | Letter  Agreement dated November 18, 2005 by and among Edge Petroleum  Exploration Company, Cinco Energy Corporation and Sellers (Incorporated by  reference from exhibit 2.02 to the Company’s Current Report on Form 8-K  filed December 6, 2005). Pursuant to Item 601(b)(2) of Regulation  S-K, the Company had omitted certain Schedules to the Letter Agreement (all  of which are listed therein) from this Exhibit 2.6. It hereby agrees to  furnish a supplemental copy of any such omitted item to the SEC on its  request. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.7    | — | Agreement  and Plan of Merger, dated July 14, 2008, among Chaparral  Energy, Inc., Chaparral Exploration, L.L.C. and Edge Petroleum  Corporation (Incorporated by reference from exhibit 2.1 to the Company’s  Current Report on Form 8-K filed July 15, 2008). Pursuant to Item  601(b)(2) of Regulation S-K, the Company had omitted the disclosure  schedules to the Merger Agreement from this Exhibit 2.1. It hereby  agrees to furnish a supplemental copy of any such omitted item to the SEC on  its request.            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.1    | — | Restated  Certificate of Incorporation of the Company effective January 27, 1997  (Incorporated by reference from exhibit 3.1 to the Company’s Current Report  on Form 8-K filed April 29, 2005).                                                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.2    | — | Certificate  of Amendment to the Restated Certificate of Incorporation of the Company  effective January 31, 1997 (Incorporated by reference from exhibit 3.2  to the Company’s Current Report on Form 8-K filed April 29, 2005).                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.3    | — | Certificate  of Amendment to the Restated Certificate of Incorporation of the Company  effective April 27, 2005 (Incorporated by reference from exhibit 3.3 to  the Company’s Current Report on Form 8-K filed April 29, 2005).                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.4    | — | Bylaws  of the Company (Incorporated by reference from exhibit 3.3 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.5    | — | First  Amendment to Bylaws of the Company on September 28, 1999 (Incorporated  by reference from exhibit 3.2 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended September 30, 1999 (File  No. 000-22149)).                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.6    | — | Second  Amendment to Bylaws of the Company on May 7, 2003 (Incorporated by  reference from exhibit 3.4 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended March 31, 2003 (File  No. 000-22149)).                                                                                                                                                                                                                                                                                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.7    | — | Certificate  of Designations establishing the 5.75% Series A cumulative convertible  perpetual preferred stock, dated January 25, 2007 (Incorporated by  reference to exhibit 3.1 to Edge’s Current Report on Form 8-K filed  January 30, 2007).                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.8    | — | Third  Amendment to Bylaws of Edge Petroleum Corporation on October 21, 2008  (Incorporated by reference to exhibit 3.4 to Edge’s Current Report on  Form 8-K filed October 23, 2008).                                                                                                                                                                                                                                                                                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 4.1    | — | Third  Amended and Restated Credit Agreement dated December 31, 2003 among Edge  Petroleum Corporation, Edge Petroleum Exploration Company, Edge Petroleum  Operating Company, Inc., Miller Oil Corporation and Miller Exploration  Company, as borrowers, the lenders thereto and Union Bank of California,  N.A., a national banking association, as Agent (Incorporated by reference  from                                                                                                                                                             |

 

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|       |   | Exhibit 4.1  to the Company’s Quarterly Report on Form 10-Q for the quarterly period  ended March 31, 2004).                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.2        | — | Agreement  and Amendment No. 1 to Third Amended and Restated Credit Agreement dated  May 31, 2005 among Edge Petroleum Corporation, Edge Petroleum  Exploration Company, Edge Petroleum Operating Company, Inc., Miller  Exploration Company and Miller Oil Corporation, as borrowers, the lenders  thereto and Union Bank of California, N.A., a national banking association,  as agent for the lenders (Incorporated by reference from exhibit 4.2 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  June 30, 2005 (File No. 000-22149)). |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.3        | — | Agreement  and Amendment No. 2 to the Third Amended and Restated Credit Agreement  dated November 30, 2005 among Edge Petroleum Corporation, Edge Petroleum  Exploration Company, Edge Petroleum Operating Company, Inc., Miller Oil  Corporation, Miller Exploration Company, and Cinco Energy Corporation, as  borrowers, the lenders thereto and Union Bank of California, N.A., a national  banking association, as Agent (Incorporated by reference from exhibit 4.3 to  the Company’s Annual Report on Form 10-K for the year ended  December 31, 2005).                  |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.4        | — | Miller  Exploration Company Stock Option and Restricted Stock Plan of 1997  (Incorporated by reference from exhibit 10.1(a) to Miller Exploration  Company’s Annual Report on Form 10-K for the year ended  December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                                                                 |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.5        | — | Amendment  No. 1 to the Miller Exploration Company Stock Option and Restricted  Stock Plan of 1997 (Incorporated by reference to Exhibit 4.2 from Miller  Exploration Company’s Registration Statement on Form S-8 filed on  April 11, 2001 (Registration No. 333-58678)).                                                                                                                                                                                                                                                                                                      |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.6        | — | Amendment  No. 2 to the Miller Exploration Company Stock Option and Restricted  Stock Plan of 1997 (Incorporated by reference from Exhibit 4.3 to Miller  Exploration Company’s Registration Statement on Form S-8 filed on  April 11, 2001 (Registration No. 333-58678)).                                                                                                                                                                                                                                                                                                      |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.7        | — | Form of  Miller Stock Option Agreement (Incorporated by reference from exhibit  10.1(b) to Miller Exploration Company’s Annual Report on Form 10-K  for the year ended December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                                                                                                 |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.8        | — | Fourth  Amended and Restated Credit Agreement dated January 31, 2007 by and  among Edge Petroleum Corporation, as borrower, and Union Bank of California,  N.A., as Administrative Agent and Issuing Lender, and the other lenders party  thereto (Incorporated by reference from exhibit 4.1 to Edge’s Current Report  on Form 8-K filed on February 5, 2007).                                                                                                                                                                                                                           |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.9        | — | Amendments  No. 1, 2 and 3 to the Fourth Amended and Restated Credit Agreement dated  January 31, 2007 by and among Edge Petroleum Corporation, as borrower,  and Union Bank of California, N.A., as Administrative Agent and Issuing  Lender, and the other lenders party thereto (Incorporated by reference from  exhibit 4.9 to Edge’s Quarterly Report on Form 10-Q filed on  May 12, 2008).                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.10       | — | Consent,  executed July 11, 2008, among Edge Petroleum Corporation, the Lenders  party thereto and Union Bank of California, N.A., as administrative agent for  such Lenders (Incorporated by reference from exhibit 4.1 to the Company’s  Current Report on Form 8-K filed July 15, 2008).                                                                                                                                                                                                                                                                                               |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| *4.11      | — | Letter  Agreement dated November 5, 2008 by and among Edge Petroleum  Corporation, Union Bank of California, N.A., as Administrative Agent and Issuing  Lender, and the other lenders party thereto.                                                                                                                                                                                                                                                                                                                                                                                                     |
|       |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| †10.1 | — | Form of  Indemnification Agreement between the Company and each of its directors  (Incorporated by reference from exhibit 10.7 to the Company’s Registration  Statement on Form S-4 (Registration No. 333-17269)).                                                                                                                                                                                                                                                                                                                                                                        |

 

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| †10.2  | — | Stock  Option Plan of Edge Petroleum Corporation, a Texas corporation (Incorporated  by reference from exhibit 10.13 to the Company’s Registration Statement on  Form S-4 (Registration No. 333-17269)).                                                                                                                                                     |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.3  | — | Employment  Agreement dated as of November 16, 1998, by and between the Company and  John W. Elias (Incorporated by reference from exhibit 10.12 to the Company’s  Annual Report on Form 10-K for the year ended December 31, 1998  (File No. 000-22149)).                                                                                         |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.4  | — | Amended  and Restated Incentive Plan of Edge Petroleum Corporation as Amended and  Restated Effective as of August 1, 2006 (Incorporated by reference from  exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the six  months ended June 30, 2006).                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.5  | — | Edge  Petroleum Corporation Incentive Plan “Standard Non-Qualified Stock Option  Agreement” by and between Edge Petroleum Corporation and the Officers named  therein (Incorporated by reference from exhibit 10.2 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).  |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.6  | — | Edge  Petroleum Corporation Incentive Plan “Director Non-Qualified Stock Option  Agreement” by and between Edge Petroleum Corporation and the Directors named  therein (Incorporated by reference from exhibit 10.3 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)). |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.7  | — | Severance  Agreements by and between Edge Petroleum Corporation and the Officers of the  Company named therein (Incorporated by reference from exhibit 10.4 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.8  | — | Form of  Director’s Restricted Stock Award Agreement under the Incentive Plan of Edge  Petroleum Corporation (Incorporated by reference from exhibit 10.12 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  June 30, 2004).                                                                                         |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.9  | — | Form of  Employee Restricted Stock Award Agreement under the Incentive Plan of Edge  Petroleum Corporation (Incorporated by reference from exhibit 10.15 to the  Company’s Quarterly Report on Form 10-Q/A for the quarterly period ended  March 31, 1999 (File No. 000-22149)).                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.10 | — | Edge  Petroleum Corporation Amended and Restated Elias Stock Incentive Plan.  (Incorporated by reference from exhibit 4.5 to the Company’s Registration  Statement on Form S-8 filed May 30, 2001 (Registration  No. 333-61890)).                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.11 | — | Form of  Edge Petroleum Corporation John W. Elias Non-Qualified Stock Option Agreement  (Incorporated by reference from exhibit 4.6 to the Company’s Registration  Statement on Form S-8 filed May 30, 2001 (Registration  No. 333-61890)).                                                                                                        |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.12 | — | Summary  of Compensation of Non-Employee Directors (Incorporated by reference from  exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2007).                                                                                                                                                                        |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.13 | — | Salaries  and Certain Other Compensation of Executive Officers (Incorporated by  reference from exhibit 10.13 to the Company’s Annual Report on Form 10-K  for the year ended December 31, 2007).                                                                                                                                                            |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.14 | — | Description  of Annual Cash Bonus Program for Executive Officers (Incorporated by  reference from exhibit 10.2 to the Company’s Current Report on Form 8-K  filed March 12, 2007).                                                                                                                                                                           |
|        |   |                                                                                                                                                                                                                                                                                                                                                                        |
| †10.15 | — | New  Base Salaries and Long-Term Incentive Awards for Certain Executive Officers  (Incorporated by reference from exhibit 10.1 to the Company’s Current Report  on Form 8-K filed August 29, 2006).                                                                                                                                                          |

 

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| 10.16       | — | Purchase  and Sale Agreement between Smith Production, Inc., as seller, and Edge  Petroleum Exploration Company, as purchaser, dated November 16, 2006  (Incorporated by reference to exhibit 10.1 to Edge’s Current Report on  Form 8-K filed January 16, 2007).                    |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.17       | — | Purchase  and Sale Agreement between Smith Production, Inc., as seller, and Edge  Petroleum Exploration Company, as purchaser, dated November 16, 2006  (Incorporated by reference to exhibit 10.2 to Edge’s Current Report on  Form 8-K filed January 16, 2007).                    |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.18       | — | First  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  December 16, 2006 (Incorporated by reference to exhibit 10.3 to Edge’s  Current Report on Form 8-K filed January 16, 2007). |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.19       | — | Second  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  January 15, 2007 (Incorporated by reference to exhibit 10.1 to Edge’s  Current Report on Form 8-K filed January 19, 2007). |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.20       | — | First  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  January 15, 2007 (Incorporated by reference to exhibit 10.2 to Edge’s  Current Report on Form 8-K filed January 19, 2007).  |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.21       | — | Third  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  January 31, 2007 (Incorporated by reference to exhibit 10.6 to Edge’s  Current Report on Form 8-K filed February 5, 2007).  |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.22 | — | New  Base Salaries of Executive Officers (Incorporated by reference from  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed  March 12, 2007).                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.23 | — | Form of  Amended and Restated Severance Agreement dated April 3, 2008, between  the Company and Executive Officers of the Company Named Therein (Incorporated  by reference from exhibit 10.1 to the Company’s Current Report on  Form 8-K filed April 4, 2008).                     |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.24 | — | Amended  and Restated Severance Agreement dated April 3, 2008, between the  Company and John W. Elias (Incorporated by reference from exhibit 10.2 to the  Company’s Current Report on Form 8-K filed April 4, 2008).                                                                     |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.25 | — | Amended  and Restated Employment Agreement dated April 3, 2008, between the  Company and John W. Elias (Incorporated by reference from exhibit 10.3 to the  Company’s Current Report on Form 8-K filed April 4, 2008).                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.26 | — | First  Amendment to Amended and Restated Severance Agreement, dated July 14,  2008, between the Company and John W. Elias (Incorporated by reference from  exhibit 10.1 to the Company’s Current Report on Form 8-K filed  July 15, 2008).                                                |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.27 | — | First  Amendment to Amended and Restated Severance Agreement, dated July 14,  2008, between the Company and Executive Officers of the Company Named Therein  (Incorporated by reference from exhibit 10.2 to the Company’s Current Report  on Form 8-K filed July 15, 2008).              |
|        |   |                                                                                                                                                                                                                                                                                                          |
| *31.1       | — | Certification  by John W. Elias, Chief Executive Officer, pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                          |
| *31.2       | — | Certification  by C.W. MacLeod, Acting Chief Financial Officer, pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                              |
|        |   |                                                                                                                                                                                                                                                                                                          |
| *32.1       | — | Certification  by John W. Elias, Chief Executive Officer, pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                    |

 

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| *32.2 | — | Certification  by C.W. MacLeod, Acting Chief Financial Officer, pursuant to Section 906  of the Sarbanes-Oxley Act of 2002. |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------|

 

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*Filed herewith.

†Denotes management or compensatory contract, arrangement or agreement.

 

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## **SIGNATURES**

##  

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|                                                      |   | EDGE  PETROLEUM CORPORATION,                     |
|-----------------------------------------------------------|--------|--------------------------------------------------|
|                                                      |   | A  DELAWARE CORPORATION                          |
|                                                      |   | (REGISTRANT)                                     |
|                                                      |   |                                             |
|                                                      |   |                                             |
| Date     November 10,  2008 |   | /s/ John W. Elias                                |
|                                                      |   |    John W. Elias                  |
|                                                      |   | Chairman of the Board, President and             |
|                                                      |   | Chief Executive Officer                          |
|                                                      |   |                                             |
|                                                      |   |                                             |
| Date     November 10,  2008 |   | /s/ C.W. MacLeod                                 |
|                                                      |   |    C.W. MacLeod                   |
|                                                      |   | Acting Chief Financial Officer and Senior Vice   |
|                                                      |   | President of Business Development & Planning |

 

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# **INDEX TO EXHIBITS**

 
| **Exhibit  No.** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1              | —     | Amended  and Restated Combination Agreement by and among (i) Edge Group II  Limited Partnership, (ii) Gulfedge Limited Partnership, (iii) Edge  Group Partnership, (iv) Edge Petroleum Corporation, (v) Edge  Mergeco, Inc. and (vi) the Company, dated as of January 13,  1997 (Incorporated by reference from exhibit 2.1 to the Company’s  Registration Statement on Form S-4 (Registration No. 333-17269)).                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.2              | —     | Agreement  and Plan of Merger dated as of May 28, 2003 among Edge Petroleum  Corporation, Edge Delaware Sub Inc. and Miller Exploration Company (“Miller”)  (Incorporated by reference from Annex A to the Joint Proxy  Statement/Prospectus contained in the Company’s Registration Statement on  Form S-4/A filed on October 31, 2003 (Registration  No. 333-106484)).                                                                                                                                                         |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.3              | —     | Asset  Purchase Agreement by and among Contango STEP, L.P., Contango Oil &  Gas Company, Edge Petroleum Exploration Company and Edge Petroleum  Corporation, dated as of October 7, 2004 (Incorporated by reference from  exhibit 2.1 to the Company’s Current Report on Form 8-K filed  October 12, 2004).                                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.4              | —     | Purchase  and Sale Agreement, dated as of September 21, 2005 among Pearl Energy  Partners, Ltd., and Cibola Exploration Partners, L.P., as Sellers; and Edge  Petroleum Exploration Company as Buyer and Edge Petroleum Corporation as  Guarantor (Incorporated by reference from exhibit 2.1 to the Company’s  Current Report on Form 8-K filed October 19, 2005).                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.5              | —     | Stock  Purchase Agreement by and among Jon L. Glass, Craig D. Pollard, Leigh T.  Prieto, Yorktown Energy Partners V, L.P., Yorktown Energy Partners VI, L.P.,  Cinco Energy Corporation, and Edge Petroleum Exploration Company and Edge  Petroleum Corporation, dated as of September 21, 2005 (Incorporated by  reference from exhibit 2.5 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended September 30, 2005).                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.6              | —     | Letter  Agreement dated November 18, 2005 by and among Edge Petroleum Exploration  Company, Cinco Energy Corporation and Sellers (Incorporated by reference from  exhibit 2.02 to the Company’s Current Report on Form 8-K filed  December 6, 2005). Pursuant to Item 601(b)(2) of Regulation S-K,  the Company had omitted certain Schedules to the Letter Agreement (all of  which are listed therein) from this Exhibit 2.6. It hereby agrees to  furnish a supplemental copy of any such omitted item to the SEC on its  request. |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 2.7              | —     | Agreement  and Plan of Merger, dated July 14, 2008, among Chaparral  Energy, Inc., Chaparral Exploration, L.L.C. and Edge Petroleum  Corporation (Incorporated by reference from exhibit 2.1 to the Company’s  Current Report on Form 8-K filed July 15, 2008). Pursuant to Item  601(b)(2) of Regulation S-K, the Company had omitted the disclosure  schedules to the Merger Agreement from this Exhibit 2.1. It hereby  agrees to furnish a supplemental copy of any such omitted item to the SEC on  its request.            |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.1              | —     | Restated  Certificate of Incorporation of the Company effective January 27, 1997  (Incorporated by reference from exhibit 3.1 to the Company’s Current Report  on Form 8-K filed April 29, 2005).                                                                                                                                                                                                                                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.2              | —     | Certificate  of Amendment to the Restated Certificate of Incorporation of the Company  effective January 31, 1997 (Incorporated by reference from exhibit 3.2  to the Company’s Current Report on Form 8-K filed April 29, 2005).                                                                                                                                                                                                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.3              | —     | Certificate  of Amendment to the Restated Certificate of Incorporation of the Company  effective April 27, 2005 (Incorporated by reference from exhibit 3.3 to  the Company’s Current Report on Form 8-K filed April 29, 2005).                                                                                                                                                                                                                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |
| 3.4              | —     | Bylaws  of the Company (Incorporated by reference from exhibit 3.3 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).                                                                                                                                                                                                                                                                                                                                                    |
|                  |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |  |

 

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| 3.5    | — | First  Amendment to Bylaws of the Company on September 28, 1999 (Incorporated  by reference from exhibit 3.2 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended September 30, 1999 (File  No. 000-22149)).                                                                                                                                                                                                                                                                                                                                               |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.6    | — | Second  Amendment to Bylaws of the Company on May 7, 2003 (Incorporated by  reference from exhibit 3.4 to the Company’s Quarterly Report on  Form 10-Q for the quarterly period ended March 31, 2003 (File  No. 000-22149)).                                                                                                                                                                                                                                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.7    | — | Certificate  of Designations establishing the 5.75% Series A cumulative convertible  perpetual preferred stock, dated January 25, 2007 (Incorporated by  reference to exhibit 3.1 to Edge’s Current Report on Form 8-K filed  January 30, 2007).                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.8    | — | Third  Amendment to Bylaws of Edge Petroleum Corporation on October 21, 2008  (Incorporated by reference to exhibit 3.4 to Edge’s Current Report on  Form 8-K filed October 23, 2008).                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.1    | — | Third  Amended and Restated Credit Agreement dated December 31, 2003 among Edge  Petroleum Corporation, Edge Petroleum Exploration Company, Edge Petroleum  Operating Company, Inc., Miller Oil Corporation and Miller Exploration  Company, as borrowers, the lenders thereto and Union Bank of California,  N.A., a national banking association, as Agent (Incorporated by reference  from Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for  the quarterly period ended March 31, 2004).                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.2    | — | Agreement  and Amendment No. 1 to Third Amended and Restated Credit Agreement dated  May 31, 2005 among Edge Petroleum Corporation, Edge Petroleum  Exploration Company, Edge Petroleum Operating Company, Inc., Miller  Exploration Company and Miller Oil Corporation, as borrowers, the lenders  thereto and Union Bank of California, N.A., a national banking association,  as agent for the lenders (Incorporated by reference from exhibit 4.2 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  June 30, 2005 (File No. 000-22149)). |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.3    | — | Agreement  and Amendment No. 2 to the Third Amended and Restated Credit Agreement  dated November 30, 2005 among Edge Petroleum Corporation, Edge Petroleum  Exploration Company, Edge Petroleum Operating Company, Inc., Miller Oil  Corporation, Miller Exploration Company, and Cinco Energy Corporation, as  borrowers, the lenders thereto and Union Bank of California, N.A., a national  banking association, as Agent (Incorporated by reference from exhibit 4.3 to  the Company’s Annual Report on Form 10-K for the year ended  December 31, 2005).                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.4    | — | Miller  Exploration Company Stock Option and Restricted Stock Plan of 1997  (Incorporated by reference from exhibit 10.1(a) to Miller Exploration  Company’s Annual Report on Form 10-K for the year ended  December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.5    | — | Amendment  No. 1 to the Miller Exploration Company Stock Option and Restricted  Stock Plan of 1997 (Incorporated by reference to Exhibit 4.2 from Miller  Exploration Company’s Registration Statement on Form S-8 filed on  April 11, 2001 (Registration No. 333-58678)).                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.6    | — | Amendment  No. 2 to the Miller Exploration Company Stock Option and Restricted  Stock Plan of 1997 (Incorporated by reference from Exhibit 4.3 to Miller  Exploration Company’s Registration Statement on Form S-8 filed on  April 11, 2001 (Registration No. 333-58678)).                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.7    | — | Form of  Miller Stock Option Agreement (Incorporated by reference from exhibit  10.1(b) to Miller Exploration Company’s Annual Report on Form 10-K  for the year ended December 31, 1997 (File No. 000-23431)).                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 4.8    | — | Fourth  Amended and Restated Credit Agreement dated January 31, 2007 by and  among Edge Petroleum Corporation, as borrower, and Union Bank of California,  N.A., as Administrative Agent and Issuing Lender, and the other lenders party  thereto (Incorporated by reference from exhibit 4.1 to Edge’s Current Report  on Form 8-K filed on February 5, 2007).                                                                                                                                                                                                                           |

 

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| 4.9         | — | Amendments  No. 1, 2 and 3 to the Fourth Amended and Restated Credit Agreement dated  January 31, 2007 by and among Edge Petroleum Corporation, as borrower,  and Union Bank of California, N.A., as Administrative Agent and Issuing  Lender, and the other lenders party thereto (Incorporated by reference from  exhibit 4.9 to Edge’s Quarterly Report on Form 10-Q filed on  May 12, 2008). |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| 4.10        | — | Consent,  executed July 11, 2008, among Edge Petroleum Corporation, the Lenders  party thereto and Union Bank of California, N.A., as administrative agent for  such Lenders (Incorporated by reference from exhibit 4.1 to the Company’s  Current Report on Form 8-K filed July 15, 2008).                                                                                                           |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| *4.11       | — | Letter  Agreement dated November 5, 2008 by and among Edge Petroleum  Corporation, Union Bank of California, N.A., as Administrative Agent and  Issuing Lender, and the other lenders party thereto.                                                                                                                                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.1  | — | Form of  Indemnification Agreement between the Company and each of its directors  (Incorporated by reference from exhibit 10.7 to the Company’s Registration  Statement on Form S-4 (Registration No. 333-17269)).                                                                                                                                                                                    |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.2  | — | Stock  Option Plan of Edge Petroleum Corporation, a Texas corporation (Incorporated  by reference from exhibit 10.13 to the Company’s Registration Statement on  Form S-4 (Registration No. 333-17269)).                                                                                                                                                                                                   |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.3  | — | Employment  Agreement dated as of November 16, 1998, by and between the Company and  John W. Elias (Incorporated by reference from exhibit 10.12 to the Company’s  Annual Report on Form 10-K for the year ended December 31, 1998  (File No. 000-22149)).                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.4  | — | Amended  and Restated Incentive Plan of Edge Petroleum Corporation as Amended and  Restated Effective as of August 1, 2006 (Incorporated by reference from  exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the six  months ended June 30, 2006).                                                                                                                                     |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.5  | — | Edge  Petroleum Corporation Incentive Plan “Standard Non-Qualified Stock Option  Agreement” by and between Edge Petroleum Corporation and the Officers named  therein (Incorporated by reference from exhibit 10.2 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).                                                |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.6  | — | Edge  Petroleum Corporation Incentive Plan “Director Non-Qualified Stock Option  Agreement” by and between Edge Petroleum Corporation and the Directors named  therein (Incorporated by reference from exhibit 10.3 to the Company’s  Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).                                               |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.7  | — | Severance  Agreements by and between Edge Petroleum Corporation and the Officers of the  Company named therein (Incorporated by reference from exhibit 10.4 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  September 30, 1999 (File No. 000-22149)).                                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.8  | — | Form of  Director’s Restricted Stock Award Agreement under the Incentive Plan of Edge  Petroleum Corporation (Incorporated by reference from exhibit 10.12 to the  Company’s Quarterly Report on Form 10-Q for the quarterly period ended  June 30, 2004).                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.9  | — | Form of  Employee Restricted Stock Award Agreement under the Incentive Plan of Edge  Petroleum Corporation (Incorporated by reference from exhibit 10.15 to the  Company’s Quarterly Report on Form 10-Q/A for the quarterly period ended  March 31, 1999 (File No. 000-22149)).                                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                                                      |
| †10.10 | — | Edge  Petroleum Corporation Amended and Restated Elias Stock Incentive Plan.  (Incorporated by reference from exhibit 4.5 to the Company’s Registration  Statement on Form S-8 filed May 30, 2001 (Registration  No. 333-61890)).                                                                                                                                                                     |

 

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| †10.11 | — | Form of  Edge Petroleum Corporation John W. Elias Non-Qualified Stock Option Agreement  (Incorporated by reference from exhibit 4.6 to the Company’s Registration  Statement on Form S-8 filed May 30, 2001 (Registration  No. 333-61890)).                                          |
|-------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.12 | — | Summary  of Compensation of Non-Employee Directors (Incorporated by reference from  exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2007).                                                                                                          |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.13 | — | Salaries  and Certain Other Compensation of Executive Officers (Incorporated by  reference from exhibit 10.13 to the Company’s Annual Report on Form 10-K  for the year ended December 31, 2007).                                                                                              |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.14 | — | Description  of Annual Cash Bonus Program for Executive Officers (Incorporated by  reference from exhibit 10.2 to the Company’s Current Report on Form 8-K  filed March 12, 2007).                                                                                                             |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.15 | — | New  Base Salaries and Long-Term Incentive Awards for Certain Executive Officers  (Incorporated by reference from exhibit 10.1 to the Company’s Current Report  on Form 8-K filed August 29, 2006).                                                                                            |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.16       | — | Purchase  and Sale Agreement between Smith Production, Inc., as seller, and Edge  Petroleum Exploration Company, as purchaser, dated November 16, 2006  (Incorporated by reference to exhibit 10.1 to Edge’s Current Report on  Form 8-K filed January 16, 2007).                    |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.17       | — | Purchase  and Sale Agreement between Smith Production, Inc., as seller, and Edge  Petroleum Exploration Company, as purchaser, dated November 16, 2006  (Incorporated by reference to exhibit 10.2 to Edge’s Current Report on  Form 8-K filed January 16, 2007).                    |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.18       | — | First  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  December 16, 2006 (Incorporated by reference to exhibit 10.3 to Edge’s  Current Report on Form 8-K filed January 16, 2007). |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.19       | — | Second  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  January 15, 2007 (Incorporated by reference to exhibit 10.1 to Edge’s  Current Report on Form 8-K filed January 19, 2007). |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.20       | — | First  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  January 15, 2007 (Incorporated by reference to exhibit 10.2 to Edge’s  Current Report on Form 8-K filed January 19, 2007).  |
|        |   |                                                                                                                                                                                                                                                                                                          |
| 10.21       | — | Third  Amendment of Purchase and Sale Agreement between Smith Production, Inc.,  as seller, and Edge Petroleum Exploration Company, as purchaser, dated  January 31, 2007 (Incorporated by reference to exhibit 10.6 to Edge’s  Current Report on Form 8-K filed February 5, 2007).  |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.22 | — | New  Base Salaries of Executive Officers (Incorporated by reference from  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed  March 12, 2007).                                                                                                                                |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.23 | — | Form of  Amended and Restated Severance Agreement dated April 3, 2008, between  the Company and Executive Officers of the Company Named Therein (Incorporated  by reference from exhibit 10.1 to the Company’s Current Report on  Form 8-K filed April 4, 2008).                     |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.24 | — | Amended  and Restated Severance Agreement dated April 3, 2008, between the  Company and John W. Elias (Incorporated by reference from exhibit 10.2 to the  Company’s Current Report on Form 8-K filed April 4, 2008).                                                                     |
|        |   |                                                                                                                                                                                                                                                                                                          |
| †10.25 | — | Amended  and Restated Employment Agreement dated April 3, 2008, between the  Company and John W. Elias (Incorporated by reference from exhibit 10.3 to the  Company’s Current Report on Form 8-K filed April 4, 2008).                                                                    |

 

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| †10.26 | — | First  Amendment to Amended and Restated Severance Agreement, dated July 14,  2008, between the Company and John W. Elias (Incorporated by reference from  exhibit 10.1 to the Company’s Current Report on Form 8-K filed  July 15, 2008).                                   |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                             |
| †10.27 | — | First  Amendment to Amended and Restated Severance Agreement, dated July 14,  2008, between the Company and Executive Officers of the Company Named Therein  (Incorporated by reference from exhibit 10.2 to the Company’s Current Report  on Form 8-K filed July 15, 2008). |
|        |   |                                                                                                                                                                                                                                                                                             |
| *31.1       | — | Certification  by John W. Elias, Chief Executive Officer, pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                             |
| *31.2       | — | Certification  by C.W. MacLeod, Acting Chief Financial Officer, pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                 |
|        |   |                                                                                                                                                                                                                                                                                             |
| *32.1       | — | Certification  by John W. Elias, Chief Executive Officer, pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                                                       |
|        |   |                                                                                                                                                                                                                                                                                             |
| *32.2       | — | Certification  by C.W. MacLeod, Acting Chief Financial Officer, pursuant to Section 906  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                 |

 

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*Filed herewith.

† Denotesmanagement or compensatory contract, arrangement or agreement.

 

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